project management- financial analysis

8/8/2019 Project Management- Financial Analysis

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Prestige Institute of Management &

Research

Project Management

Presented by: MBA (Full time)

Arun kumbhakar Arti raghuwanshi

Ritesh soni Mohd. Shabbir khan

Financial Analysis


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Contents

Financial Analysis and its Goals

Project Cost Management

Major Types of Estimates

Cash Conversion Cycle (CCC)

Cash Flow and Cash Flow vs. Profit

Capital Structure - What It Is and Why It Matters


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Financial Analysis

Financial analysis (also referred to as financial statement

analysis or accounting analysis) refers to an assessment of

the viability, stability and profitability of a business, sub-

business or project.

Major aspects of financial analysis

Cost of project

Estimated sales and productionWorking capital requirement and its financing


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Based on Financial Analysis

Management may: Make decisions regarding Investing or Lending capital;

Continue or discontinue its main operation or part of its

business;

Make or Buy certain materials in the manufacture of itsproduct;

Acquire or Rent/Lease certain machineries and equipment in

the production of its goods;

Issue stocks or negotiate for a bank loan to increase itsworking capital;

Other decisions that allow management to make an informed

selection on various alternatives in the conduct of its business.


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Goals Financial Analysis

1. Profitability - Its ability to earn income and sustain growth

in both short-term and long-term;

2. Solvency - Its ability to pay its obligation to creditors and

other third parties in the long-term;3. Liquidity - Its ability to maintain positive cash flow, while

satisfying immediate obligations;

4. Stability- It is firm's ability to remain in business in the long

run, without having to sustain significant losses in theconduct of its business.


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Project Cost Management

How do we know what a project will cost? We really don't,

until the project is complete, because we can't accurately

predict the future.

What we can do is create an estimate. An estimate is more than

pulling a random number out of the air, adding 20% for good

measure, and then saying, "That'll work."

A real estimate evolves as project details become available.

This is progressive elaboration.


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Cost ofProject

It includes all items of outlay associated with a project which

are supported by long-term funds:

Land and site development

Building and civil works Plant machinery and installation

Technology

Misc. fixed assets

Pre operative expenses

Provision for contingencies

Margin money for working capital


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Estimates ofProject

There are three major estimate types that project managers

should rely on:

1. The BallparkEstimate2. The Budget Estimate

3. The Definitive Estimate


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The BallparkEstimate

It is also known as the rough order of magnitude (ROM).

A ROM estimate is based on high-level objectives, provides a

bird's-eye view of the project deliverables, and has lots of

room for adjustment.

Most ROM estimates, depending on the industry, have a range

of variance from -25% all the way to +75%.

The project manager shouldn't invest too much time in

creating these initial estimates.


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The Budget Estimate

Also known as top-down estimate

It is a bit more accurate. Formulated fairly early in the project'splanning stage.

The budget estimate is most often based on analogousestimating, taking budget lessons learned from a similar

project and applying them to the current project.

With the budget estimate, we start at the top and work our waydown into the project details. The range of variance on the

budget estimate is from -10 percent to +25 percent.


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The Definitive Estimate

Also known as bottom-up estimate is the most accurate of the

estimate types, but takes the most time to create.

The definitive estimate requires a work breakdown structure(WBS).

A WBS is not a list of activities.

A WBS is a deliverables-oriented decomposition of the project

scope.


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Cost ofProduction

It comprises of:

Material cost

Labour cost Overheads

Utilities cost


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Profitability Projections

A. Cost of production

B. Total admin expenses

C. Total sales expenses

D. Royalty and know how cost

E. Total cost of production (A + B + C + D)

F. Expected sales

G. Gross profit (F - E)

H. Depreciation and other financial expenses

I. Operating profit (G - H)

J. Taxation and other reserves

K. Net profit (I - J)

L. Retained earning (Net profit - Dividend)


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BEP

BEP= Fixed costs / (SP- VC)

BEP= Fixed costs / Contribution = Let it is X

BEP (in terms of Volume of Production)= X * ExpectedProduction in the year

BEP (in terms of Percentage of Installed Capacity)= X *

Expected Capacity Utilization in the year

BEP (in terms of Rupees)= X * Expected Sales realization in

the year


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Cash Conversion Cycle (CCC)

The term "cash conversion cycle" refers to the time spanbetween a firm's disbursing and collecting cash.

