UNIT 3
PROJECT FORMULATION
Project- Meaning
Project is an investment opportunity or any programme of action exploited for profit. It is an investment proposal carried
out, according to a scientific plan in order to achieve a definite objective within a specified period of time and cost.
Phases of Project An entrepreneur has to consider various factors from the start to the finish in converting profitable
opportunities into realities. The phases of project may be divided into six broad phases —1). identification,
2).formulation, 3).appraisal, 4).selection, 5).implementation, and 6).management of projects.
Stages of Project Formulation
The project formulation starts with an explanation of the nature and purpose of the problem and passes through the
following stages. 1) Feasibility Analysis. 2). Techno-Economic Analysis 3). Project Design and Network Analysis
4) Input Analysis 5) Financial Analysis 6) Social Cost Benefit Analysis 7). Pre-investment Analysis.
Project finance .The Capital requirements of an entrepreneur can be sub divided into two, such as; 1. Fixed capital : Capital
required to finance fixed assets is called fixed capital. It includes share capital, debentures, long term loans , assistance from
foreign financial institutions and subsidies /margin money from promotional agencies. 2. working capital : Capital required
to meet the day to day activities of business is termed as working capital. It includes advances and overdrafts from
commercial banks, credit facilities from suppliers, discounting of bills etc.
Determinants of working capital 1. Nature of business: 2. Size of business 3. Cost and time involved in manufacture
(production cycle) 4. Terms of purchase and sales 5. Turnover of working capital 6. Trade cycle 7. Liquid current
assets:8. Other factors: Absence of banking relationships, absence of transport facilities ,etc will result in more w.c
Concept of Working Capital There are two concepts of working capital: 1. Gross Working Capital Concept : According to
this concept working capital is the total of current asset. 2. Net working capital concept: According to this concept
working capital is the difference between Current assets and current liabilities. Current assets are those assets which are
converted into cash within one year. Examples of current assets are cash in hand, cash at bank, stock, bills receivable,
debtors, etc. Current liabilities are those liabilities which are payable within aperiod of one year. Examples are Bank
overdraft, sundry creditors, bills payable, outstanding expenses, etc.
Sources of finance 1. Long Term finance This source is needed for acquiring fixed assets like land and building, plant and
machinery, furniture and fixtures etc. Sources of long term financing may be issue of shares, issue of debentures,
assistance from foreign financial institutions, loans from special financial institutions like KFC, IDBI subsidy from
promotional agencies, etc. 2. Medium term finance Medium term funds are usually required for a period ranging from 5 to
10 years. Sources of medium term funds are: issue of redeemable debentures, loans from commercial banks and other
financial institutions. 3. Short term finance This is required for financing working capital requirements. This fund is
invested in current assets like cash in hand, debtors, inventories, cash at bank, bill receivables, short term investments etc.
The sources for finding short term finance are. Advances and overdrafts from commercial banks, Credit facilities from
suppliers, installment credit
Types of Cost:-1. Fixed cost 2. Variable cost 3. Total cost . 4. Average cost 5. Marginal cost.
Marginal cost = Change in Total Cost / Change in Unit
Break Even Analysis It is a method of cost volume profit analysis widely used in practice. It is used in two senses- in
narrow sense and in broad sense. In narrow sense, it refers to a technique of determining that level of operation where
total revenue is equal to the total expenses. It is the technique of determining the no profit no loss point. In its broad sense,
breakeven analysis refers to the study of relationship of cost-volume and profit at different levels of activities.
Breakeven point It may be defined as that point of sales volume at which total revenue is equal to total cost. It is the point
of no profit no loss. Breakeven point can be stated in the form of an equation
Breakeven point (in sales) = Fixed cost/ Profit Volume (PV) Ratio
PV Ratio = Contribution/Sales 100
Breakeven point in units = fixed cost /contribution per unit or breakeven sales/selling price per unit Contribution is the
difference between sales and variable cost of sales or it is the total of fixed cost and profit.
Sales = Total cost + profit
Total cost = fixed cost + variable cost
Therefore, sales = Fixed cost + variable cost + profit
Sales- variable cost = fixed cost + profit = contribution
Contribution = sales – variable cost or fixed cost + profit
PV ratio =Contribution/sales 100 or
PV Ratio = change in profit/change in sales 100
Contribution and profit statement
Sales ***
Less Variable cost ***
Contribution ***
Less Fixed cost ***
Profit ****
Ratio Analysis
Here relation between two variables ie. liquidity, solvency, profitability and efficiency of the business. It gives a true
picture of the financial health of the unit. For analysing the feasibility of a project, the following ratios are mainly used.
1) Current Ratio/Working capital ratio 2) Debt-equity ratio 3) Debt-service coverage ratio 4) Profitability Ratio.
5) Return on Investment (ROI)
Current Ratio/Working capital Ratio
Current ratio is the most common ratio for measuring liquidity. It represents the ratio of current assets to current liabilities.
