Preparing a Feasibility Study

Expectations

• What kind of project ?

(R&D, Commercial, Profit non-profit)

• What to expect?

• What will I learn?

• How Can I use it?

• Where do I go from here?

• Applications in my field or line of work?

• Think of a project now that you can apply all these concepts to.

Outline & Schedule

• Introduction to Conducting a Feasibility Study/A Cost Benefit Analysis and its

Components

• The Environmental Study

• The Market Study

• The Technical Study

• Introduction to Financial and Economic Study

• Sensitivity Analysis

• Competitiveness in Business & Business Planning

• Case Study – Water Bottling Company

Feasibility Study

Introduction

“Man Never Plans to Fail, He Only Fails to Plan.”

• Why is it important to conduct an economic assessment (also called a feasibility study or a

cost/benefit analysis) prior to investing in a project?

• What are the ‘bad’ things that can happen to businesses that do not undertake a feasibility

study?

• What are the critical components of a feasibility study?

• Who requires a feasibility study/who is my audience?

• What is the difference between a feasibility study conducted for the private sector and for the

public sector? (Sectors: services, industry and infrastructure).

Definition: Feasibility Study

• A feasibility study is a controlled process for identifying problems, opportunities; determining

objectives, describing current situations and successful outcomes, and assessing the range of

costs and benefits associated with several alternatives for solving a problem .In other words, it

is the initial justification needed to determine or discover if a project is “ do-able”.

What is in a Feasibility Study?

• What Should a Feasibility Study (also called Cost/benefit Study/Analysis, CB Study) include?

• Checklist

• Description of the business/project

• The Environmental Analysis

• The Market Study/Analysis * (50%)

• The Technical Analysis (20%)

• The Financial Analysis (20%)

• **Sensitivity Analysis (10%)

• Projections (3-5 years)

• The Economic Analysis

• (socio-economic and commercial)

• The Final Report that determines the feasibility or lack thereof to your client/investor

• * Most critical phase of the study

• Many feasibility studies are conducted partially, where for example, the market study is avoided

completely because the sole buyer is guaranteed. This is referred to as a “Take-Off Agreement”.

• COMFAR II or III, UNIDO Product – Computer Model for Feasibility Analysis and Reporting.

• Sensitivity Analysis gives you depth in understanding the project and alerts the investor to issues

that surround the project and to the affect of changes that may occur in a number of variables.

Make new assumptions, decrease sales by a certain percentages, increase investment. In other

words, play with the numbers and the assumptions to discover the points at which the project is

at risk and in danger of being feasible and profitable.

• Does the business or project warrant further investment of time, money and further study, or is

it a non-starter?

• Note: That a F.S needs to be updated periodically.

The Workings of a Feasibility Study

• For a feasibility study, basic data is acquired from the client through a series of queries,

questions and meetings, wherein the client provides some of the research and other data and

facts to be gained from a variety of sources.

• The typical feasibility study contains, among other items, notes on financial projections, a

general description of the business, general details describing how the company or project will

be formed, managed and marketed, statements concerning the competition and a cash flow

projection based on averages.

A Feasibility Study (FS) should answer 5 pivotal questions:

• 1. Will the project/business work or not?

• 2. Is it profitable or not?

• 3. What will it cost to fund or start?

• 4. Is it worth doing?

• 5. Is it worth commissioning a business plan?

• Most studies are aborted at the Marketability stage. Investors discover that benefits will not be

actualized.

Background Information We Should Know

• The subject of feasibility studies is a very broad subject area that is applied in all fields that you

can possibility fathom. Applications and utility range from making a personal decision like

purchasing a home to building a hospital or adding new technology to your business. For the

most part, the area of feasibility study research is mostly tailored toward “small businesses”.

• The subject of feasibility studies is closely related to 2 other topics that will discuss briefly in this

course: Business Planning and Project Management.

• A small business has a 30% - 50% survival rate during the first 5 years of operation.

On-Going Feasibility Study

• What is the difference between a feasibility study and an on-going feasibility study?

• A feasibility study, the kind that we have been talking about is about a new idea, product, or

project and is hence built on assumptions about the anticipated project derived from similar

experiences or expectations.

• An on-going feasibility study of a project is based on real numbers and figures, not assumptions.

It is about revising the current status of the project and enhancing its performance and its

output.

The Environmental Study

• Consider this part of the study as a general, descriptive, explorative outlook to get a bird’s eye

view of the project and its outputs.

