Question

What if you were a project engineer that has been asked to project (forecast) a cash flow for a new project. What would you do for the following:

a. Can the forecasts be biased in any way?

b. If so, in what direction and why do you think that’s the case?

c. How can a manager and/or their firm neutralize the bias?

Answer 1

Usually, the cashflows are biased on the following major factors major factors

1.Overestimation/ Underestimation of the profits: The major factor among the following is the over and underestimation of the profits due to lack of forecast and idea about the project and its output in the upcoming market demand, we may do over or underestimate of the profits and losses.

2. Improper planning and decision making: In making the decisions from the acceptance to the final completion decision making and the team composition makes a major role, the decision making about a project should always be independent and only based on the project irrespective of any other influences and external factors, such as personal interest of other key managerial persons involved in decision making.

3. In case of new/different kind of project: in case of new projects it is difficult to estimate the probable cash flows as the company is new to experience this type of projects thus leading to biased cashflows .

4. Sponsor experience: most of the sponsership services will provide uncertainty in recognition of probable cash flows as the amount of cash inflow solely depends on the capablity , williness of the sponser and related factors thus leading to biased cashflows.

5. Inappropriate and non-reliable information: Due to inevitable changes in macro economical factors , the basis on which the cashflows are estimated may be unreliable and irrelevant for the projections leading to biased decisions in cashflow estimations.

6. Cost estimations are lower than that of actual:   Due to the effect of inflation , all the estimated costs related to a project may get deviated which will result in a higher biased cashflow for the company.

In order to neutralize the bias, it is required that the management should take proper expert and consultancy opinion and use of past project reports for analyasis, and also should hedge the inflows toward risk of uncertainty and inflation.