The Cash Conversion Cycle emerges as interval betweendisbursing cash and collecting cash).

It is measure of how long a firm will be deprived of cash if itincreases its investment in resources in order to expand

customer sales.

It is thus a measure of the liquidity risk entailed by growth.


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Cash Flow

Cash flow is the movement of cash into or out of a business,project, or financial product.

It is usually measured during a specified, finite period of time.Measurement of cash flow can be used:

To determine a project's rate of return or value.

To determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. Acompany can fail because of a shortage of cash, even

while profitable. To evaluate the risks within a financial product. E.g.

matching cash requirements, evaluating default risk, re-investment requirements, etc.


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Statement ofCash Flow in a

B

usiness's Financials The (total) net cash flow of a company over a period (typically

a quarter or a full year) is equal to the change in cash balance

over this period.

It is positive if the cash balance increases (more cash becomesavailable) and negative if the cash balance decreases.

The total net cash flow is the sum of cash flows that are

classified in three areas:

Operational cash flows

Investment cash flows

Financing cash flows


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The 3 Sources ofCash Flows

Operational cash flows:

It is cash received or expended as a result of the company'sinternal business activities.

It includes cash earnings plus changes to working capital.

Over the medium term this must be net positive if the companyis to remain solvent.

Investment cash flows:

It is cash received from the sale of long-life assets, or spent on

capital expenditure (investments, acquisitions and long-lifeassets).

Financing cash flows:

It is cash received from the issue of debt and equity, or paidout as dividends, share repurchases or debt repayments.


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Example

Description Amount (Rs.) Totals (Rs.)

Cash flow from operations: +10

Sales (paid in cash) +30

Materials -10Labor -10

Cash flow from financing: +40

Incoming loan +50

Loan repayment -5Taxes -5

Cash flow from investments: -10

Purchased capital -10

Total +40


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The net cash flow only provides a limited amount of information.

Compare, for example, the cash flows over three years of two

companies:

Company A Company B

Year 1 Year 2 Year 3 Year 1 Year 2 Year 3

Cash flow from operations +20K +21K +22K +10K +11K +12K

Cash flow from financing +5K +5K +5K +5K +5K +5K

Cash flow from investment -15K -15K -15K 0K 0K 0K

Net cash flow +10K +11K +12K +15K +16K +17K

Company B has a higher yearly cash flow.However, Company A is

actually earning more cash by its core activities and has already

spent 45K in long term investments, of which the revenues will only

show up after three years


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Importance ofCash Flow- Bear in mind that more businesses

fail for lack of cash flow than for want of profit.

Cash Flow vs. Profit- The net result ofcash cycle is that cashreceipts often lag cash payments and, whilst profits may be

reported, the business may experience a short-term cash

shortfall.

For this reason it is essential to forecast cash flows as well as

project likely profits.

The following simplified example illustrates the timing

differences between profits and cash flows:


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Illustration:

Cashf

lows relating to Month 1:

Month

1

Month

2

Month

3 Total

Receipts from sales (Rs.000) 20 35 20 75

Payments to suppliers etc. (Rs.000) 40 20 5 65

Net cash flow (Rs.000) (20) 15 15 10

Cumulative net cash flow (Rs.000) (20) (5) 10 10

Income Statement: Quarter 1

Sales (Rs.000) 75

Costs (Rs.000) 65Profit (Rs.000) 10


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This shows that the cash associated with the reported profit for

Month 1 will not fully materialize until Month 3.

And that a serious cash shortfall will be experienced duringMonth 1 when receipts from sales will total only Rs.20,000 as

compared with cash payments to suppliers of Rs.40,000.


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3. Exclusion ofFinancing Costs Principle:

Interest on long term debt is ignored while computing profits

and taxes thereon and

Expected dividends are deemed irrelevant in cash flowanalysis.

Since interest is usually deducted in the process of arriving at

PAT, an amount equals to interest (1 tax rate) should be

added back to figure of PAT

4. Post Tax Principle: Cash flow must be defined in post tax

terms.


