Financial ratios provide a succinct set of data relationships that can be applied to for-profit and nonprofit organizations to reveal red flags, fraud signals, and financial statement incongruities. [Urbancic, The Power of Cash Flow Ratios] Comparing results across regional industry averages…
Admit it. In the face of more tactical accounting issues, you’ve found yourself out of practice with NPV (Net Present Value) and IRR (Internal Rate of Return) applications. To help jog your memory, we’re offering a quick refresher on the key differences between the methods – what you are measuring and why – as well as general scenarios in which one method is more advantageous than another.
Dusting Off Your Financial Toolkit
As a finance professional, you are engaged in – if not responsible for – capital budgeting for your firm. In order to compare and prioritize investments like equipment, technology, or even an acquisition, you likely use 1 of 3 financial formulas: payback method, NPR, and IRR. While the payback method is easy to calculate and understand – determining when you’ll make back the money invested – it doesn’t account for the future value of money.
NPV is a highly effective gauge for companies using “today’s dollars for future returns” and, thanks to Excel, it’s easy to calculate. [Harvard Business Review]
NPV= ∑ [Period Cash Flow / (1+R)^T] – Initial Investment
R is the discount rate and T is the number of time periods. [Investopedia]