Audits Of Project Cash Flow Estimated

Capital budgeting audits can help the firm learn from experience. By comparing actual and estimated cash flows, the firm can try to improve upon areas in which forecasting accuracy is poor. In a survey conducted in the late 1980s, researchers found that three-fourths of the responding Fortune 500 firms audited their cash flow estimates. Nearly all of the firms that performed audits compared initial investment outlay estimates with actual costs; all evaluated operating cash flow estimates; and two-thirds audited salvage- value estimates. About two-thirds of the firms that performed audits claimed that actual initial investment outlay estimates usually were within 10 percent of forecasts. Only 43 percent of the firms that performed audits could make the same claim with respect to operating cash flows. Over 30 percent of the firms confessed that operating cash flow estimates differed from actual performance by 16 percent or more. This helps to illustrate that our cash flow estimates are merely point estimates of a random variable. Because of their uncertainty, they may take on higher or lower values than their estimated value. To be successful, the cash flow estimation process requires a commitment by the corporation and its top policy-setting managers; this commitment includes the type of management information system the firm uses to support the estimation process. Past experience in estimating cash flows, requiring cash flow estimates for all projects, and maintaining systematic approaches to cash flow estimation appear to help firms achieve success in accurately forecasting cash flows.