Discussion paper on role of a financial analyst in going about evaluating new business opportunity
New business proposal could be categorized in two ways:
1. The business proposal is a niche proposal in the market. Or,
2. The business proposal is new to the entity but an existing feature in the market.
Typically, if a totally new product or service, i.e., if a new idea is thought to be converted in business with no identical or near identical product or service currently available in the market, then the approach to analyzing or evaluating new business opportunity becomes different (as benchmarking against existing players is not possible) than that of an entity entering into a new business for itself even though the business may be existent in the market.
We can evaluate both the situations.
If the business proposal is new idea with no identical or near identical product or service currently available in the market then an analyst has to interpret not only the numbers but also go about a logical understanding of other factors that are of crucial importance to the business as a whole. However, if the business opportunity is new to the entity but an existing idea, then, in addition to evaluation of totally new idea, evaluation of the existing business opportunity but new to the entity is to be done on another important factor., ie., benchmarking and comparing with the peers.
Before analyzing a business just from numbers point of view, it is necessary to evaluate the business holistically considering other numerous factors. For a business may be good on numbers but the feasibility of achieving the same also has to be factored into if the goal is to “evaluate new business opportunity”
Feasibility analysis is used to evaluate a proposed change in a business, or a new business. This change may involve developing a new product, improving an existing product, changing marketing strategy or expanding or contracting the business. If the business is a new product itself, then understanding of the business and the desired goal has to be clearly understood for it to be successful. This is generally a measure of profit or increased value.
After a logical understanding to the idea, it needs to be seen whether there could be utilization or opportunity for leveraging the existing resources, expertise, experience etc. is possible. This would enable the analyst in understanding whether:
a) There is focused approach to the business.
b) Goals are clearly spelt and understood. This is classified further into two categories. First, what the business is expected to achieve in a given time period, while the second goal defines the minimum acceptable criteria that must exist if an analysis shows the business plan will not reach its first goal.
c) These is possibility of leveraging of existing resources and experience not only from running the business but from cost effective point of view as well
d) Understanding the factors that contribute to the risk, the probability these factors will happen and their effect on the proposed business opportunity and the advanced mitigation plan and analyzing the cost thereon.
The stages of feasibility analysis could be identified as below:
1. Examine the Idea.
2. Examine the Management Capabilities of the entrepreneur.
3. Examine the Technical Capabilities of the organization.
4. Examine the Marketing Potential for the product or service.
5. Examine the Cost and Financing needs.
A detailed questionnaire could be analysed for the aforesaid stages:
1. The Idea
· Does the idea appear to logically meet set goals?
· What factors could prevent it from being successful?
· Are the benefits from this idea sufficient to justify the cost in terms of finance and other factors?
· From business confidence point of view, whether the idea is marketable and considering the risk element in new business, whether there is good profit potential in a logical span of time?
2. The Management Capabilities
Critical factor for success in any business is the management team that makes the decisions. When evaluating a new business opportunity, consideration may be emphasized on the following:
· What management skills are lacking in order to have effective control over this enterprise?
· Can these skills be acquired?
· What specific skills need to be developed or hired?
· At what point does the lack of available skills become an obstacle?
3. The Technical Evaluation
Specific questions to evaluate the “can it be done” include:
· Is there access to the required raw materials?
· Major clearances and estimated time required to obtain the same and the current economic and political scenario to be evaluated.
· What technology, equipment and processes are required?
· Do staffs understand the required technology, equipment and processes?
· Does it appear that the production system is workable and affordable?
· At what point is it not worth the effort?
4. The Marketability Evaluation
The success of any venture depends on the ability to get the right product into the right marketplace at the right time and the right price. Effective market research report is the most important activity for a financial analyst to understand in order to evaluate the business and the risk to arrive at tenable numeric analysis.
Key areas to understand:
· Features and benefits of the product or service
· Target market (Who is most likely to buy?)
· Distribution options (Best way to reach the target buyers)
· Market demand (How many possible buyers, what volume and price?)
· Competition (What products and companies compete?)
· Trends (What is the expected life of the product?)
