MODULE I

1.1. INTRODUCTION

More specifically, what is a project? Its a temporary group activity designed to produce a unique product, service or result. A project istemporaryin that it has a defined beginning and end in time, and therefore defined scope and resources.

And a project isuniquein that it is not a routine operation, but a specific set of operations designed to accomplish a singular goal. So a project team often includes people who dont usually work together sometimes from different organizations and across multiple geographies.

The development of software for an improved business process, the construction of a building or bridge, the relief effort after a natural disaster, the expansion of sales into a new geographic market all are projects.

Someother examples of a projectare:

Developing a new product or service

Constructing a building or facility

Renovating the kitchen

Designing a new transportation vehicle

Acquiring a new or modified data system

Organizing a meeting

Implementing a new business process

And all must be expertly managed to deliver the on-time, on-budget results, learning and integration that organizations need.

Project management, then, is the application of knowledge, skills and techniques to execute projects effectively and efficiently. Its a strategic competency for organizations, enabling them to tie project results to business goals and thus, better compete in their markets.

Project managementprocessesfall into five groups:

Initiating

Planning

Executing

Monitoring and Controlling

Closing

1.2. CAPITAL EXPENDITURE (CAPITAL INVESTMENT)

The basic characteristic of a capital expenditure (also referred to as a capital investment or capital project or just project) is that it typically involves a current outlay (or current and future outlays) of funds in the expectation of a stream of benefits extending far into the future.

A capital expenditure, from the accounting point of view, is an expenditure which is shown as an asset in the balance sheet. This asset, except in the case of a nondepreciable asset like land, is depreciated over its life. In accounting, the classification of an expenditure as a capital expenditure or a revenue expenditure is governed by certain conventions, by some provisions of law and by the managements desire to enhance or depress reported profits. Often, outlays on research and development, major advertising campaigns, and reconditioning of plant and machinery may be treated as revenue expenditures for accounting purposes, even though they are expected to generate a stream of benefits in the future and, therefore, qualify for being capital expenditures.

1.2.1. CAPITAL INVESTMENTS: IMPORTANCE AND DIFFICULTIES

Importance Capital expenditure decisions often represent the most important decisions taken by a firm. Their importance stems from three inter-related reasons:

Long-Term Effects The consequences of capital expenditure decisions extend far into the future. The scope of current manufacturing activities of a firm is governed largely by capital expenditures made in the past. Likewise, current capital expenditure decisions provide the framework for future activities. Capital investment decisions have an enormous bearing on the basic character of a firm.

Irreversibility The market for used capital equipment in general is ill-organised. Further, for some types of capital equipment, custom- made to meet specific requirements, the market may virtually be non-existent. Once such an equipment is acquired, reversal of decision may mean scrapping the capital equipment. Thus, a wrong capital investment decision often cannot be reversed without incurring a loss.

Substantial Outlays Capital expenditures usually involve substantial outlays. An integrated steel plant, for example, involves an outlay of several thousand crore rupees. Capital costs tend to increase with advanced technology.

Difficulties While capital expenditure decisions are extremely important, they also pose difficulties which stem from three principal sources:

Measurement Problems Identifying and measuring the costs and benefits of a capital expenditure proposal tend to be difficult. This is more so when a capital expenditure has a bearing on some other activities of the firm (like cutting into the sales of some existing product) or has some intangible consequences (like improving the morale of workers).

Uncertainty A capital expenditure decision involves costs and benefits that extend far into the future. It is impossible to predict exactly what will happen in the future. Hence, there is usually a great deal of uncertainty characterising the costs and benefits of a capital expenditure decision.

Temporal Spread The costs and benefits associated with a capital expenditure decision are often spread out over a long period of time, usually 10-20 years for industrial projects and 20-50 years for infrastructural projects. Such a temporal spread creates some problems in estimating discount rates and establishing equivalences.

1.2.2. TYPES OF CAPITAL INVESTMENTS

Capital investments may be classified in different ways. At the simplest level, capital investments may be classified as physical, monetary, or intangible.

i. Physical assets are tangible investments like land, building, plant, machinery, vehicles, and computers.

ii. Monetary assets are financial claims against some parties. Deposits, bonds, and equity shares are examples of monetary assets.

iii. Intangible assets are not in the form of physical assets or financial claims. They represent outlays on research and development, training, market development, franchises, and so on that are expected to generate benefits over a period of time.

Capital investments may also be classified as strategic investments and tactical investments.

iv. A strategic investment is one that has a significant impact on the direction of the firm. Tata Motors decision to invest in a passenger car project may be regarded as a strategic investment.

v. A tactical investment is meant to implement a current strategy as efficiently or as profitably as possible. An investment by Tata Motors to replace an old machine to improve productivity represents a tactical investment.

Capital investments are often classified by companies in different categories for planning and control. While the system of classification may vary from one firm to another, the following categories are found in most classifications: mandatory investments, replacement investments, expansion investments, diversification investments, R&D investments, and miscellaneous investments.

vi. A mandatory investment is a capital expenditure required to comply with statutory requirements. Examples of such investments are a pollution control equipment, a fire fighting equipment, a medical dispensary, and a creche in the factory.

vii. A replacement investment is meant to replace worn out equipment with new equipment to reduce operating costs, increase the yield, and improve quality.

viii. An expansion investment is meant to increase the capacity to cater to a growing demand.

ix. A diversification investment is aimed at producing new products or services or entering into new geographical areas.

x. R&D investments are meant to develop new products and processes which would sharpen the technological edge of the firm.

xi. Finally, miscellaneous investments represent a catch-all category that includes items like interior decoration, recreational facilities, and landscaped gardens.

1.3. PHASES OF CAPITAL BUDGETING

Capital budgeting is a complex process which may be divided into six broad phases: planning, analysis, selection, financing, implementation, and review. Exhibit 1.1 portrays the relationship among these phases. The solid arrows reflect the main sequence: planning precedes analysis; analysis precedes selection; and so on. The dashed arrows indicate that the phases of capital budgeting are not related in a simple, sequential manner. Instead, there are several feedback loops reflecting the iterative nature of the process.

Planning

The planning phase of a firms capital budgeting process is concerned with the articulation of its broad investment strategy and the generation and preliminary screening of project proposals. The investment strategy of the firm delineates the broad areas or types of investments the firm plans to undertake. This provides the framework which shapes, guides, and circumscribes the identification of individual project opportunities.

Once a project proposal is identified, it needs to be examined. To begin with, a preliminary project analysis is done. A prelude to the full blown feasibility study, this exercise is meant to assess (i) whether the project is prima facie worthwhile to justify a feasibility study and (ii) what aspects of the project are critical to its viability and hence warrant an in-depth investigation.

Analysis

If the preliminary screening suggests that the project is prima facie worthwhile, a detailed analysis of the marketing, technical, financial, economic, and ecological aspects is undertaken. The questions and issues raised in such a detailed analysis are described in the following section. The focus of this phase of capital budgeting is on gathering, preparing, and summarising relevant information about various project proposals which are being considered for inclusion in the capital budget. Based on the information developed in this analysis, the stream of costs and benefits associated with the project can be defined.

Selection

Selection follows, and often overlaps, analysis. It addresses the questionIs the project worthwhile? A wide range of appraisal criteria have been suggested to judge the worthwhileness of a project. They are divided into two broad categories, viz., non-discounting criteria and discounting criteria. The principal non-discounting criteria are the payback period and the accounting rate of return. The key discounting criteria are the net present value, the internal rate of return, and the benefit cost ratio. The selection rules associated with these criteria are as follows:

To apply the various appraisal criteria, suitable cut-off values (hurdle rate, target rate, and cost of capital) have to be specified. These are essentially a function of the mix of financing and the level of project risk. While the former can be defined with relative ease, the latter truly tests the ability of the project evaluator. Indeed, despite a wide range of tools and techniques for risk analysis (sensitivity analysis, scenario analysis, simulation analysis, decision tree analysis, portfolio theory, capital asset pricing model, and so on), risk analysis remains the most intractable part of the project evaluation exercise.

