CHAPTER 4

MARKET AND DEMAND ANALYSIS

OUTLINE
Situationalanalysisandspecificationofobjectives
Collectionofsecondaryinformation
Conductofmarketsurvey
Characterisationofthemarket
Demandforecasting
Uncertaintiesindemandforecasting
Marketplanning

Key Steps in Market and Demand Analysis and their Inter-relationships

Collection of
Secondary
Information

Situational
Analysis and
Specification
of Objectives

Demand
Forecasting

Characterisation
of the Market

Conduct of
Market Survey

Market
Planning

Situational Analysis
Inordertogetafeeloftherelationshipbetweentheproductandits
market, the project analyst may informally talk to customers,
competitors,middlemen,andothersintheindustry.Whereverpossible,
he may look at the experience of the company to learn about the
preferencesandpurchasingpowerofcustomers,actionsandstrategiesof
competitors,andpracticesofthemiddlemen.

Collection of Secondary Information

Secondary information is information that has been gathered in

someothercontextandisreadilyavailable.

Secondary information provides the base and the starting point

for the market and demand analysis. It indicates what is known
and often provides leads and cues for gathering primary
informationrequiredforfurtheranalysis.

Evaluation of Secondary Information

Whilesecondaryinformationisavailableeconomicallyandreadily(providedthemarket
analyst is able to locate it), its reliability, accuracy, and relevance for the purpose under
considerationmustbecarefullyexamined.Themarketanalystshouldseektoknow:
Whogatheredtheinformation?Whatwastheobjective?
Whenwastheinformationgathered?Whenwasitpublished?
Howrepresentativewastheperiodforwhichtheinformationwasgathered?
Havethetermsinthestudybeencarefullyandunambiguouslydefined?
Whatwasthetargetpopulation?
Howwasthesamplechosen?
Howrepresentativewasthesample?
Howsatisfactorywastheprocessofinformationgathering?
Whatwasthedegreeofsamplingbiasandnon-responsebiasintheinformation
gathered?
Whatwasthedegreeofmisrepresentationbyrespondents?

Market Survey
Secondary

information, though useful, often does not provide a

comprehensivebasisformarketanddemandanalysis.Itneedstobe
supplemented with primary information gathered through a market
survey.

The market survey may be a census survey or a sample survey;

typicallyitisthelatter.

Information Sought in a Market Survey

The information sought in a market survey may relate to one or more of the
following:
Totaldemandandrateofgrowthofdemand
Demandindifferentsegmentsofthemarket
Incomeandpriceelasticitiesofdemand
Motivesforbuying
Purchasingplansandintentions
Satisfactionwithexistingproducts
Unsatisfiedneeds
Attitudestowardvariousproducts
Distributivetradepracticesandpreferences
Socio-economiccharacteristicsofbuyers

Steps in a Sample Survey

Typically,asamplesurveyinvolvesthefollowingsteps:
1. Definethetargetpopulation.
2. Selectthesamplingschemeandsamplesize.
3. Developthequestionnaire.
4. Recruitandtrainthefieldinvestigators.
5. Obtaininformationasperthequestionnairefromthe
sampleofrespondents.
6. Scrutinisetheinformationgathered.
7. Analyseandinterprettheinformation.

Characterisation of the Market

Basedontheinformationgatheredfromsecondarysourcesandthrough
themarketsurvey,themarketfortheproduct/servicemaybedescribed
intermsofthefollowing:
Effectivedemandinthepastandpresent
Breakdownofdemand
Price
Methodsofdistributionandsalespromotion
Consumers
Supplyandcompetition
Governmentpolicy

MethodsofDemandForecasting
IQualitativeMethods:Thesemethodsrelyessentiallyonthejudgmentofexpertsto

translatequalitativeinformationintoquantitativeestimates.Theimportant
qualitativemethodsare:
Juryofexecutivemethod
Delphimethod
IITimeSeriesProjectionMethods:Thesemethodsgenerateforecastsonthebasisof
ananalysisofthehistoricaltimeseries.Theimportanttimeseriesprojection
methodsare:

Trendprojectionmethod
Exponentialsmoothingmethod
Movingaveragemethod
IIICausalMethods:Moreanalyticalthantheprecedingmethods,causalmethods
seektodevelopforecastsonthebasisofcause-effectrelationshipsspecifiedinan
explicit,quantitativemanner.Theimportantcausalmethodsare:
Chainratiomethod
Consumptionlevelmethod
Endusemethod
Leadingindicatormethod
Econometricmethod

Jury of Executive Opinion Method

Thismethodinvolvessolicitingtheopinionofagroupofmanagerson
expectedfuturesalesandcombiningthemintoasalesestimate

Pros
Itisanexpeditiousmethod
Itpermitsawiderangeoffactorstobeconsidered
Itappealstomanagers

Cons
The biases cannot be unearthed easily
Its reliability is questionable

Delphi Method
This method is used for eliciting the opinions of a group of experts with the
helpofamailsurvey.Thestepsinvolvedinthismethodare:
1.

