Methods of Project Appraisal and Risks Associated

Methods of Project Appraisal and Risks Associated

Finance is the key resource that a company requires for any project that it wishes to undertake or see growth and profit avenues into. But before putting our money on anything, a proper assessment helps to know whether or not it would be a good idea. There are various factors( e.g. economic, technical)and techniques (NPV, IRR) for assessing the feasibility of any project so let's take one thing at a time and learn everything about project appraisal in this article.

What Is Project Appraisal?

A company comes across various projects, the purpose of which can be either growth, expansion, funding, etc., which it would like to invest into. Going by the principle of economics, because financial resources are scarce, choices would have to be made. These choices can be based on various factors and techniques, but the project which offers the maximum avenues for growth and profits is chosen and financed. This whole process is known as project appraisal.

Parameters

When you go to purchase the smallest thing like a pen, you base your decision upon many factors such as cost, use, longevity, attractiveness, so when a company invests crores of money into a project, it also has to base the decision upon various parameters like the following:

Financial 

  • The whole idea behind project appraisal is finance, so it is also the first parameter to analyze while assessing the project.
  • In this parameter, we assess the fixed capital and working capital of the business.
  • As you might already know, fixed capital is what the company keeps as fixed assets in the company like land, machinery, building, etc., and working capital cash, stock, debtors, etc., is what it requires in its day-to-day working.
  • Here both aspects have to be assessed.
  1. The fixed capital and working capital requirements of the project.
  2. The fixed and working capital requirements of the business as a whole have to be set aside, and then the money is invested into the project so that the company's liquidity is not affected.
  • Also, while making this analysis, factors that eventually affect the fixed capital and working capital have to be taken into consideration as well, for example, size and scale of operations, time of investment, cost of the asset and all other additional costs, depreciation, salvage value, etc.

Economical

  • In this parameter, factors that are usually assessed are:

Product demand, anticipated sales, forecasted profits, expected costs, the scale of working, and capacity utilization, i.e. anything and everything related to the product/ service we are trying to go for.

  • Factors outside the product/service include location, geography, access to resources, government policies, applicable laws, etc.

Technical

  • Technical competence of the business to undertake the project is a very important parameter because advanced and competent technology has the power of innovation, power of cutting down costs, and many other ways in which it can be the X-Factor of our product.
  •  
  • Here two main points are evaluated:
  1. Whether the business already has the required technology for this project in the form of sufficient know-how, adequate and updated plant and machinery.
  2. Whether the business needs to either acquire the technology needed for this project or outsource it, for this the availability, accessibility, cost are to be considered.
  • Here, the assessment can be of land, plant, and machinery, people who will utilize the plant and machinery, inputs like water, transport, raw material, i.e. all the resources are well in place with the project.

Market 

  • Again, a very important parameter that can make or break the project if not properly analyzed.
  • Every product has a particular market and a particular target audience that must be recognized and then attracted.
  •  So here, we assess the market to find the target audience and target market, if any. Yes, if any, because you might be launching a product or service about which the people are still unaware, so leave the target market; first, people should know a product like that exists, and then demand is forecasted. The demand forecasting takes place through surveys offline and online, direct interaction, etc.
  • If the product and service already exist, has a target market and a target audience, we need to analyze the stage of its product life cycle. There are four stages: introduction, growth, maturity, and decline, and the respective sales, costs, and profits vary with each stage, hence making this a very important proposition.

Ps- If you read strategic management someday, one of the reasons for divestment in the decline stage is " the project was wrongly assessed before investing", so do not be that person and make the right choice.

Management.

You can have the best resources in the world and still fail if you do not have people who make it work for you, i.e. management. So to analyze whether the existing management is competent enough for the project in consideration or people with newer perspectives would have to be brought on board to go forward is what we do here.

Techniques of Project Appraisal

Now let's get into the various techniques involved in the process of assessing a project. Yes, it includes calculations but can get very interesting and help you make the right choice once you understand them well. Let us hear discuss the most important 3.

  • NPV

The most commonly used tool in financial management is Net Present Value.

Here, the first outflow of money is subtracted from the recurring inflows of each year of the project( which are first brought at their present value by adjusting the cost of capital and added together), which results in an amount which is called the Net Present Value.

This technique adjusts the time value for money and gives a basis for decision at the present date even when the actual worth can be determined much later.

If the NPV is 0, the project is neutral, i.e. we are just recovering what we invested. If the NPV is positive, the project should be accepted because we have an additional inflow than what was invested. If the NPV is negative, the project shouldn't be undertaken because we are losing more and gaining less.

  • IRR

Internal rate of return is the rate at which the initial outflow is equal to the total inflow, i.e. no gain, no loss. The rate at which discounted costs become equal to discounted benefits is usually used along with the rate of return. i.e. if the rate of return is higher, the project would have a positive NPV. But when used stand-alone, the Higher the IRR, the stronger is the project.

  • PAYBACK PERIOD 

The payback period is the time it takes to recover the project's initial investment. This could be one year or several years in the form of recurring cash inflows.

What looks better from the investment perspective is when the investment is recovered within a shorter payback period rather than a long payback period because it is very risky to predict things for a very long period, and money could even be lost altogether.

Also, when larger amounts of money are recovered in the starting years itself sends a positive signal across in terms of success.

PROJECT RISK

  • No project can be entirely risk-free, and there's always a certain risk attached even after making all the analysis on all the bases and after using all the techniques. 
  • They could be in the form of project-related risk( change in technology completely), overall business risk (crunch of resources), outside risks( laws as well as market-related), and risk due to wrong assessment of the project’s feasibility ( assuming some factor as not important which later becomes important, not adjusting time value of money in calculations).
  • The main perspective here is to reduce the risk to as low as possible, use proper judgments, assumptions, and calculations, and use proactive and reactive strategies.

Conclusion

Finance is the lifeblood of the business, making it very important to understand the project completely well before undertaking it and investing the financial resources. Thus, it is essential to do proper analysis and assessment, giving equal importance to all the factors before making the final choice.

Contact Us for Project Appraisal Services in Delhi, Noida, Gurgaon and all across the India: write to us at accounts@especia.co.in. Or Call On :(+91)-9711021268 +91-9310165114

- Share this post on -