Basically, uneven cash flows refer to a series of unequal payments made over a given period of time. For example, one may receive the following annual payments over a five year period: $500 US Dollars (USD), $300 USD, $400 USD, $250 USD and $750 USD. On the other hand, if the regular payments were fixed to a particular amount, then the cash flows would be equal. For instance, one may receive a $500 USD annual payment, which is also known as an annuity. Moreover, uneven cash flows may be associated with all sorts of financial situations including capital budgeting.
In finance, capital budgeting is basically the process of making decisions pertaining to long-term investments. During this process, managers may use various financial management tools to forecast and estimate the value of spotty cash flows associated with a particular investment. This will give them a basis with which to make the decision of either accepting or rejecting the project.
Both fixed and uneven cash flows are vital elements of valuing all types of investments. Financial managers use financial formulas to find the present value of a series of future cash flows. This process helps them calculate the fair value of the investment in question. For example, a financial manager may calculate that the present value of a series of uneven cash flows is $1,000 USD. If this stream of spotty cash flows was produced by a given asset, then he or she may decide that the maximum he or she is willing to pay for the asset is the present value, which is the $1,000 USD.
Another example of a series of uneven cash flows is the payments received from investing in what are known as non-conventional bonds. Unlike common bonds, also known as vanilla bonds, non-conventional bonds do not pay a regular fixed coupon or interest rate. These bonds include index-linked bonds, named so for being linked to an index, such as the consumer price index (CPI) that measures the inflation rate. With these bonds, the cash flows reflect the changes in the index to which they are linked.
To illustrate, consider a hypothetical index-linked bond with cash flows tied to the changes in CPI. Suppose that after its issuance, the bond pays a $100 USD in interest. In the following year, however, if the CPI rose by a given percentage rate, then the interest payment would rise accordingly. For example, it may rise to $105 USD. In a nutshell, it is rather difficult to estimate the cash flows associated with such a bond with certainty as the changes in CPI will spawn uneven cash flows.
