To identify the financial and economic indicators of the projects, it is necessary to make a financial analysis of the project in the justification reports. Since the purpose of implementing projects is to earn money and profit, so it should be possible to estimate the amount of profitability.
Therefore, to reach the appropriate criteria and indicators to determine the amount of profit of projects, previous financial and economic indicators should be used.
Financial analysis of the justification plan:
As mentioned earlier, the ultimate goal of implementing business plans is to generate sales revenue and profit, which to be informed of, it is necessary to consider a suitable benchmark and index.
The necessary data for calculating financial and economic indicators, investment costs, and production costs are presented in the technical studies section of the forecast report.
In this part of the report, the following tables and information are prepared and adjusted using investment costs:
- Production costs
- Projected annual revenue for the scheme
- Profit (loss) invoice
- Cash flow statement
- Projected balance sheet
- Other financial and economic tables
It can be said that in the financial analysis of a justification plan, an attempt is made to examine the financial status of the project. Therefore, at this stage, the status of income and expenses during the year is determined, and the required capital is determined, then the cash flow during the previous years is examined.
It should be noted that in the financial analysis of projects, design analysis in operational conditions, sensitivity analysis, and risk analysis are also performed.
Determine the resources required for the project:
The resources required for the plans are divided into 3 general categories that should be considered in the development of the justification plan:
1_ Fixed investment:
Fixed capital is one of the resources required to implement the plan, the components of which are as follows:
- Cost of research, tests, and initial studies
- Cost of machinery, equipment, buildings, and ancillary facilities
- Organizational fees, royalties (licenses), and…
- Land costs, natural resources, and operating costs such as land leveling
- Startup course fee
- Cost of basic facilities such as labor costs, warehouses, and offices
- Exploitation cost during the project implementation period
- Unforeseen and miscellaneous costs such as fire insurance during project implementation
2_ Working capital:
Working Capital is the resources required for the period of operation of the project. Since in industrial activities, machines, facilities and… and in-service activities, the existence of offices and office equipment alone is not enough to produce products and goods, so in industrial activities, the necessary raw materials, spare parts, and materials must be stored, and also in service activities, it is necessary to attract the right people.
During the production process, some goods are being produced, some goods have been made and are in the sales stage, and some goods have been ordered. Therefore, there are always debtors that indicate the need for current capital.
Working capital is the current capital required for production and distribution, which by definition includes all current assets, including initial balance, semifinished and produced product, cash in the fund, and bank accounts. Advance payments are to sellers and…
Note 1: From the point of view of bankers and accountants, net working capital is equivalent to the difference between current assets and current liabilities.
Tip 2: The most common mistake that can be made in estimating project costs and causing failure is incorrect and inadequate working capital estimates.
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Working capital calculation methods:
There are two direct and indirect methods for calculating working capital, which is one of the most important measures, which are described below.
Direct method: In the direct method for calculating working capital, current liabilities are deducted from current assets. Current assets include all assets that can be easily sold or consumed, which include the following:
- Cash Equivalents or investment bonds with a maturity of fewer than 3 months
- Accounts Receivable
- Consumer securities
- Prepaid debts
Also, current liabilities are the short-term financial liabilities of the company that must be settled for a year or in a normal operating cycle, and the most common are payables and accounts payable.
In this method, the annual production cost is used to calculate working capital, which should be based on the following method:
- Divide the annual production cost by full capacity by 365 to obtain the daily production cost.
- Product order time should be determined according to the day.
- Estimate inventory storage time based on the day.
- Estimate the average time required to produce the product based on the day.
- Estimate the shelf life of the product made in the warehouse.
- Estimate the average receivables’ collection period and debt repayment period and calculate the difference in this amount.
- The number of days specified in paragraphs 2 to 6 is summed, and the number obtained is calculated at the cost of daily production and then multiplied by the first paragraph.
Result: After the above steps, the approximately required working capital is determined.
