Chapter -5

Financial Analysis
5.1.Objectives of Financial Analysis

I. Assessment of financial impact

• To assess the financial effects the project will have on

participants (farmer, firms, government, etc).

• This assessment is based on the comparison of each

participant’s current and future financial status with the
project.
II. Judgment of efficient resource Use
For management especially, overall return is important because managers
must work within the market price framework they face.
Investment analysis & financial ratio analysis provide the tool for this review.

III. Assessment of Incentives

The financial analysis is of critical importance in assessing the incentives for
different participants of the project.
Will participants have an incremental income large enough to compensate
them for the additional effort and risk they will incur?
IV. Provision of sound financial plan
The financial plan provides a basis for determining

the amount and timing of investment,

 debt repayment capacity,

and also helps to coordinate financial contributions.

 5.2.Market Analysis

• Market analysis is a process of assessing the level of demand for

the product or service to be produced by the project.

• A market is any place where the sellers can meet with the buyers
where there is a potential for a transaction to take place.

• Marketing is a business activity of presenting products or

services to potential customers in such a way as to make them
eager to buy.
 The ways to conduct market analysis

A. Situational analysis and specification of objectives

An informal survey of what information is available in the area.

 In order to get a feel for the relationship between the product and

its market.
The project analyst may talk to consumers, competitors, middlemen,

and other in the industry.

It is conduct by:
Who are the buyers of this product? (Consumers)?

What is the total current demand for the product?

 What price will the consumers be willing to pay for the product?

What channels of distributions are most suited for the product?

B. Collection of secondary information
Secondary information is information that has been gathered in some other
context and is already available.

SECONDARY SOURCES OF DATA

1. Ethiopian Economic Survey
2. Census of Ethiopia
3. Reports of Export Working Groups on Various Industries
4. Census of Manufacturing Industries
5. Monthly Statistical Bulletin
6. Annual Report of NBE
7. Annual Survey of industries
Generally, the information sought in market survey may relate to one
or more of the following.
 Total demand and rate of growth of demand
 Demand in different segments of the market
 Income and price elasticity’s of demand
 Motives for buying
 Purchasing plans and interventions
 Satisfaction with existing products
 Attitudes towards various products
 Socio economic characterization of buyers
 5.3. Pricing Project Costs and Benefits
Once costs and benefits have been identified, if they are to be
compared, they must be valued.
The only practical way to compare differing goods and
services directly is to give each a money value.
Therefore, we must find the proper prices for the costs and
benefits in our analysis.
 5.3.1. Finding Market Prices
Project analysis characteristically are built:-
first by identifying the technical inputs and
output for a proposed investment,
then by valuing the inputs and outputs at market prices to construct the
financial accounts.
Thus, the first step in valuing costs and benefits is finding the market prices
for the inputs and outputs.
To do so, the project will have to consult many sources such as merchants,
consumers, experts, published statistical bulletins, etc
 Point of first sale and farm gate price
In project analysis, a good rule for determining a market price for agricultural
commodities produced in the project is to seek the price at the “point of first
sale.
If the product is sold only in central markets, no local market, then the analyst
must find out the value of marketing service to arrive at price at project site.

However, prices for most of agricultural products are subject to seasonal

fluctuations

In this case, a decision must be made about the price in the seasonal cycle at
which to choose the price to be used for the analysis.
A good starting point is the farm-gate price at the peak of the harvest season.

This is probably close to the lowest price in the cycle.

The reason is that the rise in price is due to marketing services .

 Predicting Future Prices

• Is predictoing what the future prices of inputs and outputs may be.
 The best starting point is to see the trend of these prices over the past few
years.
 Having this data, the project analyst can forecast the price with certain
degree of precision.
 5.3.2.Change in prices
Change in prices could be :-

change in relative prices of goods or

general change in price

Change in Relative prices of goods

This is when relative price of inputs or outputs are variable over time,

i.e., PX0/PY0 ≠ PX1/PY1 ≠ PX2/PY2 --------- ≠ PXt/PYt

These changes in relative price of items imply a change in marginal productivity

of inputs in production or a change in marginal satisfaction (MU) in consumption.
Thus, changes in relative prices must be reflected in project accounts in the
years when such changes are expected.

This can be judged from past trends

For example, the price of agricultural products to price of inputs may rise
over time.

This would have a real effect on the net benefit of the firm.
 General change in price (Inflation)
Inflation is common for every country although the magnitude may vary
between countries.

However, the approach most often taken is to work the project analysis in
constant price.

It is assumed that inflation will affect most prices to the same extent so that
prices retain their same general relations.

