Page 1 of 5

FINANCIAL ANALYSIS
Financial analysis is defined as the process of discovering economic facts about an enterprise or
a project on the basis of an interpretation of financial data. It seeks to look at the capital cost,
operations cost and operating revenue. It is concerned with the development of the financial
profile of the project.

We may identify following features and characteristics:

i. The purpose of financial analysis is to find out:

 Whether the project is attractive enough to secure funds and
 Whether it has ability to generate enough economic values

in order to achieve its goals and objectives for which it is sought to be implemented.

ii. This way it obtains a clear-cut understanding about the project from the financial point
of view.
iii. It provides an insight into two important areas of management— return on investment
and soundness of the company's financial position.
iv. It can be utilized for a comparative appraisal of the projects.
v. A financial analysis reveals where the company stands with respect to profitability,
liquidity, leverage and an efficient use of its assets.
vi. Financial reports are the key through which an effective control of a business enterprise
is exercised.
vii. In recent years, the ownership of capital of most public companies has become broad-
based. A number of parties and bodies, including creditors, potential suppliers,
debenture-holders, credit institutions like banks, industrial finance corporations,
potential investors, employees, trade unions, important customers, economists,
investment analysts, taxation authorities and government have a stake in the financial
results of a company.
viii. It concludes about the financial health, profitability and efficiency of an enterprise and
also to compare an enterprise with other similar undertakings.

Following are the factors on which we need to gather financial estimates and projections. Such
data/information are then summarized and analyzed for being presented to competent authorities.

i. Cost of Project
ii. Means of Finance
iii. Estimates of Sales and Production
iv. Cost of Production
v. Working Capital Requirement and its Financing
vi. Estimates of Working Results (Profitability Projections)
vii. Break-Even Point
 Page 2 of 5

viii. Projected Cash Flow Statements

ix. Projected Balance Sheets

1. Cost of Project

Conceptually, the cost of project represents the total of all items of outlay associated with a
project which are supported by long-term funds. It is the sum of outlays on the following:

 Land and Site Development

 Building and Civil Works

 Plant and Machinery

The cost of plant and machinery is based on the latest available quotation
adjusted for possible escalation.

 Technical Know-How and Engineering Fees

Given the complexities of the undertaken project, management/promoter may
require to engage consultants or may enter into collaboration to get help in
various technical matters like preparation of Feasibility Studies, Detailed project
Report, choice of technology, technical know-how selection of plant and
machinery, detailed engineering services and so on. The amount payable to them
for setting up of project is component of project cost whereas the royalties
payable shall be treated as an operating cost.
 Expenses on foreign technician and training of Indian technicians abroad

 Miscellaneous fixed assets

Fixed assets and machinery which are not part of the direct manufacturing process
may be referred to as miscellaneous fixed assets. Expenses incurred for
procurement or use of patents, licenses, trademarks, copyrights etc are included
here.
 Preliminary and capital issue expenses
Expenses incurred for identifying the project, conducting the market survey,
preparing the feasibility report, drafting the memorandom and articles of
association and incorporating the company are referred to as preliminary
expenses.
Expenses borne in connection with the raising of capital from the publicare
referred to as capital issue expenses. The major components of capital issue
 Page 3 of 5

expenses are: under writing commission, brokerage, advertrising and publicity

expenses, listing fees and stamp duty.
 Pre-operative expenses
Expenses of the following types incurred till the commencement of
commercial production are referred to as pre-operative expenses: establishment
expenses, rent, rates and taxes, travelling expenses, interest and commitment
charges on borrowings, insurance charges, mortgage expenses, interest on
deferred payments, start-up expenses and miscellaneous expenses.
 Provision for contingencies
A provision for contingencies to provide for certain unseen expenses and price
increase over and above the normal inflation rate which is already incorporated in
cost estimates.
 Margin money for working capital
The principal support for working capital is provided by commercial banks and
trade creditors. However, a certain part of working capital requirement has to
come from long-term sources of finance, referred to as margin money.
 Initial cash losses
Failure to make provision for initial cash losses in the project cost generally
affects the liquidity position and impairs the operations.

2. Means of Finance
To meet the cost of project, the following means of finance are available:
 Share Capital
 Equity Capital
 Preference Capital
 Term Loans (Secured Borrowings)
 Rupee Term Loans
 Foreign Currency Term Loans
 Debenture Capital
Debentures are instruments for raising debt capital.
 Non-convertible Debentures
 Convertible Debentures
 Deferred Credits
 Incentive Sources
 Seed Capital Assistance
 Capital Subsidy
 Tax Deferment or Exmptions
 Miscellaneous Sources.
 Unsecured Loans
 Public Deposits
 Leasing and Hire Purchase Finance
 Page 4 of 5

3. Estimates of Sales and Production

Sales and production are closely inter-related. They may be estimated together. While estimating
sales revenue projections, we need to be observant that:
 Hundred percent or high capacity utilization in the beginning is very difficult due to
certain constraints. However with the passage of time capacity utilization can be
gradually augmented with the passage of time.
 It may be assumed that production would be equal to sales.
 Selling price used should be the present selling price.
Format: Form XII A may be used to estimate sales revenue.
4. Cost of Production
The major components of production cost are:
 Material Cost
It comprises of the cost of raw materials, components and parts, and consumables
required for production.
 Utility Cost
The cost of utilities is the sum of the cost of power, water, and fuel.
 Labour Cost
The labour cost includes the cost of all manpower employed in the factory.
 Factory Overhead Cost
The expenses on repairs and maintenance, rent, taxes and insurance on factory
assets, and son are collectively referred to as factory overheads.

5. Working Capital Requirement and its Financing

We seek projected information on these factors:
Raw Materials and Components, Work-in-process, Stock of Finished Goods, Debtors and
Operating Expenses.
Sources of Finance:
Working Capital Advances provided by Commercial Banks, Trade Credit
Accruals and Provisions, and Long term sources of financing.
Format: Form IX B may be used to estimate the working capital requirement, the
amount of bank finance available and the margin money for working
capital to be provided from long term sources.
6. Profitability Projections (Estimates of Working Results): (Multi-Year Projections)

Typically, the starting point for profitability projections is the forecast for sales revenues. In
estimating sales it is reasonable to assume that capacity utilization would be somewhat low in the
first year and rise thereafter gradually to reach the maximum level in the third or fourth year of
operation.
 Page 5 of 5

Given the estimates of sales revenues and cost of production, next step is to prepare the
profitability projections or estimates of working results. This projection statement should be
prepared for a number of successive years.

Format: Form XII may be used to prepare the estimate profitability

estimates of working results.
7. Break-Even Point
The profitability projections or estimates of working results are based on the assumption that the
project would operate at a given levels of capacity utilization in future. The break-even analysis
helps in knowing:

 What the projected profits would be at certain levels of capacity utilization and
 What the level of operation should be to avoid losses.
 As a first step in computing the break-even point, the costs are divided into two broad
categories, fixed costs and variable costs.

8. Projected Cash Flow Statements (Multi-Year Projections)

The cash flow statement shows the movement of cash into and out of the firm and its net impact
on the cash balance with the firm. This projection statement should be prepared for a number of
successive years.

9. Projected Balance Sheets (Multi-Year Projections)

The balance sheets, showing the balances in various assets (how funds have been used in the
business) and liability (source of finance employed by the business) accounts, reflecrts the
financial condition of the firm at a given point of time. This projection statement should be
prepared for a number of successive years.