Financial Financial AnalysisAnalysis

Balance Sheet

Cash Flow Statement

Means of Finance and Time Phasing

Cost of Project and time phasing

Interest and loan Repayment

Depreciation

Estimate of working Result

Interest of ECA Cost of Production

Working Capital Needs

Working Capital Advance (WCA)

Tax Factor

Production Plan

Projected Sales

Financial AnalysisFinancial Analysis Cost of projectCost of project Means of financingMeans of financing Elements of sales and productionElements of sales and production Cost of productionCost of production Working capital requirement and its Working capital requirement and its

financingfinancing Estimates of working resultsEstimates of working results Break- even pointBreak- even point Projected cost flow statementProjected cost flow statement Projected balance sheets.Projected balance sheets.

Cost of ProjectCost of Project Land and site developmentLand and site development Buildings and civil worksBuildings and civil works Plant and MachineryPlant and Machinery Technical know how and engineering feesTechnical know how and engineering fees Expenses on foreign technician and training Expenses on foreign technician and training

of Indian Technicians abroadof Indian Technicians abroad Misc. fixed assetsMisc. fixed assets Preliminary and capital issue expensesPreliminary and capital issue expenses Pre-Operative expensesPre-Operative expenses Provision for contingenciesProvision for contingencies Margin money for working capitalMargin money for working capital Initial cash lossesInitial cash losses

Working Capital requirement Working Capital requirement and its financingand its financing

In estimating the working capital In estimating the working capital

requirement and planning for its financing,requirement and planning for its financing,

the following points have to be borne in the following points have to be borne in

mind.mind.

1. The W.C. requirement 1. The W.C. requirement consists of the followingconsists of the following

Raw materials and componentsRaw materials and components

WIP stockWIP stock

Stocks of finished goodsStocks of finished goods

DebtorsDebtors

Operating expensesOperating expenses

2. The principal sources of 2. The principal sources of working capital finance areworking capital finance are The advances provided by commercial The advances provided by commercial

banksbanks

Trade creditTrade credit

Accruals and provisionsAccruals and provisions

Long term sources of financingLong term sources of financing

3. The Advances from commercial bank3. The Advances from commercial bank OAOA MarginMargin

MPBF as MPBF as per per Lending Lending norms norms prescribeprescribed d By By Tondon Tondon CommitteCommitteee

Against each Against each current current assetsassets a a certain certain amount of amount of margin margin Money has Money has to be to be provided by provided by firm firm

R.M.R.M. 10 –25 percent10 –25 percent

WIPWIP 10 –40 - do-10 –40 - do-F.Goods F.Goods 30 –50 - do - 30 –50 - do -

Debtors Debtors 30 –50 - do -30 –50 - do -

4. 4. Tondon committeeTondon committee Tondon committee has suggested Tondon committee has suggested

three methods for determining the three methods for determining the MPBF for WC. Second method is MPBF for WC. Second method is generally employedgenerally employed – 75% of CA – CL (like trade credit and 75% of CA – CL (like trade credit and

provisions)provisions)– At least 25% of CA must be supported At least 25% of CA must be supported

by long term sources of financeby long term sources of finance

Financial Analysis based on Financial Analysis based on Commercial profitabilityCommercial profitability

Indended direct benefits of a Indended direct benefits of a

project is likely to achieve at the project is likely to achieve at the

prevailing market pricesprevailing market prices

Investment Investment ProfitabilityProfitability AnalysisAnalysis

Financial Financial AnalysisAnalysis

Aims at assessing Aims at assessing the earning powerthe earning power Of the resources Of the resources deployed for the deployed for the bothering of the bothering of the sources of financing sources of financing

Takes care of the Takes care of the financialfinancial features for features for the smooth the smooth operation of the operation of the project project

Simple rate of return pay back

N.PV IRR ,Financial ratios

Financial Analysis based on social – cost – Financial Analysis based on social – cost –

benefit profitabilitybenefit profitability

Attempts to give replies to a varied set of Attempts to give replies to a varied set of questions relating to the proposed project questions relating to the proposed project such as –such as – – Whether it is being set up in consonance Whether it is being set up in consonance

with the general policy of the country ?with the general policy of the country ?– It meets the priority needs of the peopleIt meets the priority needs of the people– It is linked with the objectives and goals It is linked with the objectives and goals

of national planning and developmentof national planning and development ? ?

