Download ch 4 financial study

Chapter (2)
1
FINANCIAL FEASIBILITY STUDY
Lecturer. Ahmed El Rawas
chapter content
1. Purpose and definition of financial study
2. Financial statements
3. Financial analysis
4. Appraisal methods
2
Lecturer. Ahmed El Rawas
(1)Purpose of a Financial Feasibility Study
 A financial feasibility study looks at how much cash
is needed, where it will come from, and how it will be
spent.
3
Lecturer. Ahmed El Rawas
What is a Financial Feasibility Study?
 A financial feasibility study is an assessment of the
financial aspects of something. If this case, for
starting and running a business. It considers many
things including
1. Expenses &Revenues.
2. Assets &liabilities
3. Cash in & cash out.
Other portions of a complete feasibility study will also
contribute data to your basic financial study.
4
Lecturer. Ahmed El Rawas
What is a Financial Feasibility Study?
 A financial feasibility study can focus on one
particular project or area, or on a group of projects
(such as advertising campaigns). However, for the
purpose of establishing a business or attracting
investors, you should include at least three key
things in your comprehensive financial feasibility
study:
1. Start-Up Capital Requirements,
2. Start-Up Capital Sources, and
3. Potential Returns for Investors.
Lecturer. Ahmed El Rawas
5
Start-Up Capital Requirements
 Start-up capital is simply how much cash you need to
start your business and keep it running until it is
self-sustaining. You should include enough capital
funds (cash, or access to cash) to run the business for
one to two years.
 Estimated budget should includes all the main
components of the project includes fixed assets such
land, buildingconstruction, equipment, furniture,
investment cost.
6
Lecturer. Ahmed El Rawas
Finding Start-Up Capital Funding Sources
( capital structure)
 Financing arrangement determine how the value of
the firm is sliced up, either by taking loans the
person or institutions that buy debt from the firm are
called creditors. Or through equity, The holders of
equity shares are called shareholders.
25%
Equity
Debt
75%
7
Lecturer. Ahmed El Rawas
This amount will be financed as
follows
Item
Owner's
equity
Long Term
Debt
Total
Amount in
L.E.
255,000,000
Percentage
130,000,000
33%
385,000,000
100%
Lecturer. Ahmed El Rawas
67%
8
Legal forms of organizing firms.
9
 Sole proprietorship: is a business owned by one
person
1. It is the cheapest business to form, few government
regulation.
2. Pays no corporate income taxes, all profit are taxed
as individual income.
3. Has unlimited liability.
4. The life is limited by the life of the sole proprietor
Lecturer. Ahmed El Rawas
Legal forms of organizing firms.
10
 Partnership: any two or more can get together and
form a partnership, there are two types of
partnership
1. General: the one who manage the business, has
unlimited liability for all dept, is terminated when a
general partner dies or withdraw.
2. Limited: do not participate in managing business,
the liability is usually limited to the contribution
each has made to the partnership.
 Inexpensive and easy to form, taxed as personal
income,
Lecturer. Ahmed El Rawas
Legal forms of organizing firms
11
 Corporation: it is a distinct legal entity
 There should be an article of incorporation includes
name, business purpose, number of shares
authorized to issue, nature of the rights granted to
shareholders, number of member in the BOD.
 Has unlimited life because it is separate from its
owners.
 Ownership can be transferred to new owners.
 Has limited liability.
Lecturer. Ahmed El Rawas
Requirements for establishing corporation
( IN EGYPT )
12
Capital must not be less than 500,000 LE.
2. the founders must own 10 % of the authorized
shares.
3. The shares authorized should not be less than 49%
to Egyptian citizens..
4. 25% from the par value must be paid at the time of
purchase and the rest of the amount should be in
installment. ( max period is 10 years from the
establishing data of the company.)
1.
Lecturer. Ahmed El Rawas
Potential Returns for Investors Feasibility
Study
 Investors can be a friends, family members, client,
partners, share holders, or investment institutions.
Any business or individual willing to give you cash
can be a potential investor. Investors give you money
with the understanding that they will receive
“returns” on their investment, that is, in addition to
the amount that is invested they will get a percentage
of profits.
13
Lecturer. Ahmed El Rawas
Potential Returns for Investors Feasibility
Study
 In order to entice investors you need to show how
your business will make profits, when it will begin to
make profits, how much profit it will make, and what
investors will gain from their investment. The
investment return section should offer both a
description of how investors will be involved and
discuss different variables that will affect the
profitability of your business, offering more than one
scenario.
14
Lecturer. Ahmed El Rawas
(2)Financial statements
 Financial statements provide an overview of a
business or person's financial condition in both short
and long term. All the relevant financial information
of a business enterprise, presented in a structured
manner and in a form easy to understand, are called
the financial statements. There are three basic
financial statements:
1. Balance sheet
2. Income statement
3. Statement of cash flow
15
Lecturer. Ahmed El Rawas
Purpose of financial statements