Agroup of experts is sent a questionnaire by mail and asked to express

theirviews.

2.

The responses received from the experts are summarised without

disclosingtheidentityoftheexperts,andsentbacktotheexperts,along
withaquestionnairemeanttoprobefurtherthereasonsforextremeviews
expressedinthefirstround.

3.

The process may be continued for one or more rounds till a reasonable
agreementemergesintheviewoftheexperts.

Pros
Itisintelligibletousers
Itseemstobemoreaccurateandlessexpensivethanthe
traditionalface-to-facegroupmeetings

Cons
Therearesomequestionmarks:Whatisthevalueoftheexpertopinion?
Whatisthecontributionofadditionalroundsandfeedbacktoaccuracy?

Trend Projection Method

The trend projection method involves (a) determining the trend of
consumption by analysing past consumption statistics and (b)
projectingfutureconsumptionbyextrapolatingthetrend.
Linearrelationship

:Yt=a+bT

Exponentialrelationship

:Yt=aebt

Polynomialrelationship

:Yt=a0+a1t+a2t2.antn

CobbDouglasrelationship :Yt=atb

Exponential Smoothing Method

In exponential smoothing, forecasts are modified in the light of
observed errors. If the forecast value for year t, Ft , is less than the
actualvalueforyeart,St,theforecastfortheyeart+1,Ft+1,issethigher
thanFt.IfFt> St ,Ft+1issetlowerthanFt.Ingeneral
Ft+1=Ft + et

(4.7)

whereFt+1=forecastforyeart+1
=smoothingparameter(whichliesbetween0and1)
et=errorintheforecastforyeart=St-Ft

Moving Average Method

Asperthemovingaveragemethodofsalesforecasting,theforecastfor
thenextperiodisequaltotheaverageofthesalesforseveralpreceding
periods.
Insymbols,
St+St-1++St-n+1
Ft+1=

(4.8)
n

where Ft+1=forecastforthenextperiod
St =salesforthecurrentperiod
n =periodoverwhichaveragingisdone

Chain Ratio Method

The potential sales of a product may be estimated by applying a series of factors to a
measure of aggregate demand. For example, the General Foods of the U. S estimated the
potential sales for a new product, a freeze-fried instant coffee (Maxim), in the following
manner:
Totalamountofcoffeesales

174.5millionunits

Proportionofcoffeeusedathome

0.835

Coffeeusedathome

145.7millionunits

Proportionofnon-decaffeinatedcoffeeusedathome

0.937

Non-decaffeinatedcoffeeusedathome

136.5millionunits

Proportionofinstantcoffee

0.400

Instantnon-decaffeinatedcoffeeusedathome

54.6millionunits

Estimatedlong-runmarketshareforMaxim

0.08

PotentialsalesofMaxim

4.37millionunits

Consumption Level Method

The method estimates consumption level on the basis of elasticity
coefficients, the important ones being the income elasticity of demand
andthepriceelasticityofdemand.

Income Elasticity of Demand

Theincomeelasticityofdemandreflectstheresponsivenessofdemandtovariations
inincome.Itismeasuredasfollows:
Q2-Q1 I1+I2
EI=
x
(4.9)
I2I1 Q2+Q1

whereEI=incomeelasticityofdemand
Q1=quantitydemandedinthebaseyear
Q2=quantitydemandedinthefollowingyear
I1=incomelevelinthebaseyear
I2=incomelevelinthefollowingyear.