• A simplified environmental study of your project will show the following environmental factors:

• If your project will have adverse affects on the environment. E.g. If it is an industrial project,

pollution may be an externality. What level of pollution is acceptable legally, and socially?

• Socioeconomic acceptability of the project.

• Religious, ideological, cultural,…. Acceptability of the project.

• Is it offensive to any specific segment of society?

• Is it an important project for the nation?

• Social benefit-cost analysis and national economic profitability.

General Environment

• Environmental study is where the non-financial factors of the study are presented and factored

in to the study. Consider it a general, pre-feasibility or pilot study.

• The environmental study may be split into 2 parts:

• Are the outputs of the project socially acceptable?

• Will cultural, religious or any other social norms reject the project or product?

• Is the market ready for the product? Is it appropriate technologically, and in principle? Is it

suitably fitted to the educational attainment of that society?

• Is local labor available?

Socio-Economic

Study

Environment

al Study

Financial

Study

Market

Study

Technical

Study

• Legal issues related to the project?

• Is funding available?

• Are raw materials available locally?

• What about the sociopolitical setting? (

• This is especially important to foreign investors and locals alike, - sequestrations,

nationalizations

Specific Environment

• Is the product monopolized in the market?

• Is competition internal or external?

• Are there any price ceilings (by govt.) or do supply and demand forces set prices?

• Are there similar projects in the market?

• Will they affect pricing?

• Who are your clients?

Results of the Environmental Study?

• Should the project idea be revised or modified?

• Is the preliminary information encouraging to go ahead with the project or more in depth study

is required?

The Market Study

• Introduction

The market study, whether it be for a product or a service will determine what is already available in the

market and what is required. Most importantly it will determine the size of demand. This is why this is

the initiation point of the feasibility study. This is where we acquire our initial figures and hence the

entire feasibility is built on this point. Subsequent steps will be based on these ground blocks, which

hence require prudence.

Market Study Determines:

• Physical attributes of the product that include size, exterior dimensions, shape

• Channels of distribution

• End-users

• Competitors, whether internal or external

• Pricing

• Determination of risk and

• Recommendation of the optimal marketing strategy

Data Constraints

• Acquiring data is often a problem, especially with respect to the competitive analysis where

competitors will not disclose their prices, agents, suppliers….., in which case, potential investors

need to rely on more inventive methods for data acquisition

• Hence it becomes very difficult to know your competition and one has to rely on:

• Statistical Publications,

• Estimations and Forecasts, and

• Market Intelligence.

• Size of demand in the market for the proposed product or service, sources of D, how does D

occur ?

• Existing suppliers

• Nature of the competition

• Forecasts with respect to the size of demand, prices, and supply.

To Conduct a Market Study You Need:

– A detailed description of the product or service that is to be marketed.

– Sometimes, the analyst needs to help the investor define these parameters). This step is

very important and affects the technical and financial study – revenue definition .

– The availability of qualified experts to conduct the study.

The Importance of the Market Study

• It is arguably the most important part of a feasibility study. This is because it forms the basis for

the rest of the study, since this is where the SIZE OF DEMAND IS DETERMINED.

– It typically consumes 50% of the time,

– And 50% of the funds/costs allocated to the study.

• Information on REVENUES needs to be fed into your financial study.

• It has been the case in many LDC (less developed countries) that the Technical Study was

considered of paramount importance, for a number of reasons:

Supply and Demand

• Markets in these countries are immature and unsaturated and are in need of any new

projects/products/services.

• Lack of state of the art technologies, hence the hope of technology transfer, that these

economies will later internalize and develop further.

• Lack of adequate data to conduct a market study effectively.

Data

• The market analyst is the only person in a position to decide on the sufficiency and adequacy of

the data available, based on how it will be used .

Market Analysis

Will address the following issues:

• Is it a homogenous or a heterogeneous market?

• What is the time frame for the study?

• How much funds are available for the market study?

• What kind of product will be marketed and what is the required level of detail on it?

Type of Data

• 2 types of data are used in a market study :

• Primary Data (published, reliable and official)

• Secondary Data (acquired from the market/field research, if accurate, it is extremely useful).

• Analysts will usually seek secondary data first, and will later seek primary data when the former

proves insufficient. However, it is important to note that both forms of data are important and

complement each other .

Secondary Data

May include the following :

• Population statistics (available in Kuwait since 1965)

• Exchange rates (CBK)

• Interest Rates (CBK)

• GNP, GDP

• Rates of Consumption

• Export/Import Statistics (External Trade, the best form)

• Others

• The market analyst must be very well-versed and experienced with the local market and with

market information .