It is also called working capital ratio. Currents assets includes Cash in hand, Cash at bank, Bills receivable, Sundry
debtors, Stock, Prepaid expenses, short term investments, etc. Current Liabilities consists of creditors, bills payable, bank
overdraft, outstanding expenses, income tax payable, Proposed dividend ,etc. An ideal current ratio is 2:1.
Current Ratio/Working Capital Ratio: = Current assets/Current liabilities.
1.Debt-equity ratio :-This ratio indicates the relative proportion of debt and equity in financing the assets of a firm. This
ratio is computed by dividing the total debt of firm by its net worth. Here debt refers to the outside liabilities such as long
term loans, debentures etc Equity refers to net worth or shareholders fund. Shareholders fund includes Equity capital +
Preference Capital + Reserves + Surplus – Fictitious assets. An ideal debt equity ratio is 2:1.
Debt-equity ratio = Debt / Equity OR Outsiders' Fund / Shareholders fund
2.Debt-service coverage ratio :
This ratio expresses the relation between earning before interest and tax and fixed interest charges. This ratio shows how
many times the interest charges are covered by EBIT out of which they will be paid. Higher the ratio, better is the position
of long term creditors and vice versa.
Debt-service coverage ratio = EBIT / Fixed Interest Charges
3.9.4 Profitability ratio:- It reveals the profit earning capacity of the business.
Important profitability ratios are : 1. Gross profit ratio: It helps in ascertaining whether the average percentage of
profit on the goods is maintained or not. Gross profit ratio = Gross Profit / Net sales X 100 .
2. Net profit ratio: It is used to measure the overall profitability. It is an index of an efficiency and profitability of the
business. Higher the ratio, better is the operational efficiency of the concern. Net profit ratio = Net Profit / Sales X 100
Return on Investment (ROI)
ROI is found out by dividing the net benefit /net profits after depreciation but before interest by the capital employed.
ROI = Net profit (after depreciation before interest and tax) / Capital employed X 100
Cash flow statement
A cash flow statement is a statement depicting the reasons for the change in cash position from one period to another. A
projected cash flow statement will help the management in ascertaining how much cash will be available to meet the
obligations to trade creditors, to repay bank loan and to pay dividend to share holders.
Projected Income statement :Sales *******
Less: cost of sales ******
Gross profit *******
Less: administration and selling expenses ******
Operating profit *******
Projected Balance Sheet
Liabilities Amount Assets Amount
Current Liabilities **** Current assets-cash and cash equivalents ****
Long term liabilities **** Bills receivables ****
Sundry debtors ****
Capital **** Stock ****
Retained earnings **** Investments ****
Fixed assets less depreciation ****
Other assets ****
Total ****** Total ******
**********************************
PROJECT FORMULATION
Project- Meaning
Project is an investment opportunity or any programme of action exploited for profit. It is an investment proposal carried
out, according to a scientific plan in order to achieve a definite objective within a specified period of time and cost.
Phases of Project An entrepreneur has to consider various factors from the start to the finish in converting profitable
opportunities into realities. The phases of project may be divided into six broad phases —1). identification,
2).formulation, 3).appraisal, 4).selection, 5).implementation, and 6).management of projects.
Stages of Project Formulation
The project formulation starts with an explanation of the nature and purpose of the problem and passes through the
following stages. 1) Feasibility Analysis. 2). Techno-Economic Analysis 3). Project Design and Network Analysis
4) Input Analysis 5) Financial Analysis 6) Social Cost Benefit Analysis 7). Pre-investment Analysis.
Project finance .The Capital requirements of an entrepreneur can be sub divided into two, such as; 1. Fixed capital : Capital
required to finance fixed assets is called fixed capital. It includes share capital, debentures, long term loans , assistance from
foreign financial institutions and subsidies /margin money from promotional agencies. 2. working capital : Capital required
to meet the day to day activities of business is termed as working capital. It includes advances and overdrafts from
commercial banks, credit facilities from suppliers, discounting of bills etc.
Determinants of working capital 1. Nature of business: 2. Size of business 3. Cost and time involved in manufacture
(production cycle) 4. Terms of purchase and sales 5. Turnover of working capital 6. Trade cycle 7. Liquid current
assets:8. Other factors: Absence of banking relationships, absence of transport facilities ,etc will result in more w.c
Concept of Working Capital There are two concepts of working capital: 1. Gross Working Capital Concept : According to
this concept working capital is the total of current asset. 2. Net working capital concept: According to this concept
working capital is the difference between Current assets and current liabilities. Current assets are those assets which are
converted into cash within one year. Examples of current assets are cash in hand, cash at bank, stock, bills receivable,
debtors, etc. Current liabilities are those liabilities which are payable within aperiod of one year. Examples are Bank
overdraft, sundry creditors, bills payable, outstanding expenses, etc.
Sources of finance 1. Long Term finance This source is needed for acquiring fixed assets like land and building, plant and
machinery, furniture and fixtures etc. Sources of long term financing may be issue of shares, issue of debentures,
assistance from foreign financial institutions, loans from special financial institutions like KFC, IDBI subsidy from
promotional agencies, etc. 2. Medium term finance Medium term funds are usually required for a period ranging from 5 to
10 years. Sources of medium term funds are: issue of redeemable debentures, loans from commercial banks and other
financial institutions. 3. Short term finance This is required for financing working capital requirements. This fund is
invested in current assets like cash in hand, debtors, inventories, cash at bank, bill receivables, short term investments etc.