Criterion

Accept

Reject

Payback period (PBP)

PBP < target period

PBP > target period

Accounting rate of return (ARR)

ARR > target rate

ARR< target rate

Net present value (NPV)

NPV> 0

NPV< 0

Internal rate of return (IRR)

IRR> cost of capital

IRR< cost of capital

Benefit cost ratio (BCR)

BCR> 1

BCR< 1

Financing

Once a project is selected, suitable financing arrangements have to be made. The two broad sources of finance for a project are equity and debt. Equity (referred to as shareholders funds on balance sheets in India) consists of paid-up capital, share premium, and retained earnings. Debt (referred to as loan funds on balance sheets in India) consists of term loans, debentures, working capital advances and so on.

Flexibility, risk, income, control, and taxes (referred to by the acronym FRICT) are the key business considerations that influence the capital structure (debt-equity ratio) decision and the choice of specific instruments of financing.

Implementation

The implementation phase for business project that involves setting up of industrial facilities that consists of several stages such as

1. Project and engineering designs2. Negotiations and contracting3. Construction4. Training, and5. Plant commissioning

Translating an investment suggestion into a material is a complex, time- consuming, and risk burdened task. Delays in implementation that are common, can lead to considerable cost overruns. For speedy implementation at a rational cost, the below are helpful.

i) Adequate Formulation of Projects: A major reason for the delay is inadequate formulation of projects. Put differently, if the necessary homework in terms of preliminary studies and comprehensive and detailed formulation of the project is not done, many surprises and shocks are likely to spring on the way. Hence, the need for adequate formulation of the project cannot be over-emphasised.

ii) Use of the Principle of Responsibility Accounting: Assigning specific responsibilities to project managers for completing the project within the defined time-frame and cost limits is helpful in expeditious execution and cost control.

iii) Use of Network Techniques: For project planning and control two basic techniques are available - PERT (Programme Evaluation Review Technique) and CPM (Critical Path Method). These techniques have, of late, merged and are being referred to by a common terminology that is network techniques. With the help of these techniques, monitoring becomes easier.

Review

Once the project is commissioned, the review phase has to be set in motion. Performance review should be done periodically to compare actual performance with projected performance. A feedback device, it is useful in several ways: (i) It throws light on how realistic were the assumptions underlying the project; (ii) It provides a documented log of experience that is highly valuable in future decision making; (iii) It suggests corrective action to be taken in the light of actual performance; (iv) It helps in uncovering judgmental biases; (v) It induces a desired caution among project sponsors.

1.4. CHARACTERISTICS OF PROJECT

1) Objectives: A project has a set of objectives or a mission. Once the objectives are achieved the project is treated as completed.

2) Life cycle: A project has a life cycle. The life cycle consists of five stages i.e. conception stage, definition stage, planning & organising stage, implementation stage and commissioning stage.

3) Uniqueness: Every project is unique and no two projects are similar. Setting up a cement plant and construction of a highway are two different projects having unique features.

4) Team Work: Project is a team work and it normally consists of diverse areas. There will be personnel specialized in their respective areas and co-ordination among the diverse areas calls for team work.

5) Complexity: A project is a complex set of activities relating to diverse areas.

6) Risk and uncertainty: Risk and uncertainty go hand in hand with project. A risk-free, it only means that the element is not apparently visible on the surface and it will be hidden underneath.

7) Customer specific nature: A project is always customer specific. It is the customer who decides upon the product to be produced or services to be offered and hence it is the responsibility of any organization to go for projects/services that are suited to customer needs.

8) Change: Changes occur throughout the life span of a project as a natural outcome of many environmental factors. The changes may vary from minor changes, which may have very little impact on the project, to major changes which may have a big impact or even may change the very nature of the project.

9) Optimality: A project is always aimed at optimum utilization of resources for the overall development of the economy.

10) Sub-contracting: A high level of work in a project is done through contractors. The more the complexity of the project, the more will be the extent of contracting.

11) Unity in diversity: A project is a complex set of thousands of varieties. The varieties are in terms of technology, equipment and materials, machinery and people, work, culture and others.

1.5. Characteristics of Project Plans

A project plan can be considered to have five key characteristics that have to be managed:

Scope:defines what will be covered in a project.

Resource:what can be used to meet the scope.

Time:what tasks are to be undertaken and when.

Quality:the spread or deviation allowed from a desired standard.

Risk:defines in advance what may happen to drive the plan off course, and what will be done to recover the situation.

Balanced Plans

The sad thing about plans is you cannot have everything immediately. Many people plan using planning software packages, without realising the trade-offs that must be made. They assume that if they write a plan down, reality will follow their wishes. Nothing is further from the truth. The point of a plan is to balance:

Thescope, andqualityconstraint against,

Thetimeandresourceconstraint,

While minimising therisks.

1.6. Project: Identification, Selection & Formulation

The process of identifying a candidate idea for developing into a project is called Project Identification. This is a systematic process and sometimes it may be aserendipitousact.Sources of Project ideas

Observation

Trade and Professional magazines

Bulletin of Research organizations

Government sources

Project selectionis a careful study of each project idea in detail and choosing one of them for further consideration and development. A project idea is universal. However, a project must be implemented in the background of factors such as

Technology

Equipment

Investment

Location

Market

Project Formulation

The process of studying a selected project further with reference to investment decisions is called project formulation. It considers issues such as relevance and feasibility of the project. Itinvolvesa step-by-step procedure to investigate and develop project further.

1.7. TAXONOMY OF PROJECTS

The term taxonomy refers to the science of classifying things by naming and identifying them. Projects can be classified under different heads, some of which are explained below.

Based on the Type of Activity

Under this category, projects can be classified as industrial projects and non-industrial projects. Industrial projects are set up for the production of some goods. Projects like health care projects, educational projects, irrigation projects, soil conservation projects, pollution control projects, highway projects, water supply projects etc. come under the category of non-industrial projects. Investments in non-industrial projects are made by the Government and the benefits from such projects are enjoyed by the entire society of people. It is difficult to quantify the benefits enjoyed by the society out of non- industrial projects.

Based on the Location of the Project

Under the category, projects can be classified as national projects and international projects. National projects are those set up within the national boundaries of a country, while international projects are set up in other countries. International projects may be either projects set up by the Government or by the private sector. The following are the major forms of international projects.

Setting up of fully owned subsidiaries abroad

Setting up of joint ventures abroad

Setting up of projects abroad by way of mergers & acquisitions

Handling of international projects needs more expertise and greater efforts in view of higher risk proportion and procedural formalities involved.

Based on Project Completion Time

Based on the constraints on project completion time, projects can be classified into two types, viz., normal projects and crash projects. Normal projects are those for which there is no constraint on time. Crash projects are those which are to be completed within a stipulated lime, even at the cost of ending up with a higher project cost. For example, construction of canal lining with the condition that the work should be completed before the monsoon starts is a crash project.

Based on Ownership

Based on ownership, projects can be classified into private sector projects, public sector projects and joint sector projects. A private sector project is one in which the ownership is completely in the hands of the project promoters and investors. Profit maximization is the prime objective of private sector projects since the investors invest their money in such projects only with the sole idea of earning better returns.

Public sector projects are those that are owned by the state. The evolution and growth of public sector enterprises is the natural consequences of the efforts of Governments for undertaking developments in a country. The growth of public sector enterprises vary from country to country. In a country that follows only the system of private enterprises (USA, for example) there is hardly any public sector enterprise except for essential sectors like defense sectors, public utility services etc. In socialist countries (China, for example) public enterprises dominate the economy and they have become public property. In countries that follow a system of mixed economy (India, for example) both private and public sector enterprises exist.