Example Thefollowinginformationisavailableonquantitydemandedandincome
level:Q1=50,Q2=55,I1=1,000andI2=1,020.Whatistheincomeelasticityof
demand?Theincomeelasticityofdemandis:

5550
1,000+1,020
EI=
x=4.81

Price Elasticity of Demand

Thepriceelasticityofdemandmeasurestheresponsivenessofdemandtovariations
inprice.Itisdefinedas:
Q2Q1 P1+P2
Ep=
x
(4.10)
P2P1
Q2+Q1
whereEp=priceelasticityofdemand
Q1=quantitydemandedinthebaseyear
Q2=quantitydemandedinthefollowingyear
P1=priceperunitinthebaseyear
P2=priceperunitinthefollowingyear

Example Thefollowinginformationisavailableaboutacertainproduct:
P1=Rs.600,Q1=10,000,P2=Rs.800, Q2 =9,000.Whatisthepriceelasticityof
demand?Thepriceelasticityofdemandis:
9,00010,000
Ep =

600+800
x

- 0.37

End Use Method

Suitableforestimatingthedemandforintermediateproducts,theendusemethod,also
referredtoastheconsumptioncoefficientmethod,involvesthefollowingsteps:
1.Identifythepossibleusesoftheproduct.
2.Definetheconsumptioncoefficientoftheproductforvarioususes.
3.Projecttheoutputlevelsfortheconsumingindustries.
4.Derivethedemandfortheproduct.

Project Demand for Indchem

This method may be illustrated with an example. A certain industrial chemical,
IndchemisusedbyfourindustriesAlpha,Beta,Gamma,andKappa.

Theconsumptioncoefficientsfortheseindustries,theprojectedoutputlevelsforthese
industries for the year X, and the projected demand for Indchem as shown in the
followingslide.

Consumptio
Projected
n
Output in year
Coefficient *
X

Projected
Demand for
Indchem in year
X

Alpha
Beta

2.0
1.2

10,000
15,000

20,000
18,000

Kappa
Gamma

0.8
0.5

20,000
30,000

16,000
15,000

Total
69,000
* This is expressed in tonnes of Indchem required per unit of
output of the consuming industry

Bass Diffusion Model - 1

Developed by Frank Bass, the Bass diffusion model seeks to estimate the pattern of
salesgrowthfornewproducts,intermsoftwofactors:
p:Thecoefficientofinnovation.Itreflectsthelikelihoodthatapotentialcustomer
wouldadopttheproductbecauseofitsinnovativefeatures.
q : Thecoefficientofimitation.Itreflectsthetendencyofapotentialcustomerto
buytheproductbecausemanyothershaveboughtit.Itcanberegardedasa
networkeffect.
Accordingtoalinearapproximationofthemodel:
nt=pN+(q p )Nt-1+(q /N )x(Nt-1)2
wherent,isthesalesinperiodt,pisthecoefficientofinnovation,Nisthepotentialsize
of the market, q is the coefficient of imitation, and Nt is the accumulative sales made
untilperiod.

Bass Diffusion Model - 2

Anewproducthasapotentialmarketsizeof1,000,000.Thereisanolderproductthat
issimilartothenewproduct. p = 0.030andq=0.080 describetheindustrysalesof
thisolderproduct.Thesalestrendofthenewproductisexpectedtobesimilartothe
olderproduct.
ApplyingtheBassdiffusionmodel,wegetthefollowingestimatesofsalesinyear1
andyear2.
0.080
n1=0.03x1,000,000+(0.080.03)x+x0 2=30,000
1,000,000

n2=0.03x1,000,000+(0.080.03)x30,000+(0.08/1,000,000)x(30,000) 2

=31,572

Leading Indicator Method

Leading indicators are variables which change ahead of other variables, the
laggingvariables.Hence,observedchangesinleadingindicatorsmaybeused
topredictthechangesinlaggingvariables.Forexample,thechangeinthelevel
ofurbanisation(aleadingindicator)maybeusedtopredictthechangeinthe
demandforairconditioners(alaggingvariable)
Two basic steps are involved in using the leading indicator method: (i)
First, identify the appropriate leading indicator(s).(ii) Second, establish the
relationshipbetweentheleadingindicator(s)andthevariabletobeforecast.
Theprincipalmeritofthismethodisthatitdoesnotrequireaforecastof
an explanatory variable. Its limitations are that it may be difficult to find
appropriateleadingindicator(s)andthelead-lagrelationshipmaynotbestable
overtime.

Econometric Method

Aneconometricmodelisamathematicalrepresentationofeconomic
relationship(s)derivedfromeconomictheory.Theprimaryobjective
of econometric analysis is to forecast the future behaviour of the
economicvariablesincorporatedinthemodel.