Problems with Secondary Data

Especially in developing countries :

• Inaccuracy.

• Short time series.

• Insufficiency or lack thereof altogether of direct data related to the project target.

• Outdated data that sometimes cannot be updated.

Resorting to Primary Data

• Questionnaires – (example in the appendix(

• Test for 3 kinds of information:

• Facts.

• Opinions.

• Preferences / motivations.

• Direct and Indirect questions.

• Open and closed questions (these tools are later collected, analyzed and used for cross-

referencing and asking questions in various ways to correlate the answers. E.g. Income vs.

spending questions. (E.g. choosing a car, local vs. imported).

• Closed Questions include questions about age, monthly income, level of education, social status,

there is no room for opinion.

• After gathering the data the analyst will.

• Describe the product in general.

Determining the Previous and Present Size of Demand

• State the previous and present price of the product/service.

• Determine the present level of supply for this product and its substitute.

• Identify the present suppliers, agents and /or distributor.

• Determine the nature of the product, is it a consumer product, an industrial product, is it new or

old?

• Are there any barriers to entry?

Factors that Influence Demand

– The number of competitors in the market and the level of competition.

– Technical and Pricing factors that distinguish this product from other substitutes.

– Elasticity of Demand: Is the product income related or is it a basic product that will be

purchased regardless of income.

– Is income the determining factor whether this product will be brought, at least at break

even levels or not ?

– Basic vs. Luxury.

The Marketability Study

• The main objective of the market study is to show evidence that there is a reasonable

opportunity to market and sell the proposed product or service in acceptable quantities to the

investor, and that enable the project to remain on track in the long run with profitability.

• Acceptable Quantities: Quantities that will equal or exceed other investments that would have

consumed the same resources.

• I.e .Opportunity Cost

Outputs of the Market Study

• Determination of the difference between the current supply and demand in the market for the

proposed product and for substitutes.

• Productivity and how to increase it.

• Target Prices in the market and how to develop them .

• A forecast of the supply and demand and prices for the next 5 years .

• Recommend a strategy.

Study Requirements

• Abundant, up-to-date market data.

• A market analyst that is trained and experienced sufficiently in data analysis and running the

appropriate forecasting techniques.

Study Requirements

• Abundant, up-to-date market data.

• A market analyst that is trained and experienced sufficiently in data analysis and running the

appropriate forecasting techniques.

The Importance of the Study

• It is considered the cornerstone of the F.S, why?

• It identifies marketing opportunities for the product or service at hand.

• It determines the size of demand.

• Which will help determine the production capacity required?

• Based on that the appropriate technical methodology for production will be decided upon.

• Production and sales plan will be devised.

• Physical and technical attributes of the product will be agreed upon in light of current prices and

the production strategy .

• After determining the lines of production and the technology/know how that will be used,

REVENUES are ESTIMATED and hence this initiates and is in effect, the input for the financial

study, which will make the decisive decision as to whether this project is FEASIBLE OR NOT .

• IRR, NPV, Break even point.

Cornerstones of the Marketing Study

The team that is preparing the feasibility study or the analyst must decide on a number of things:

• Identify the market or markets that you will market your products in.

• Characteristics of your market (geographical, legal, investment climate, commercial climate,

economic climate, demographics, infrastructure, financial structure,…….)

• Characteristics and sources of supply for substitute products.

• Demand, and what affects it.

• Analysis of previous, current and future demand.

• Profile of consumers.

• Price structure.

• Competition.

• The development of supply and demand and the price structure.

Determining the Size of Demand

• Definition: Schedule of quantities of a good that will be bought at various prices.

• Extensively, demand may be defined as the quantity of a good or service that people want to

buy. The demand function relates demand to the factors determining it, which include

customers’ incomes, the good’s own price, and the prices of competing goods and of other

goods in general; factors affecting the demand of individuals, for example, their family

circumstances; and factors affecting demand at particular times, for example, weather

conditions. The demand curve relates demand for a good to its own price, holding all other

factors constant.

• Price elasticity of demand is the proportional increase in quantity demanded divided by the

proportional reduction in price.

• Income elasticity of demand is the proportional increase in quantity demanded at a given price

divided by the proportional rise in income.

• Aggregate demand is the total demand for goods and services in the economy.