The objective of financial statements is to provide
information about the financial position,
performance and changes in financial position of
an enterprise that is useful to a wide range of users
in making economic decisions."Financial
statements should be understandable, relevant,
reliable and comparable. Reported assets, liabilities
and equity are directly related to an organization's
financial position. Reported income and expenses
are directly related to an organization's financial
performance.
16
Lecturer. Ahmed El Rawas
Purpose of financial statements
 Financial statements are intended to be understandable
by readers who have "a reasonable knowledge of business
and economic activities and accounting and who are
willing to study the information."Financial statements
may be used by users for different purposes:
1. Owners and managers require financial statements to
make important business decisions that affect its
continued operations. Financial analysis is then
performed on these statements to provide management
with a more detailed understanding of the figures.
These statements are also used as part of
management's annual report to the stockholders.
17
Lecturer. Ahmed El Rawas
Purpose of financial statements
2. Employees also need these reports in making
collective bargaining agreements (CBA) with
the management, in the case of labor unions or for
individuals in discussing their compensation,
promotion and rankings.
3. Prospective investors make use of financial
statements to assess the viability of investing in
a business. Financial analyses are often used by
investors and are prepared by professionals
(financial analysts), thus providing them with the
basis for making investment decisions.
18
Lecturer. Ahmed El Rawas
Purpose of financial statements
4. Financial institutions (banks and other lending
companies) use them to decide whether to grant a
company with fresh working capital or extend debt
securities (such as a long-term bank loan ) to
finance expansion and other significant
expenditures.
5. Government entities (tax authorities) need
financial statements to ascertain the propriety and
accuracy of taxes and other duties declared and
paid by a company.
19
Lecturer. Ahmed El Rawas
Purpose of financial statements
6. Vendors who extend credit to a business require
financial statements to assess the
creditworthiness of the business.
7. Media and the general public are also interested in
financial statements for (transparency in front of
the community )
20
Lecturer. Ahmed El Rawas
Balance sheet:
21
 Balance sheet: 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.
 Another definition: is an accountant snapshot of the
firms accounting value on a particular date, as
through the firm stood momentarily still.
 The balance sheet shows what assets the firm
controls at a point in time and how it financed the
assets.
 Assets= Liabilities + owners equity
Lecturer. Ahmed El Rawas
Balance sheet
22
 Assets are economic resources that are expected to
produce economic benefits for their owner.
 Liabilities are obligations the company has to outside
parties. Liabilities represent others' rights to the
company's money or services. Examples include bank
loans, debts to suppliers and debts to employees.
 Shareholders' equity is the value of a business to its
owners after all of its obligations have been met. This net
worth belongs to the owners. Shareholders' equity
generally reflects the amount of capital the owners have
invested, plus any profits generated that were
subsequently reinvested in the company.
Lecturer. Ahmed El Rawas
Balance Sheet
Assets
Cash in hand
Cash in bank
Account Receivables
Notes receivables
Total Inventory( raw materials, finished goods, spare
parts)
 Total Current Assets










Land,
Plant, Equipment and Furniture
(-)Accumulated Depreciation
Total fixed Assets
 Total assets
23
Lecturer. Ahmed El Rawas
Balance sheet