An enterprise is considered as public enterprise when the state or any other national, regional or local authority holds at least 51% of its capital and the enterprise is under the control of the state. In India, public sector undertakings can be owned either by the Central Government or by the State Governments. Government undertakes investment in public sector enterprises due to many reasons.

Both developing and under-developed countries need a planned economy for their sustained growth. The Government announces industrial and trade policies in tune with its plans to direct the growth of the economy in the desired direction. It becomes imperative for the Government to invest in growth sectors.

Private sector in developing and under-developed countries are not willing to take up investments in many planned sectors (sectors that the Government considers as thrust areas for the development of the economy) either due to huge investments required or due to unattractive returns from the investments in such projects. Hence it becomes the responsibility of the Government to invest and nurture industries in such planned sectors.

Investment in strategic sectors (defense, space research, atomic research etc.) cannot be given to the private sector for obvious reasons. Also, public utility services sectors can also be not left fully to the private sector since the private sector by nature is oriented only towards profit maximization and not in welfare maximization.

The natural resources of a country are the properties of the Government. The natural resources can be exploited only by the public sector enterprises since the investment required is huge and the ownership of the resources rests with the Government, (example: mining, construction of dams for irrigation purposes, hydro power plants.)

Joint sector projects are those in which the ownership is shared by the Government and by private entrepreneurs. The main consideration for the Governments investment in joint sector projects is to make use of the managerial talents, entrepreneurial capabilities and marketing skills of the private entrepreneurs. Joint sector offers hope to the private entrepreneurs since the Government shares the investment required for the project.

Based on Size

Projects can be classified based on the size into three categories, viz. small projects, medium sized projects and large projects. The size is normally expressed in terms of the amount of investment required. The investment limit for the different categories of projects are announced by the Government and this undergoes periodical changes keeping in view the inflation, the decision to offer certain incentives to projects categorized as small scale projects etc. As per the directives of the Govt. of India, projects with investment on plant and machinery up to Rs. 1 crore are categorized as small scale projects while those with investment in plant and machinery above Rs. 100 crores are categorized as Large scale projects. Projects with investment limit between these two categories are Medium scale projects.

Based on Need

Projects can be classified under the following groups, based on the need for project.

1. New project.

2. Balancing project.

3. Expansion project.

4. Modernization project.

5. Replacement project.

6. Diversification project.

7. Backward integration project.

8. Forward integration project.

PROJECT MANAGEMENT

(4Project Management)

PROJECT MANAGEMENT

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1.8. THE 7-S OF PROJECT MANAGEMENT

In the modern age of cutting-edge technology and continuous innovation, product life cycle is ever shortening. There is constant pressure on companies to differentiate from competition and earn customer satisfaction. In such a business environment, it is essential that internal organization network is strong and efficient to deal with any kind of changes.

The 7S framework introduced by McKinsey is one of the ways through which analysis can be done to determine the efficiency of organization in meeting strategic objective.

The 7-S framework provides a comprehensive set of issues that need to be considered. It also allows classification of tasks within the remit of the project manager, which reduces the complexity of the role. In addition, classifying issues in this manner ensures that the project manager will know where to look to find sources of help if novel situation arises. Knowing that interpersonal problem in a team are aggravated by the style /culture that a project manager promotes provides a means for finding solutions to the problem

The Seven Elements

The McKinsey 7S model involves seven interdependent factors which are categorized as either "hard" or "soft" elements:

Hard Elements

Soft Elements

Strategy

Structure

Systems

Shared Values

Skills

Style

Staff

"Hard" elements are easier to define or identify and management can directly influence them: These are strategy statements; organization charts and reporting lines; and formal processes and IT systems.

"Soft" elements, on the other hand, can be more difficult to describe, and are less tangible and more influenced by culture. However, these soft elements are as important as the hard elements if the organization is going to be successful.

The way the model is presented in the figure below depicts the interdependency of the elements and indicates how a change in one affects all the others.

Let's look at each of the elements specifically:

Strategy:the plan devised to maintain and build competitive advantage over the competition.

Structure:the way the organization is structured and who reports to whom.

Systems:the daily activities and procedures that staff members engage in to get the job done.

Shared Values:called "superordinate goals" when the model was first developed, these are the core values of the company that are evidenced in the corporate culture and the general work ethic.

Style:the style of leadership adopted.

Staff:the employees and their general capabilities.

Skills:the actual skills and competencies of the employees working for the company.

1.8.1. 7 S Work Sheet

1.9. FACETS OF PROJECT ANALYSIS

The important facets of project analysis are:

Market analysis

Technical analysis

Financial analysis

Economic analysis

Ecological analysis

Market Analysis:

Market analysis is concerned primarily with two questions:

What would be the aggregate demand for the proposed product/service in the future?

What would be the market share of the project under appraisal?

To answer the above questions, the market analyst requires a wide variety of information and appropriate forecasting methods. The kinds of information required are:

Consumption trends in the past and the present consumption level

Past and present supply position

Production possibilities and constraints

Imports and exports

Structure of competition

Cost structure

Elasticity of demand

Consumer behaviour, intentions, motivations, attitudes, preferences, and requirements

Distribution channels and marketing policies in use

Administrative, technical, and legal constraints

Technical Analysis:

Analysis of the technical and engineering aspects of a project needs to be done continually when a project is formulated. Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonably good choices have been made with respect to location, size, process, etc. The important questions raised in technical analysis are:

Whether the preliminary tests and studies have been done or provided for?

Whether the availability of raw materials, power, and other inputs has been established?

Whether the selected scale of operation is optimal?

Whether the production process chosen is suitable?

Whether the equipment and machines chosen are appropriate?

Whether the auxiliary equipments and supplementary engineering works have been provided for?

Whether provision has been made for the treatment of effluents?

Whether the proposed layout of the site, buildings, and plant is sound?

Whether work schedules have been realistically drawn up?

Whether the technology proposed to be employed is appropriate from the social point of view?

Financial Analysis:

Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense of being able to meet the burden of servicing debt and whether the proposed project will satisfy the return expectations of those who provide the capital. The aspects which have to be looked into while conducting financial analysis are:

Investment outlay and cost of project

Means of financing

Cost of capital

Projected profitability

Break-even point

Cash flows of the project

Investment worthwhileness judged in terms of various criteria of merit

Projected financial position

Level of risk

Economic Analysis:

Economic analysis, also referred to as social cost benefit analysis, is concerned with judging a project from the larger social point of view. In such an evaluation the focus is on the social costs and benefits of a project which may often be different from its monetary costs and benefits. The questions sought to be answered in social cost benefit analysis are:

What are the direct economic benefits and costs of the project measured in terms of shadow (efficiency) prices and not in terms of market prices?

What would be the impact of the project on the distribution of income in the society?

What would be the impact of the project on the level of savings and investment in the society?

What would be the contribution of the project towards the fulfillment of certain merit wants like self-sufficiency, employment, and social order?

Ecological Analysis:

In recent years, environmental concerns have assumed a great deal of significance and rightly so. Ecological analysis should be done particularly for major projects which have significant ecological implications (like power plants and irrigation schemes) and environment-polluting industries (like bulk drugs, chemicals, and leather processing). The key questions raised in ecological analysis are:

What is the likely damage caused by the project to the environment?

What is the cost of restoration measures required to ensure that the damage to the environment is contained within acceptable limits?

1.10. FEASIBILITY STUDYThe feasibility study is concerned with the first four phases of capital budgeting, viz., planning, analysis, selection (evaluation), and financing, and involves market, technical, financial, economic, and ecological analysis. The schematic diagram of the feasibility study is shown below

1.10.1. Market & Demand Analysis

In most cases, the first step in project analysis is to estimate the potential size of the market for the product proposed to be manufactured and get an idea about the market share that is likely to be captured. Given the importance of market and demand analysis, it should be carried out in an orderly and systematic manner.

