What is incremental cash flow?
Incremental cash flow is the additional revenue generated when a company or other type of organization launches a new project. Cash flow of this type is considered outside the organization's standard and usual sources of cash and remains in that class or state until the project is fully integrated into the entity's normal operations. One of the benefits of identifying this recipe is that it makes it the task of measuring progress, or lack thereof, associated with the new project. This, in turn, helps to assess the project's value to the organization, making it easier to determine whether the project should continue or be abandoned.
In identifying the true contribution of incremental cash flow, several factors must be considered. First, the costs of starting and continuing to operate the project are compared to the revenue the project generates. Assuming that the initial return is greater than the launch and operating costs of the project, this means that there is a positive incremental cash flow statement. This is the company's ultimate goal as it serves as a strong indicator that the project is a viable source of revenue and has the potential to be integrated into the company's core operations.
When the cash flow is determined to be negative, it means that the return generated by the project does not cover the projected costs. At this juncture, the company may choose to scrap the project and reduce its losses, or consider reworking it in an attempt to make it more profitable. Assuming the negative flow can be turned into a positive, the company can take a second look at the project and determine whether the returns are worth the time and resources needed to maintain the project. At this point, the project becomes part of the main operation or is terminated.
Companies typically have more than one source of incremental cash flow operating at the same time. The source of revenue may include marketing projects that are testing new products in regional areas or the sale of a new product in a market new to the company. As some of these projects are likely to end up with negative cash flow, companies may incur a loss that is typically used to claim tax deductions at the end of the qualifying period.