• Effective demand is what is actually demanded, as contrasted with,

• Nominal demand which is what people would demand if all markets were in equilibrium.

• So, demand, in other words, is the quantity demanded of a particular product or service to users

in a market, and it is also demand that may be created for a new product or service where new

uses have arisen, whether it be for its technical superiority, price effectiveness, and hence

consumers prefer it.

Estimating Demand - Directly

• Import – Export = Apparent Consumption

• Approaches differ from study to study, based on the nature and size of the project. For small

industrial projects, analysts may make use of official statistics about the product to be produced,

especially those related to imports and exports. It is through tracking the discrepancy between

imports and exports of a particular product in the previous years, apparent demand is

estimated.

• Apparent Demand + Domestic Production = Aggregate Demand

Estimating Demand - Indirectly

• When conducting a market study about a product where reliable information, data and statistics

is unavailable, one may resort to the following methods:

• Correlating data with an already existing product that has reliable, credible data on it.

(Cross-referencing)

• E.g. I want to market water faucets but I cannot find any direct stats. on this specific product,

however, I can form an indirect relationship or correlation between faucets and boilers and rely

on the data that is available for water boilers or licensing from the Ministry of Public Works.

• Using surveys to forecast annual demand for a product by distributing surveys to shops

that sell ,.e.g. water coolers and calculating the total of all stores that sell this product OR

/ surveying a sample group of consumers and calculating how many coolers were

produced within a specific period OR/ monitoring purchasing patterns in outlets. A field

survey and evaluating what has been sold over a 2 week period, taking into account

seasonal influences.

Forecasting

Three main methods are popularly used :

• Quantitative Techniques

• Time Series Analysis

• Causal Models

Quantitative Techniques

This includes :

• Surveys

• Estimations

• Market Research

• Historical Correlation

• OLS

• World Bank Approach,

• Weighted Average, and many others.

• These methods are especially useful in cases when data is deficient about your product or when

a product is newly introduced in the market.

Competition Analysis

• Competition analysis is a very important part of the study, because it helps the analyst or the

investor form a good idea about the size of market share that their product will be able to

claim .However, this part of the study is usually challenged by poor, inaccurate and incredible

data, especially in LDCs. However, the core data that is required to conduct the competitiveness

analysis includes the following:

• The number and names of your competitors.

• The productive capacity of each competitor.

• Potential for their future expansion,

• Possibilities of new market entrants/producers/competitors,

• Prices and quality of the competitors’ product(s).

• The market analyst must also be interested in the current status of the competition in the

market, at the time of the onset of the project and five years into the project. This will aid

him/her in determining the project’s productive capacity (minimum and maximum) and enable

him/her to make recommendations as to graduating levels of production, in light of the size of

demand and the competition.

• This part of the study may reveal the project’s expected market share, however, analysts must

be careful when making such estimates, so that their numbers are not over-optimistic and

hence over-estimated, which will exaggerate sales and revenues, and all of the other financial

indicators will follow suit.

• Conservative estimates are always safe.

• Do not be over-optimistic.

• Hate the project, then do the market study.

• Start with a pessimistic, worst case scenario.

Market Overview

• Gives a brief picture of the market.

• Segmentation of the market (dividing it into homogenous groups of customers that have

common characteristics for marketing exploitation).

• Summarize the key characteristics of the market

– Major products, markets (or segments), which are likely to provide the business

opportunities suitable for the organization.

– How are they changing? Growth Vs. decline

– Brief description of what is happening in the market (present this thoroughly by using

bar charts, pie charts…..)

At the end of the study, the following should be accomplished:

– The physical and technical characteristics of the product must be well-defined.

– Determine production capacity and how to develop it.

– Target prices and how to develop them.

– Recommend a marketing strategy.

SWOT Analysis

• SWOT Analysis is a very effective way of identifying your Strengths and Weaknesses, and of

examining the Opportunities and Threats you face. Carrying out an analysis using the SWOT

framework helps you to focus your activities into areas where you are strong and where the

greatest opportunities lie.

Strengths

• What advantages do you have?

• What do you do well?

• What relevant resources do you have access to?

• What do other people see as your strengths?

Weaknesses

• What could you improve?

• What do you do badly?

• What should you avoid?

Opportunities

• Where are the good opportunities facing you?

• What are the interesting trends you are aware of?

Useful opportunities can come from such things as:

• Changes in technology and markets on both a broad and narrow scale

• Changes in government policy related to your field

• Changes in social patterns, population profiles, lifestyle changes, etc.