· Expected Price (Highest, lowest and most often prices)
· Expected Sales (Volume and market conditions)
Criteria Considerations for evaluating the business opportunity:
· What are the minimum values on sales volume and price needed to be viable?
· Is the potential for growth in sales adequate?
· Is this product the best option available?
5. The cost and financial analysis
Each of the previous analyses generated information on anticipated costs and expected returns. Once this information is transferred to a numbers, three statements can be created:
· Pro Forma (Projected) Income and Expense Statement
· Cash Flow Statement
· Balance Sheet
These statements are essential to creating a solid business case to justify the proposed venture. In the original goals, return on investment (ROI) might have been stated. It is possible to calculate a projected ROI.
The analyst can seek answers to the following questions:
· Are the setup costs within the range of financial options?
· Will this proposal provide sufficient return on investment?
· How will the investment affect net worth?
· Is the cost of sales acceptable relative to the product price?
· Does the venture meet or exceed the profit goals?
· Does the expected return meet or exceed the minimum acceptable level?
· Is there a better way to reach financial goals?
6. Risk Evaluation
Investments are made in the expectation of a return. In general, the greater the return expected, the more is the willingness to invest. People vary in their ability and their willingness to take risks. The ability varies with the extent of the cost and the wealth or asset value of the stakeholder. The willingness varies with the amount of those assets that the stakeholder is willing to place at risk. These risks may be financial or social.
Evaluating risk is a function of evaluating the factors that contribute to possible losses against the investment. Feasibility analysis is a risk-management tool because it helps to identify the risk factors involved in the project. Other risk management tools are those practices that contribute to consistent quality and safety of the product being sold or that contribute to a low unit cost of production.
The critical considerations may involve:
· What can go wrong with the project?
· Is there a way to prevent any of these from happening?
· What is the probability that any of these factors will go wrong?
· What is the probability that two or more of these will go wrong?
· What will be the effect on the project and a detailed scenario analysis?
· Can the effect of these risks be reduced through insurance and at what cost?
· How able and willing is the entrepreneur to assume these risks?
· Do the risks involved in this venture exceed the benefits?
· What specific risks need to be avoided or controlled?
· Is the cost of risk abatement through prevention and insurance affordable?
· What is the maximum amount of risk that can be handled?
Finally business plan is evaluated on the financial parameters.
The total project cost and means of finance is to be analysed in deep with the aforesaid discussed evaluation criteria with a view to ascertaining investible surplus, expected cash accruals during the implementation of the proposed new/expansion/diversification project. Other aspects to be studied include inventory and receivable levels maintained vis-à-vis normative requirements and/or industry standards. Other factors of analyzing a project includes BEP analysis, DSCR calculations, IRR calculations, NPV and sensitivity analysis on sales and major inputs. Debt servicing capacity of the project at different DSCR levels may be worked out where the project DSCR is lower than the benchmark figure for the limits sought.
The optimum finance mix is to be evaluated based on the projection mix.
Based on the understanding the feasibility study in detail, financial projections are prepared on a clear, well-conceived, workable strategy and is to be evaluated covering realistic financial projections with most likely, pessimistic, and optimistic scenarios.
The finance projection is to be analysed on the following:
1. The optimum finance mix and cost of the funds, the repayment schedule etc and the financial impact of the same.
2. The taxation benefits applicable on setting up of new business, if any and analyzing the financial impact of the same.
3. The prices of key raw material or man power planning and availability of the same and the financial impact of the same.
4. The marketability of the products and estimated effective realization.
5. The analysis with respect to major indicative factors like Break-even point, Debt Service Coverage Ratio, Internal rate of return, Net present value, working capital requirements, EBIDTA, other profitability margins, working capital assumptions etc.
For any evaluation, a holistic approach has to be first taken by the financial analyst to evaluate any business opportunity. If the idea is clear based on the discussed parameters, financial projections are prepared and optimum finance mix and other factors, financial projections, cash flow analysis and various ratios are calculated to know whether there are desired results or how and under what circumstances and modifications, desired results could be obtained or whether to abandon the project as a whole.
Upon identifying the same, an opinion on the business opportunity could be obtained.