Liabilities
Accounts Payable
short term loans
Bank over draft
Notes payable
current term liabilities
Long Term Loans,
Owner's Equity
Capital
+Net profit or – net loss
(-)drawing
Total Liabilities and Equity
Lecturer. Ahmed El Rawas
24
BALANCE SHEET COMPONENTS ASSETS
25
Total Assets
Total assets on the balance sheet are composed of:
1. Current Assets – These are assets that may be
converted into cash, sold or consumed within a year or
less. These usually include:
Cash – This is what the company has in cash in the bank.
Cash is reported at its market value at the reporting date
in the respective currency in which the financials are
prepared. (Different cash denominations are converted
at the market conversion rate.
Lecturer. Ahmed El Rawas
BALANCE SHEET COMPONENTS ASSETS
26
 Accounts receivable – This represents the money that is
owed to the company for the goods and services it has
provided to customers on credit. Every business has
customers that will not pay for the products or services the
company has provided. Management must estimate which
customers are unlikely to pay and create an account called
allowance for doubtful accounts. Variations in this account
will impact the reported sales on the income statement.
Accounts receivable reported on the balance sheet are net of
their realizable value (reduced by allowance for doubtful
accounts).
Lecturer. Ahmed El Rawas
BALANCE SHEET COMPONENTS ASSETS
27
 Notes receivable – This account is similar in nature to accounts
receivable but it is supported by more formal agreements such as a
"promissory notes" (usually a short term-loan that carries interest).
Furthermore, the maturity of notes receivable is generally longer
than accounts receivable but less than a year. Notes receivable is
reported at its net realizable value (what will be collected).
 Inventory – This represents raw materials and items that are
available for sale or are in the process of being made ready for sale.
These items can be valued individually by several different means at cost or current market value - and collectively by FIFO (first in,
first out), LIFO (last in, first out) or average-cost method. Inventory
is valued at the lower of the cost or market price to preclude
overstating earnings and assets.
Lecturer. Ahmed El Rawas
BALANCE SHEET COMPONENTS ASSETS
28
 2. Long-term assets – These are assets that may
not be converted into cash, sold or consumed within
a year or less. The heading "Long-Term Assets" is
usually not displayed on a company's consolidated
balance sheet. However, all items that are not
included in current assets are long-term Assets.
These are:
Lecturer. Ahmed El Rawas
Fixed assets
29
 Fixed assets – These are durable physical
properties used in operations that have a useful life
longer than one year. This includes:
 Land
– The land owned by the company on
which the company's buildings or plants
are sitting on. Land is valued at historical
cost and the only fixed asset that has no
depreciation.
Lecturer. Ahmed El Rawas
Fixed assets
30
 Machinery and equipment – This category
represents the total machinery, equipment
and furniture used in the company's
operations. These assets are reported at
their historical cost less accumulated
depreciation.
Lecturer. Ahmed El Rawas
Fixed assets
31
 Buildings (plants) – These are buildings that
the company uses for its operations. These
assets are depreciated and are reported at
historical cost less accumulated
depreciation.
Lecturer. Ahmed El Rawas
BALANCE SHEET COMPONENTS LIABILITIES
32
Total Liabilities
Liabilities have the same classifications as assets:
current and long-term.
Current liabilities – These are debts that are due
to be paid within one year or the operating cycle,
whichever is longer; further, such obligations will
typically involve the use of current assets, the
creation of another current liability or the providing
of some service.
Lecturer. Ahmed El Rawas
BALANCE SHEET COMPONENTS LIABILITIES
33
 Accounts payable – This amount is owed to
suppliers for products and services that are delivered
but not paid for.
Notes payable (short-term loans) – This is an
amount that the company owes to a creditor, and it
usually carries an interest expense.
Long-term Liabilities – These are obligations
that are reasonably expected to be liquidated at some
date beyond one year or one operating cycle. Longterm obligations are reported as the present value of
all future cash payments.
Lecturer. Ahmed El Rawas
SHAREHOLDERS' (STOCKHOLDER'S)
EQUITY BASICS
34
Components of Shareholder’s Equity
Also known as “equity” and “net worth”, the shareholders’ equity refers
to the shareholders’ ownership interest in a company.
Usually included are: Preferred stock – This is the investment by
preferred stockholders, which have priority over common shareholders
and receive a dividend that has priority over any distribution made to
common shareholders. This is usually recorded at par value. Has no
right to vote in the BOD.
 Common stock – This is the investment by stockholders, and it is
valued at par or stated value. Has the right to vote in the BOD.
 Retained earnings – This is the total net income (or loss) less the
amount distributed to the shareholders in the form of a dividend since
the company’s initiation.
Lecturer. Ahmed El Rawas
Income statement:
 Income statement: also referred to as Profit and
Loss statement reports on a company's income,
expenses, and profits over a period of time. Profit &
Loss account provide information on the operation
of the enterprise. These include sale and the various
expenses incurred during the processing state.
 The income statement indicates the flow of sales,
expenses, and earnings during a period of time.
 Revenues- Expenses= Income
35
Lecturer. Ahmed El Rawas
INCOME STATMENT