Twotypesofeconometricmodelsareemployed:thesingleequation
modelandthesimultaneousequationmodel

Single Equation Model

The single equation model assumes that one variable, the dependent
variable (also referred to as the explained variable), is influenced by
oneormoreindependentvariables(alsoreferredtoastheexplanatory
variables).Inotherwords,one-waycausalityispostulated.Anexample
ofthesingleequationmodelisgivenbelow:

Dt=a0+a1Pt+a2Nt

(4.11)

whereDt=demandforacertainproductinyeart
Pt=pricefortheproductinyeart
Nt=incomeinyeart

Simultaneous Equation Model

The simultaneous equation model portrays economic relationships in
terms of two or more equations. Consider a highly simplified threeequationeconometricmodelofIndianeconomy.
GNPt=Gt+It+Ct
It=a0+a1GNPt
Ct=b0+b1GNP1

(4.12)
(4.13)
(4.14)

whereGNPt=grossnationalproductforyeart
Gt=governmentalpurchasesforyeart
It=grossinvestmentforyeart
Ct=consumptionforyeart

Improving Forecasts
Youcanimproveforecastsbyfollowingsomesimpleguidelines:

Checkassumptions
Stressfundamentals
Bewareofhistory
Watchoutforeuphoria
Dontbedazzledbytechnology
Stayflexible

Uncertainties in Demand Forecasting

Demandforecastsaresubjecttoerroranduncertaintywhicharisefrom
threeprincipalsources:
Dataaboutpastandpresentmarket
Methodsofforecasting
Environmentalchange

Coping with Uncertainties

Given the uncertainties in demand forecasting, adequate efforts, along the
followinglines,maybemadetocopewithuncertainties.

Conductanalysiswithdatabasedonuniformandstandarddefinitions.

Inidentifyingtrends,coefficients,andrelationships,ignoretheabnormalorout-of-
the-ordinaryobservations.

Criticallyevaluatetheassumptionsoftheforecastingmethodsandchooseamethod
whichisappropriatetothesituation.

Adjust the projections derived from quantitative analysis in the light of

unquantifiable,butsignificant,influences.

Monitortheenvironmentimaginativelytoidentifyimportantchanges.

Considerlikelyalternativescenariosandtheirimpactonmarketandcompetition.

Conduct sensitivity analysis to assess the impact on the size of demand for
unfavourable and favourable variations of the determining factors from their most
likelylevels.

Market Planning
Amarketingplanusuallyhasthefollowingcomponents:
Currentmarketingsituation
Opportunityandissueanalysis
Objectives
Marketingstrategy
Actionprogramme

SUMMARY

Giventheimportanceofmarketanddemandanalysis,itshouldbecarriedoutinan
orderlyandsystematicmanner.Thekeystepsinsuchanalysisare(i)situational
analysis and specification of objectives, (ii) collection of secondary information,
(iii) conduct of market survey, (iv) characterisation of the market, (v) demand
forecastingand(vi)marketplanning.

The project analyst may do an informal situational analysis which in turn may
providethebasisforaformalstudy.

Forpurposesofmarketstudy,informationmaybeobtainedfromsecondaryand/or
primarysources.

Secondaryinformationisinformationthathasbeengatheredinsomeothercontext
andisalreadyavailable.Whilesecondaryinformationisavailableeconomically,its
reliability, accuracy, and relevance for the purpose under consideration must be
carefullyexamined.

Secondary information, though useful, often does not provide a comprehensive

basis for market and demand analysis. It needs to be supplemented with primary
information gathered through a market survey, specific to the project being
appraised,thatislikelytobeasamplesurvey.

Typically, a sample survey consists of the following steps: (i) Define the target
population (ii) Select the sampling schemes and sample size. (iii) Develop the
questionnaire.(iv)Scrutinisetheinformationgathered.(vii)Analyseandinterpret
theinformation.

Based on the information gathered from secondary sources and through market
survey, the market for the product/service may be described in terms of the
following:effectivedemandinthepastandpresent;breakdownofdemand;price;
methodsofdistributionandsalespromotion;consumers;supplyandcompetition;
andgovernmentpolicy.

Aftergatheringinformationaboutvariousaspectsofthemarketanddemandfrom
primaryandsecondarysources,anattemptmaybemadetoestimatefuturedemand.

Awiderangeofforecastingmethodsisavailabletothemarketanalyst.Thesemay
be divided into three broad categories, viz., qualitative methods, time series
projectionmethods,andcausalmethods.

