The experts of 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 of capital budgeting hold that there are two reasons of the overestimation of profits from a particular project. The first reason is that the initial investments that have been calculated are much low. At the same time, the operating cash inflows are estimated to be much more.
There are several reasons behind the overestimation of project profitability. Firstly, lack of experience of the sponsors is behind such activities of overestimation of the profits. On the other hand, there are certain firms that are interested in providing wrong information about the project profits because that can attract the investors. For this purpose, the project costs are always estimated lower than the requirement.
Apart from this, underestimating the project profits is also one of the major biases in cash flow estimation. The underestimation of a particular project's profit is done due to over-conscious attitude of the sponsors. Apart from any other reason, there are the incidents of neglecting some of the important factors like value of future options from the estimation process.
A number of new investment options develop with the starting of a new project by any firm. This means that a new project often leads to another project or creates base for that. Because of this the profitability of the firm rises obviously. While estimating, these factors should be considered with due importance.
At the same time, there are certain intangible benefits that are also not calculated while estimating the profits from the project. The salvage values are also not estimated properly by the estimators.
