Guide to Financial Analysis. Contents. Purpose of this Guide Financial Analysis defined Defining Costs Capital Costs Operating Costs Benefits The Financial Calculator The value of money NPV Payback period Sensitivity Analysis Further assistance. The Purpose of this Guide.
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Comparing the costs and benefits over time to determine whether a project is profitable or not.
To achieve this the following financial indicators are used:
There are different ways of defining costs:
Capital costs are the expenses incurred in purchase of items that are recorded as assets; their value is depreciated over time and they are recorded in the Balance Sheet.
Identify the capital costs for the project for the following items:
*Non-consumable materials are capital costs because these are materials that persist (eg. furniture, bricks)
Operating costs are expenses incurred in the execution of the project or in the operation of the business (after the project) They are not depreciated over time and are recorded in the profit and loss statement.
Identify the operating costs for the project for the following:
*Consumable materials are operating expenses because they are materials that are used up by the project (eg. stationery, batteries)
Refer to the guide to benefits analysis
Identify the benefits that the project will provide, and the value that can be assigned to each benefit.
For each year enter the anticipated capital and operating expenses into the financial calculator spreadsheet.
For each year enter the anticipated benefits into the spreadsheet.
Adjust the discount rate if appropriate.
Enter sensitivity values (% cost increase and % revenue decrease values)
The spreadsheet will automatically calculate the financial indicators
Financial indicators used in the spreadsheet are:
If the Net Present Value is less than zero then this indicates the project is not financially worthwhile.
Note: The discount factor is based on a discount rate of 13%. Hence at the end of the first year $1 is worth 87c, drops to 75.6c in the second year, 65.8c in the third year etc.
Internal Rate of Return
Is defined as the discount rate at which an investment has a zero net present value.
The internal rate of return equates to the interest rate, expressed as a percentage, that would yield the same return if the funds had been invested over the same period of time.
Therefore, if the internal rate of return for the project is less than the current bank interest rate it would be more profitable to put the money in the bank than execute the project
Projects do not always run to plan. Costs and benefits estimated at an early stage of a project may indicate a profitable project, but this profit could be eroded by an increase in costs or a decrease in the value of the benefits (the revenue).
Sensitivity analysis provides a means of determining the financial impact of this type of fluctuation.
By entering an anticipated percentage increase in costs or decrease in revenue the financial impact on the project can be identified by looking at the change to the NPV or IRR measures.
For additional supporting guides refer to: