At the same time, these estimates are very important to a firm. Because of this, there are several ways to make these estimates. Experts in the field hold that there are several types of biases in cash flow estimation. Overestimation of profit and understatement of profit are the two most common biases.These experts say that there are two reasons for the overestimation of profits from a particular project. The first reason is that the initial investments that have been calculated are too low. At the same time, the operating cash inflow estimates are too high.There are several factors behind the overestimation of project profitability. One is lack of sponsor’s experience. On the other hand, there are some firms who attract investors by intentionally providing inaccurate information about their projects. For their purposes, costs are always estimated to be lower than the actual requirements of the project.
Underestimating the project profits is also one of the major biases in cash flow estimation. The underestimation of a particular project’s profit is due to an over-conscious attitude on the part of the sponsors. There are the incidents of neglecting some important factors such as value of future options from the estimation process.
A number of new investment options develop with the undertaking of a new project by any firm. This means that a new project often leads to another project or creates a base for beginning another project. Because of this, the profitability of the firm rises. While estimating, these factors should be considered important.
At the same time, there are certain intangible benefits that are also not calculated while estimating profits from a project, and the salvage values are also not estimated properly by the estimators.