Definition: Terminal cash flow is the final net inflows and outflows of a project or investment after disposing of necessary equipment and paying all expenses and taxes. In other words, it’s the final amount of money a company will be left with after a project is terminated, the equipment is disposed of, the working capital is recouped, and all expenses and taxes are paid.
This is an important concept in capital rationing and budgeting because it shows management how much of their investment will be recouped by the company at the end of the project. Thus, management must include this figure in their earnings and return estimates before they decide to accept or turn down a job.
What Does Terminal Cash Flow Mean?
For example, if a company decided to take on a construction job that required a crane, they would have to purchase one. They do not however have to keep this crane forever. After the job is finished, they can sell or dispose of the crane and recoup much of the crane’s cost. This last payment received from disposing the crane is part of the terminal cash flow.
The terminal cash flow formula is calculated by adding the after tax proceeds from disposal to the change in working capital after the equipment has been disposed. Here is the equation:
TCF = After Tax Proceeds from Equipment Disposal + Any Change in Working Capital
Let’s look at an example.
Let’s go back to our construction example for a minute. Assume that Bill’s Construction Company is debating whether or not to accept a contract to build a building because it needs to purchase a crane. The crane originally costs $50,000 and has a salvage value of $20,000.
Here are the key components to the terminal cash flow equation:
- Salvage value of the crane: $20,000
- Net working capital recoupment: $10,000
- Tax reduction from disposal loss because the salvage is less than the book value: $2,000
- Net terminal cash flow: $32,000
Bill would have to add up the operating cash flows from the total building project and add them to the net TCF in order to decide whether this project was worth pursuing or not. If the total cash flow was positive and gave Bill a good return, he should pursue it. If it’s negative, Bill would end up with a loss and he should look for other opportunities.