FinancialFinancial AnalysisAnalysis based on based on social – cost – benefit profitabilitysocial – cost – benefit profitability

– It is fitted in to overall economics and social It is fitted in to overall economics and social development of the country ?development of the country ?

– WhoWho will benefit from the project ?will benefit from the project ?

– Who will hurt from the project ?Who will hurt from the project ?

– What are the requirements for the local What are the requirements for the local people to contribute/participate in the people to contribute/participate in the project ?project ?

Parameters which should weigh Parameters which should weigh while selecting sitewhile selecting site

Size and cost of landSize and cost of land Raw materialsRaw materials Utilities electricity, water, sanitary Utilities electricity, water, sanitary

and sewerage services etcand sewerage services etc ManpowerManpower Transport facility – Sea, air, rail-roadTransport facility – Sea, air, rail-road

Incentives and concessions – Incentives and concessions – control and state Govt. provide – control and state Govt. provide –

– Loans, capital subsidy and Loans, capital subsidy and assistanceassistance

– Transport subsidy on a/c of transport Transport subsidy on a/c of transport cost of raw materials and finished cost of raw materials and finished products between the selected rail-products between the selected rail-headsheads

– Income-tax exemptions extendable Income-tax exemptions extendable up to first 10 A.Y.up to first 10 A.Y.

– Purchase of machinery on hire Purchase of machinery on hire purchase basispurchase basis

– Preferential treatment for import of raw Preferential treatment for import of raw materialsmaterials

– Price preference on Govt. purchasesPrice preference on Govt. purchases– Sales tax and other tax exemptionsSales tax and other tax exemptions– Uninterrupted supply of power at Uninterrupted supply of power at

concessional ratesconcessional rates– Concessional financeConcessional finance– Land acquisition and industrial estates Land acquisition and industrial estates

development on lease and subsidized development on lease and subsidized rent basisrent basis

– Assistance to technical entrepreneurs in Assistance to technical entrepreneurs in form of loansform of loans

– Investment subsidy to the units located Investment subsidy to the units located in backward areasin backward areas

– Extending export supportExtending export support

i.i. Environmental considerations-Environmental considerations-

i.i. Climatic and Natural hazard Climatic and Natural hazard considerations temperature, humidity considerations temperature, humidity etc/cool and dryetc/cool and dry

i.i. Technological Aspects – technology Technological Aspects – technology has to be selected in a way that it has has to be selected in a way that it has a low running cost, cheap and easy a low running cost, cheap and easy maintenance, High productivity per maintenance, High productivity per unit of capital and other scarce unit of capital and other scarce resources resources

Demand and supply Analysis – Demand and supply Analysis – Research MethodsResearch Methods

Sampling scheme and its size taking care of Sampling scheme and its size taking care of constraints of time resources, reliability and constraints of time resources, reliability and accuracy of data – combination of different accuracy of data – combination of different methods like quota sampling, random, cluster methods like quota sampling, random, cluster systematic, stratified etc.systematic, stratified etc.

Make use of mailed questionnaire, personal Make use of mailed questionnaire, personal interviews, telephone interviews etc.interviews, telephone interviews etc.

Data collected has been obtained through Data collected has been obtained through primary and secondary sources – has to be primary and secondary sources – has to be processed analysed and interpreted and processed analysed and interpreted and presented in the form of tables, charts graphs presented in the form of tables, charts graphs etc.etc.

(C)(C) Economic Analysis – determines Economic Analysis – determines the viability of a project over a period of the viability of a project over a period of

timetime

Capital costCapital cost Working capital requirementsWorking capital requirements Operating costsOperating costs

DirectDirect IndirectIndirect

Material, Labour, Material, Labour, exp.exp.

Supervisory and Supervisory and accounting staff stores accounting staff stores operations technical operations technical staff rentals Utility staff rentals Utility costs consultants’ fees, costs consultants’ fees, interest in working interest in working capital Adm, Sales capital Adm, Sales Promotion and Promotion and distribution exp distribution exp AdvertisingAdvertising

Estimates of operating revenues, sales Estimates of operating revenues, sales volume and price of the end productvolume and price of the end product

Depreciation/taxesDepreciation/taxes ProfitsProfits Due weight age to factors like-Due weight age to factors like-

• Price fluctuationsPrice fluctuations

• InflationInflation

• Changes in Govt. policyChanges in Govt. policy

• Adaptation of new technologyAdaptation of new technology

(D) Financial (D) Financial Analysis-Analysis-

Model formats designed by UNIDO Model formats designed by UNIDO and planning commission.and planning commission.

