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:
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.
Financial analysis is an important prerequisite for any successful 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.
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
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:
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:
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.
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 is highly beneficial. It results in the following benefits:
Various companies that perform project appraisals in Gurgaon also face certain risks and disadvantages. These are:
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.