Qualitative methods rely essentially on the judgment of experts to translate

qualitative information into quantitative estimates. The important qualitative
methodsare:JuryofexecutivemethodandDelphimethod.

Causalmethodsseektodevelopforecastsonthebasisofcause-effectrelationships
specified in an explicit, quantitative manner. The important causal methods are:
chainratiomethod,consumptionlevelmethod,endusemethod,leadingindicator
method,andeconometricmethod.

To enable the product to reach a desired level of market penetration, a suitable

marketingplan,coveringpricing,distribution,promotion,andservice,needstobe
developed.

CHAPTER 5
TECHNICAL ANALYSIS

Outline
ManufacturingProcess/Technology
TechnicalArrangements
MaterialsandInputs
ProductMix
Plantcapacity
Locationandsite
Machineriesandequipments
StructuresandCivilWorks
EnvironmentalAspects
ProjectChartsandLayouts
ProjectImplementationSchedule
NeedforConsideringAlternatives

Manufacturing Process/Technology
For manufacturing a product / service often two or more alternative
technologies are available . The choice of technology is influenced by a
varietyofconsiderations:

Choice of Technology
Thechoiceoftechnologyisinfluencedbyavarietyofconsiderations
Plantcapacity
Principalinputs
Investmentoutlayandproductioncost
Usebyotherunits
Productmix
Latestdevelopments
Easeofabsorption

Technical Arrangements
Satisfactory arrangements must be made to obtain the technical know-how needed
for the proposed manufacturing process. When collaboration is sought, inter alia,
thefollowingaspectsoftheagreementmustbeworkedoutindetail.

Thenatureofsupporttobeprovidedbythecollaboratorsduringthedesigningof
theproject,selectionandprocurementofequipment,installationanderectionof
the plant, operation and maintenance of the plant, and training of project
personnel

Processandperformanceguaranteesintermsofplantcapacity,productquality,
andconsumptionofrawmaterialsandutilities.

Thepriceoftechnologyintermsofonetimelicensingfeeandperiodicroyalty
fee.

The continuing benefit of research and development work being done by the
collaborator.

Theperiodofcollaborationagreement

The assistance to be provided and the restrictions to be imposed by the

collaboratorwithrespecttoexports.

If the technical collaboration is backed by financial collaboration, the level of

equityparticipationandthemannerofsharingmanagementcontrol.

Assignmentoftheagreementbyeithersideincaseofchangeofownership.

Terminationoftheagreementorotherremedieswheneitherpartyfailstomeet
itsobligation

Approachtobeadoptedinforce majeuresituations.

Material Inputs and Utilities

Animportantaspectoftechnicalanalysisisconcernedwithdefiningthe
materialsandutilitiesrequired,specifyingtheirpropertiesinsomedetail,
andsettinguptheirsupplyprogramme.
Materialsandutilitiesmaybeclassifiedintofourbroadcategories:
Rawmaterials
Processedindustrialmaterialsandcomponents
Auxiliarymaterialsandfactorysupplies
Utilities

Product Mix

Thechoiceofproductmixisguidedbymarketrequirements.In
theproductionofmostoftheitems,variationsinsizeandquality
areaimedatsatisfyingabroadrangeofcustomers.

While planning the production facilities of the firm, some

flexibilitywithrespecttotheproductmixmustbesought.

Plant Capacity

Plant capacity (also referred to as production capacity) refers to the

volume or number of units that can be manufactured during a given
period. Plant capacity may be defined in two ways: feasible normal
capacityandnominalmaximumcapacity.

Severalfactorshaveabearingonthecapacitydecision:
Technologicalrequirement
Inputconstraints
Marketconditions
Resourcesofthefirm
Governmentalpolicy

Location and Site

Location refers to a broad area; site refers to a specific piece of land.
Thechoiceoflocationisinfluencedbyavarietyofconsiderations:
Proximitytorawmaterialsandmarkets
Availabilityofinfrastructure
Laboursituation
Governmentalpolicies
Otherfactors

Machineries and Equipment

Therequirementofmachineriesandequipmentisdependenton
production technology and plant capacity. It is influenced by
thetypeofproject.

For a process-oriented industry, like a petrochemical unit,

machineries and equipments required should be such that the
variousstagesarematchedwell.

Thechoicesofmachineriesandequipmentsforamanufacturing
industryissomewhatwider.

