Project managament and fianance

1. Unit 6 Project Financial Analysis Methods
Prepared by
Mr. Digvijay B Kanase
(Assistant Professor)
Department of Electrical Engineering
Annasaheb Dange College of Engineering and Technology

2. Content

3. Project Financial Analysis
• Financial analysis is the process of evaluating projects and other
finance-related transactions to determine their performance and
suitability.
• Typically, financial analysis is used to analyze whether an entity is
stable, solvent, liquid, or profitable enough to warrant a monetary
investment.

4. Investment Analysis
• Definition
• Investment analysis is defined as the process of evaluating an
investment for profitability and risk.
• It ultimately has the purpose of measuring how the
given investment is a good fit for a portfolio.
• Furthermore, it can range from a single bond in a personal portfolio,
to the investment of a startup business, and even large scale
corporate projects.

5. Need of Investment Analysis
• Investment Analysis is the method adopted by analysts to evaluate
the investment opportunities, profitability and its associated risks in
their portfolio. It helps them to determine whether the investment is
worth it or not.
• Investment analysis is essential because it helps you make informed
investment decisions that can minimize the risk of loss and increase
your return potential.

6. Break Even Point
• Break Even Analysis
• It implies that the total revenue equals the total cost at some point of
operation.
• Break Even Point
• It is where there will be neither profit nor loss.
• Break-even analysis tells you how many units of a product must be
sold to cover the fixed and variable costs of production.
• The break-even point is considered a measure of the margin of safety.

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Break-even analysis tells you how many units of a product must be sold to
cover the fixed and variable costs of production.

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• The linear plots of the total cost and total sales revenue are shown in
the figure.
• The intersection point of the above two lines is called break even
point and the corresponding quantity in the X axis is the break even
quantity.
• For any production quantity which is less than the break even
quantity the firm will make loss because total cost > total revenue.
• For any production quantity which is more than the break even
quantity the firm will make profit because total revenue > total cost.

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• Break Even Chart
• It shows the relation between costs and revenue at a given time.
• TC = Total Cost
• FC = Fixed Cost
• VC = Variable cost Q = Volume of Production s = selling price per unit v = variable cost per unit
• Total Cost = Fixed Cost + Variable cost
• TC = FC + vQ
• The total revenue (S) is given by S = sQ
• Profit = Sales – (Fixed Cost + Variable cost)
• = sQ – (FC + vQ)
• Break Even Quantity = Fixed Cost / (Selling price per unit - variable cost per unit) = FC / (s-v)

12. Role does financial analysis play in Project Management
• What role does financial analysis play in Project Management?
• According to Investopedia, financial analysis is a method used to
examine economic trends, set financial policies, construct long-term
business plans, and identify ideal companies or projects for
investment.

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• Financial analysis is conducted not just during the initial planning
phases of the project, but throughout the project lifecycle. Three
prominent stages in financial planning in project management
include:
• Creation of an estimate: Following a cost benefit analysis process,
which confirms the project’s viability, an estimate is created prior to
commencing the project. The estimate is determined on the basis of
various models including reserve analysis, time & materials analysis,
fixed price estimates and cost of quality analysis.

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• Supervision of project progress: Project managers need to be vigilant
regarding any deviations from the budget. Financial analysis allows
them to address any such deviations, by regularly comparing the
amount of money spent with the budgeted amount.
• Post-project analysis: Upon completion, a post-project financial
analysis is conducted, with the aim of determining how profitable the
project actually was.

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• Project financial analysis is what happens before a project is
approved, and is a way of making sure that the company is spending
its investments wisely by making smart choices about what projects
to take forward. Thorough analysis is important to ensure that you
don’t end up doing projects that lose money.

16. Investment analysis methods
• Following are the common financial metrics:
• NPV: NET PRESENT VALUE
• ROI: RETURN ON INVESTMENT (ROI)
• IRR: INTERNAL RATE OF RETURN (IRR)
• Payback period
• Time value of money

17. NET PRESENT VALUE (NPV)
• NPV is really useful, because it helps you work out project financials
as they relate to what money is worth today. A positive NPV is what
you are looking for: that translates as the project forecasts being
worth an amount that generates future cash at an acceptable rate.
• NPV targets, minimum rates and discount rates may be set as industry
standards or by your finance team, so check how if there are any
specific variables or values you are expected to consider in the
calculations (or better still, get a finance person to give you a
template where you just plug the project forecasts in and get the NPV
out). NPV is expressed as a financial value

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• Net Present Value (NPV)
• Net Present Value (NPV) is the difference between the present value of cash inflows and the
present value of cash outflows over a period of time.
• Net present value is a tool of Capital budgeting to analyze the profitability of a project or
investment. It is calculated by taking the difference between the present value of cash inflows
and present value of cash outflows over a period of time.
• Cash inflow is the money going into a business. That could be from sales, investments or
financing. Cash outflow, which is the money leaving the business. A business is considered healthy
if its cash inflow is greater than its cash outflow.
• Formula for NPV
• NPV = (Cash flows) / ( 1-r)^t – Initial Investment
• Cash flows= Cash flows in the time period
• r = Discount rate
• t = time period

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• Net present value (NPV). NPV shows the difference in the current
value of cash and the value that cash will have in the future, or the
sum of the present cash flow value (both positive and negative) for
each year associated with the investment, that is then discounted so
that it is expressed in today’s currency value. In project management,
this is used to calculate whether the expected profit of a project will
outweigh the present-day investment costs.

