Project Assessment

Essentials of Corporate Finance Chapters 4, 8, 9, 12

Materials Created by Glenn Snyder San Francisco State University

Topics

Internal Financial Analysts

The Importance of Internal Analysts

Criteria and Project Types Projections Cost of Capital IRR vs. NPV Scenario Analysis Business Impact Decision Making

Investment Pool Funding

Career Advice for an Internal Financial Analyst

Materials Created by Glenn Snyder San Francisco State University
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Internal Financial Analysts

An Internal Financial Analyst is a member of the Finance organization that works to analyze, consult, project, and generate ideas to make the company more financially sound. Internal Financial Analysts usually work in groups called:

Financial Planning & Analysis Corporate Planning & Development Finance Business Partners

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Materials Created by Glenn Snyder San Francisco State University

The Importance of Internal Financial Analysts

Internal Financial Analysts do:

Budgeting and Variance Analysis Strategic Planning for internal business units Internal Financial Reporting Profitability Analysis Growth and Trend Analysis Liaising between Finance and other business units Strategic Project Analysis

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Investment Pool Funding

Investment Pools are funds the company sets aside at the beginning of the fiscal year for strategic projects Senior Finance and business leaders make up the Investment Pool Committee and decide which projects the company is willing to take on, and which ones will be put on hold. Internal Financial Analysts typically Organize and summarize all of the requests Provide insight to the Investment Pool Committee Assist business units in constructing their proposals Track and report on expenses and revenues after the projects are approved
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Investment Pool Funding

When a project is submitted to the Investment Pool, it would include:

Description of the project Description of the need Cost projections for the project Additional non-direct project costs / resources Benefits to the organization IRR / NPV Analysis Scenario Analysis Time schedule of milestones and estimated completion

February 26, 2007

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Criteria and Project Types

To apply for Investment Pool Funding, the project has to cost more than the minimum threshold, e.g. $500,000. Strategic Projects include:

System Upgrades and Purchases Small Acquisitions Strategic Initiatives

Companies can easily have over 300 Investment Pool projects going at one time

Many more projects can be submitted and not approved

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Projections

Cost and Benefit Projections

Cost Projections would include:

Direct Costs Actual costs to do the project Indirect Costs Support costs from other areas of the company (e.g. HR, Finance, IT, etc.) Impact to net revenue Impact to sales Impact to market share and/or competitors Efficiency gains and how they equate to the bottom line Impact to the organization beyond the projects life
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Benefit Projections would include:

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Cost of Capital

Most companies dont calculate (or even know) their cost of capital

Typically, the company uses a standard or average rate, such as 12% for the cost of capital

Why dont companies use their actual cost of capital?

The rate could change every month It would require resources to constantly update the cost of capital It would add confusion to the business units that submit multiple projects using similar templates/forms.
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IRR vs. NPV

Most companies prefer to see some kind of ROI (return on investment) calculation

Since ROI is stated as a rate (Return on investment), IRR is the calculation used the most Many companies use both IRR and NPV, as NPV is much easier to understand

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IRR vs. NPV

Problems with IRR and NPV

Many times, a business unit is not aware of all of the costs (indirect in particular) that go into a project

Thus, the IRR is badly overstated (e.g. 600% returns)

Corporations try to simplify the process to get information that is directionally correct

80 / 20 rule 80% of the answer for 20% of the effort

When the business unit that wants the project approved submits the projections and analysis, the data is often much to favorable for the project
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Scenario Analysis

Each project should be presented in three scenarios:

Best Case What would happen if everything went perfectly Worst Case What would happen if little went right Most Likely Case The case that the business truly thinks will happen Sometimes, the best case scenario, may be the worst for cash flow.

Projects that drastically increase sales, may constrain cash flow and require financing, which is an additional cost.
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Business Impact

Many projects get approved not on their financial contribution, but their impact to the business.

Upgrade from Windows 2000 to Windows XP

This upgrade could cost a company millions, but will not enhance revenue or sales
These enhancements may be in new systems or personnel They may not generate revenue, but keep existing clients from leaving

Enhancements to a customer service call center

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Decision Making

The Investment Pool Committee must decide which projects will have the greatest impact on the organization.

Financial Impact

Increase Revenue Reduction of Expenses Greater production from existing resources

Positive public awareness
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Efficiency Impact

Market Impact

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Decision Making

The senior management team that makes up the Investment Pool Committee is often rated based on the impact of the projects they approve

Incentive to pick the best projects for the organization

Strong projects can add to a senior managers bonus and rating at year-end

Senior managers must be careful not to play favorites with projects submitted from their divisions

Many cases there are conflicts of interest, which is why the decisions are made by a committee and not an individual

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Career Advice for an Internal Financial Analyst

Skills required to be a successful internal financial analyst Adaptability Be willing and able to adapt to an ever-changing environment Intelligence The faster you can learn, the more value you can add to the company Creativity The ability to be able to develop new ideas and solutions Career Path for an Internal Financial Analyst Just about anything

Internal Financial Analysts are exposed to many areas of the company and build skills that apply just about everywhere

Many companies offer management training programs

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