Structures and Civil Works

Structuresandcivilworksmaybedividedintothreecategories:
Sitepreparationanddevelopment
Buildingsandstructures
Outdoorworks

Environmental Aspects
Theenvironmentalaspectsofprojectshavetobeproperlyexamined.
Thekeyissuesthatneedtobeconsideredinthisrespectare:

Whatarethetypesofeffluentsandemissionsgenerated?

What needs to be done for proper disposal of effluents and

treatmentofemissions?

Willtheprojectbeabletosecureallenvironmentalclearances
andcomplywithallstatutoryrequirements?

Plant Layout
Theimportantconsiderationsinpreparingtheplantlayoutare:

Consistencywithproductiontechnology
Smoothflowofgoodsfromonestagetoanother

Properutilisationofspace

Scopeforexpansion

Minimisationofproductioncost

Safetyofpersonnel

Schedule of Project Implementation

Aspartoftechnicalanalysis,aprojectimplementationscheduleisalso
usuallyprepared.Forpreparingtheprojectimplementationschedulethe
followinginformationisrequired:

List of all possible activities from project planning to

commencementofproduction.

Thesequenceinwhichvariousactivitieshavetobeperformed.

Thetimerequiredforperformingvariousactivities.

Theresourcesnormallyrequiredforperformingvariousactivities.

Theimplicationsofputtingmoreresourcesorlessresourcesthan
arenormallyrequired.

The Need for Considering Alternatives

Therearealternativewaysoftransforminganideaintoaconcrete
project. These alternatives may differ in one or more of the
followingaspects:
Natureofproject
Productionprocess
Productquality
Scaleofoperationandtimephasing
Location

Key Project Inter-linkages

Product / Service
Demand
Size
Technology
Location
Selling Price

Production Costs
Financial
Requirements
Profitability

Investment
Outlay

SUMMARY

For manufacturing a product/service often two or more alternative technologies

are available. The choice of technology is influenced by a variety of
considerations: plant capacity, principal inputs, investment outlay, production
cost,usebyotherunits,productmix,latestdevelopments,andeaseofabsorption.

Satisfactory arrangements have to be made to obtain the technical know-how

neededfortheproposedmanufacturingprocess.

Animportantaspectoftechnicalanalysisisconcernedwithdefiningthematerials
andinputsrequired,specifyingtheirpropertiesinsomedetail,andsettinguptheir
supplyprogramme.Materialsmaybeclassifiedintofourbroadcategories:(i)raw
materials, (ii) processed industrial materials and components, (iii) auxiliary
materialsandfactorysupplies,and(iv)utilities.

Theacquisitionoftechnologyfromsomeotherenterprisemaybebywayof(i)
technologylicensing,(ii)outrightpurchase,or(iii)jointventurearrangement.

Appropriatetechnologyreferstothosemethodsofproductionwhicharesuitable
tolocaleconomic,social,andculturalconditions.

Several factors have a bearing on plant capacity decision: technological

requirements,inputconstraint,investmentcost,marketconditions,resourcesof
thefirm,andgovernmentalpolicy.

Thechoiceoflocationisinfluencedbyavarietyofconsiderations:proximityto
raw materials and markets, availability of infrastructure facilities, and other
factors.Onceabroadlocationischosen,theattentionneedstobefocusedonthe
selectionofsiteaspecificpieceoflandwheretheprojectwouldbesetup.

The requirement of machinery and equipment is dependent on production

technologyandplantcapacity.Further,itisinfluencedbythetypeofproduct.

Structures and civil works may be divided into three categories : (i) site
preparation and development, (ii) buildings and structures, and (iii) outdoor
works.

A project may cause environmental pollution in various ways. Hence the

environmentalaspectshavetobeproperlyexamined.

Oncedataisavailableontheprincipaldimensionsoftheproject,projectcharts
andlayoutmaybeprepared.Theimportantchartsandlayoutdrawingsare:(i)
general functional layout, (ii) material flow diagrams, (iii) production line
diagram, (iv) transport layout, (v) utility consumption layout, (vi)
communicationlayout(vii)organisationallayout,and(viii)plantlayout.

Aspartoftechnicalanalysis,aprojectimplementationscheduleisalsoprepared.

The work schedule reflects the plan of work concerning installation as well as
initialoperation.

There are alternative ways of transforming an idea into a concrete project.

Thesealternativesmaydifferinoneormoreofthefollowingaspects:nature
of project, production process, quality of products, scale of operation, time
phasing,andlocation.