The key steps involved in market and demand analysis are as follows:

Situational analysis and specification of objectives

Collection of secondary information

Conduct of market survey

Characterization of the Market

Demand forecasting

Formulation of the Market Plan

Key steps in Market and Demand analysis

What Is Market Demand Analysis?

Companies use market demand analysis to understand how much consumer demand exists for a product or service. This analysis helps management determine if they can successfully enter a market and generate enough profits to advance their business operations. While several methods of demand analysis may be used, they usually contain a review of the basic components of an economic market which are:

1. Market identification

2. Business cycle

3. product niche

4. growth potential

5. competition

Market Identification

The first step of market analysis is to define and identify the specific market to target with new products or services. Companies will use market surveys or consumer feedback to determine their satisfaction with current products and services. Comments indicating dissatisfaction will lead businesses to develop new products or services to meet this consumer demand. While companies will usually identify markets close to their current product line, new industries may be tested for business expansion possibilities.

Business Cycle

Once a potential market is identified, companies will assess what stage of the business cycle the market is in. Three stages exist in the business cycle: emerging, plateau and declining. Markets in the emerging stage indicate higher consumer demand and low supply of current products or services. The plateau stage is the break-even level of the market, where the supply of goods meets current market demand. Declining stages indicate lagging consumer demand for the goods or services supplied by businesses.

Product Niche

Once markets and business cycles are reviewed, companies will develop a product that meets a specific niche in the market. Products must be differentiated from others in the market so they meet a specific need of consumer demand, creating higher demand for their product or service. Many companies will conduct tests in sample markets to determine which of their potential product styles is most preferred by consumers. Companies will also develop their goods so that competitors cannot easily duplicate their product.

Growth Potential

While every market has an initial level of consumer demand, specialized products or goods can create a sense of usefulness, which will increase demand. Examples of specialized products are iPods or iPhones, which entered the personal electronics market and increased demand through their perceived usefulness by consumers. This type of demand quickly increases the demand for current markets, allowing companies to increase profits through new consumer demand.

Competition

An important factor of market analysis is determining the number of competitors and their current market share. Markets in the emerging stage of the business cycle tend to have fewer competitors, meaning a higher profit margin may be earned by companies. Once a market becomes saturated with competing companies and products, fewer profits are achieved and companies will begin to lose money. As markets enter the declining business cycle, companies will conduct a new market analysis to find more profitable markets.

Situational analysis & specification of objectives

In order to get a feel of the relationship between the product and its market, the project analyst may informally talk to customers competitors, middlemen and other in the industry.

Where and how to market the new product/service the objectives of the market and demand analysis in this case may be to answer the questions.

1. Who are buyers of the new product/service?

2. What is the current demand for the new product/service?

3. How is demand distributed temporally and geographically?

4. What is the breakup of demand for the new product/service of different sizes?

5. What price and warranty will ensure its acceptance?

6. What channels distribution is most suited for the new product/service?

7. What trade margins will induce distributors to carry it?

8. What are prospects of immediate sales?

Collection of secondary information

Information may be obtained from secondary and primary sources. Secondary information is information that has been gathered in some other context and is already available. Primary information on the other hand represents information that is collected for the first time to meet the specific purpose on hand secondary information provides the base and starting point market and demand analysis.

General sources of secondary information: The important sources of secondary information useful market and demand analysis in the country are mentioned below:

1. National Census

2. National sample survey reports

3. Plan reports

4. statistical abstract of national union

5. Statistical year book

6. Economic survey

7. Guidelines to industries

8. Annual survey of industries

9. Annual reports of the Department of commerce and industry.

10. The exchange directory

11. Monthly bulletin of reserve bank.

12. Publications of advertising agencies

Evaluation of secondary information

While secondary information is available economically and readily. Its reliability, accuracy and relevance for the purpose under consideration must be carefully examined. The market analyst should seek to know:

1. Who gathered the information?

2. What was the objective?

3. When was the information gathered?

4. When was it published?

5. Have the terms in the study been carefully and unambiguously defined?

6. What was the target population?

7. How was the sample chosen?

8. How representative was the sample?

9. How satisfactory was the process of information gathering?

10. What was the degree of sampling bias and non-response in the information gathered?

11. What was the degree of misrepresentation by respondents?

Conduct of market survey

The information sought in a market survey may relate to one or more of the following.

1. Total demand and rate of growth of demand

2. Demand in different segments of market

3. Income and price elasticitys of demand

4. Motives for buying

5. Purchasing plans and intentions

6. Socioeconomic characteristics of buyers

7. Unsatisfied needs

8. Attitudes toward various products

9. Distributive trade practices and preferences

10. Satisfaction with existing products

Steps in a sample survey:

1. Define the target population

2. Select the sampling scheme and sample size

3. Develop the questionnaire

4. Recruit and train the field investigators

5. Obtain information as per the questionnaire from the sample of respondents

6. Scrutinise, analyse & interpret information.

Characterization of the Market

Based on the information gathered from secondary sources and through the market survey, the market for the product or service to be offered may be described in terms of the following:

1. Effective demand on the past and present

2. Breakdown of demand

3. Price

4. Methods of distribution and sales promotion

5. Consumers

6. Supply of competition

7. Government Policy

Demand forecasting

After gathering information about various aspects of the market and demand from primary and secondary sources. An attempt may be made to estimate future demand. These may classified in three categories as shown

1. Qualitative Methods

2. Time series projection Methods

3. Causal Methods

Methods of Demand Forecasting

Qualitative Forecasting Methods

Your company may wish to try any of the qualitative forecasting methods below if you do not have historical data on your products' sales.

Qualitative Method

Description

Jury of executive opinion

The opinions of a small group of high-level managers are pooled and together they estimate demand. The group uses their managerial experience, and in some cases, combines the results of statistical models.

Sales force composite

Each salesperson (for example for a territorial coverage) is asked to project their sales. Since the salesperson is the one closest to the marketplace, he has the capacity to know what the customer wants. These projections are then combined at the municipal, provincial and regional levels.

Delphimethod

A panel of experts is identified where an expert could be a decision maker, an ordinary employee, or an industry expert. Each of them will be asked individually for their estimate of the demand. An iterative process is conducted until the experts have reached a consensus.

Consumer market survey

The customers are asked about their purchasing plans and their projected buying behaviour. A large number of respondents is needed here to be able to generalize certain results.

Quantitative Forecasting Methods

There are two forecasting models here (1) the time series model and (2) the causal model. A time series is a set of evenly spaced numerical data and is obtained by observing responses at regular time periods. In thetime series model, the forecast is based only on past values and assumes that factors that influence the past, the present and the future sales of your products will continue.

On the other hand, thecausal modeluses a mathematical technique known as the regression analysis that relates a dependent variable (for example, demand) to an independent variable (for example, price, advertisement, etc.) in the form of a linear equation. The time series forecasting methods are described below:

Time Series Forecasting Method

Description

Nave Approach

Assumes that demand in thenextperiod is the same as demand inmost recentperiod; demand pattern may not always be that stable

For example:

If July sales were 50, then Augusts sales will also be 50

Time Series Forecasting Method

Description

Moving Averages (MA)

MA is a series of arithmetic means and is used if little or no trend is present in the data; provides an overall impression of data over time

Asimple moving averageuses average demand for a fixed sequence of periods and is good for stable demand with no pronounced behavioral patterns.

