Creating a Financial Business Case

OPI OEA L1A

© 2012 PETROLIAM NASIONAL BERHAD (PETRONAS)

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 When to use
To provide a financial business case to justify the investment in a project, equipment or business.

 What you get

A business case, which set the cost of the investment against the projected return over a period
of time, together with an assessment of the financial return from different business scenarios.
 Time
From 2 – 4 hours for a small project to days for a larger multifaceted business or project.

 Number of people
1 – 2 people
 Equipment
The business case can be prepared using an account analysis pad but it is much more effective
when produced on a computer spreadsheet.

© 2014 Petroliam Nasional Berhad (PETRONAS)

 Method
1. Fully understand the cost associated with the project particularly the phasing of the cash flow,
i.e. the points at which cash will flow out of the company over the life of the project. Do not
forget any additional overhead costs, e.g. people, tooling, design and possible trials. Also build
in a contingency to recover from any shortcoming.
2. Fully understand all the elements of the project that have come together to make the project
whole and the cost and cash flow at each stage. See Tool 94: Work Package Breakdown.
3. Set up the analysis chart or spreadsheet with the vertical axis showing all items of expenditure
and when the cash flow is expected to occur on the horizontal axis.
4. Also set up on the analysis sheet or spreadsheet all of the items where cost is saved or revenue
generated on the vertical axis and when benefits are expected to be achieved on the horizontal
axis. From this it is possible to generate a graph of cost outflow and inflow to determine the
cash payback period.
5. From the above, it is possible to calculate the return on investment over any period of time.
Initially the return on investment will be negative until cash flow breakeven point in reached.
6. It is now necessary to calculate the value of the investment at today’s date. There are a number
of financial methods available to do this. The one detailed here is the discounted cash flow
(DCF) which discounts the return on the investment in the later years for the expected currency
inflation and cost of borrowing. The DCF is calculated by putting an interest cost on the capital
used to breakeven point and reducing the return value by inflation back to today’s date.

© 2014 Petroliam Nasional Berhad (PETRONAS)

7. It is now necessary to understand how sensitive your business case is likely to be to changes in
the market environment, possible delays in introduction of the project and maybe changes in the
cost of borrowing or inflation. Look specifically at its impact on cash flow and the business. This
can be done easily using a spreadsheet.
 Example
See page opposite.

 Exercise
Considering investing in an energy efficient light bulb, taking the claim of the electricity savings
made by the manufacture, the lost opportunity of the investment at your current bank interest rate,
the manufacturer’s life of the bulb compared to a normal light bulb etc.

 Key points
The financial evaluation of a project provides one element of a justification; it does not take into
account the positive or negative impact on the less tangible issues, like branding, quality or market
positioning in terms of achieving the company’s strategic goals. Tools to help link measures, both
financial and non-financial to strategy are, tools 2: Balanced Scorecard or 35: Forward
Measurement.

© 2014 Petroliam Nasional Berhad (PETRONAS)

 Other information
They are many financial books in the market, here are a few to get you started: E. F. Brigham,
Fundamental of Financial Management, Holt-Sauder International Editions, 1983; J. Covello and B.
Hazelgren, Your First Business Plan: A Simple Question and Answer Format Designed to Help you
Write your Own Plan, Source Books, 1997; B. Finch, 30 Minutes to Write a Business Plan, Kogan
Page, 1997.

© 2014 Petroliam Nasional Berhad (PETRONAS)

Cash flow analysis (simple)
This simple version does not take into account the lost opportunity of interest earned on the
outstanding cash balance. It suggest the breakeven point would be year 4.
Year 1 2 3 4 5 6

£k Expenditure 100 0 0 0 0 0

£k Savings 25 25 25 25 25 25

£k Cash flow (75) 25 25 25 25 25

£k Cumulative cash flow @ year end (75) (50) (25) 0 25 25

However, a company could expect to team say 10 per cent on the capital invested. Note that when
this is included now the breakeven point is between Years 15 and 6.
Year 1 2 3 4 5 6

£k Lost interest opportunity 10 8.5 6.9 5.04 3.04 0.84

£k Balance to be recovered 85 68.5 50.4 30.9 8.4 (15.7)

© 2014 Petroliam Nasional Berhad (PETRONAS)

Net present value (NPV)
The basic idea for NPV is to value the benefits of the investment in today’s money, i.e. the date the
investment was made. To do this you will be required to understand what the company has
determined as the normal opportunity value or standard at which funds can and should be employed
in the business.

For our example we will use 12 per cent. This will enable us to calculate the present value of all
outlays and all inflows of cash. The resulting NPV represents an investment over the life of the
project better than the companies standard. (The NPV Factors can be found in standard accounting
NPV table.)

Year 0 1 2 3 4 5 6
£k Cash flows (100) 25 25 25 25 25 25
PV Factors as 12% 1 0.89 0.80 0.71 0.64 0.57 0.51
£k Present value (PV) (100) 22.3 19.9 17.8 15.9 14.2 12.7
£k Cumulative PV (100) (77.7) (57.8) (39.9) (24.1) (9.9) 2.8

© 2014 Petroliam Nasional Berhad (PETRONAS)