The analyst then need only adjust future price estimates for anticipated
relative changes, not for any change in the general
price level.
 5.3.3. Financial export and import parity price
The project may use imported inputs and export its output to foreign
markets.
If there are domestic markets for these inputs and outputs, and if the firm is
free to sell or buy at the domestic or world market, we take the domestic
price with appropriate adjustment to reflect the price at the projectsite.
If commodities of the project are produced only for foreign market or if the
domestic demand cannot absorb the firm’s output, we will take export-parity
and import parity prices ever in financial analysis.
• Parity prices are used to compare prices of a commodity in two different
locations, when the two locations are in different countries.
 Export or import parity prices are the estimated prices at the farm gate or
project boundary, which are derived by adjusting the c.i.f. (cost, insurance,
and freight) or f.o.b (Free on Board).
Cost, insurance, and freight (CIF) is an international shipping
agreement, which represents the charges paid by a seller to cover the costs,
insurance, freight.
Suppose a project exports coffee to Canada, we start with c.i.f. price at
Canada port.

Export Parity Price

C.i.f. at point of import (say, Canada port)
Deduct- unloading at point of import
Deduct- freight to point of import (in this case air freight)
Deduct – insurance
 Equals – f.o.b. at point of export (A.A)
Convert foreign currency to domestic currency at official exchange rate (OER)

Deduct –tariff (export duties)

Add - subsidy

Deduct - local port charges

Deduct - local transport & marketing (if not part of project)

Equals export parity price as project boundary

Deduct - local storage, transport & marketing costs (if not part of project
cost)

Equal export parity price at project location (farm gate)

• Similarly if a project uses an imported input or the project’s output is intended
to substitute imports, we can derive the import parity price as follows:-

Import Parity Price

 F.o.b. price at point of export

 Add-freight charges to point of import
 Add-insurance charges
 Add- unloading from ship to pier at port

 Equals – C.i.f. Price at the port of importing countries

 Convert foreign currency to domestic one (multiply by OER)

  Add-tariffs (import duties)
 Deduct-subsidies
 Add-local port charges
 Add-transport & marketing costs to relevant wholesale market

 Equals price at wholesale market

 Deduct-local storage & other marketing costs (if not part of project
cost)

 Equals import parity price at project location (Farm/project gate price)

Exercise 1: An agricultural project in Ethiopia is engaged in producing flower
for export to New York, USA. The project is located at Debrezeit and the
boundary is at Addis Ababa.
Given the following information, calculate the financial export parity price.
C.i.f at New York US$639.33
Insurance, freight and unloading charges US$39.33
Export duties or tariff Birr 100
 Local transport and marketing Birr 200
Local storage, transport, and marketing costs Birr 150
Official Exchange Rate (OER) 1$=Birr 125
 Solution
C.I.F at point of import US$639.33
Deduct- Insurance, freight and unloading US$39.33
Equals-f.o.b. at point of export US$600
Convert foreign currency to domestic currency 125*600= 75,000 birr

Deduct-tariff 75,000-100= 74,900 birr

Deduct-local transport & marketing 74,900-200= 74,700 birr
Equals export parity price at project boundary 74,700 birr

Deduct-local storage, transport & marketing 74,700-150= 74,550 birr

costs
farm gate price 74,550 birr
Exercise 2: If Ethiopia wants to import fertilizer from Canada. Given the
following information, calculate the financial import parity price.
F.o.b. at point of export $72
Freight charge, insurance and unloading $5
Tariff 1000 birr
Subsidy 2000 birr
local transport 1000 birr
local storage, transport. 1500 birr
• Solution
F.o.b. at point of export $72
Freight charge, insurance and unloading $5
Equals C.I.F price at the port of importing country $77
Convert foreign currency to domestic currency 9625 birr
Add- tariff 1000 birr

Deduct subsidy 2000 birr

Add local transport 1000 birr
Add local storage and transport 1500 birr
Farm gate price 11,125 birr
 5.4. Farm Investment Analysis
• Farm investment analysis is undertaken to determine the attractiveness a
proposed investment to framers and to other participants, including the
society as a whole.

• The analysis is projected over the useful life of the investment.

• The initial investment is shown at the beginning of the projection, and a

residual valve at the end.
 In general, the analysis is cast in constant prices, although allowances
may have to be made for inflation.
Farm investment analysis can be prepared for farms of any size.

• Large commercial farms & plantation how ever are more like other
business enterprises than they are like small, family – operated farms.

• In considering small farms, the analysis will be particularly concerned with

the effect of the project on the total income of the farm family.

• The basic difference between small farm family and the business firm is on
their fundamental objective.

•
• The effectiveness of the proposed new technology on small farms must be realistically
assessed, and the technological assumptions must be checked to ensure that they reflect
on-farm conditions and not those of an experiment station.

• The analyst must form a judgment about how rapidly farmers will be willing to adopt new
practices.

• The analyst must test the effect of risk on family income by undertaking sensitivity
analysis.

• He must ask such questions as what will happen to their income, if price fall below
expectation.

• If the expected output is not realized, if input requirement, if farmers face bad weather
condition etc.
Principal elements of farm investment analysis farm resource use.

Land use – allocation of each piece of land (cultivated area and crop type pasture,
forest houseplant, etc.).

• Land use calendar when will the piece of land be used for what purpose?

Labor use

 Annual labor requirement by crop operation for 1 ha

 Labor distribution by crop & month per hectare

 Labor requirement by crop & month

 Hired labor by crop and month

 Off-farm labor