Equation:

F 4 = [D 1 + D2 + D3] / 4

F forecast, D Demand, No. Period

Aweighted moving averageadjusts the moving average method to reflect fluctuations more closely by assigning weights to the most recent data, meaning, that the older data is usually less important. The weights are based on intuition and lie between 0 and 1 for a total of 1.0

Equation:

WMA 4 = (W) (D3) + (W) (D2) + (W) (D1)

WMA Weighted moving average, W Weight, D Demand, No. Period

Exponential Smoothing

Theexponential smoothingis an averaging method that reacts more strongly to recent changes in demand by assigning a smoothing constant to the most recent data more strongly; useful if recent changes in data are the results of actual change (e.g., seasonal pattern) instead of just random fluctuations

F t + 1 = a D t + (1 - a ) F t

Where

F t + 1 = the forecast for the next period

D t = actual demand in the present period

F t = the previously determined forecast for the present period

= a weighting factor referred to as thesmoothing constant

Trend Projection Method

This time-series forecasting method fits a trend line to a series of historical data points and then projects the line into the future for medium- to long range forecasts. There are several mathematical trend equations that can be developed viz. linear, exponential, quadratic etc. Here we will concentrate only on the linear trends. Of the components of a time series, secular trend represents the long-term direction of the series. One way to describe the trend component is to fit a line visually to a set of points on a graph. Any given graph, however, is subject to slightly different interpretations by different individuals. We can also fit a trend line by the method of least squares

Uncertainties in demand forecasting

Demand forecasts are subject to error and uncertainty which from three principal source.

1. Data about past and present market.The analysis of past and present markets, which serve as the springboard for the projection exercise, may be vitiated by the following inadequacies of data:

. Lack of Standardization: Data pertaining to market features like product, price, quantity, cost, income, etc. may not reflect uniform concepts and measures.

. Few observations: observations available to conduct meaningful analysis may not be enough.

. Influence of abnormal factors: Some of the observations may be influenced by abnormal factors like war or natural calamity.

Method of forecasting.Methods used for demand forecasting are characterized by the following limitations:

. Inability to handle unquantifiable factors: most of the forecasting methods, being quantitative in nature, cannot handle unquantifiable factors which sometimes can be of immense significance.

. Unrealistic assumptions: Each forecasting method is based on certain assumptions. For example, the trend projection method is based on the mutually compensating affects premise and the end use method is based on the constancy of technical coefficients. Uncertainty arises when the assumptions underline the chosen method tend to be realistic and erroneous.

. Exercise data requirement:In general, the more advanced a method, the greater the data requirement. For example, to use an econometric model one has to forecast the future values of explanatory variables in order to project the explained variable.

Environmental Change.The environment in which a business functions is characterized by numerous uncertainties. The important sources of uncertainty are mentioned below:

. Technological Change: This is a very important and very hard-to-predict factor which influences business prospects. A technological advancement may create a new product which performs the same function more efficiently and economically, thereby cutting into the market for the existing product. For example, electronic watches are encroaching on the market for mechanical watches.

. Shift in Government Policy: Government resolution of business may be extensive. Changes in government policy, which may be difficult to anticipate, could have a telling effect on the business environment.

. Development on the International Scene: Development on the International Scene may have a profound effect on industries.

. Discovery of New Sources of Raw Material: Discovery of new sources of raw materials, particularly hydrocarbons, can have a significant effect on the market situation of several products.

. Vagaries of the Weather: Weather plays an important role in the economy of a country, is somewhat unpredictable. Extreme weather influences, directly or indirectly, the demand for a wide range of products.

Coping with Uncertainties:

Given the uncertainties in demand forecasting, adequate efforts, along the following lines, may be made to cope with uncertainties.

1. Conduct analysis with data based on uniform and standard definitions.

2. In identifying trends, coefficients, and relationships, ignore the abnormal and out-of-the-ordinary observations.

3. Critically evaluate the assumptions of the forecasting methods and choose a method which is appropriate to situation.

4. Adjust the projections derived from quantitative analysis in the light of unquantifiable, but significant, influences.

5. Monitor the environment imaginatively to identify important changes.

6. Consider likely alternative scenarios and their impact on market and competition.

7. Conduct sensitivity analysis to access the impact on the size of demand for unfavourable and favourable variations of the determining factors from their most likely levels.

Market planning

A marketing plan usually has the following components

1. Current marketing situation

. Where is your organisation now?

. Who are your customer groups? What are their needs and requirements? How large and diverse are they?

. What kinds of products and services do you currently provide?

. How do you reach your customer groupings?

. Do you have any competition?

. What factor/s in your environment has an effect on your organisation?

Opportunity and issue analysis(S.W.O.T. analysis). This identifies key issues and opportunities for your organisation and it comprises an analysis of your internal operations

. Strengths

. Weaknesses

Also those external factors, which affect your organisation

. Opportunities

. Threats

Objectives. Having identified the key issues affecting your organisation you can make some decisions about future objectives. These guide the development of strategies and action plans.

. Objectives should meet certain criteria e.g. financial, and marketing which will be customer focused.

. They should be clearly stated, measurable and listed in order of importance

. They should be attainable and consistent with your organisation's culture.

Marketing strategy. This is the game plan that needs to be implemented to achieve the objectives. It addresses the following:

. Whom are you now targeting?

. What do you want your position to be in terms of new product/service delivery?

. Do you want to change your organisation profile and will you need to rebrand your organisation?

. Will you change the way you promote and advertise yourself?

. Will there be any changes in how you reach your customer groupings?

. Any changes in staff?

. Is there a need for more research?

Action program.This describes:

. What will be done

. When will it be done?

. Who will do it?

. How much will it cost?

Budget and controls.

. The Budget is essentially a cash flow statement and profit/loss statement to support the marketing plan

. Control mechanisms and procedures should be established to monitor the progress of the plan to determine if anything needs changing. It would include a contingency plan in case something adverse should happen.

1.10.2. TECHNICAL ANALYSISAnalysis of technical and engineering aspects is done continually when a project is being examined and formulated. Other types of analyses are dependent and closely intertwined with technical analysis. Technical analysis is concerned primarily with: Materials and inputsAn important aspect of technical appraisal is concerned with defining the materials and inputs required, specifying their properties in some detail, and setting up their supply programme. There is an intimate relationship between the study of materials and inputs and other aspects of project formulation, particularly those concerned with location, technology, and equipment

Materials and inputs may be classified into four broad categories: (i) raw materials, (ii) processed industrial materials and components, (iii) auxiliary materials and factory supplies, and (iv) utilities.

(i) Raw materials Raw materials (processed and / or semi- processed) may be classified into four types: (i) agricultural products, (ii) mineral products, (iii) livestock and forest products, and (iv) marine products.

(ii) Processed industrial materials and components Processed industrial materials and components (base metals, semi-processed materials, manufactured parts, components, and sub-assembly represent an important input for a number of industries. In studying them the following questions need to be answered: In the case of industrial materials, what are their properties? What is the total requirement of the project? What quantity would be available from domestic source? What quantity would be available from foreign sources? How dependable are the supplies? What has been the past trend in prices? What is the likely future behaviour of prices?

(iii) Auxiliary materials and factory supplies In addition to the basic raw materials and processed industrial materials and components, a manufacturing project requires various auxiliary materials and factory supplies, like chemicals, additives, packaging materials, paints, varnishes, oils, grease, cleaning materials, etc. The requirements of such auxiliary materials and supplies should be taken into account in the feasibility study.

(iv) Utilities A broad assessment of utilizes (power, water, steam, fuel, etc.) may be made at the time of input study though a detailed assessment can be made only after formulating the project with respect to location, technology, and plant selection. Since the successful operation of a project critically depends on adequate availability of utilities the following points should be raised while conducting the input study: What quantities are required? What are the sources of supply? What would be the potential availability? What are the likely shortages/bottlenecks? What measures may be taken to augment supplies.

Production technology

For manufacturing a product/service often two or more alternative

technologies are available. For example:

Steel can be made either by the Bessemer process or the open hearth process.

Cement can be made either by the dry process or the wet process.

Soda can be made by the electrolysis method or the chemical method.

Paper, using bagasse as the raw material, can be manufactured by the kraft process or the soda process.

