Financial Appraisal
FINANCIAL APPRAISAL
Financial appraisal is a method by which we can evaluate the viability of a project. It helps us in doing so by assessing the value of net cash flows that are the result of the project’s implementation. A financial appraisal shows investment decisions from the view of organizations that undertake the investment. Therefore, it only measures the direct effects of an investment decision on the cash flow of the organization.
The survey shows that employers today have overestimated themselves as far as fulfilling expectations of the employees is concerned. The percentage of employers who are satisfied with
their salary policy is 68%, while with the employees, it is only 47%. According to 69% of the employers, they make sufficient investment in training and education of the employees, whereas, only 40% of the employees believe so. Thus, in order to continue the business, policies must be made to inspire and retain employees. So, it is necessary to assess the needs of potential employees and respond proactively to those needs. That requires a lot of extra attention and investment. Making sure that one is regarded as an attractive employer does not have to do anything with high costs. Assessing the needs and expectations of the employees gives input to the management to map out an appropriate policy.
Finding the flexibility in the labour market is important for both employers and employees. But, this is not for the same reasons. Employers seek flexibility to respond adequately to peaks in demand from market, demand for labour and to be less sensitive to the economic situation. They achieve it by offering part-time work, flexible working hours, work from home and temporary employees etc. Employees seek flexibility to optimise their work/life balance. Thus, staffing enables companies to strengthen their position in the market and ensure the continuity of production. According to a study, almost every company invests in some form of sustainability, e.g. Energy conservation and reduction of CO2 emissions.
Let us now discuss financial appraisal in terms of credit checks. Credit check is a check that is performed on the financial backing of the counterparties in a forex transaction. It ensures that both parties have the sources that are necessary to cover their positions in the trade and is done before any transaction takes place. Without this, one party will not have any assurance about the creditworthiness of the other party involved. Credit history or credit report is a record of a company’s or an individual's past borrowing and repaying. It also includes the information about bankruptcy or late payments. This information is generally used by the credit card lenders to determine one's credit worthiness, or his willingness to repay a debt. Another factor which determines whether a lender will provide a customer a loan or a credit is dependent on income. The higher the income, the more credit the consumer can get. However, lenders make decisions to grant credit based on both income and the credit report. This report has become very important with the adoption of risk-based pricing on lending in the financial services industry, because it is usually the only element used to choose the grace period, APR (annual percentage rate) and other contractual obligations of the loan or credit card.
Financial position of a concern is one of the foremost considerations required to grant credit facilities for implementation of any project. Various techniques are employed by banks for financial appraisal. However, there are no standard norms fixed for financial appraisal. It varies from bank to bank and from project to project within the same bank. There are, however, some important common features of financial appraisal, which will be discussed in this chapter.
Financial appraisal revolves around two important statements that need to be submitted to the bank along with the loan application. These financial statements are balance sheet and Profit & Loss a/c. Balance sheet exhibits the financial position of an organisation at any particular point of time while profit and loss a/c provides the summary of operations during an operating year.
Financial appraisal is an important tool used by the bankers and forms the basis of the credit decisions taken by them. Thus, it is very important to ensure the credibility of the financial statements that are to be submitted to the banks. It is preferable that balance sheet and profit and loss a/c are submitted after audit. Thus, they are considered to be reliable. It is very important to note that financial statements of a single year may not be considered sufficient to form any view about the financial position of an organisation. The banks prefer to establish the trend in which the business is conducted year after year, usually the last three years.
In the area of development, financial appraisal engages the computation of the expansion values that a project is proposed to generate GDV minus all maturity costs that include all charges and planning obligations. It also takes into account the developer’s profits from sales and other income that includes funding in public sector. Various appraisal tools and methodologies can be swiftly used to evaluate the viability of the project. For example, the applicant/developer may already have appraised an area using a “residual” land value approach. The developer/applicant may also develop in-house tools for appraisal in order to reflect their internal accounting processes, generally through the use of commercial accounting software.
Also, there are other public sector models for appraisal, which have been developed for their use in the planning process. The spreadsheet based models that can be used for this purpose are the Affordable Housing Development Control Toolkit (Greater London Authority) and the Development Appraisal Tool (HCA). The HCA has produced another model, the Area Wide Viability Model to test viability across different sites with differing characteristics. Projects involving public sector expenditure to need to go through a different appraisal process to make sure that the projects deliver value for money and that they are considered in a transparent consistent way. Wherever a dispute arises about the ability of a project to meet certain objectives and financial viability, the first option should be the willingness of the applicant/developer to go open-book with the appraisal process they have adopted, and their figures.