Sales Revenue
(-)Cost of Goods Sold (COGS)
Gross Profit ( the real activity of the company)
(-)Operating Expenses
(-)Depreciation
(-)General and Administrative Expenses
(-) maintenance
(-) bad debt
Earnings Before Interest and Taxes (EBIT)
(-)Interest ( 10%------ 16%)
Earnings Before Taxes (EBT)
(-)Taxes ( 40%)
Net Income (Loss)
36
Lecturer. Ahmed El Rawas
Statement of cash flows
37
 Statement of cash flows: reports on a company's cash flow




activities, particularly its operating, investing and financing
activities.
This statement helps to explain the change in accounting cash and
equivalents.
The statement of cash flows shows the effect on the firm's cash flows
of earnings and changes in the assets, current liabilities, long-term
liabilities and net worth.
Cash inflow- cash outflow = net Cash flow
The statement of cash flow reports the impact of a firm's operating,
investing and financial activities on cash flows over an accounting
period. The cash flow statement is designed to convert the accrual
basis of accounting used in the income statement and balance sheet
back to a cash basis.
Lecturer. Ahmed El Rawas
Statement of cash flows
38
 1. Cash Flow from Operating Activities (CFO)
CFO is cash flow that arises from normal operations such as
revenues and cash operating expenses net of taxes.
This includes:
Cash inflow (+)
 Revenue from sale of goods and services

Cash outflow (-)
 Payments to suppliers
 Payments to employees
 Payments to government
 Payments to lenders
 Payments for other expenses

Lecturer. Ahmed El Rawas
Statement of cash flows
39
 Cash Flow from Investing Activities (CFI)
CFI is cash flow that arises from investment activities such as the
acquisition or disposition of current and fixed assets.
This includes:
Cash inflow (+)



Sale of property, plant and equipment
Sale of debt or equity securities (other entities)
Collection of principal on loans to other entities
 Cash outflow (-)



Purchase of property, plant and equipment
Purchase of debt or equity securities (other entities)
Lending to other entities

Lecturer. Ahmed El Rawas
Statement of cash flows
40
 Cash flow from financing activities (CFF)
CFF is cash flow that arises from raising (or decreasing) cash
through the issuance (or retraction) of additional shares,
short-term or long-term debt for the company's operations.
This includes:
Cash inflow (+)


Sale of equity securities
Issuance of debt securities
 Cash outflow (-)
 Dividends to shareholders
 Redemption of long-term debt




Repayment of Loans
Installments
Interests
Taxes
Lecturer. Ahmed El Rawas
CASH FLOW