Major items of expenditure and the Major items of expenditure and the business plans during the like cycle business plans during the like cycle of a project of a project

.Generation of funds & expenditure.Generation of funds & expenditure

Division of a project in three Division of a project in three phasesphases

  – pre – investmentpre – investment

– ConstructionConstruction

– ImplementationImplementation

Techniques to analyse Techniques to analyse investment project-investment project-

Net national value addedNet national value added Employment effectEmployment effect Distribution effectDistribution effect Foreign exchange effectForeign exchange effect Infrastructure effectInfrastructure effect Environmental complicationsEnvironmental complications

All these details regarding Technical All these details regarding Technical Economic, Financial Commercial, Economic, Financial Commercial, Organizational, Managerial, Social, Organizational, Managerial, Social, Environmental when put together in Environmental when put together in one document known as pre-one document known as pre-investment report, project report, investment report, project report, feasibility reports the like.feasibility reports the like.

Planning commission guidelines Planning commission guidelines (1992) (1992)

insist that instead of the term insist that instead of the term feasibility reportfeasibility report

the term detailed FR should be used the term detailed FR should be used to to

facilitate the proper appraisal of the facilitate the proper appraisal of the investment.investment.

The proposal to prepare feasibility The proposal to prepare feasibility report is considered by public report is considered by public investment Board (PIB)- It consists of investment Board (PIB)- It consists of secretary expenditure as chairman.secretary expenditure as chairman.

Secretary Planning commission Secretary Planning commission and and

Secretary of adm. Ministry as Secretary of adm. Ministry as membersmembers

Project appraisal attempts to Project appraisal attempts to consolidate the result of exercises consolidate the result of exercises made at various levels, from made at various levels, from different angles on various aspects different angles on various aspects of the project.of the project.

The important aspects studied in monitoring The important aspects studied in monitoring the key sectors of the environment-the key sectors of the environment-

Economic SectorEconomic Sector Competitor SectorCompetitor Sector State of the economy, State of the economy, overall rate of Growth, overall rate of Growth, cyclical fluctuations, cyclical fluctuations, Inflation Rate,. Linkage Inflation Rate,. Linkage with world economy, with world economy, trade trade Surplus/deficits ,BOP Surplus/deficits ,BOP situation situation

No. of firms in the industry and No. of firms in the industry and the mkt. share of the top few the mkt. share of the top few Degree of homogeneity and Degree of homogeneity and differentiation among products differentiation among products Entry barriers Entry barriers Comparison with substitutes in Comparison with substitutes in terms of quality, price, appeal, terms of quality, price, appeal, function function Marketing policies and practices Marketing policies and practices

Marketing policies and practicesMarketing policies and practices Industrial policy.Industrial policy. Govt. programmes & ProjectsGovt. programmes & Projects Tax frame-workTax frame-work Subsidies, incentives and concessions Subsidies, incentives and concessions Import & export policies Import & export policies Financing norms Financing norms Lending conditions of FI & C.Bs Lending conditions of FI & C.Bs

Cash Flows From Long Term Cash Flows From Long Term FundsFunds

This method is based on the assumption that This method is based on the assumption that funds invested in a project come from both funds invested in a project come from both equity share holders and long term lenders.equity share holders and long term lenders.

When calculating net cash flows using this When calculating net cash flows using this method; the interest paid on long term loans method; the interest paid on long term loans is excluded. The rationale for this approach is is excluded. The rationale for this approach is that the net cash flows are defined from the that the net cash flows are defined from the view point of suppliers of long term funds.view point of suppliers of long term funds.

Hence the post tax cost of funds is used as Hence the post tax cost of funds is used as the interest rate for discounting.the interest rate for discounting.  

The post tax cost of long term funds The post tax cost of long term funds obviously includes the post tax cost of long obviously includes the post tax cost of long term debt.term debt.

Therefore, if the interest on long term debt Therefore, if the interest on long term debt is considered for the purpose of is considered for the purpose of determining net cash flows, an error due to determining net cash flows, an error due to double counting would occur.double counting would occur.

1.1. Operating cash flow = Pat +Depreciation +other non Operating cash flow = Pat +Depreciation +other non cash charges +interest on long term (1-T.)cash charges +interest on long term (1-T.)

