Day 12-Financial Analysis

Financial Viability
J.M.Pant
Management Consultant, Trainer and Visiting Professor +919811030273, jm.pant@gmail.com www.jemsconsultancy.com
Financial Analysis Of Projects

Useful for: Entrepreneurs Financial institutions/ banks Shareholders Venture capitalist All those involved in project appraisal A financially weak project will soon become sick and ultimately close down
J.M.Pant, Management Consultant, Trainer & Visiting Professor +919811030273, jm.pant@gmail.com, www.jemsconsultancy.com
Financial Viability
Objective is to assess project viability by examining:

Estimates of cost of project: whether complete and realistic Estimates of working capital Source of funds and timely availability- capital structuring Production capacity, selling price, various cost items Cost of production and profitability Balance sheet Fund flow Debt and equity servicing capacity of project Break even, payback, NPV,IRR, EPS
Cost Of Project
Particulars
1. 2. Land and site development (cost of land, development, documentation expenses) Buildings (main factory, administration, stores, utilities, canteen, housing etc. Cost proportional to type of construction and covered area)
Rs lakhs
3.
Plant and Machinery (equipment, spares, excise, customs duty, sales tax, packing and forwarding, freight, insurance, foundation, erection and commissioning. Also whether basis of cost is FOB, CIF, C&F, ex-works, landed cost)
Cost Of Project
Particulars
4. 5. 6. Technical knowhow (lumpsum fees) Training and deputation including foreign technicians Miscellaneous assets and Utilities and services (furniture, office equipment, vehicles, laboratory equipment, fire fighting, water, power, gas related items, workshop, communication etc) Preliminary expenses (company formation expenses, memorandum and articles of association, registration fees,professional fees of CA, legal fees, public share issue expenses-underwriting, brokerage, publicity, merchant banker fee etc)
Rs lakhs
7.
Cost Of Project
Particulars
8. Preoperative expenses (expenses incurred prior to start of commercial production like establishment expenses-rent, telephone, salaries, travel, power; interest on term loan during construction, insurance, trial run, market development expenses etc) Contingencies (for non-firm cost, unforeseen events- taken at 5 to 10% of estimated value of items 1 to 8) Margin Money for Working Capital (Total Working Capital Bank loan for Working Capital)
Rs lakhs
9. 10.
Total Cost Of Project = sum of sl. 1 to 10

Means Of Finance
Particulars 1. Equity share capital Promoters contribution (desirable 25 to 30% of cost of project) Public issue Government institutions, SFC, SIDC, banks Mutual funds Venture Capital Term Loans Capital Subsidy Unsecured loans Total source of funds= sum of sl. 1 to 4 = Total cost of project
Rs lakhs
2. 3. 4.
Working Capital
Current Assets 1. 2. 3. 4. 5. A. B. Materials Work in progress Finished goods Bill receivables Basis (for example) 1 month (of consumption) 1 week(of cost of production) 2 weeks (of cost of sales) 2 months of sales I II III IV V
Operating expenses 1 month (rent, salaries, power etc) Total C.A Current Liabilities = sum 1 to 5
1.
Material on credit
Total Working Capital(A-B)
15 days
= Current Assets Current Liabilities
Working Capital
Basis (for example)
C. Bank Borrowings for Working Capital Margin Money for working Capital = 75% of Current Assets Current Liabilities = Total Working Capital Bank Borrowings for Working Capital
II
III
IV V
D.
This has to be met through long term finance
During analysis, one should closely examine: Basis of inventory computation, and norms of inventory Adequacy of working capital. One should never under estimate working capital requirement. Be specifically particular about bill receivables. Trade creditors for current liabilities
Working Capital Cycle

Finished Goods
WIP
Accounts Receivables
Wages,Salaries, Factory Overheads
Materials
Cash
Suppliers
Estimation Of Operations/Production & Sales

Year1 Year2 Year3 Year4 Year5
1. 2. 3. 4. 5. 6.
Installed capacity (Quantity/day or per year) No. of working days Estimated annual operations/production (Quantity) Estimated output as % of plant capacity Sales (Quantity)..after adjusting stocks Value of Sales
Cost of Operations and Profitability

1.
Raw materials, chemicals, consumables and stores
2.
3. 4. 5.
Utilities- power, water, fuel

Labour-wages and salaries plus benefits Factory overheads-repairs and maintenance, rent, insurance etc Administrative expenses-salaries, remuneration to directors, professional fees, postage, telephone, fax, office supplies (stationery, printing etc)

Yr 1 Yr2 Yr3 Yr4 Yr5
6.
Marketing expenses: promotion including advertisement, channel, incentives, salaries Sales expenses Royalty Total cost of operations (1 to 7) Expected sales
7. 8. 9.
10.
11.
Gross profit before interest and depreciation (9-8)

Financial expenses: Interest on term loans Interest on working capital loan Other interest (unsecured loans etc)

12 Depreciation 13 Profit (10-11-12) 14 Preliminary expenses written off
15 Profit/loss before tax (NPBT)(13-14)

16 Tax 17 Profit after tax NPAT (15-16) 18 Dividend on equity capital
19 Retained profit (17-18)

20 Net cash accruals (19+12+14)
Projected Cash Flow Statement

Year 0
Year1
Year2
Year3
Year4
A 1
Source of Funds Share Capital
2
3 4
Profit before tax with interest on term loans added back