Cash In
Sales
Loans
Total Cash In
Cash Out
Investment Costs
Operating Expenses
Repayment of Loans
Installments
Interests
Taxes
Buying new fixed assets
Total Cash Out
Net Cash Flow
41
Lecturer. Ahmed El Rawas
(3)Financial analysis
 Financial ratios can be used to estimate systematic
risk.
 Financial analysis often assess the firm's:
1. Profitability - its ability to earn income and
sustain growth in both short-term and long-term. A
company's degree of profitability is usually based on
the income statement, which reports on the
company's results of operations;
2. Solvency or effeciency. - its ability to pay its
obligation to creditors and other third parties in the
42
long-term.
Lecturer. Ahmed El Rawas
Financial analysis
3.Liquidity - its ability to maintain positive cash flow,
while satisfying immediate obligations;
 Both 2 and 3 are based on the company's balance
sheet, which indicates the financial condition of a
business as of a given point in time.
4. Stability- the firm's ability to remain in business in
the long run, without having to sustain significant
losses in the conduct of its business. Assessing a
company's stability requires the use of both the
income statement and the balance sheet, as well as
other financial and non-financial indicators.
43
Lecturer. Ahmed El Rawas
Financial ratios
 A. Liquidity Ratios: Ratios that show the relationship of






a firm's cash and other current assets to its current
liabilities.
1. Current Ratio: Indicates the extent to which current
liabilities are covered by assets expected to be converted
into cash in the near future.
Current Ratio= Current Assets / Current Liabilities
2. Quick (Acid Test) Ratio: It is a measure of the firm's
ability to pay off short-term obligations without relying on
the sale of inventories.
Quick Ratio= Current Assets – Inventories / Current
Liabilities
3. Working Capital: A firm's investment in short term
assets.
Working Capital= Current Assets – Current Liabilities
44
Lecturer. Ahmed El Rawas
45
Lecturer. Ahmed El Rawas
Financial ratios
 B. Profitability Ratios: Ratios showing the effect of
liquidity, asset management and debt management on
operating results.
 1. Return On Equity (ROE): Ratio of net income to
equity measuring the rate of return on investment.
Return On Equity= Net Income / Owner's Equity x 100
 2. Net Profit Margin on Sales: Measures net income per
pound of sales.
Net Profit Margin on Sales= Net Income / Sales x 100
 3. Return on asset (ROA): this ration measure net
income to total asset
Return on asset= Net income / total assets
46
Lecturer. Ahmed El Rawas
Financial ratios
 C. solvency, Asset Management Ratios or efficiency






ratios: Ratios that measure how effectively a firm is managing
its assets.
1. Receivables Collection Period: It is the average length of
time required to convert the firm's receivables into cash.
Receivables Collection Period= Receivables / Sales x 365
2. Inventory Conversion Period: It is the average length of
time required to convert materials into finished goods and then
to sell these goods.
Inventory Conversion Period= Inventory / Cost of Goods Sold x
365
stability, D. Capitalization Ratio: Determines how much is
a project relying on internal forces (owner's equity) compared to
external resources (loans)
Capitalization= Long Term Liabilities / Owner's Equity x 100 47
Lecturer. Ahmed El Rawas
Current Ratio ( Example)
This ratio measures how much current liabilities is
covered by current assets,
For our project: each L.E 1 current liabilities is
covered by 0.91 current assets in year 2004 and
0.8 current assets in year 2005 and 1.05 current
assets in year 2006. It decreases in 2008,2009
then it goes up again in 2010, and that’s a good
sign.
Lecturer. Ahmed El Rawas
48
Appraisal methods
49
Pay back period
2. Net present value
3. Internal rate of return
1.
Lecturer. Ahmed El Rawas
Pay back period
50
 The payback, also called pay-off period, is defined as
the period required to recover the original
investment outlay through the accumulated net
cashflow earned by the project.
 Year+ cumulative net cash flow in previous period\
Net cash flow in the next period
Lecturer. Ahmed El Rawas
Net present value
51
 The net present value of a project is defined as the
value obtained by discounting, at a constant interest
rate and separately for each year, the differences of
all annual cash outflows and inflows accruing
throughout the life of a project.
 NPV= ∑NCFn\ (1 + r)n
 Accept a project if the NPV is greater than Zero
 Reject a project if the NPV is less than Zero
Lecturer. Ahmed El Rawas
Internal rate of return
52
 The internal rate of return is the discount rate at
which the present value of cash inflows is equal to
the present value of cash outflows.
Lecturer. Ahmed El Rawas