Vinyl chloride can be manufactured by using one of the following reactions: acetylene on hydrochloric acid or ethylene or chlorine.

Choice of technology

The choice of technology is influenced by a variety of considerations:

(i) Principal inputs The choice of technology depends on the principal inputs available for the project. In some cases, the raw materials available influences the technology chosen. For example, the quality of limestones determines whether the wet or dry process should be used for a cement plant. It may be emphasized that a technology based on indigenous inputs may be preferable to one based on imported inputs because of uncertainties characterizing imports, particularly in a country like India.

(ii) Investment outlay and production cost The effect of alternative technologies of investment outlay and production cost over a period of time should be carefully assessed.

(iii) Use by other units The technology adopted must be proven by successful use by other units, preferably in India.

(iv) Product mix The technology chosen must be judged in terms of the total product-mix generated by it, including saleable by-products.

(v) Latest developments The technology adopted must be based on latest development in order to ensure that the likelihood of technological obsolescence in the near future, at least, is minimized.

(vi) Ease of absorption The ease with which a particular technology can be absorbed can influence the choice of technology. Sometimes a high-level technology may be beyond the absorptive capacity of a developing country which may lack trained personnel to handle that technology.

Product Mix

The choice of product mix is guided primarily by market requirements. In the production of most of the items variations in size and quality are aimed the production of most of the items, variations in size and quality are aimed at satisfying a broad range of customers. For example, production of shoes to different customers. It may be noted that sometimes slight variations in quality can enable a company to expand its market and enjoy higher profitability. For example, a toilet soap manufacturing unit may by minor variation in raw material, packaging, and sales promotion offer a high profit margin soap to consumers in upper-income brackets.

While planning the production facilities of the firm, some flexibility with respect to the product mix must be sought. Such flexibility enables the firm to alter its product mix in response to changing market conditions and enhances the power of the firm to survive and grow under different situations. The degree of flexibility chosen may be based on a careful analysis of the additional investment requirements for different degrees of flexibility.

Plant capacity

Plant capacity (also referred to as production as capacity) refers to the volume or number of units that can be manufactured during a given period. Several factors have a bearing on the capacity decision.

(i) Technological requirement For many industrial projects, particularly in process type industries, there is a certain minimum economic size determined by the technological factor. For example, a cement plant should have a capacity of at least 300 tonnes per day in order to use the rotary kiln method; otherwise, it has to employ the vertical shaft method which is suitable for lower capacity.

(ii) Input constraints In a developing country like India, there may be constraints on the availability of certain inputs. Power supply may be limited; basic raw materials may be scarce; foreign exchange available for imports may be inadequate. Constraints of these kinds should be borne in mind while choosing the plant capacity.

(iii) Investment cost When serious input constraints do not obtain, the relationship between capacity and investment cost is an important consideration. Typically, the investment cost per unit of capacity decreases as the plant capacity increases. This relationship may be expressed as follows:

Where C1 = derived cost for Q1 units of capacity

C2 = known cost for Q2 units of capacity a = a factor reflecting capacity-cost relationship. This is

usually between 0.2 and 0.9.

(iv) MarketconditionsThe anticipated market for the

product/service has an important bearing on plant capacity. If the market for the product is likely to be very strong, a plant of higher capacity is preferable. If the market is likely to be uncertain, it might be advantageous to start with a smaller capacity. If the market, starting from a small base, is expected to grow rapidly, the initial capacity may be higher than the initial level of demand- further additions to capacity may be affected with the growth of market.

(v) Resources of the firm The resources, both managerial and financial, available to a firm define a limit on its capacity decision. Obviously, a firm cannot choose a scale of operations beyond its financial resources and managerial capability.

(vi) Governmental policy The capacity level may be constrained by governmental policy. Given the level of additional capacity to be created in an industry, within the licensing framework of the government the government may decide to distribute the additional capacity among several firms.

Location and site

The choice of location and site follows an assessment of demand, size, and input requirement. Though often used synonymously, the terms 'location' and 'site' should be distinguished. Location refers to a fairly broad area like a city, an industrial zone, or a coastal area; site refers to a specific piece of land where the project would be set up.

The choice of location is influenced by a variety of considerations: proximity to raw materials and markets, availability of infrastructure, governmental policies, and other factors.

(i) Proximity to raw materials and markets An important consideration for location is the proximity to sources of raw materials and nearness to the market for final products. In terms of a basic locational model, the optimal location is one where the total cost (raw material transportation cost plus production cost plus distribution cost for final product) is minimized. This generally implies that: (i) a resource-based project like a cement plant or a steel mill should be located close the source of basic material (for example, limestone in the case of a cement plant and iron-ore in the case of a steel plant); (ii) a project based on imported material may be located near a port; and (iii) a project manufacturing a perishable product should be close to the center of consumption.

However, for many industrial products proximity to the source of raw material or the center of consumption may not be very important. Petro-chemical units or refineries, for example, may be located close to the source of raw material, or close to the center of consumption, or at some intermediate point.

(ii) Availability of infrastructureAvailability of power,

transportation, water, and communications should be carefully assessed before a location decision is made.

Adequate supply of power is a very important condition for location insufficient power can be a major constraint, particularly in the case of an electricity-intensive project like an aluminium plant. In evaluating power supply the following should be looked into: the quantum of power available, the stability of power supply, the structure of power tariff, and the investment required by the project for a tie-up in the network of the power supplying agency.

For transporting the inputs of the project and distributing the outputs of the project, adequate transport connectionswhether by rail, road, sea, inland water, or air are reqired. The availability, reliability and cost of transportation for various alternative locations should be assessed.

Given the plant capacity and the type of technology, the water requirement for the project can be assessed. Once the required quantity is estimated, the amount to be drawn from the public utility system and the amount to be provided by the project from surface or sub-surface sources may be determined. For doing this the following factors may be examined: relative costs, relative dependabilities, and relative qualities.

In addition to power, transport, and water, the project should have adequate communication facilities like telephone and fax etc.

(iii) Governmental policies Governmental policies have a bearing on location. In the case of public sector projects, location is directly decided by the government. It may be based on a wider policy for regional dispersion of industries.

In the case of private sector projects, location is influenced by certain governmental restrictions and inducements. The government may prohibit the setting up of industrial projects in certain areas which suffer from urban congestion. More positively, the government offers inducements for establishing industries in backward areas. These inducements consist of outright subsidies, concessional finance, tax relief, and other benefits.

(iv) Other factors Several other factors have to be assessed before reaching a location decision: ease in coping with environmental pollution, labour situation, climatic conditions, and general living conditions.

A project may cause environmental pollution in various ways: it may throw gaseous emission; it may produce liquid and solid discharges; it may cause noise, heat, and vibrations. The location study should analyse the costs of mitigating environmental pollution to tolerable levels at alternative locations.

The labour situation at alternative locations may be assessed in terms of: (i) the availability of labour, skilled, semi-skilled, and unskilled; (ii) the past trends in labour rates, the prevailing labour rates, and the projected labour rates; and (iii) the state of industrial relations judged in terms of the frequency and severity of strikes and lockouts and the attitudes of labour and management.

The climatic conditions (like temperature, humidity, wind, sunshine, rainfall, snowfall, dust and fumes, flooding, and earthquakes) have an important influence on location. They have a bearing on cost as they determine the extent of air-conditioning, de-humidification, refrigeration, special drainage, etc., required for the project.

General living conditions, judged in terms of cost of living, housing situation, and facilities for education, recreation, transport, and medical care, need to be assessed at alternative locations.

