An Overview Of Project Appraisal For Finance- Methods And Risk

An Overview Of Project Appraisal For Finance- Methods And Risk

July 21, 2021 Admin
Project appraisal for finance Project appraisal Project appraisal in Gurgaon Project appraisal finance Project appraisal finance methodsProject Appraisal services

Under the project appraisal process, a financial institution conducts an assessment of various aspects of an investment proposition independently and objectively to come to a viable financing decision. Project appraisal for finance is done using five methods that are discussed below:


1. Economic Analysis

Under economic analysis, the following project aspects are taken into account:  raw material requirements, level of capacity utilization, expected sales, expected costs, and plausible profits.

A business should always ascertain the profit volumes of the company as the same would determine other economic variables such as sales, purchase, expenses, etc. The company needs to anticipate the targeted sales required to achieve the forecasted profit volumes. The sales in turn depend on the demand for the product. Thereby, enlisting the product demand as a quintessential factor for ascertaining the project feasibility.

.Also, the location for setting up the enterprise is essential in ascertaining the viability of the project. While selecting the location, various government policies, incentives, and concessions offered by the government schemes need to be contemplated. Therefore, location is an important attribute of economic analysis.


2. Financial Analysis

Financial analysis is an important prerequisite for any successful business. The project appraisal involves assessing  the fixed capital and working capital requirements of the business to ascertain the financial viability of the business

Fixed capital, also known as ‘fixed assets’ in a company, include both the tangible as well as intangible assets, which once purchased are used repetitively over a period of time. Fixed assets shall include land and building, vehicle, plant and machinery, equipment, etc. Depending upon the type of operation, scale of operation, and time of investment, the requirement of fixed capital in a company varies. While evaluating the requirement of Fixed Capital, various factors should be taken into consideration, such as, the cost of the asset, architect and engineer’s fees, electrification and installation charges (which normally come to 10 percent of the value of machinery), depreciation, pre-operation expenses of trial runs, etc., Likewise, any cost incurred in remodeling, repair, and additions of buildings should also be captured in the project report.

Working capital is the excess of current assets over current liabilities. A ratio of 2:1 (Current Assets: Current Liabilities) is considered to be viable. Current assets are those assets that can be conveniently converted into cash within one week. Whereas, Current liabilities refer to those obligations that can be repaid in a period of one week. Thus, working capital suffices an organization’s day-to-day requirements and hence serves as a lubricant for the smooth transition of the business. Insufficiency of working capital may adversely impact the working of the business.


3. Market Analysis:

Before commencing the production of the product, the business must conduct a market analysis to understand the potential demand for the product. Market analysis involves demand forecasting. Demand Forecasting probes into anticipating and identifying the requisite market for the product to be purchased. Some of the common methods of demand forecasting include:

i) Opinion Polling Method: A survey is conducted and the opinions of the ultimate customers are considered. The various methods are: Under this method, sales are estimated by simply adding the probable demands of all customers

  • Sample Survey: Under this method, a random sample of the total population is approached to ascertain the demand of the product during the forecasted period of This date of the defined sample is taken and summed. The total demand of the sample is used to calculate the total demand of the population.
  • Sales Experience method: A sample market is surveyed before the sale of the new product under this method. The results of the survey are then projected to that of the entire universe in order to assimilate the total demand.
  • Vicarious Method: In this method, consumers are approached indirectly via dealers who have an understanding of the potential customers. In this method, the dealer’s opinion about the customer’s opinion is captured.

ii) Life cycle Segmentation Analysis: It is based on the concept, that like humans a product also has a defined life cycle. The product life cycle captures the  following stages:

  • Introduction
  • Growth 
  • Maturity
  • Saturation
  • Decline


4. Technical Feasibility:

Technical feasibility refers to evaluating and assessing the adequacy of the proposed plant and equipment to produce the said product within the prescribed norms.  is evaluated. It is done to Technical feasibility evaluates that whether the business has the sufficient know-how or the same needs to be procured from somewhere else. And if the arrangement is to be made, then the right sources are being researched. In the case of foreign collaboration, the terms and conditions of the same shall be clearly spelled out.

While assessing the technical feasibility of the project, the following factors should be duly considered:

  • Availability of land and site.
  • Availability of adequate raw materials as per defined quantity and quality.
  • Availability of other inputs like water, power, transport, communication facilities.
  • Availability of servicing facilities like machine shops, electric repair shops, etc.
  • Adequate licenses for coping with anti-pollution law.
  • Availability of workforce as per required skill and arrangements proposed for training-in-plant and outside.


5. Managerial Competence:

The ability of the management to run a business successfully is quintessential for assessing the viability of any project. A poor project may flourish with the backing of good management support. Thus, evaluating the competence of the management or the talent of the promoter serves as a strategic advantage for the success of the project.


An Overview Of Project Appraisal For Finance- Methods And Risk

Approaches to Better Project Appraisal for finance

Before investing in a project, it is important to evaluate it effectively. Certain approaches are followed by experts who conduct project appraisal services. These are:


Payback Period Analysis:

This method calculates the period it will take to recover the net initial investment in the project in form of cash flows. Investments that have a shorter payback period are considered to be less risky and on the other hand, investments with huge payback periods are considered to be risky.

This method has certain drawbacks like it ignores factors like time value of money and net cash flows post-recovery of the initial investment.


Accounting Rate of Return (ARR)

This method calculates the accounting rate of return by taking net annual income and dividing it by the amount of initial investment on the project. The simplicity of the formula makes it popular, however, it also ignores the time value of money and cash flows which are the crucial elements for any project.


Net Present Value (NPV)

By bringing all predicted future financial inflows and outflows to the present time, the net present value (NPV) technique assesses the expected net monetary gain or loss from a project.

The NPV helps entrepreneurs to account for the time value of money when valuing long-term projects, even when the actual worth of the project can only be determined once it is completed.


Internal Rate of Return (IRR)

The internal rate of return (IRR) calculates a project's average yearly rate of return during its lifetime. The IRR, like the NPV, is a discounted cash flow analysis, which means it accounts for money's diminishing worth over time. The higher a project's projected IRR is, the more desirable it is under this method.

IRR is commonly used along with NPV. That's because, depending on the initial investment outflows and net future inflows, a project could have a low IRR yet a high NPV. This indicates that the project's rate of return may be lower than anticipated, but its contribution to the company's overall worth is significant. IRR will also give short projects a better ranking, undervaluing projects that repay their worth over the long term.


Project Appraisal Benefits and Risk

Project appraisal is highly beneficial. It results in the following benefits:

  • It helps in ascertaining the viability of the project.
  • They are simple to use and can be applied by both small and large firms for various projects
  • It is a great tool for big companies who are willing to invest in short-term projects.

Various companies that perform project appraisals in Gurgaon also face certain risks and disadvantages. These are:

  • The discounting of cash flows is not done in the majority of the methods
  • It ignores the time value of money. For instance, the value of the dollar in comparison to its value after five years.
  • Cash flows before the cut off are essentially discounted at a rate of zero
  • It mostly ignores the timing of cash flows and is slightly biased towards short-term investments.

Apart from the risks and disadvantages associated with the project appraisal services, many companies follow it to ascertain the viability of various projects. It provides a better understanding of the business and is essential for new businesses.

Resurgent India is a leading financial advisory firm that provides project appraisal services. The brand is known to create custom-made solutions for its clients and is among the leading companies that provide project appraisals in India.

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