2.2. Terminal Cash flow = Net salvage value of fixed Asset Terminal Cash flow = Net salvage value of fixed Asset +net recovery of working +net recovery of working

Net salvage is arrived after adjusting the sale value Net salvage is arrived after adjusting the sale value of on asset for either tax or tax shield. If a fixed asset of on asset for either tax or tax shield. If a fixed asset realizes more than its book value, the profit is taxed realizes more than its book value, the profit is taxed and needs to be adjusted. Similarly if there is a loss and needs to be adjusted. Similarly if there is a loss on the sale of a fixed asset, you get shield on the loss on the sale of a fixed asset, you get shield on the loss and needs to be adjusted .and needs to be adjusted .

NSV =Sales value- Tax/tax shieldNSV =Sales value- Tax/tax shield

Cash Flows From Equity funds Cash Flows From Equity funds Point of ViewPoint of View

          1.When cash flows are computed from 1.When cash flows are computed from the equity funds point of view, only the the equity funds point of view, only the funds contributed by the equity holders funds contributed by the equity holders towards the project are considered as an towards the project are considered as an initial investment. initial investment.

2.The operating cash flow includes profit2.The operating cash flow includes profit after taxes,depreciation, other non-cash after taxes,depreciation, other non-cash charges and preference dividend. charges and preference dividend.

The terminal cash flow will be equal to The terminal cash flow will be equal to the net salvage value of fixed asset the net salvage value of fixed asset minus repayment of term loans, minus repayment of term loans, redemption of preferences capital, redemption of preferences capital, repayment of working capital repayment of working capital advances, and retirement of trade advances, and retirement of trade credit and other dues.credit and other dues.

Operating flow = Pat+DepreciationOperating flow = Pat+Depreciation

-repayment on long and short-term -repayment on long and short-term loans.loans.

Cash Flow From Total Funds Point Cash Flow From Total Funds Point of Viewof View

When cash flows are computed from the When cash flows are computed from the total funds point of view , the funds total funds point of view , the funds contributed by all the suppliers of funds contributed by all the suppliers of funds towards the project are considered for the towards the project are considered for the calculation of the initial investment.calculation of the initial investment.

The operating cash flows are calculated by The operating cash flows are calculated by adding profit after taxes, depreciation, adding profit after taxes, depreciation, non cash charges, interest on long term non cash charges, interest on long term borrowing (1-t)and interest on short term borrowing (1-t)and interest on short term borrowers (1-t)borrowers (1-t)

The terminal cash flow will be The terminal cash flow will be equalequal to the net salvage value of fixed to the net salvage value of fixed assetasset and net recovery of W.C. margin.  and net recovery of W.C. margin.  Operating flow = Pat Operating flow = Pat +depreciation ++depreciation + interest on long and short term interest on long and short term loans(1-t)loans(1-t)

Benefit Cost RatioBenefit Cost Ratio

The BCR is a time adjusted capital The BCR is a time adjusted capital budgeting technique. Also known as budgeting technique. Also known as the profitability index, it measures the profitability index, it measures the present value of returns per the present value of returns per rupee invested. BCR is defined as the rupee invested. BCR is defined as the ratio of the present value of benefits ratio of the present value of benefits to the initial investment to the initial investment

   BCR = PVB or PVCIF/IBCR = PVB or PVCIF/I

Decision criteria Decision criteria    Accept all proposals with a BCR > 1.Accept all proposals with a BCR > 1.

If projects are mutually exclusive, If projects are mutually exclusive, the project with higher BCR should the project with higher BCR should chosen. chosen.

Capital Rationing Among Capital Rationing Among Multiple ProjectMultiple Project

An Enterprise may be planning to An Enterprise may be planning to invest in two or more project while invest in two or more project while the funds available may be the funds available may be insufficient to take up all the project insufficient to take up all the project for implementation, though all for implementation, though all project are considered good for project are considered good for investment(if it satisfies any one of investment(if it satisfies any one of the following investment criteria.)the following investment criteria.)

The NPV is positiveThe NPV is positive The IRR > cost of capitalThe IRR > cost of capital The PI > 1.00The PI > 1.00 The BCR > 1.00The BCR > 1.00

Capital Rationing may be defined Capital Rationing may be defined as the process of judiciously as the process of judiciously allocating the available allocating the available demarcated funds towards the demarcated funds towards the capital.The capital outlay of two or capital.The capital outlay of two or more project that are considered more project that are considered good for investment, in such a way good for investment, in such a way that the return on investment is that the return on investment is maximized.maximized.