• Local Events

Threats

• What obstacles do you face?

• What is your competition doing?

• Are the required specifications for your job, products or services changing?

• Is changing technology threatening your position?

• Do you have bad debt or cash-flow problems?

• Could any of your weaknesses seriously threaten your business?

• Carrying out this analysis will often be illuminating - both in terms of pointing out what needs to

be done, and in putting problems into perspective.

• You can also apply SWOT analysis to your competitors. This may produce some

interesting insights!

• What are the differential S +W versus the competition?

• What is your niche, why will customers differentiate you?

• Identify the Critical Success Factors

• Factors that determine success = performance, breadth of services, speed of services, low costs

and so on .

• Provide Summary of Performance

• Bird’s eye view of total marketing activities.

– Last 3 years’ volume/turnover, gross profit……

– Summary for reasons for good and poor performance.

– Summary of financial projections to show financial implications over the full year’s

planning period.

– Marketing objectives should be quantitative and should be expressed where possible, in

terms of:

• Value

• Volume

• market Share

Business Directions

• Enter

• Improve

• Maintain (aggressive strategies required – at niche)

• Harvest (reduce various aspects of the business to stress others)

• Exit (Divest due to weak competitive position / cost of staying is too prohibitive)

• Commercial Growth

• Change is inevitable, hence commercial growth may emanate from two fronts:

– Product Development

– Market Development

• Marketing objectives are concerned with:

• Selling existing products and existing segments.

• Developing new products for existing segments.

• Extending existing products to new segments.

• Developing new products/new needs; creating new markets.

Market Objectives

• Market penetration.

• The introduction of new products to existing markets.

• The introduction of existing products to new markets. (International and domestic)

• The introduction of new products to new markets.

Market Strategies

• Change product design, performance, quality and features.

• Change advertising / promotion.

• Change unit price.

• Change delivery or distribution.

• Change service levels.

• Improve marketing productivity (ie. improve sales mix)

• Improve administrative productivity.

• Consolidate product line.

• Withdraw from markets.

• Consolidate distribution.

• Standardize design.

• Acquire markets, products and facilities.

In a Capstone, this is the Output of your Market Study:

• Demand (for the life of the project)

• Size of Demand (based on domestic production)

• Prices

• Exports and Imports

• Net Domestic Consumption

• Current Prices for this product in the market or for substitutes

• % of sales in the market

• Market Share

• Revenue/Income

• Studies will differ based on the size of the project, the type of project, whether industrial, real-

estate, commercial…, each product or service has its own idiosyncrasies and hence different

factors may require a different level of attention and depth of study, based on the market in

which they will be marketed and operate .

• Hence, the credibility and accuracy of the market study will always depend on these factors

along with the level of care that was given to the data, in its collection and treatment .

The Technical Study

Outline of the Technical Study

• After confirmation that there is a market for the product that you wish to sell, determining the

current and future demand, determining the size of demand and the descriptive and technical

attributes of the product, the technical study can do the following ;

• Determine the required line of production.

• And hence the machinery that is required.

• Sourcing of the raw materials and machinery, hard ware required.

• Determining the physical and technical attributes of the product.

• Engineers set plant capacity, designs, building designs, etc..

• Resources are identified, in terms of assets, physical capital,…

• Cost of the factory, plant, capital is determined, operating expenses, and maintenance and raw

materials are also determined.

• Annual production capacity, production plan and quantities to be produced are also determined

here in the technical study, based on sales forecasts.

• 2 types of capacities: name plate capacity (or design capacity) and permissible capacity.

• Permissible Capacity: is the productive capacity that is achievable under standard conditions,

taking in to consideration not only machinery and technical operating conditions but also

managerial style .

• Maximum Name Plate Capacity: is the production capacity that is technically achievable

according to the machinery and facilities in place .Maximum name plate capacity may be

considered a benchmark with which to operating efficiency is measured throughout its

productive life .

• standard measure of a project’s productive capacity = 8 hour work days, 300 days per year.

– Note that some factories operate eternally 24 hours, 365 days a year, without

shutdowns, 15 days is usually accounted for spare/security, so 350 days per year.

Choosing the Line of Production

• After having decided on the design of the product, the productive capacity and the technical

characteristics of the product, companies specialized in manufacturing machines are sourced to

fit the production line required. Companies then submit their financial and technical offers, bids.

These offers are then compared technically and financially and the best one is chosen.

