In business school we (MBAs) are taught that capital budgeting is used to determine whether or not an investment should be made in a project or asset. We are taught to look at the cash flows before and after the project is completed. We are taught that the time value of money is one of the most important factors in capital budgeting and that a company should only move forward on a project if the return on investment (ROI), or internal rate of return (IRR), is higher than the weighted average cost of capital (WACC). We are taught that all projects must have a net present value (NPV) greater than $0 and that any project with a payback period less than one year should be automatically accepted.
One great thing about finance is that unlike most other disciplines which continue to evolve over time, the economy is a function of cycles—contractions and expansions followed by recessions and booms—and the metrics above continue to help financiers make decisions about the best way to invest capital. However, while these metrics are relevant they must be customized to suit the needs of the situation.
In the world of business, credit is about future cash flows not your history of repayment so you're better off focusing on projects that create the most cash flows over the next three months as opposed to projects that require a longer gestation period, but perhaps have a higher ROI or IRR. Focusing on payback period is the best capital budgeting metric to use when working with high interest loans.
It is important to make a distinction between revenues and cash. Bankers care about cash, not revenues. Lenders only care about how much cash you can bring in today, not on credit. The cash flow statement also helps to determine where your cash is coming from and is divided into three parts: operating, investing, and financing. These are the only three ways a firm can generate cash, and while bankers want to see more cash coming from operations than financing, they really don't care where it comes from as long as they get their money back.
One common metric learned in B school is free cash flow (FCF). It is defined as EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure. In layman's terms this equation starts with net income, adds back non-cash "accounting" items, and subtracts asset or equipment purchases in order to determine true cash flows available for loan repayment.
Building Cash Flows
From a practical perspective this means you're looking for projects that can be completed with loans that can be paid off quickly AND provide the most cash flows for the nine months following the end of that project.
Let's do a quick example. Let's say you need $100K to expand your business. Make a list of what you will do with that money. Pick out those projects/assets that are less than $25K. Estimate the cash flows (not revenue) for that project over the next 3 months. Now determine how much cash those projects will bring in the following nine months.
Sort your projects by total cash flows over the full nine months and only borrow the cash that the first three months bring in. Once that loan is paid off, don't just go to the next project on the list. Reassess the situation. Did anything change in the last three months? If so, how does that effect which projects will bring in the most cash flow? Next, create another short list and repeat the process. If and when you decide to go for another loan, your cash flows will be stronger and your high rate of interest should decrease.
Not only does this exercise help to prioritize projects, but it helps to connect business decisions to the bottom line. By focusing on low hanging fruit (defined as projects that can deliver cash flows quickly) you can increase your cash flow which will also lower your future interest rates. Each time you complete a project it should add to your future cash flows which will reduce the interest on your future loans. The ideal situation to work up to is a revolving line of credit with low interest that your company can use as needed. Until you get to that point, use this method to build up cash flows.