Machinery and equipment

The requirement of machinery and equipment is dependent on production technology and plant capacity. It is also influenced by the type of project. For a process-oriented industry, like a petrochemical unit, machinery and equipment required should be such that the various stages have to be matched well. The choice of machinery and equipment for a manufacturing industry is somewhat wider as various machines can perform the same function with varying degrees of accuracy. For example, the configuration of machines required for the manufacture of refrigerators could take various forms. To determine the kinds of machinery and equipment requirement for a manufacturing industry, the following procedure may be followed: (i) Estimate the likely levels of production over time. (ii) Define the various machining and other operations. (iii) Calculate the machine hours required for each type of operation. (iv) Select machinery and equipment required for each function.

The equipment required for the project may be classified into the following types: (i) plant (process) equipment, (ii) mechanical equipment, (iii) electrical equipment, (iv) instruments, (v) controls, (vi) internal transportation system, and (vii) other machinery and equipment.

In addition to the machinery and equipment, a list should be prepared of spare parts and tools required. This may be divided into: (i) spare parts and tools to be purchased with original equipment, and (ii) spare parts and tools required for operational wear and tear.

Constraints in selecting machinery and equipment In selecting the machinery and equipment, certain constraints should be borne in mind:

(i) there may be a limited availability of power to set up an electricity intensive plant like, for example, a large electric furnace; (ii) there may be difficulty in transporting a heavy equipment to a remote location; (iii) workers may not be able to operate, at least in the initial periods, certain sophisticated equipment such as numerically controlled machines; (iv) the import policy of the government may preclude the import of certain types of machinery and equipment.

Structures and civil works

Structures and civil works may be divided into three categories: (i) site preparation and development, (ii) buildings and structures, and (iii) outdoor works.

(i) Site preparation and development This covers the following: (i) grading and leveling of the site, (ii) demolition and removal of existing structures, (iii) relocation of existing pipelines cables, roads, powerlines, etc., (iv) reclamation of swamps, draining and removal of standing water, (v) connections for the following utilities from the site to the public network: electric power (high tension and low tension), water (use water and drinking water), communications (telephone, fax, etc.), roads, railway sidings, and (vi) other site preparation and developmental work.

(ii) Buildings Buildings and structures may be divided into: (i) factory or process buildings; (ii) ancillary buildings required for stores, warehouses, laboratories, utility supply centers, maintenance services, and others; (iii) administrative buildings; (iv) staff welfare buildings, cafetaria, and medical service buildings; and (v) residential buildings.

(iii) Outdoor works Outdoor works cover (i) supply and distribution of utilities (water, electric power, communication, steam and gas); (ii) handling and treatment of emissions, wastages, and effluents; (iii) transportation and traffic arrangements (roads, railway tracks, paths, parking areas, sheds, garages, traffic signals, etc.): (iv) outdoor lighting; (v) landscaping; and (vi) enclosure and supervision (boundary wall, fencing, barriers, gates, doors, security posts, etc.).

Project charts and layouts

Once data is available on the principal dimension of the project market size, plant capacity, required technology, equipment and civil works, conditions obtaining at plant site, and supply of inputs to the project project charts and layouts may be prepared. These define the scope of the project and provide the basis for detailed project engineering and estimation of investment and production costs.

Work Schedule

The work schedule, as its name suggests, reflects the plan of work concerning installation as well as initial operation. The purpose of the work schedule is:

To anticipate problems likely to arise during the installation phase and suggest possible means for coping with them.

To establish the phasing of investments taking into account availability of finances.

To develop a plant of operations covering the initial period (the running in period).

Often, it is found that the required inputs like raw material and power are not available in adequate quantity when the plant is ready for commissioning, or the plant is not ready when the raw material arrives.

1.10.3. FINANCIAL ANALYSISFinancial analysis is defined as the process of discovering economic facts about an enterprise and/or a project on the basis of an interpretation of financial data. Financial analysis also seeks to look at the capital cost, operations cost and operating revenue. The analysis decisively establishes a relationship between the various factors of a project and helps in maneuvering the project's activities. It also serves as a common measure of value for obtaining a clear-cut understanding about the project from the financial point of view.An analysis of several financial tools provide an important basis for valuing securities and appraising managerial programmes. Financial analysis is vital in the interpretation of financial statements. It can provide an insight into two important areas of management return on investment and soundness of the company's financial position.Internal management accounts provide information which is valuable for the purpose of control. The information is made available in the form of accounting data, which may be manifested as financial and accounting statements. A financial analysis reveals where the company stands with respect to profitability, liquidity, leverage and an efficient use of its assets. Financial reports provide the framework within which business planning takes place. They are the key through which an effective control of a business enterprise is exercised. It is the process of determining the significant financial characteristics of a firm. It may be external or internal. The external analysis is performed by creditors, stockholders and investment analysis. The internal analysis is performed by various departments of a firm. Significance of financial analysisFinancial analysis primarily deals with the interpretation of the data incorporated in the proforma financial statements of a project and the presentation of the data in a form in which it can be utilized for a comparative appraisal of the projects. It is, in effect, concerned with the development of the financial profile of the project. Its purpose is to find out whether the project is attractive enough to secure funds needed for its various constituent activities and once having secured the funds, whether the project will be able to generate enough economic values to achieve the objectives for which it is sought to be implemented. It deals not only with the financial aspects of a project but also with its operational aspects. As such, it is necessary to undertake such an analysis not only in the case of industrial projects but also in the case of non-industrial projects.Analysis of financial statements has become very significant due to the widespread interest of various parties in the financial results of a company. 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. Various people look at the financial statements from various angles. A number of techniques have been developed to undertake analysis of financial statements in order to reach conclusions about the financial health, profitability and efficiency of an enterprise and also to compare an enterprise with other similar undertakings. The technique of ratio analysis is the most important tool of financial analysis. It helps in comparing the performance of various companies and judge their financial soundness. Utility of financial and accounting statementsUtility of financial analysisFinancial statements play a vital role in the internal financial control of an enterprise. These should, therefore, the properly constructed, analysed and interpreted by executives, bankers, creditors and investors.The entire future of a company hinges on the manager's ability to decide relevant financial data with a view to planning profit ability moves. Learning to read financial statements is the first essential element in any businessman's attempt to acquire financial management skills. The change in the elitism of stock ownership to broad public ownership has necessitated a concomitant change in the entire process of reporting corporate financial results. The role of management in the matter of preparation of financial statements is to add understanding to these statements, the fairness of which is to be viewed through the eye of the user, while that of the accountant is to close the communication gap and of the auditor to add credibility to them. For evolving a good economic information system, accounting innovations are of great economic information system. Without these, communication with the financial community would be difficult, the interest of present and future potential investors would not be served, the ability of the company to raise additional capital would be impaired and the government's regulatory measures and policies would not serve the best interest of society. Though a financial statement reveals less than it conceals, it provides the indicators of the enterprise's performance during the year.Financial analysis seeks to spotlight the significant facts and relationships concerning managerial performance, viz., corporate efficiency, financial strengths and weaknesses and creditworthiness of the enterprise.1.10.4. SOCIAL COST BENEFIT ANALYSIS

The economic evaluation of any investment proposal involves an analysis of social profitability arising out of the investment. Apart from the direct financial benefits as a result of revenue which will flow in the national exchequer from duties and taxes levied, there are various indirect benefits which will accrue such as opening up of employment opportunities in downstream/ancillary industries, transport and other secondary and tertiary sectors of commercial activity. This analysis which basically determines whether an investment is worthwhile from the point of view of the society as a whole, involves adjustment on cost and return to the enterprise taking into account the direct and indirect benefits leading to revalued inputs and outputs. Thus,

Social cost benefit analysis (SCBA) is a methodology for evaluating project from social point of view. It is also referred as economic analysis and is developed for evaluating investment project from the point of view of the society. In recent years particularly in the developing countries where GOVT is playing significant role in economic development (SCBA) is playing a very important role. It is concerned with tactical decision making within the framework of broad strategic choice defined by planning at the macro level.