3_ Unforeseen expenses:
Unforeseen costs (miscellaneous costs) are present in all projects. It can be said that the costs of any project are not completely predetermined, because there is uncertainty in the environment, and also estimates are always made with error. Therefore, it is necessary to allocate some resources to unforeseen factors for the just plan to be sufficiently accurate.
Preparation of income statement:
It can be said that the most important part of the financial analysis of justification plans is the estimation of the income statement, which indicates the expected profitable sales.
The income statement estimates the business operations over a while using the following formula.
“Net profit after tax = sales – refunds and discounts – costs of goods sold”
”Operating Expenses + Other Income – Interest Expenses – Income Tax”
Preparation of liquidity statement:
The purpose of presenting liquidity statements is to show the number of cash inflows and outflows in the business in question, which helps the employer identify the amount of liquidity required for the courses, the number of debts and bills, and proceed to pay them.
Lenders, on the other hand, want to know if the borrower has enough cash to pay their installments. Therefore, preparing financial statements for the employer and the investor is very significant, with the help of which the following benefits can be achieved.
- Identify the amount of cash needed to start a business
- Schedule loan repayment times and grace periods
- Ensure that there is the desired cash flow for all payments and debts ahead
Note: Therefore, it is recommended that in writing the justification plan, the liquidity statement be prepared for the year before operation and the first year, monthly and for the following years quarterly. Because planning for the early years needs to be done more carefully.
Balance sheet preparation:
The balance sheet in the businesses that have started will show the current situation, and the projects and plans that have not been put into operation will show the situation from a certain time of the operation period. The balance sheet shows what the business is in, which depends on the income situation and cash flow.
The balance sheet includes all sources of income as well as the share of partners and owners. To evaluate its profitability, it is necessary to prepare and adjust the balance sheet for at least the first 5 years of the plan, which is prepared monthly.
After its preparation and also the formation of financial and economic tables, effective indicators are identified that will be effective in deciding whether to implement the plan. Therefore, the goals and indicators defined in the financial and economic analysis must be different from each other.
Business profitability analysis:
In preparing a justification plan, it is necessary to examine the commercial profitability of the plan from the following two perspectives:
1_ Measuring the profitability of the investment:
In other cases, other alternatives may be considered, and profitability measurements are used to select the best alternative. Therefore, the analyst can obtain profitability measurements for a project or project understudy in the following ways.
- Profitability measurements with non-temporal value
- Net income from assets
- First-year income from the initial investment
- Average net income from average investment
- Profitability measurements in terms of the time value of money
- Discounted cash flow methods
- Current value
- Internal return rate
- The ratio of benefits to expenses
2_ Financial analysis:
Financial analysis in justification plans is done in two parts: liquidity analysis and capital composition analysis. Liquidity analysis is done by analyzing the cash flow statement. Also, the purpose of capital composition is to determine how to provide capital, part of which is provided by the employer and another part of which is provided by obtaining a loan, granting shares, or issuing bonds.
Financial analysis and economic analysis are the two main ways to test the desirability of a plan. The tools used to perform these two tests are not different, but their approach and attitude are fundamentally different. Financial valuation deals with cost-benefit flows from the perspective of an investor (firm or individual) and economic valuation deals with cost-benefit flows from society. As a result, economic analyzes or tests take into account costs and benefits from a broader perspective.
An enterprise or individual focuses on financial gain and profit stability when investing, while a society or government thinks of broader goals such as increasing national income, creating jobs, eradicating poverty, and benefits to society as a whole. As a result, the goals of the two tests are different. Therefore, if the purpose of assessing the benefits of the project for society and from a national perspective (such as national projects), economic evaluation is used.
Professor Siavosh Kaviani was born in 1961 in Tehran. He had a professorship. He holds a Ph.D. in Software Engineering from the QL University of Software Development Methodology and an honorary Ph.D. from the University of Chelsea.
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