OUTLINE
CostofProject
Meansoffinancing
Estimatesofsalesandproduction
Costofproduction
Workingcapitalrequirementanditsfinancing
Profitabilityprojections
Projectedcashflowstatements
Projectedbalancesheets

Financial Projections
Balance Sheet
Cash Flow
Statement
Cost of Project and
Time Phasing

Means of Finance
and Time Phasing
Interest and Loan
Repayment

Depreciation
Cost of Production

Estimate of
Working Results

Working Capital
Needs

Working Capital
Advance (WCA)

Production Plan
Projected Sales

Interest on WCA
Tax Factor

Cost of Project
Thecostofprojectrepresentsthetotalofallitemsofoutlayassociatedwitha
projectwhicharesupportedbylong-termfunds.Itisthesumoftheoutlayson
thefollowing:
Landandsitedevelopment

Buildingsandcivilworks
Plantandmachinery
Technicalknow-howandengineeringfees
ExpensesonforeigntechniciansandtrainingofIndiantechniciansabroad
Miscellaneousfixedassets
Preliminaryandcapitalissueexpenses
Pre-operativeexpenses
Marginmoneyforworkingcapital
Initialcashlosses

Means of Finance
Tomeetthecostoftheprojectthefollowingmeansoffinanceare
available:
Share capital
Term loans
Debenture capital
Deferred credit
Incentive sources
Miscellaneous sources

Project Financing Decision

The key business considerations relevant for the project financing
decisionsare:

Cost

Risk

Control

Flexibility

Estimates of Sales and Production

Inestimatingsalesandproduction,assumethat:

Thecapacityutilisationwouldbeat40-50percentoftheinstalled
capacityinthefirstyear,50-80percentinthesecondyear,and8090percentfromthethirdyearonwards.

Productionandsaleswillbeequal.

Thesellingpriceusedmaybethepresentsellingprice.

Estimates of Production and Sales

(Details may be furnished separately for each product and until the plant reaches
maximum capacity utilisation)
Product
1st 2nd 3rd
yr yr yr
1.

Installed capacity (qty per day per annum)

2.

No. of working days

3.

No. of shifts

4.

Estimated production per day (qty)

5.

Estimated annual production(qty)

6.

Estimated output as % of plant capacity

7.

Sales (qty) (after adjusting stocks)

8.

Value of sales (in000 of Rs)

Product
4th
yr

1st 2nd 3rd 4th

yr yr yr yr

Product
(i)
(ii)
(iii)
Note : Production in the initial period should be assumed at a reasonable level of utilisation of
capacity increasing gradually to attain full capacity in subsequent years.

Cost of Production
Giventheestimatedproduction,thecostofproductionmaybeworked
out.Themajorcomponentsofcostofproductionare:

Materialcost

Utilitiescost
Labourcost
Factoryoverheadcost

Working Capital Requirement and Its Financing

In estimating the working capital requirements and planning for its financing,
bearinmindthefollowing:

The working capital capital requirement consists of raw materials and

components, work-in-process, finished goods, consumable stores,
debtors,andoperatingexpenses.

The principal sources of working capital finance are working capital

advances provided by commercial banks, trade credit, accruals and
provisions,andlong-termsourcesoffinancing.

Therearelimitstoobtainingworkingcapitaladvancesfromcommercial
banks. They relate to the maximum permissible bank finance for
working capital and the amounts that can be raised against each
individualcurrentasset.

Profitability Projections (or Estimates of Working Results)

Giventheestimatesofsalesrevenuesandcostofproduction,thenextstepistoprepare
theprofitabilityprojectionsorestimatesofworkingresults(astheyarereferredtoby
term-lending financial institutions in India). The estimates of working results may be
preparedalongthefollowinglines:
ACostofProduction
BTotaladministrativeexpenses
CTotalsalesexpenses
DRoyaltyandknow-howpayable
ETotalcostofproduction(A+B+C+D)
FExpectedsales
GGrossprofitbeforeinterest
HTotalfinancialexpenses
IDepreciation

JOperatingProfit(G-H-I)
KOtherincome
LPreliminaryexpenseswrittenoff
MProfit/lossbeforetaxation(J+K-L)
NProvisionfortaxation
OProfitaftertax(M-N)
LessDividendon
-Preferencecapital
-Equitycapital
PRetainedprofit
QNetcashaccrual(P+I+L)

Cash Flow Statement

Sources of Funds
1.

Share issue

2.