• It is best at this point to consult with your financial experts and with your technicians when

making this choice.

• The technical study will also cover the following:

• An estimation of the investment costs that are required to complete the project is carried out

here. It includes:

• Fixed assets

• Buildings

• Cost of machinery + cost of freight and port costs + transportation to the factory/project site,

• Any related tasks that include electrical set ups, mechanical or civil works.

• Cost of any preparations undertaken at the project’s site.

• Cost of buildings and construction.

• Cost of engineering consulting services.

• Furniture

• Cars.

Production Costs

• Based on the type and the nature of the line of production chosen for the project, the analyst

will estimate the factory’s annual needs of:

• Direct Labor

• Indirect labor (secretary, accountants, management – unrelated to direct production)

• Marketing costs

• Public utilities (Electricity, Gas, water,…..)

• Raw materials in light of the expected production capacity

• Training

• Interest

• Depreciation $ from here is included as liquidity for the plant; can go to profits for

reinvestment.

• Any other costs that may be incurred in the process of production.

Pre-operating Expenses

• Patents

• Licensing Costs

• Studies, like feasibilities

• Visits

• Govt. Fees,

• Interest on loans before operating the plant.

Easing into Financials

• Many concepts used to conduct a feasibility study will appear in different parts of the study and

may be conducted in different parts of the study.

• Break Even analysis, for example, may be conducted here in the market study or in the

economic study. Both cases are acceptable. For the purposes of this course, it shall be discussed

in the market study section of the course.

Break-Even Analysis

• Break even analysis looks at the effects or probability of changes in the project's cost, volume of

output and selling price . It is used to determine the lowest production and/ or sales levels at

which the project can operate without impairing its viability. The technique is also useful for

profit planning and decisions on pricing and production capacity .

• The analyst segregates the project's costs into the projects cost into the fixed elements, which

are independent of the volume of production, and the variable elements, which change with the

volume of production.

The Break-Even Point

• The analyst estimates the volume of output at which sale revenues equals total cost (break-even

point).

• The analyst also compares break even sales with the project's production levels until it reaches

steady state , to determine whether profits or losses will be incurred in the early years .

Expected output during theses years can be expressed as a percentage of the breakeven.

• The use of break-even analysis as a tool is recommended in the feasibility study, but the analyst

should note its limitations.

Limitations

• Fixed costs are not indefinitely constant . They may become variable at a certain volume.

• It is not always easy to divide costs neatly into fixed and variable components.

(Costs, Revenues) $

Profit Area

Loss Area

Breakeven point

(Production, Selling Levels) units

Total Cost

(TC)

Total Revenue (TR)

Fixed Cost Line

Fixed Cost

Variable Cost

• Selling prices may change when a large volume of sales is made.

• Production and sales volume may not always be equal.

• Multi- product output may add complications to break-even analysis.

Assumptions of Break-Even Analysis

• Costs can be reasonably arranged into fixed and variable components.

• All cost-volume-profit relationships are linear.

• Sales prices will not change in volume.

Calculating the Break-Even Point

• Once the analyst has identified prices and variable cost per unit, he should calculate the

breakeven point, where sales revenues equal the total of fixed and variable costs. These

allow a measurement of the breakeven point as a specific level of sales volume. The

break-even point may also be defined as that point at which fixed cost equal variable

margin (sales less variable cost). • To calculate the breakeven point the analyst needs to have the following data that we have

discussed them such as :

• Unit estimated Selling Price .($/unit)…….Market Study.

• Variable Cost .($/unit )…………………..Cost Analysis.

• Fixed Cost .($/year)……………………... Cost Analysis.

• So breakeven point indicates the production level where total revenue equals total cost as

follow:

• Total Revenue (TR ( = Total cost (TC (

• =Fixed Cost + Variable Cost

• Production Level * Unit Price = Fixed Cost + Variable Cost

• Let us assume that Production level which must be produced to equilibrate the total cost

with total revenues is X and variable cost equals to Production Level times Variable cost per

unit, then Break-even Point in units is :

Fixed Cost

• X = Unit Selling Price – Unit Variable Cost

• Break even point in dollars )$( using the X Production level is :

• X

Y =Annual Fixed Cost –Variable Cost

Financial & Economic Feasibility

Once your analyses of environmental, marketing and technical have been completed, the next step of a

feasibility analysis is to take a look at key financial and economic issues.

Total Capital Requirements And Financial Needs:

The Basics

Financial & Economic Feasibility

Total capital requirements

• Assess the capital needs of the business project and how these needs will be met.

