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Explain why cash flows rather than profits from the Income Statement are used in the net...

Explain why cash flows rather than profits from the Income Statement are used in the net present value method of investment appraisal.

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Answer #1

Net Present Value method uses only cash flows instead of cash flows as the formula for NPV = PV of cash-in-flows - PV of cash-out-flows

Only cash inflows & outflows are used because the profits from the income statement will have both non-cash & cash inflows & outflows like Depreciation, Accrued expenses & other estimates.

The Investment appraisal to be evaluated only based on the real cash flows but not on estimate based non-cash expenses. It is the cash that really matters rather than the profits which was computed based on estimates.

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