Depreciation Increase in term loans
5
6 7
Increase in bank borrowings for working capital

Increase in capital subsidy Increase in unsecured loans
Total A (1 to 7)

Year 0
Year1
Year2
Year3
Year4
B 1 2 3 4 5 6
Use of Funds Capital Expenditure Increase in working capital Decrease in term loans Decrease in unsecured loans Decrease in bank borrowings for working capital Interest on term loans
7
8
Taxation
Dividends Total B (1 to 8)

Year 0
Year1
Year2
Year3
Year4
Opening balance Net surplus/ deficit (A-B)
Closing Balance
One must have enough cash to meet the requirements, else default in payments to suppliers, employees etc will occur. Excess money has to be parked in sound investment schemes. If adequate cash is not available in any period, one has to pump in more equity or borrow money.
Projected Balance Sheet

Year 0 Year1 Year2 Year3 Year4
Liabilities 1 2 3 4 5 Share Capital Reserves and surplus Term loans Unsecured loans Current liabilities & provisions Total Liabilities Assets
Fixed assets Less depreciation Net Block Assets

Current Assets Cash and Bank Balance Total Assets
2 3
Break Even Analysis

Break Even point as a % of capacity
= [Fixed cost/(Sales-Variable cost)]* % capacity utilization Take the estimates from cost of operations statement for a year of maximum capacity utilization Lower the BEP, better is the project
Sales
Total cost =fixed cost + variable cost

Fixed cost
Variable cost
Rs
BEP
Volume
Pay Back Period

Payback period is when cumulative benefits (profits) is equal to the initial investment. Lower the payback period better is the project.
Year
Cost 150000
Net Benefit -
PV of net benefit at 18% interest -
Cumulative PV -
1
2 3 4
40000
60000 80000 70000
33898
43091 48691 36105
33898
76989 125680 161785
Payback period is about 4 years

Debt Service Coverage Ratio

DSCR (average) = (PAT+Dep+Int on term loan)/(Term loan instalments + Int of term loan)
Use estimates from cost of operations and cash flow statement. Sum them up for all years based on the loan repayment period, and take the ratio as above.
DSCR measures the capacity of the project to service the term loan instalments and interest. DSCR of 2 is good. It provides adequate cover. If DSCR is high, reduce the repayment period and increase instalments as project has that capacity. DSCR below 1.5 requires caution .
Internal Rate of Return

IRR is that rate at which the discounted cash inflow = discounted cash outflow, or the NPV=0 Higher the IRR, better is the project. IRR measures the intrinsic efficiency of the investment. It can be used to compare your project with other projects.It can be used as a benchmark figure for accepting or rejecting a project.
IRR must be computed and analyzed for large investment decisions.
Internal Rate of Return

The projections are made over the life of the project (10 to 15 years) For the terminal year, salvage value may be added.
Yr
Cash Inflow (A)
Sum A
Cash Outflow (B)
Sum B
Net Cash flow (AB)
NPAT+interest on term loan
Dep.
Salvage value
Capital Increase in expenditure current assets (working capital)
0 1.. 15 J.M.Pant, Management Consultant, Trainer & Visiting Professor +919811030273, jm.pant@gmail.com, www.jemsconsultancy.com
Ratios
Debt Equity Ratio: Debt/Equity

SSI units- 2:1 to 3:1 Medium-1.5:1 Large- 1:1or lower
Current Ratio Current Assets/Current Liabilities. Desirable 1.33:1. NPV- select one with highest NPV Simple ROI= (NPBT +Interest on term loans)/(Total Investment)
Ratios
Turnover Ratios Inventory turnover ratio=Net sales/Inventory Average collection period=Receivables/Average sales per day Sales to capital employed=Sales/Capital employed Sales to Receivables=Sales/Receivables (For example, 12:1 = one month book debts, 3:1 = 4 months book debts) Profitability ratios like margin on sales. These ratios must be used for comparison with industry averages

Day 12-Financial Analysis

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Day 12-Financial Analysis

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Financial Viability

Financial Analysis Of Projects

Total Cost Of Project = sum of sl. 1 to 10

This has to be met through long term finance

Working Capital Cycle

Estimation Of Operations/Production & Sales

Cost of Operations and Profitability

Raw materials, chemicals, consumables and stores

Utilities- power, water, fuel

Cost of Operations and Profitability

Gross profit before interest and depreciation (9-8)

Cost of Operations and Profitability

12 Depreciation 13 Profit (10-11-12) 14 Preliminary expenses written off

15 Profit/loss before tax (NPBT)(13-14)

19 Retained profit (17-18)

Projected Cash Flow Statement

Source of Funds Share Capital

Profit before tax with interest on term loans added back

Increase in bank borrowings for working capital

Projected Cash Flow Statement

Projected Cash Flow Statement

Opening balance Net surplus/ deficit (A-B)

Projected Balance Sheet

Fixed assets Less depreciation Net Block Assets

Break Even Analysis

Total cost =fixed cost + variable cost

Pay Back Period

PV of net benefit at 18% interest -

Payback period is about 4 years

Debt Service Coverage Ratio

Internal Rate of Return

Internal Rate of Return

Cash Inflow (A)

Cash Outflow (B)

Net Cash flow (AB)

NPAT+interest on term loan

Capital Increase in expenditure current assets (working capital)

SSI units- 2:1 to 3:1 Medium-1.5:1 Large- 1:1or lower

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