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Component ofCash Flows

Initial Investment

Operating Cash Flows

Terminal Cash Flows: It is cash flow occurring at the end of

the project life on account of liquidation of project


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Initial Investment

New Project

Installation cost

(+) Working capital margin

(+) Preliminary and

Preoperative expenses

(-) Tax shield, if any on

capital assets

Replacement Project

Installation cost

(+) Change in Working

capital margin

(-) Post tax proceeds from

the sale of old capital assets

(-) Tax shield, if any on

replacement of capital assets


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Operating Cash Flows

New Project

Profit after tax

(+) Depreciation

(+) Other non cash charges

(+) Interest on long term

debt (1-tax rate)

Replacement Project

Changes in Profit after tax

(+) Change in Depreciation

(+) Changes in other non

cash charges

(+) Changes Interest on long

term debt (1-tax rate)


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Terminal Cash Flows

New Project

Post tax proceeds (net

salvage value) from the sale

of capital assets (+) Net recovery of Working

capital margin

Replacement Project

Post tax proceeds from the

sale of replacement capital

assets (+) Post tax proceeds from

the sale of present capital

assets

(+) Net recovery of Workingcapital margin


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Capital Structure - What It Is and

Why It Matters

The term capital structure refers to the percentage of capital

(money) at work in a business by type.

Broadly speaking, there are two forms of capital: equity capital

and debt capital.

Each has its own benefits and drawbacks.

The perfect capital structure is formed in terms of risk / reward

payoff for shareholders.


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Equity Capital: This refers to money put up and owned by the

shareholders (owners). Typically, equity capital consists of two

types:

Contributed capital, which is the money that was originally

invested in the business in exchange for shares of stock orownership and

Retained earnings, which represents profits from past years that

have been kept by the company and used to strengthen the

balance sheet or fund growth, acquisitions, or expansion.

Debt Capital: The debt capital in a company's capital structure

refers to borrowed money that is at work in the business.


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Seeking the Optimal Capital

Structure Many individuals believe that the goal in life is to be debt-free.

Of course, how much debt you take on comes down to how securethe revenues your business generates.

Again, this is where managerial talent, experience, and wisdomcome into play. The great managers have a knack for consistentlylowering their weighted average cost of capital by increasing

productivity, seeking out higher return products, and more.

Optimum capital structure is combination of debt and equity thatleads to maximum value of firm and hence wealth to its ownersminimizing cost of capital.


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Features ofoptimum capital

structure

It should be flexible

Maximum possible use of leverage (use of fixed cost funds

because it maximizes returns to equity)

Use tax leverage Avoid undue financial/ business risk with the increase of debt

Use of debt should be in capacity of firm. The firm should be

in position to meet its obligations in paying the loan and

interest charges as and when due. It should involve minimum possible risk of loss of control

It must avoid undue restriction in agreement of debt


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Cost ofcapital

For Debt

1. Kd= (I / C)* 100

I = Contractual rate + [(Floating charges + Premium

Discount)/ Period of issue] C = Par value [(Floating charges + Premium

Discount)/ 2]

2. Kdt = Kd (1-t)

For equity

1. Ket = (D/C) * 100 + G (growth rate in dividend)

2. Ke = Ket / (1-t)


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References

Chandra Prasanna (1995). Projects: Planning, Analysis, Selection,

Implementation and Review, New Delhi: Tata McGraw- Hill ed. 4th.

Gopalkrishnan P. and V. E. R. Moorthy (1993). Project Management,New

Delhi: Macmillan India ltd.

Gupta S. K. & R.K. Sharma (2004). Financial Management, Ludhiana:Kalyani Publishers ed. 4th.

http://en.wikipedia.org/wiki/Financial_analysis

http://www.interplansystems.com/html-docs/cost-estimating-project-

planning.html

http://www.projectsmart.co.uk/project-cost-management.html http://en.wikipedia.org/wiki/Cash_conversion_cycle

http://en.wikipedia.org/wiki/Cash_flow

http://www.planware.org/cashflowforecast.htm

http://beginnersinvest.about.com/od/financialratio/a/capital-structure.htm


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Thank you

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