Financial Analysis

Financial Analysis
• To judge a project from the financial angle, we need
information about the following:
• Cost of project
• Means of financing
• Estimates of sales and production
• Cost of production
• Working capital requirements and financing
• Estimates of working results
• Break-even point
• Projected cash flow statements
• Projected balance sheets
 Cost of Projects
• Land and site development
• Buildings and civil works
• Plant and machinery
• Technical know-how and engineering fees
• Expenses on foreign technicians and training of Indian
technicians abroad
• Miscellaneous Fixed Assets
• Preliminary and capital issue expenses
• Pre-operative Expenses
• Provision for contingencies
• Margin Money for Working Capital
• Initial cash losses
 Land & Site Development

Items to be included Documents/ Particulars to be

scrutinised for Appraisal
•Cost of land •Agreement for sale of land
•Legal Charges for •Rates of legal charges
registration •Total area of roads and cost
•Cost of levelling and per sq. metre
development •Total length of fencing and
•Cost of laying roads the basis for calculation
•Cost of fencing
•Cost of gates
•Cost of tube wells
 Buildings
Items to be included
•Main Factory Buildings
•Ancillary Factory Buildings
•Administrative Buildings
•Godowns
•Canteen, Guest House, etc.
•Quarters for essential staff
•Silos, tanks, wells, etc.
•Cost of sewers, drainage, etc.
•Garages
•Architects’ fees
Documents/ Particulars to be
scrutinised for Appraisal
•Design of Buildings
•Different types of construction and
area under each type of construction
•Rate per sq. ft. of each construction
•Agreement with building contractor, if
any
•A note on past record of building
contractor and architect
 Plant and Machinery
Items to be included
Imported Plants
•FOB value of plant to be imported
•Shipping, freight and insurance
•Import duty
•Clearing, loading and unloading,
and transportation charges
Indigenous Plants
•Main plants and other equipment
•Machinery stores and spares
•Sales tax
•Transportation charges
•Foundation & installation charges
Documents/ Particulars to be
scrutinised for Appraisal
Imported Plants
•Quotations of plant to be imported
•Orders, if already placed
•Import licence, if required
•Report of an independent
engineer, if second hand
machinery is being imported
Indigenous Plants
•List of main items to be bought
•Quotations received
•Orders of machinery if placed
•Contract entered into between the
company and machinery suppliers
Technical know-how, Engineering Fees
& Expenses on Technicians
Items to be included
•Expenses of foreign technicians
•Expenses for training Indian
technicians
•Technical know-how fees
•Expenses on drawings
•Consultancy fees for preparing
project report
Documents/ Particulars to be
scrutinised for Appraisal
•Contract between the company
and foreign collaborators
•Contract between the company
and consultants
•A note on past record of
consultants
•Relationship, if any, between
promoters of a project and
consultants
 Miscellaneous Fixed Assets
Items to be included Documents/ Particulars to be
scrutinised for Appraisal
•Furniture •Details of various items of
•Office machinery and equipment furniture, office machinery,
•Cars, trucks, etc. equipment, etc. and cost thereof
•Cost of installation, cabling, etc. •Contracts regarding electric
for distribution of power and light installation, piping, etc.
•Equipment and pipes for •Price list of laboratory equipment,
distribution of water, air and steam workshop equipment, etc.
•Laboratory equipment
•Workshop equipment
•Fire fighting equipment
•Effluent collection, treatment and
disposal arrangement
•Any other misc. fixed assets
 Preliminary and Capital Issue
Expenses & Pre-operative Expenses
Items to be included Documents/ Particulars to be
scrutinised for Appraisal
•Brokerage and Commission on •Check the basis for calculating
Capital Issue expenses on capital issue,
•Other capital issue expenses mortgage expenses, etc.
•Commitment charges
•Interest on term loans during
construction period
•Mortgage expenses
•Miscellaneous expenses during
construction period
•Start-up expenses
 Provision for Contingencies
Items to be included
•Probable increase in costs due to
new additions
•Probable increase in costs due to
rise in prices, sales, tax, excise
duty, transportation charges,
fluctuations in foreign exchange
rates, etc. of items taken into
account
Documents/ Particulars to be
scrutinised for Appraisal
•Divide total costs into two groups
– considered firm and non-firm
•Provide provision for
contingencies – at say 5% to 10%
on non-firm items of cost
 Margin Money for Working Capital
Items to be included Documents/ Particulars to be
scrutinised for Appraisal
•Indigenous raw materials •Calculate total requirement of
•Imported raw materials working capital on the basis of
number of months of requirement
•25% of total current assets should
be financed by long term sources
and should be included in the
capital cost of the project
 Sources of Funds
• All-India Financial institutions like IDBI, IFCI
• State level institutions like State Financial Corporations and
State Industrial Development Corporations
• Insurance companies like LIC
• Commercial banks
• Deferred payments
• Public deposits
• Internal accruals
• Subsidy
• Unsecured loans from promoters
• Public issue
• International funding sources
 Promoters’ Contribution

Items to be included in Promoters’ Contribution:

• Share capital to be subscribed by promoters
• Unsecured loans from promoters
• Right shares issued to existing promoters
• Convertible bonds issued as rights to existing
shareholders
• Cash accruals
 The Basic Capital Budgeting Model
• When an investment is made, a cash outlay is
exchanged for cash benefits to be realized in the future.
Proposed investments should be judged by their
expected return.
• Will a particular investment meet investors’
requirements?
• Is the probable profile of cash inflows versus outflows
good enough to meet investment criteria and what
should these criteria be?
• Will the effect of an investment decision be a gain to the
firm’s share price?
• These questions are at the heart of the capital
investment decision – whether domestic or international.
 Formulae for calculating ratios: Fixed
Charge Coverage:
• Net tangible asset/ long-term debt =
(Stockholders’ equity – Intangibles + Long term debt) /
Long term debt
• Interest coverage before tax =
(Total interest expense + Income before tax) / Total
interest expense
• Interest coverage after tax =
(Total interest expense + Income after tax) / Total
interest expense
• Debt Service Coverage Ratio =
(Profit after tax + Depreciation + other non-cash charges
+ Interest on term loans) / (Interest on term loans +
Repayment of term loan)
 Estimating Cash Flows
• One of the most important aspects of capital budgeting is
turning the economics and technicalities of a project into
estimated cash flows. The final cash projections obtained
are only as good as the business logic and accuracy of
the underpinning assumptions and estimates.
• For each investment proposal, we need to provide data
on expected future cash flows on an after-tax basis
backed by detailed economic, competitive and technical
reviews.
• The calculations should be based on an incremental
basis, so that we analyze only the difference between
the cash flows of the firm with and without the project.
 Depreciation
• The Income Tax Act specifies that the written
down value (WDV) method should be used for
tax purposes. It further specifies the rate of
depreciation applicable to different kinds of
assets.
• For company law (financial reporting) purposes,
the method of depreciation may be either WDV
or the straight line (SL) method.
 Depreciation Rates
In percentage terms

Single Shift Double Shift Triple Shift

WDV SL WDV SL WDV SL

Buildings (other than factory 5.00 1.63

buildings)

Factory buildings 10.00 3.34

Plant and machinery (general 15.00 5.15 22.50 8.09 30.00 11.31
rate)