Sometimes, the financial appraisal process is carried out by the developers but is more usually undertaken by a team that involves valuers, property agents, cost consultants and quantity surveyors. In most circumstances, using a financial analysis to value a project's inputs and outputs will tell the analyst whether a project will be financially profitable or not. A financial analysis rarely measures a project's contribution to the welfare of the community.
Like businesses, charities also need to produce accurate and clear sets of accounts annually. This is a formal requirement and must have a precise information of in and out transactions of charity’s accounts. It also provides the financial position of a charity at the end of a financial year. So, the financial records may be the manual records of the credits and debits. It is specially important for a charity to maintain these records because it handles money donated by others for the purpose of furthering the aims of the concerned organization. The records can also be maintained on the computer, using either the spreadsheet or other finance packages that are available for personal or business use. Being able to maintain the records of the transactions will assist the inspection of accounts at the end of each financial year. This may include receipts, invoices, letters of acknowledgement etc.
Since, there is a risk involved in anything, similarly, the risk is associated with finance as well. But, the risks can be managed using proper management techniques. The requirement of financial risk management is to determine which things go wrong and how to guard against them. For the last 30 years, the industry has grown up with the assumption that the behavior of the financial markets can be outsmarted by the mathematical models. But the markets are ever changing. So, ultimately, the financial firms have learned that the mathematics have less power to calculate the likelihood of extreme events. Thus, risk management at the extremes challenges even the wildest of imaginations. The risks may be mitigated by various types of decisions made by an organization, e.g. investment decisions, financial decisions etc. The companies that want to optimize their financing choices should match the characteristics of debt to more of the project which is funded with the debt. If it fails to do so, it increases the risk and the cost of debt. Thus, the cost of capital is increased and the firm value is lowered. On the other hand, matching debt to assets reduces the risk and cost of debt, thus increasing the firm value. One way to protect against risk is to buy insurance that covers specific risk event. A company can buy insurance to protect their assets against loss just as an owner of a home buys insurance on his or her house to protect against any loss. Derivatives have also been used to manage risk, but they are available only for a few firms and at high cost because they have to be customized for each user.
There are different ways to raise the capital of a company like debt and equity. Debt is a contract obligation to pay interest along with the principal. Equity is ownership stake in a company. Although equity involves higher capital cost, yet debt carries higher financial risk. As debt increases, the leverage also increases which increases the chances of financial distress. Lowering the financial leverage will lower the financial risk of the company, but total risk cannot be lowered. There are some times when decreasing financial leverage can increase the risk of the company. If a company is in distress, then paying off loans will send the company into worse capital position where it will have little or no cash. So, decreasing financial leverage will increase risk in this case. If a company is facing a threat from its competitors and it has to defend itself, then decreasing leverage can again limit what it could do. This can give advantage to the company’s competitors and send the business into downward spiral.
Thus, it is clear from the above discussion that it has been a huge hastle for resolution makers in businesses to evaluate the possible venture projects that can sop up assets. The evaluation is very critical for the prospect of the particular firm, since it describes the level of shareholders’ wealth. In finance, several appraisal methods have been developed to help accountants or financial managers to evaluate cash flows, profitability and viability of any venture project with certainty. Business know-how has revealed that the appraisal of a few projects is even more intricate because the execution of a precise method may be ambiguous. The basis of fund that is used to finance an investment project may manipulate the long-standing financial position of a firm, hence influencing the wealth of shareholders'. The financial judgment makers are involved in the financial appraisal. If a firm wants that the shareholders’ wealth be maximized, then the expected rate of return from the investments that are financed with debt capital should not exceed the rate of return that is expected from the investments that are financed with equity capital, otherwise the firm might face liquidation. Once a project has been evaluated and approved, financial decision makers decide how and from where they will get the capital to fund the project. So, firms can finance their projects using various sources such as shares, long term loans, government subsidiaries or internal finance. All these capital sources create different sets of obligations to the firm and are rated differently in terms of risk.
References
1. Paul Edwards, 2011, The Employment Relationship and the field of industrial relations viewed 15 January 2012, http://www.blackwellpublishing.com/content/BPL_Images/Content_store/Sample_chapter/9780631222576/Edwards_C01.pdf
2. The role of business in society viewed on 15 January 2012, http://www.ioe-emp.org/fileadmin/user_upload/documents_pdf/memberpublications/english/csr_sweden01_roleofbusiness.pdf
3. National advisory committee on creative and cultural education, 1999 viewed on 15 January 2012 http://sirkenrobinson.com/skr/pdf/allourfutures.pdf
4. Ethical leadership, decision making and organizations, 2011viewed on 15 January 2012, http://www.businessballs.com/ethical_management_leadership.htm
