Financial Analysis

FINANCIAL ANALYSIS

What is the first question you ask yourself if you feel that the product/service has got a market and it is technically possible? Is it financially viable?

Sanjeev Bajaj
Reader, Finance Area

Financial Analysis
Financial analysis consists of :
Estimation of cost of project Means of financing / capital structure Projections of sales and production Estimation of cost of production Working capital requirement and its financing Projection of profit and cash flows Projection of balance-sheet

Estimation of Cost of Project

It is the sum total of
Land and site development Building and civil work Plant and machinery Technical know-how and engineering fees Expenses on visit of foreign technicians and training of personnel. Other fixed assets Preliminary and capital issue expenses Pre-operative expenses Margin money for working capital Initial cash losses Provisions for contingencies

Means of Finance and Capital Structure

Most complicated task in project financial analysis is planning of capital structure. Because it depends upon many factors like
Return and risk associate with the project Nature of project and Gestation period Control sought by promoters Flexibility of change in capital structure Cost of capital and leveraging Governmental policy and norms of FIs, etc.

Projections of Sales and Production

Another important aspect of financial analysis is projection of sales and production. Depending upon the demand forecasts made and capacity planned a reasonable estimate of production and sales (or clients to be serviced) are made. Normally while projecting production and sales full capacity utilization is not considered in initial years. Projections are made using different capacity utilizations and different sales prices (flexible budgeting techniques are used)

Projections of Sales and Contd. Production

Projections are also considered for varying product mix offered. When the products in mix are substitute to each other it becomes more important.

Pro-forma statement
In excel file

Estimation of Cost of Production

Cost of production consists of
Material cost Labor cost Factory overheads Cost of utilities

Working Capital Requirement and Financing

In a project working capital consists of
Raw-material and consumables Stocks of goods in process Stock of finished goods Debtor and Bills receivable Operating Expenses

Banks do not finance 100% working capital requirement. Normally 25% margin is to be arranged from long term financing.

Working Capital Estimation

For estimation of working capital many techniques are used. Banks/FIs ask for detailed estimation based on production, sales and other items. Normally it is based on operating cycle method of estimation. Estimation file

Projection of Profit
One of the most important aspects of financial analysis is preparation of projected profit and loss account. Depending upon the period of finance projections are required from 5 to 10 years. These projections are prepared based on the forecasts made for demand, price of product / service, raw material costs, price level changes, wage rate changes and others.

Projection of Cash-flows
Based on the projections for profit and plan for investment a statement of cash-flow is prepared for a similar period as profit and loss estimates. This statement is very important for the financer to understand the flow of cash and coverage of interest and principal.

Projection of balance-sheet
Based on the financial plan, projections for profit and cash-flows a statement showing project balance sheet is also prepared for the similar period. Project balance sheet tells the status of project at the end of each year.

Analysis of Various Financial Projections

Last but of utmost importance is the analysis part of estimates. Various tools are applied to do the analysis like trend analysis, ratios etc.