20. RETURN ON INVESTMENT (ROI)
• This measure relates to the project’s financial return given the
investment made to deliver the project. In the business case or
financial documents, it is expressed as a percentage of the total
anticipated project cost, often including the Year 1 to 5 opex or
running costs too, but the exact calculation will depend on the criteria
set by your finance team.
• ROI is a way to clarify what the business gets back from its
investment. Typically, the higher the ROI, the better, as it means that
the company is going to receive more income from the investment
and it will pay off in a better way.

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• Return on investment (ROI). This compares the profit value that can be
earned from a project against the cost of investment, as a percentage
value. The higher the percentage, the better the ROI
• Return on investment (ROI) is a financial metric that is widely used to
measure the probability of gaining a return from an investment.
• It is most commonly measured as net profit divided by the original capital
cost of the investment. The higher the ratio, the greater the benefit
earned.
• Formula for ROI
• ROI = Net profit / Cost of Investment * 100
• =%

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23. INTERNAL RATE OF RETURN (IRR)
• IRR refers to the amount the project ‘earns’ for the business. IRR is
expressed as a percentage, and relates to the efficiency of the investment.
• Let’s say you put your project budget in the bank and didn’t do the project.
Instead, you just claimed the interest that the bank paid on the money.
Your investment is safe, and you make some money back. But bank interest
rates are pretty rubbish for the most part.
• What if you did the project instead? The IRR calculation tells you what the
‘interest’ rate would be – it’s a different way of looking at the way project’s
generate return. If the IRR is better than what you’d get in a bank, then the
project is worth doing. If the IRR is less than what the bank could offer, you
may as well save your time and effort and put the cash in the bank –
assuming that financial returns are what you want to get.

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• Internal rate of return (IRR). The IRR method of financial analysis
factors in the time value of money, allowing the project manager to
find the interest rate that matches the expected financial returns
from the project. Once this rate is known, it can be compared against
rates that might be earned from investing elsewhere to determine if
this is a financially viable project

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• Internal Rate of Return (IRR)
• The internal rate of return is a metric used in financial analysis to estimate the
profitability of potential investments. The internal rate of return is a discount
rate that makes the net present value (NPV) of all cash flows equal to zero in a
discounted cash flow analysis.
• IRR is the annual rate of growth an investment is expected to generate.
• IRR is calculated using the same concept as NPV, except it sets the NPV equal to
zero.
• Internal rate of return is a method of calculating an investment’s rate of return.
The term internal refers to the fact that the calculation excludes external factors,
such as the risk-free rate, inflation, the cost of capital, or financial risk.
• IRR measures a rate of return as a percentage and NPV shows how much wealth
is created from a project in dollars.

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• Formula and Calculation for IRR
• The formula and calculation used to determine this figure is as
follows.

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28. PAYBACK PERIOD
• This measure relates to how long it takes before the project starts to
generate a return. On a programme, that could be before the end
(and I’d hope it would be) because individual projects should be
generating benefits as they complete.
• Nieto-Rodriguez talks about the duration of the payback period being
set by the organisation. Then if the project earns back the investment
before that time is up, it’s a worthwhile investment. If it’s going to
take longer than that, it’s time to think again. Typically, shorter
payback periods are better, as it means the project starts to earn back
more than it cost to do in a shorter time.

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• Payback Period
• Payback period is the time required to recover the initial cost of an
investment. It is the number of years it would take to get back the
initial investment made for a project. Therefore, as a technique of
capital budgeting, the payback period will be used to compare
projects and derive the number of years it takes to get back the initial
investment. The project with the least number of years usually is
selected.
• Payback period formula is as follows:
• Payback Period =Initial Investment / Net Cash Flow per Period
• Payback Time in years = Cost of project (Investment) / Annual cash
inflows

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• Payback period analysis. This is the simplest way of looking at one or
more project ideas, as it calculates how long it will take to earn back
the project capital. This is calculated as follows: Cost of project
divided by annual cash inflow equals payback period

