What is Unconventional Cash Flow?
An unconventional cash flow profile is a series of cash flows that don’t go in one direction over a period of time. It is characterized by not just one but several changes in the direction of the cash flow, usually represented by the positive (+) and negative (–) signs where (+) denotes an inflow of cash while (–) denotes an outflow of cash.
Unconventional cash flows would look like the example below:
- 2015: +1,000,000
- 2016: –300,000
- 2017: +500,000
- 2018: –200,000
Looking at the list above, it can be said that the company shows an unconventional cash flow profile because of the series of changes in the direction of its cash flows, specifically from 2016 to 2018.
Additionally, unconventional cash flows are more difficult to deal with, given that they may include more than one Internal Rate of Return or IRR.
What is Internal Rate of Return (IRR)?
Internal Rate of Return (IRR) is a financial tool used for measuring cash flow, specifically to evaluate investments and record acquisitions, in order to gain a general overview of the financial status of a company, as well as predict its most possible financial results.
A company with a conventional cash flow profile will normally just show one IRR, but a company with an unconventional cash flow profile will show more than one IRR because of the different directions in its cash flows.
Note: Always be sure to use XIRR instead of IRR in Excel.
Conventional cash flow vs. Unconventional cash flow
Here are the differences between conventional cash flow and unconventional cash flow:
Conventional cash flow reflects only one direction in the cash flow of a company or organization. Usually, there is only one cash outflow, which is at the beginning of a project, and the rest becomes all inflows. The outflow is, of course, the capital to be used for starting a project while the inflows are the profits or return received after the commencement of the project or it could be the payment for the outflow if it was borrowed from a bank or an institution.
For example, Company Z wants to put up a branch office in one of the major cities in the south and borrows a certain amount from the bank. The money that the bank will put in the company’s account will be withdrawn to finance the project and is now known as the first cash outflow. As the company pays back the bank in installments, the money is deposited into the account that the bank then takes. The deposit is then identified as a cash inflow.
Unconventional cash flow, on the other hand, reflects a series of cash flows in different directions over a period of time. It usually depends on the type of business, but it is very common among those that require periodic maintenance.
Say, for example, an investor who owns a 20-room hostel could see an unconventional cash flow because once in every 5 years, a maintenance check and renovation need to be done to ensure the quality of the amenities that the guests will use.
Another example of unconventional cash flow can be seen in people’s daily lives, such as in the simple process of withdrawing money for one’s monthly expenses. A person who keeps a list of monthly expenses would know how much he or she needs to withdraw from the bank. However, one who isn’t sure of how much his monthly expenses are or with inconsistent monthly expenses will tend to withdraw more and deposit back to the bank whatever extra money is left from that.
Challenges of an unconventional cash flow
Unconventional cash flow, as already mentioned earlier, is characterized by a series of cash flows in different directions over a period. Because of such a reason, there is more than one IRR, which will make it more difficult to evaluate a given company. The IRRs are compared to the company’s hurdle rate or the lowest possible return rate of a project. If there is more than one, it would be hard to forecast the financial outcome of the project or company.
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