Net incremental cash flows are the combination of the cash inflows and the cash outflows occurring in the same time period, and between two alternatives. For example, a company could use the net incremental cash flows to decide whether to invest in new, more efficient equipment or to retain its existing equipment.
Net incremental cash flows are necessary for calculating an investment's:
- net present value
- internal rate of return
- payback period
To illustrate net incremental cash flows let's assume that Your Corporation has the opportunity to purchase a product line from Divesting Company for a single cash payment of $800,000. Your Corporation expects that the product line will result in the following cash flows occurring in each year for 10 years:
- additional cash receipts or cash inflows of $900,000 (from the collection of accounts receivable related to product sales)
- additional cash payments or cash outflows of $750,000 (for payments related to the product line's costs and expenses)
These cash flows indicate that the net incremental cash flows are expected to be a positive $150,000 per year for 10 years, or that there will be net incremental cash inflows of $150,000 per year for 10 years.