31. Time Value of Money (TVM)
• Time Value of Money (TVM)
• Time value of money is the difference between an amount
of money in the present and that same amount of money in the
future. Having money now is more valuable than having money later.
• The present amount is called the present value, the future amount is
called the future value, and the appropriate rate that relates the two
amounts is called the discount rate.
• Present Value = Future Value / (1 + Discount Rate)
• Future Value = Present Value x (1 + Discount Rate)

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• There are four (4) variables that you need to know:
• Present value (PV) - This is your current starting amount. It is the money
you have in your hand at the present time, your initial investment for your
future.
• Future value (FV) - This is your ending amount at a point in time in the
future. It should be worth more than the present value, provided it is
earning interest and growing over time.
• The number of periods (N) - This is the timeline for your investment (or
debts). It is usually measured in years, but it could be any scale of time
such as quarterly, monthly, or even daily.
• Interest rate (I) - This is the growth rate of your money over the lifetime of
the investment. It is stated in a percentage value, such as 8% or .08.

33. Financial Statement Analysis
• Cash flow
• Balance sheet

34. Cash flow
Cash Flow
• Cash flow is the net amount of cash and cash-equivalents being
transferred into and out of a business.
• At the most fundamental level, a company’s ability to create value for
shareholders is determined by its ability to generate positive cash
flows, or more specifically, maximize long-term free cash flow (FCF).

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• Positive cash flow indicates that a company is adding to its cash reserves, allowing
it to reinvest in the company, pay out money to shareholders, or settle future
debt payments.
• Cash flow comes in three forms: operating, investing, and financing.
• Operating cash flow includes all cash generated by a company's main business
activities.
• Investing cash flow includes all purchases of capital assets and investments in
other business ventures.
• Financing cash flow includes all proceeds gained from issuing debt and equity as
well as payments made by the company.
• Free cash flow, a measure commonly used by analysts to assess a company's
profitability, represents the cash a company generates after accounting for cash
outflows to support operations and maintain its capital assets.

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• Uses of Cash Flow
• Cash Flow has many uses in both operating a business and in
performing financial analysis. In fact, it’s one of the most important
metrics in all of finance and accounting.
• The most common cash metrics and uses of CF are the following:
• Net Present Value – calculating the value of a business by building
a DCF Model (Discounted cash flow (DCF) ) and calculating the net
present value (NPV)
• Internal Rate of Return – determining the IRR an investor achieves for
making an investment

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• Liquidity – assessing how well a company can meet its short-term financial
obligations
• Cash Flow Yield – measuring how much cash a business generates per
share, relative to its share price, expressed as a percentage
• Cash Flow Per Share (CFPS) – cash from operating activities divided by the
number of shares outstanding
• P/CF Ratio – the price of a stock divided by the CFPS (see above),
sometimes used as an alternative to the Price-Earnings, or P/E, ratio
• Cash Conversion Ratio – the amount of time between when a business
pays for its inventory (cost of goods sold) and receives payment from its
customers is the cash conversion ratio

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• Funding Gap – a measure of the shortfall a company has to overcome
(how much more cash it needs)
• Dividend Payments – CF can be used to fund dividend payments to
investors
• Capital Expenditures – CF can also be used to fund reinvestment
and growth in the business

39. Balance sheet
• Balance sheet
• The balance sheet is a report of a company's financial worth in terms of
book value. It is broken into three parts to include a company’s
assets, liabilities, and shareholders' equity. Short-term assets such as cash
and accounts receivable can tell a lot about a company’s operational
efficiency. Liabilities include its expense arrangements and the debt capital
it is paying off. Shareholder’s equity includes details on equity capital
investments and retained earnings from periodic net income. The balance
sheet must balance with assets minus liabilities equaling shareholder’s
equity. The resulting shareholder’s equity is considered a company’s book
value. This value is an important performance metric that increases or
decreases with the financial activities of a company.
• Shareholder’s equity = Assets - Liabilities

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• The balance sheet is the core of the financial statements (the other
major financial statements are the income statement (statement of
comprehensive income), statement of changes in equity and
statement of cash flows). Unlike the other financial statements,
balance sheet is accurate only at one moment in time, not a period of
time.
• The balance sheet comprises assets (e.g. cash, inventory, etc.),
liabilities (e.g. debt, accounts payable, etc.) and equity (e.g. share
capital, retained earnings, reserves, etc.).

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• The Role of the Balance Sheet in Financial Statements
• For every business, there are three important financial statements you
should examine:
• The Balance Sheet tells investors how much money a company or
institution has (assets), how much it owes (liabilities), and what is left
when you net the two together (net worth, book value, or shareholder
equity).
• The Income Statement is a record of the company's profitability. It tells you
how much money a corporation made or lost.
• The Cash Flow Statement is a record of the actual changes in cash
compared to the income statement. It shows you where the cash was
brought in and where the cash was disbursed.