Sound financial management is one of the best ways for the business to remain profitable and solvent. How well one manages the finances of the business is the cornerstone of every successful business venture. Each year thousands of potentially successful businesses fail because of poor financial management. As a business owner, one will need to identify and implement policies that will lead to and ensure that you will meet your financial obligations. The basic data required for a financial feasibility analysis can be grouped as under:
I. Cost of project and means of financing
II. Cost of production and profitability
III. Cash flow estimates during currency of loans
IV. Proforma balance sheets at the end of each financial year during the period of the loan
I. COST OF PROJECT
The cost of the project can be broadly classified into the following:
Land and site development
Plant and machinery
Transportations erections and commissioning
Miscellaneous assets
Preliminary and pre- operative expenses
Contingency expenses
Working capital margin
Though the cost of machinery often constitutes a major element in the total project cost, its estimation need not pose problems since this can be based on competitive quotations. On the other hand, cost of items such as land, site development expenses, ancillary facilities like power and water connections, intangibles like preliminary expenses and preoperative expenses, necessitates a careful inquiry and assessment. A realistic assessment of project cost with built in cushions (a reasonable contingency margin) for absorbing normal cost escalations could take care of the consequences of delay and cost overrun. Inflation factors are also considered.
II. MEANS OF FINANCING
There is no ideal pattern concerning means of financing for a project. The means of financing is determined by a variety of factors and considerations like magnitude of funds required, risk associated with the enterprise, nature of industry, prevailing taxation, laws etc.
The following are the sources of finance:
Share capital
Subsidies
Long term borrowing (financial institutes / banks)
Loans from friends and relatives
Retained earnings
Financial institutes specify certain debt equity ratios and promoters will have to raise own finance to match these ratios.
III. COST OF PRODUCTION AND PROFITABILITY
The next step is the assessment of the earning capacity of the project. The unit should be in a position to manufacture the product at a reasonable cost and sell them at a reasonable price, which would allow adequate profit margin even in a competitive market. The profitability of an enterprise depends on the total cost of production and aggregate sale price of the output. The cost of production and sale estimates are also useful in working out the break-even point, the point at which the income sales would cover the working costs of the project. At this point the unit begins to make profit.
IV. CASH FLOW ESTIMATES
The cash flow estimates are essential to ensure availability of cash to meet the requirements of the project from time to time. The cash flow estimates will show the sources of funds including those arising from depreciation and profits as well as uses of funds including repayment of term loan installments. The debt service coverage ratio is arrived at by dividing cash accruals comprising net profits by total interest charges and installments. This will indicate whether the cash flow would be adequate to meet the debt obligations and also provide sufficient margin of safety, repayment of term loans beings drawn taking into consideration the above aspect.
V. PROFORMA BALANCE SHEETS
Proforma balance sheets are drawn for existing concerns going for expansions as well as for new projects. However in the case of existing concerns going for expansion the balance sheets for the past three years are also analyzed and compared, with the projections. The projected balance sheets can be drawn for the cash flow estimates and profitability projections. Various ratios are derived from the balance sheets and inferences drawn there from.
I. Cost of project and means of financing
II. Cost of production and profitability
III. Cash flow estimates during currency of loans
IV. Proforma balance sheets at the end of each financial year during the period of the loan
I. COST OF PROJECT
The cost of the project can be broadly classified into the following:
Land and site development
Plant and machinery
Transportations erections and commissioning
Miscellaneous assets
Preliminary and pre- operative expenses
Contingency expenses
Working capital margin
Though the cost of machinery often constitutes a major element in the total project cost, its estimation need not pose problems since this can be based on competitive quotations. On the other hand, cost of items such as land, site development expenses, ancillary facilities like power and water connections, intangibles like preliminary expenses and preoperative expenses, necessitates a careful inquiry and assessment. A realistic assessment of project cost with built in cushions (a reasonable contingency margin) for absorbing normal cost escalations could take care of the consequences of delay and cost overrun. Inflation factors are also considered.
II. MEANS OF FINANCING
There is no ideal pattern concerning means of financing for a project. The means of financing is determined by a variety of factors and considerations like magnitude of funds required, risk associated with the enterprise, nature of industry, prevailing taxation, laws etc.
The following are the sources of finance:
Share capital
Subsidies
Long term borrowing (financial institutes / banks)
Loans from friends and relatives
Retained earnings
Financial institutes specify certain debt equity ratios and promoters will have to raise own finance to match these ratios.
III. COST OF PRODUCTION AND PROFITABILITY
The next step is the assessment of the earning capacity of the project. The unit should be in a position to manufacture the product at a reasonable cost and sell them at a reasonable price, which would allow adequate profit margin even in a competitive market. The profitability of an enterprise depends on the total cost of production and aggregate sale price of the output. The cost of production and sale estimates are also useful in working out the break-even point, the point at which the income sales would cover the working costs of the project. At this point the unit begins to make profit.
IV. CASH FLOW ESTIMATES
The cash flow estimates are essential to ensure availability of cash to meet the requirements of the project from time to time. The cash flow estimates will show the sources of funds including those arising from depreciation and profits as well as uses of funds including repayment of term loan installments. The debt service coverage ratio is arrived at by dividing cash accruals comprising net profits by total interest charges and installments. This will indicate whether the cash flow would be adequate to meet the debt obligations and also provide sufficient margin of safety, repayment of term loans beings drawn taking into consideration the above aspect.
V. PROFORMA BALANCE SHEETS
Proforma balance sheets are drawn for existing concerns going for expansions as well as for new projects. However in the case of existing concerns going for expansion the balance sheets for the past three years are also analyzed and compared, with the projections. The projected balance sheets can be drawn for the cash flow estimates and profitability projections. Various ratios are derived from the balance sheets and inferences drawn there from.