Rationale for SCBAIn SCBA the focus is on social cost and benefits of a project. These often tend to differ from the cost incurred in monetary terms and benefits earned in monetary terms by the project.

The principle reasons for discrepancies are -:

Market imperfections -: The common market imperfections found in developing countries are

Rationing -: rationing means control over the prices and distribution of a commodity. The price paid by the consumer in case of rationing is much less than the price prevailing in the competitive market.

Prescription of minimum wage rates -: in case of minimum wage rates the wages paid to the labourers are more than what the wages would be in a competitive labour market free from such wage legislation.

Foreign exchange regulations -: the official rate of foreign exchange in most of the developing countries which exercise close regulation over foreign exchange is typically less than the rate that would prevail in the absence of foreign regulation.

Externalities: - a project may have beneficial external effects, for e.g. a project may create certain infrastructure facilities like roads which benefit the neighbouring areas, or a may have harmful external effects like it may create environmental pollution. Such benefits/losses are ignored in assessing the monetary benefits to the project sponsors but such externalities are relevant in SCBA because in such analysis all cost and benefits, irrespective to whom they accrue and whether they are paid for or not, are relevant.

Taxes and subsidies -: in case of monetary cost and benefit of a project taxes and subsidies are to be considered because they are definite monetary gains, however, taxes and subsidies are ignored in case of SCBA because they are considered as transfer payments.

Concern for savings -: in case of monetary cost benefit analysis a private firm is least concerned as to how its benefits are divided between consumption and savings, but from social point of view, however, the division of benefit between saving and consumption is relevant because while doing SCBA it is assumed that a rupee of benefit saved is more valuable than a rupee of benefit consumed. Thus a higher concern of society for saving and investment is duly reflected in SCBA where higher valuation is put on saving than on consumption.

Concern for redistribution -: while doing monetary cost and benefit analysis a private firm is least concerned about as to how its benefits are being distributed among various groups of the society, but while doing SCBA this factor is kept in mind because it is assumed that a rupee of benefit going to the poor section is considered more valuable than a rupee of benefit going to an affluent section.

Merit wants -: while merit wants are not relevant from the private point of view, they are important from the social point of view. E.g. GOVT may prefer to promote an adult education programme even though they are of no benefit to the consumers in market, but from the point of view of the society they are important.

APPROACHES to SCBA

1. UNIDO Approach

2. L & M Approach

3. Approach Adopted By Financial Institutions

A. UNIDO Approach -: the UNIDO approach was first articulated in the guidelines of project evaluation. It involves five stages :

Calculation of financial profitability of the project, measured at the market prices of resources and output.

Calculation of the net benefit of project measured in terms of economic prices. Some resources are priced at international prices and for others shadow prices are considered.

Adjustment for the impact of the project on saving and investment.

Adjustment for the impact of project on income distribution.

Adjustment for the impact of project on merit goods and demerit goods whose social value differ from their economic values.

i. Financial Analysis -: to judge a project from the financial angle, we need following information.

Cost of the project

Means of financing

Estimates of sales and production

Cost of production

Working capital requirement and its financing

Estimates of working results (profitability projections)

Break even point

Projected cash flow statements

Projected balance sheets

Cost of project -: represent the sum of all items of outlays associated with a project, which are supported by long term funds. It is the sum total of following:

Land and site development

Building and civil work

Plant and machinery

Technical know-how and engineering fees

Expenses on foreign technicians abroad

Miscellaneous fixed asset

Preliminary and capital issue expenses

Pre-operative expenses

Provisions of contingencies

Margin money of working capital

Initial cash losses

Means of financing -: to meet the cost of the project; the following sources of finances may be available -:

Share capital (equity and preference share capital)

Term loan (rupee term loan and foreign currency loans)

Debenture capital

Deferred credit

Incentive sources (seed capital, capital subsidy etc )

Tax deferment

Miscellaneous sources (unsecured loans, public deposits)

Estimates of sales and production -: the starting point for profitability projection is the forecast of sales revenues. In estimating sales it is reasonable to assume that capacity utilisation will be somewhat low in the first year and rise thereafter gradually to reach the maximum level in the third and fourth year of operation.

Cost of production -: the major components of cost of production are -:

Material cost

Labour cost

Factory overhead cost

Working capital requirement and its financing -: to estimate the working capital requirement and planning for its financing, the following points must be borne in mind -:

The built of current assets till the rated level of capacity utilisation is reached.

The maximum permissible bank finance.

Margin requirement against various current assets.

Profitability projections -: the profitability projections are based on the following lines :

Cost of production

Total administrative expenses

Total sales expenses

Royalty and know-how payable

Total cost of production

Expected sales

Gross profit

Other incomes

Preliminary expenses written off

P & L before tax

Provision for taxation

PAT

Dividend

Retained profits

Net cash accrual

Break even point -: it is a point at which the project neither make profit nor incur losses it is calculated as follow

Fixed cost

________________________________________

Unit selling price unit variable cost

The cash flow statement shows the movement of cash into and out of the firm and its net impact on the cash balances of the firm.

The balance sheet, showing the balances in various assets means liability accounts, reflects the financial condition of the firm.

ii. Net benefit in terms of economic prices

Stage two is concerned with determination of economic prices also referred as shadow prices. A key issue in shadow pricing is that in what unit the input or output is expressed i.e. in what unit of currency should benefit or cost be expressed, whether the cost and benefit should be valued at current or constant prices. Shadow price is also known as hidden price, a price that is hidden under monetary cost and benefits.

Another issue in shadow pricing is whether a good is tradable or not. For a traded good the shadow price is the border price translated in the domestic currency at market exchange rate. The shadow price in case of non-tradable good is consumer willingness to pay or cost of production depending on the impact of the project on the rest of the economy.

Regarding taxes, the UNIDO approach says that if a project result in diversion of non- traded input from the producer or addition of non-traded input, taxes should be included. If a project augment domestic production by other producers, taxes should be excluded and for fully traded goods taxes should be ignored.

Sources of shadow pricing

Basis of valuation

Increase/decrease total consumption

Consumer willingness to pay

Increase /decrease total production

Cost of production

Increase/decrease export or imports

Foreign exchange value

Shadow pricing for specific resources

Tradable input and output -: a good is fully traded if its domestic changes in demand or supply affect just the level of import or export. For a good being tradable the following condition should be met-:

The import quota, if any should not be restrictive.

The import supply should be perfectly elastic.

There is no surplus capacity in the domestic industry.

If, additional demand exist inland, the imported goods even after taking into account the cost of transport from port to the point of inland demand should be less than the marginal cost of local production.

The imported input cost should be less than the domestic marginal cost of purchase.

Non tradable inputs and outputs -: a good is non-tradable if following conditions are satisfied -:

If its CIF prices is greater than its domestic cost of production.

Its FOB price is less than its domestic cost of production.

For traded goods the shadow price border price translated in domestic currency, at market exchange rate.

For non-traded goods the shadow price is measured in terms of consumer willingness to pay or cost of production, depending on the impact of project on the rest of the economy.

Externalities -: since SCBA seeks to consider all cost and benefits, to whomsoever they may accrue external effects should also be taken into account. The valuation of external effects is rather difficult because they are often intangible in nature and there is no market price, which can be used as a starting point.

Labour inputs -: the principle of shadow pricing may be applied to labour as well, though labour is considered to be services. When a project takes away labour from other employment, the shadow pricing of labour is equal to what other user of labour are willing to pay.The shadow prices associated with inducing additional production of workers consist of the marginal product of labour in previous employment plus certain other costs.

The social cost of associated with import of foreign labour is the wage they command. However, a premium should added on account of foreign exchange remitted abroad by these workers from their savings.

Capital input -: the shadow pricing in case of capital investment involves -:

What is the value of physical assets?

What is the opportunity cost of capital?

The value of physical assets is determined the way values of other resources are calculated.

The opportunity cost of capital depends on how the capital requir