The sources for finding short term finance are. Advances and overdrafts from commercial banks, Credit facilities from
suppliers, installment credit
Types of Cost:-1. Fixed cost 2. Variable cost 3. Total cost . 4. Average cost 5. Marginal cost.
Marginal cost = Change in Total Cost / Change in Unit
Break Even Analysis It is a method of cost volume profit analysis widely used in practice. It is used in two senses- in
narrow sense and in broad sense. In narrow sense, it refers to a technique of determining that level of operation where
total revenue is equal to the total expenses. It is the technique of determining the no profit no loss point. In its broad sense,
breakeven analysis refers to the study of relationship of cost-volume and profit at different levels of activities.
Breakeven point It may be defined as that point of sales volume at which total revenue is equal to total cost. It is the point
of no profit no loss. Breakeven point can be stated in the form of an equation
Breakeven point (in sales) = Fixed cost/ Profit Volume (PV) Ratio
PV Ratio = Contribution/Sales 100
Breakeven point in units = fixed cost /contribution per unit or breakeven sales/selling price per unit Contribution is the
difference between sales and variable cost of sales or it is the total of fixed cost and profit.
Sales = Total cost + profit
Total cost = fixed cost + variable cost
Therefore, sales = Fixed cost + variable cost + profit
Sales- variable cost = fixed cost + profit = contribution
Contribution = sales – variable cost or fixed cost + profit
PV ratio =Contribution/sales 100 or
PV Ratio = change in profit/change in sales 100
Contribution and profit statement
Sales ***
Less Variable cost ***
Contribution ***
Less Fixed cost ***
Profit ****
Ratio Analysis
Here relation between two variables ie. liquidity, solvency, profitability and efficiency of the business. It gives a true
picture of the financial health of the unit. For analysing the feasibility of a project, the following ratios are mainly used.
1) Current Ratio/Working capital ratio 2) Debt-equity ratio 3) Debt-service coverage ratio 4) Profitability Ratio.
5) Return on Investment (ROI)
Current Ratio/Working capital Ratio
Current ratio is the most common ratio for measuring liquidity. It represents the ratio of current assets to current liabilities.
It is also called working capital ratio. Currents assets includes Cash in hand, Cash at bank, Bills receivable, Sundry
debtors, Stock, Prepaid expenses, short term investments, etc. Current Liabilities consists of creditors, bills payable, bank
overdraft, outstanding expenses, income tax payable, Proposed dividend ,etc. An ideal current ratio is 2:1.
Current Ratio/Working Capital Ratio: = Current assets/Current liabilities.
1.Debt-equity ratio :-This ratio indicates the relative proportion of debt and equity in financing the assets of a firm. This
ratio is computed by dividing the total debt of firm by its net worth. Here debt refers to the outside liabilities such as long
term loans, debentures etc Equity refers to net worth or shareholders fund. Shareholders fund includes Equity capital +
Preference Capital + Reserves + Surplus – Fictitious assets. An ideal debt equity ratio is 2:1.
Debt-equity ratio = Debt / Equity OR Outsiders' Fund / Shareholders fund
2.Debt-service coverage ratio :
This ratio expresses the relation between earning before interest and tax and fixed interest charges. This ratio shows how
many times the interest charges are covered by EBIT out of which they will be paid. Higher the ratio, better is the position
of long term creditors and vice versa.
Debt-service coverage ratio = EBIT / Fixed Interest Charges
3.9.4 Profitability ratio:- It reveals the profit earning capacity of the business.
Important profitability ratios are : 1. Gross profit ratio: It helps in ascertaining whether the average percentage of
profit on the goods is maintained or not. Gross profit ratio = Gross Profit / Net sales X 100 .
2. Net profit ratio: It is used to measure the overall profitability. It is an index of an efficiency and profitability of the
business. Higher the ratio, better is the operational efficiency of the concern. Net profit ratio = Net Profit / Sales X 100
Return on Investment (ROI)
ROI is found out by dividing the net benefit /net profits after depreciation but before interest by the capital employed.
ROI = Net profit (after depreciation before interest and tax) / Capital employed X 100
Cash flow statement
A cash flow statement is a statement depicting the reasons for the change in cash position from one period to another. A
projected cash flow statement will help the management in ascertaining how much cash will be available to meet the
obligations to trade creditors, to repay bank loan and to pay dividend to share holders.
Projected Income statement :Sales *******
Less: cost of sales ******
Gross profit *******
Less: administration and selling expenses ******
Operating profit *******
Projected Balance Sheet
Liabilities Amount Assets Amount
Current Liabilities **** Current assets-cash and cash equivalents ****
Long term liabilities **** Bills receivables ****
Sundry debtors ****
Capital **** Stock ****
Retained earnings **** Investments ****
Fixed assets less depreciation ****
Other assets ****
Total ****** Total ******
**********************************
Post A Comment:
0 comments: