MBA management
The primary objective of any firm is to maximize profits; the financial aspects of a project idea must be studied carefully. Even if the project is marketable and technically feasible, it cannot be implemented if it is not financially viable in the medium to long-term. To assess the financial feasibility of a project idea, the project manager must examine the capital costs, operating costs and revenues of the proposed project.

Financial analysis is largely an effort to assess financial performance, i.e., how well or how poorly a firm performed with money entrusted to it. Financial analysis is considered a part of firm’s accountability. Exactly how financial reporting is done depends in part on the model selected. In addition, many types of financial reports can be generated but a considerable amount of attention is given to the quantitative financial statements, which are one type of report, but usually the major consists of financial, sources, budgeted estimates and expenditures.

Assumptions in Financial Analysis

Demand and price estimates are derived from the market feasibility study. Project costs and operating costs are derived from the technical feasibility study. The estimates need to be supplemented with:

1) Tax implications depending upon the prevailing tax laws, and
2) Financial costs enacting from the financing alternative are considered for the project.

That provides enough information for the calculation of the financial bottom-line of the project. The financial feasibility check involves a detailed financial analysis.

The financial analysis includes quite a few assumptions, workings and calculations. They are follows:

i) Projections: Projections are made for prices of products, the cost of various resources required for manufacturing goods and capacity utilization. Use of the thumb rule or actual data of some comparable projects are generally included in the estimates.
ii) Period of Estimation: The period of estimation id determined and the value of the project at the terminal period of estimation is forecast. The period of estimation should be justified by factors like the product life cycle, business cycle, ability to forecast, period of debt funds, etc.
iii) Financing: financing alternatives are considered and a tentative choice of financing mix is made together with assumptions regarding the cost of funds and repayment schedules.
iv) Basic workings: Basic workings are shown in different statements. Some of the schedules made for this purpose include:
• An interest and repayment schedule,
• The working capital schedule,
• The working capital loan, interest and repayment schedule,
• The depreciation schedule for income tax purposes,
• The depreciation schedule for the purpose of reporting under Companies Act, 1956 (if depreciation policy is different than income tax rules).

V) Financial Statements: Some financial statements are prepared in the project feasibility report. They include:
• Profit and Loss accounts of the company,
• Balance-Sheets of the Company,
• Cash flow statements for the proposed project.

vi) Financial Indicators: Financial indicators are calculated using data derived in various financial statements. Two basic financial parameters are used for judging the viability of the project:
• Debt-Service coverage ratio (DSCR): Debt- Service Coverage Ratio (DSCR) uses the same numerator as the interest cover ratio, but that is compared with the interest payment and principal sum repayment in a particular year. The formula is DSCR=PAT + Depreciation + Interest/Interest+ Principal Sum Repayment

Academically and according to many lading financial institutions and average DSCR of 1.5 is considered very well. This is also the safety indicator for lender of money. A project that generates enough funds during the period of loan taken for the project is considered good from the business prudence angle.

** Net Present Value Method: The net present value method is a modern method of evaluating investment proposals. This method takes into consideration the time value of money and attempts to calculate the return on investments by introducing the factor of time element. It recognized the fact that a rupee earned today is worth more than the same rupee earned tomorrow. The net present value of all inflows and outflows of each occurring during the entire life of the project is determined separately for each year by discounting these flows by the firm’s cost of capital or pre-determined rate.

Some firms also prefer to calculate:
• Payback Period: The payback period is defined as the number of years required for the proposal’s cumulative cash inflows to be equal to its cash outflows. In other words , the payback period is the length of time required to recover the initial cost of the project. The payback period therefore, can be looked upon as the length of time required for a proposal to ‘break even’ on its net investment.
• Interest Cover Ratio: The interest cover ratio indicates the safety and timely payment of interest to lenders of money. It is calculated with the help of the following formula: Interest cover ratio = PAT + Depreciation + interest/Interest

This shows how many times the operating cash flow before interest is earned against the interest liability. However, this is not a very important indicator of project viability.

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