• Estimate initial investment needs and Start up costs (capital requirements for facilities,

equipment and inventories)

• Estimate working capital needs.

Financial & Economic Feasibility

Initial Investment

This is the investment made at the beginning of the project. The value is usually negative, since most

projects involve an initial cash outflow. The initial investment can include licensing fees and startup

costs.

Financial & Economic Feasibility

Working Capital =

Current Assets – Current Liabilities

Working capital measures how much in liquid assets a company must have to build its business. It also a

measure of both a company's efficiency and its short-term financial health . Working capital is the

amount of money that a company has tied up in funding its day to day operations

Financial & Economic Feasibility

Current assets are those assets that are expected to be used (sold or consumed) within a year, unlike

fixed assets. Current assets are shown on the balance sheet, and are listed in order of increasing liquidity

(i.e. how easy they are to convert to cash) .

The current asset position of a company is important, both for assessing its financial strength

financial position and for gauging its operational efficiency. Current Assets as Cash, Account Receivables

and Inventory

Financial & Economic Feasibility

Current liabilities are the liabilities that are to be settled in less than a year (including debt repayable

on demand such as overdrafts). Current liabilities are one of the major groups of items on the balance

sheet.

Current liabilities are very important in gauging a company's financial health as the company needs

to have the money to meet these commitments in the short term.

Financial Needs

• Identify the Sources of Financing, the project is either internally financed (self financed) or

externally financed.

• Assess alternative sources for financing; banks, government (i.e. direct loans or loan

guarantees), grants, local and state economic development incentives.

• Assess expected financing needs and alternative sources; what are the interest rates, terms,

conditions, etc.

• Establish debt-to-equity levels.

“Indicators”

There are endless financial and economic indicators that can be developed and derived, based on the

needs of tour particular project. We will identify the most important and critical ones.

Important Financial and Economic Indicators

• Internal Rate of Return - IRR

• Return on Investment – ROI

• Break-Even Point – BEP

• Break – Even Sales

• Net Profit

• Industrial Profit

• Net Present Value – NPV

• Future Value - FV

• Pay Back Period

• Percentage of Profit to Investment

• Percentage of Salaries to Total Cost of Production (TCOP)

• Percentage of Raw Materials to TCOP

Profitability Indicators

• Return on sales Indicators

• Return on Assets Indicators

• Return on Equity Indicators

Income Indicators

• Net Income to Sales

• Net Income to Total Assets

• Net Income to Total Equity

Operating Efficiency Indicators

• Actual Sales to Maximum Sale

• Capital Investment Indicators:

• Capital Expenditure to Sales

• Capital Expenditure to Total Assets

• Capital Expenditure

Financial Planning (Expected Budget and Alternatives)

• Costs and revenue estimation. (variable and fixed)

• Estimate the profit margin and expected net profit.

• Estimate the break-even point.

• Estimate the returns under various scenarios with different levels of production, price and sales.

• Create a benchmark against industry averages and/or competitors (cost, margin, profits, ROI,

etc.).

• Determine project expected cash flow during the start-up period.

• Report the project’s financial statements, balance sheet when reaching full operation. Calculate

some financial ratios.

Revenue Projections

Revenue: Price per unit x Expected Sales

Estimate the sales or revenue that your business will generate annually. The sales estimation

was done in the marketing analysis .The following results of the market study will be used for revenues

estimation:

• The demand on the product or the service the project will provide which represents the annual

expected sales of the project.

• The Price of the product or service.

Financial Statement

• Financial statements (or financial reports) are formal records of a business' financial

activities. These statements provide an overview of a business' profitability and financial

condition in both short and long term. There are three basic financial statements: (Three

to Five years highlight)

Financial Reports & Statements

• Balance Sheet: also referred to as statement of financial position or condition, reports on a

company's assets, liabilities and net equity as of a given point in time. Three years highlight

• Income Statement: also referred to as Profit or loss statement, reports on a company's results

of operations over a period of time.

• Balance Sheet: Income Statements and Cash flow can be used to perform many analyses, which

is called Ratio Analysis

10 Reasons Why Businesses Fail

– Undercapitalization

– Bad Cash Flow

– Inadequate Planning

– A Competitive Edge

– Mushy Marketing

– Inadequate Flexibility

– Ignoring the Next Step

– Forgetting there is no red ‘S’ on your chest

– Great boss, mediocre staff

– Uncontrolled Growth

Sensitivity Analysis

Estimate the returns and costs with different scenarios under various production, price and sales

levels and their impact on the net profit or return on capital.

