FINANCIAL ANALYSIS

MEANING
It is the process of obtaining relevant information

about a project in order to ascertain its financial availability. Comparing the costs and benefits over time to determine whether a project is profitable or not

STEPS INVOLVED IN
Estimation of total capital outlay involved in the

project Estimation of operating costs Estimation of operating revenues(sales)

TECHNIQUES OF FINANCIAL ANALYSIS

Fund flow analysis

Cash flow analysis

Ratio analysis Break-even analysis

Sensitivity analysis
Risk analysis

Fund flow analysis

Fund flow statement is prepared to show the

movement of funds between two periods. it shows the change in assets,liabilities, and networth between two balance sheet dates The term fund means working capital.Flow of fund means the changes in working capital. i.e, increase or decrease in working capital

Cash flow analysis

Cash flow statement is prepared to ensure that the

business unit will have necessary cash with it and it will not face liquidity problem. It shows the movements of cash into and out of the firm and its net effect on the cash balance with the firm.It shows sources of cash and their uses. It is useful to; determine the amount of cash needed to start enterprise Plan for timing of loan funds ensure that if projected cash flows are met, cash will be available to meet payments as they become due

Ratio analysis
Ratio analysis helps to compare current

performance with the past and also in measuring effectiveness and efficiency of the organization in the light of norms of performances. They help the management in the discharge of its key functions such as forecasting, planning, coordinating, controlling and communicating

Break-even analysis
It is the point at which project incur no profit or no

loss. A company's breakeven point is the point at which its sales exactly cover its expenses. The company sells enough units of its product to cover its expenses without making a profit or taking a loss. If it sells more, then it makes a profit. On the other hand, if it sells less, it takes a loss

 In order to calculate your company's breakeven

point, use the following formula: Fixed Costs/Price - Variable Costs = Breakeven Point in Units

Advantages of BEP
It helps to take investment decision.

It is a tool of product pricing

It is useful in forecasting sales and profit It brings out the effect of increase or decrease in

fixed and variable costs on profit It helps to determine the selling price which gives a desired profit It is used in profit planning It helps to find out the volume of sales which gives a desired return on capital empolyed

Disadvantages of BEP
It is very difficult to separate costs into fixed and

variable It assumes fixed costs remain fixed for any level of production.But actually it will remai fixed only up to a certain level of activity. IT assumes that variable costs vary in direct proportion to volume of production.But the variable cost need not necessarily vary in direc proportion of output Break eve point completely ignores the capital employed in project IT has limited application in the long range planning

Sensitivity analysis
It helps in studying the impact of crucial variables like

raw material, sales volume,sales price,degree of capacity utilization etc over the economic viability of an enterprise Change is affected in one variable and the values of other variables are assumed constant and the results are analysed to find out sensitivity of various variables with respect to their impact on profit margin. It is useful to identifying critical variables which may have considerable influence on the financial returns of a project. It is also called as what if analysis

Risk analysis
It helps in identifying the sources of risks such as

rise in prices of raw material,taxes and duties,product price etc. which have great bearing in determining the future returns for the project. risk analysis offers an opportunity to the investor to redesign his proposed project.

Net Present Value Method(NPV)

Net present value (NPV) provides a means to

compare these by adjusting the value to todays value. This is achieved by modifying the future value by a factor that represents the change in value of money from todays value. This factor is called the discount factor. It is calculated as: 1 (discount rate / 100)

ADVANTANGES
It takes into account the time value of money

It considers the cash flow stream over the entire life

of project It focuses attention on the objective of maximisation of the wealth of the firm This method is most suitable when cash inflows are uniform

Disadvantages
The method may not provide satisfactory results in

case of two projects having different useful lives This method is not suitable in case of projects involving different amounts of investment. It involves complicated calculations

Internal Rate of Return

Is defined as the discount rate at which an investment

has a zero net present value.

The internal rate of return equates to the interest rate,

expressed as a percentage, that would yield the same return if the funds had been invested over the same period of time.

Therefore, if the internal rate of return for the project is

less than the current bank interest rate it would be more profitable to put the money in the bank than execute the project

Advantages
This method considers all the cash flows over the

entire life of the project It takes into account the time value of money Cost of capital need not be calculated Project having different degrees of risk can be easily compared

Disadvantages
The IRR method is difficult to understand and use

in practice because it involves tedious and complicated calculation Sometimes it may yield negative rate or multiple rate which is rather confusing

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