Financial methods in environmental decisions
Financial methods in environmental decisions

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Financial methods in environmental decisions

Benefit

Benefits are the converse of costs and represent any cash inflow resulting from an activity. However you should also note that a reduction in cash outflow is also defined as a benefit even if it doesn’t result in a positive inflow of cash. So if a householder installs double glazing there will be a benefit to that person in reduced heating bills although the installation will not generate any inflow of cash. Of course there will also be benefits to society as a whole such as the reduction in carbon dioxide and other emissions – assuming that the householder uses less heating fuel.

Cash outflows are the costs and expenses (whether capital or revenue in nature) incurred to implement and run a project.

Cash inflows are the benefits that a project is expected to provide. In this context, any savings or reductions in costs resulting from a project, which are in fact benefits, are treated as cash inflows.

The term net cash flow simply means the difference between the cash outflows and the cash inflows of a project. If the cash inflows of a project exceed the cash outflows, then there is a net cash inflow. This may also be referred to as a positive net cash flow. If the cash outflows of a project exceed the cash inflows, then there is a net cash outflow. This may also be referred to as a negative net cash flow.

In this context the word cash is not being used in its narrow sense, which is ‘money’. The cash flows of a project certainly include money spent or received, but they also include movements of money’s worth, that is, any form of funds, finance or value lost or gained as a result of a project.

Activity 1 Cash inflows and outflows

Timing: Allow 20 minutes to complete this activity

Imagine that ten years ago you acquired an ailing warehouse and road transport company whose assets consisted of some insubstantial buildings used as garages and a storage depot, together with five lorries which at that time were relatively new and in quite good condition. Under your direction, the business (now known as Fatcat Haulage) has grown rapidly. The premises are now quite inadequate, expensive to heat and maintain, and expensive to insure as there is only a primitive firefighting sprinkler system installed. The five lorries are now uneconomic to run. Diesel and repair bills have become prohibitive, breakdowns and lost running hours are excessive.

With more lorry capacity, better reliability and a faster service you could easily obtain more business. You decide to rebuild the depot with better equipment, full insulation, an effective sprinkler system and in-company lorry maintenance. You also decide to replace the five old lorries (which have been written down to scrap value in your books) with new ones.

Make a list of the cash flows relative to your investment project. Show separately:

  • a.capital cash outflows
  • b.capital cash inflows
  • c.revenue cash outflows
  • d.revenue cash inflows.

Do not attempt to attach money values to your cash flows at this stage. List the items under the above categories in descriptive terms only. Indicate which ones you think will be one-off and which ones will recur with time.

Answer

  • a.Capital cash outflows:
    • planning and design costs
    • costs of demolition and site clearance
    • site preparation work, for example civil engineering work, including access, mains services
    • erection of new buildings
    • new fixtures and fittings, including sprinkler system in warehouse, insulation, new racking
    • new lorries
    • machinery for garage
    • warehouse handling equipment (for example cranes, fork-lift trucks)
    • installation costs.
  • b.Capital cash inflows:
    • any cash inflow received from the disposal of existing hardware, for example the scrap value of the lorries
    • any grants payable by the local authority or a local development corporation or by government departments towards any of the capital costs of the project.
  • c.Revenue cash outflows:
    • higher rates for new premises
    • payroll cost of fitters to take on in-company repair and maintenance work
    • increased power consumption for garage
    • higher water rates and costs for uprated sprinkler system (using metered supply).
  • d.Revenue cash inflows:
    • increased revenue from increased business levels.
    • reduction of insurance premium due to installation of new sprinkler system
    • saving of outside repair and maintenance costs
    • saving in heating costs (better insulation)
    • saving in fuel costs (better fuel consumption).

    All the capital items (a and b) will be one-off. All the revenue items (c and d) will be recurring during the life of the project.

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