For Example:

• Scenario 1 the production costs will increase/decrease 5 % yearly

• Scenario 2 the sales will increase/decrease by 2% per year

Strategic Planning and Management

• Strategic planning and management is the art and science of planning, formulating,

implementing and evaluating cross-functional decisions that will enable an organization to

achieve its objectives.

• This is the highest level of managerial activity ( job of the CEO)

• Provides overall direction of the organization.

• Strategic Management is composed of 3 components:

• 1. Situation analysis

• 2. Self evaluation

• 3. Competitor analysis

Competition

The rules of competition are embodied in

5 competitive forces:

(they determine industry profitability)

1. Entry of new competitors

2. Threat of substitutes

3. Bargaining power of buyers

4. Bargaining power of suppliers

5. Rivalry among existing competitors

Porter’s Theory

• The Theory of Competitive Advantage and it utility and application expounded to the world in

Michael Porter’s book in 1985:

Competitive Advantage: Creating and Sustaining Superior Performance

What is your Competitive Advantage

Evaluate your firm’s competitive position and implement the specific actions necessary to

improve it.

Sustaining Competitiveness

Includes the following strategies:

• Cost leadership.

• Understanding the behavior of costs and sustaining a cost advantage.

• Identifying value activities.

• Identifying what creates value for the buyer and hence differentiation.

• Defining the value chain.

• Linkages within the value chain.

• Identifying competitors and deciding on the market share and mix to optimize long term

profitability.

• Improving industry structure.

• Aiding market development.

Value Chain Analysis

• A high level model of how businesses receive raw materials as input, add value to the raw

materials through various processes, and sell finished products to customers.

• Value Chain analysis looks at every step a business goes through, from raw materials to the

eventual end-user. The goal is to deliver maximum value for the least possible total cost.

• Engaging in value-enhancing activities.

• Differentiation strategy (uniqueness).

• Eg. Diamond cutting

GAP Analysis

• Gap analysis is a business resource assessment tool enabling a company to compare its actual

performance with its potential performance.

• It is a formal study of what a business is doing currently and where it wants to go in the future. It

can be conducted, in different perspectives, as follows:

• Organization (e.g., human resources)

• Business direction

• Business processes

• Information technology

• This goal of the gap analysis is to identify the gap between the optimized allocation and

integration of the inputs and the current level of allocation.

• Important concepts related to Gap analysis include:

• Benchmarking

• Growth share mix

• PPF production possibilities frontier

• Existing usage

• Market potential

• Usage gap = market potential – existing usage

• Product Gap

• Competitive Gap

Business Planning and Competitiveness

• If a project is seen to be feasible the next logical step is to commission a business plan.

• A business plan is designed to plan in advance how a business or a project will be started,

implemented and managed; in short, a working ‘blue print’ of the entire business or

project.

• The Purpose of it :

• To provide a structured method to focus on problems, identify objectives, evaluate alternatives,

and aid in the selection of the best solution.

• To improve confidence that the recommended action is the most viable solution to the problem.

Marketing Section of a Business Plan

• What is your product or service?

• Who are your competitors?

• What is your competitive advantage?

• How will you determine your prices?

• What is your pricing objective?

• What are your pricing policies?

• What is your average markup or gross margin?

• Market Segmentation: How will you segment your target market?

• What is your ideal location?

• Is it retail or a service business?

• What promotional objectives do you have?

• What is your promotional budget?

• What types of advertising will be used?

• What about public relations and publicity?

Financial Section of a Business Plan

• How will the business be financed?

• Debt financing

• Bank loans

• Personal funds

• Private investors

• Partners

• Venture capital firms

• Stock sales

• The cost of financing

• Accounting methods

• Cash basis

• Accrual basis

• The balance sheet

• Projected income statement

• Break even point

• What is your break even point?

• Have you identified fixed and variable expenses?

• How many customers are needed to break even?

• Who will be your suppliers/ your distribution channels?

• Risks, Assumptions and Conclusions

• What are your uncontrollable risks?

• What are your assumptions and conclusions.

In Retrospect

• Let us go back and consider the projects we had in mind at the start of the workshop.

• Do you see things differently or with greater clarity now?

• Which areas do you think you need to focus on with greater depth depending on the type of

business, product or service you wish to launch?

• What are the areas that need greater and more sophisticated analysis?