As far as finance is concerned, every project is a set of flows of money (cash flows). Most projects require an upfront cash outflow (an investment or expense or cost) and are followed by a series of later cash inflows (payoffs or revenues or returns). It does not matter whether the cash flows come from garbage hauling or diamond sales. Cash is cash. However, it is important that all costs and benefits are included as cash values. If you would have to spend more time to haul trash, or merely find it more distasteful than other projects, then you would have to translate these project features into equivalent cash negatives. Similarly, if you want to do a project “for the fun of it,” you must translate your “fun” into a cash positive. The discipline of finance takes over after all positives and negatives (inflows and outflows) from the project “black box” have been translated into their appropriate monetary cash values.
This does not mean that the operations of the firm are unimportant—things like revenues, operations, inventory, marketing, payables, working capital, competition, etc. These business factors are all of the utmost importance in making the cash flows happen, and a good (financial) manager must understand these. After all, even if all you care about is cash flows, it is impossible to understand them well if you have no idea where they come from and how they can change in the future.
Projects need not be physical. For example, a company may have a project called “customer relations,” with real cash outflows today and uncertain future inflows. You (a student) are a project: you pay for education and will earn a salary in the future. In addition, some of the payoffs from education are metaphysical rather than physical. If knowledge provides you with pleasure, either today or in the future, education yields a value that should be regarded as a positive cash flow. Of course, for some students, the distaste of learning should be factored in as a cost (equivalent cash outflow)—but I trust that you are not one of them. All such non-financial flows must be appropriately translated into cash equivalents if you want to arrive at a good project valuation!
A firm can be viewed as just a collection of projects. Similarly, so can a family. Your family may own a house, a car, tuition payments, education investments, etc.,—a collection of projects. This blog assumes that the value of a firm is the value of all its projects’ net cash flows, and nothing else. It is now your goal to learn how to determine these projects’ values, given cash flows.
There are two important specific kinds of projects that you may consider investing in—bonds and stocks, also called debt and equity. As you will learn later, in a sense, the stock is the equivalent of investing to become an owner who is exposed to a lot of risk, while the bond is the equivalent of a lending money, an investment which is usually less risky. Together, if you own all outstanding bonds (and loans) and stock in a company, you own the firm:
Entire Firm = All Outstanding Stocks + All Outstanding Bonds and Loans .
This sum is sometimes called the enterprise value. Our blog will spend a lot of time discussing these two forms of financing—but for now, you can consider both of them just investment projects: you put money in, and they pay money out. For many stock and bond investments that you can buy and sell in the financial markets, we believe that most investors enjoy very few, if any, non-cash based benefits.