Financial Analysis for Commercial Projects

Financial Analysis For Commercial Projects

All projects require some form of financial analysis because they involve the expenditure of money, which must be both planned and justified. The main purposes of the financial analysis of projects are

• To provide an adequate financing plan for the proposed investment

• To determine the profitability of a project from the point of view of the owners or the project beneficiaries

• To assist in planning the operation and control of the project, by providing management information to both internal and external users.

In the financial analysis of projects the two most important concepts are those of liquidity and profitability. Financial analysis statements also provide performance indicators on a number of other issues for management information.

The concept of liquidity is concerned with the availability of funds for the continued implementation and operation of the project. The liquidity status of a project is determined primarily from the cash flow. This statement is also described by some people as the sources and applications of funds statement or as the funds flow statement. Liquidity is an important issue for all projects.

The concept of profitability is concerned with the question of whether the project is worthwhile from the point of view of the investor. Accountants’ measures of profitability are determined primarily from the profit and loss account, which is also known as the income statement, particularly in U.S. practice. Discounted measures of the value of a project to the owners can be derived from the cash flow. Measures of profitability to the project owners are only relevant to those projects with an output that is sold commercially.

Performance indicators of the financial status of an enterprise are derived from both the profit and loss account and the balance sheet, which together with the cash flow make up the three main statements for financial analysis. However, these statements cannot be derived without the supporting statements described in the next section.

Many different layouts and approaches for the various statements can be found in the literature. To make matters worse, the terminology used by economists when writing about financial analysis may not be very precise from the point of view of accountants. This is due in part to differences in perspectives and objectives. Figure 5.1 shows. Some of the connections between the various schedules included in a financial analysis and the annual statement of costs and benefits the construction of the balance sheet is shown separately in Figure 5.2. The numerical example of the cotton textile project used in Chapter 4 is extended in this chapter to cover the main financial statements through Tables 5.1 to 5.5.

Supporting Statements

The five main supporting statements required for the financial analysis of a project are

• Fixed assets schedule

• Depreciation schedule

• trading account

• Working capital schedule (current assets and current liabilities)

• Loan payment schedules

The Fixed Assets Schedule (Investment Cost Schedule)

This schedule includes details of investment costs (fixed assets), the timing of investments and replacements, and the terminal (salvage) value at the end of the project life. These details were provided in Table 4.1 in Chapter 4•

The Depreciation Schedule

Depreciation is a means of charging the cost of an asset against profit over a number of years. The term depreciation is used both to refer to the physical deterioration of assets over time and to refer to a charge used in the calculation of tax liability.

The former use of the term relates to the measure of depreciation that might be made by a company for internal accounting purposes to determine

The level of funds needed to be set aside for financing the replacement of worn-out assets. This measure might be the same as the measure used for the calculation 6f tax if the rate for tax purposes were closely related to the expected life of the asset. However, if depreciation rates for tax purposes are affected by tax incentive considerations, the two measures may be different. When conducting the financial analysis of