Profit before taxation with interest added back

3.

Depreciation provision for the year

4.

Development rebate reserve

5.

Increase in secured medium and long-term borrowings for the project

6.

Other medium/long-term loans

7.

Increase in unsecured loans and deposits

8.

Increase in bank borrowings for working capital

9.

Increase in liabilities for deferred payment (including interest) to machinery

suppliers

10. Sale of fixed assets

11. Sale of investments
12. Other income (indicate details)
Total (A)

Disposition of Funds
1.

Capital expenditure for the project

2.

Other normal capital expenditure

3.

Increase in working capital*

4.

Decrease in secured medium and long-term borrowings

- All India Institutions
- SFCs
- Banks

5.

Decrease in unsecured loans and deposits

6.

Decrease in bank borrowings for working capital

7.

Decrease in liabilities for deferred payments (including interest) to machinery

suppliers

8.

Increase in investments in other companies

9.

Interest on term loans

Multi-Year Projections
Having learnt the basics of projections, we shall now look at an illustration
whereinfinancialprojectionsaremadeoveralongertimeframe.
Anewfirm,ABCLimited,isbeingsetuptomanufacturealloysteel.The
expected outlays and proposed financing during the construction and the first
twooperatingyearsareshowninExhibit6.9.
Theprojectedrevenuesandcostsforthefirsttwooperatingyearsareshown
inExhibit6.10.Itmaybeassumedthat(i)thetaxrateforthefirmwillbe60
per cent, (ii) no deductions (reliefs) are available, (iii) preliminary and preoperativeexpenseswillnotbewrittenoffduringthefirsttwooperatingyears,
and(iv)nodividendwillbepaidinthefirsttwooperatingyears.
Based on the above information, the projected profit and loss statements,
projectedcashflowstatements,andprojectedbalancesheetsmaybeprepared
asshowninExhibits6.11,6.12,and6.13.

Exhibit 6.11
Projected Profit and Loss Statements of ABC Limited

Exhibit 6.12
Projected Cash Flow Statements for ABC Limited

Exhibit 6.13
Projected Balance Sheets of ABC Limited

Financial Modeling Using Spreadsheet

SUMMARY
Tojudgeaprojectfromthefinancialangle,weneedinformationaboutthe
following:(i)costofproject,(ii)meansoffinancing,(iii)estimatesofsalesand
production,(iv)costofproduction,(v)workingcapitalrequirementandits
financing,(vi)estimatesofworkingresults(profitabilityprojections),(vii)breakevenpoint,(viii)projectedcashflowstatements,and(ix)projectedbalancesheets.
Thecostofprojectrepresentsthesumofallitemsofoutlayassociatedwitha
projectwhicharesupportedbylong-termfunds.Itisthesumofoutlaysonthe
following:
(i)landandsitedevelopment,(ii)buildingsandcivilworks,(iii)plantand
machinery,(iv)technicalknow-howandengineeringfees,(v)expensesonforeign
techniciansandtrainingofIndiantechniciansabroad,(vi)miscellaneousfixed
assets,(vii)preliminaryandcapitalissueexpenses,(viii)pre-operativeexpenses,
(ix)provisionforcontingencies,(x)marginmoneyforworkingcapital,and(xi)
initialcashlosses.

Tomeetthecostofproject,thefollowingsourcesoffinance(referredtocommonly
asthemeansoffinance)maybeavailable:sharecapital(equitycapitaland
preferencecapital),termloans(rupeetermloansandforeigncurrencytermloans),
debenturecapital(non-convertibledebenturesandconvertibledebentures),deferred
credit,incentivesources(seedcapitalassistance,capitalsubsidy,andtaxdeferment
orexemption),andmiscellaneoussources(unsecuredloans,publicdepositsandlease
andhirepurchasesfinance)
Todeterminethespecificmeansoffinanceforagivenproject,thefollowing
shouldbeborneinmind:(i)normsofregulatorybodiesandfinancialinstitutions,
and(ii)keybusinessconsiderations,namelycost,risk,control,andflexibility.
Typically,thestartingpointforprofitabilityprojectionsistheforecastforsales
revenues.Inestimatingsalesitisreasonabletoassumethatcapacityutilisation
wouldbesomewhatlowinthefirstyearandrisethereaftergraduallytoreach
themaximumlevelinthethirdorfourthyearofoperation.
Themajorcomponentsofcostofproductionare:materialcost,utilitiescost,
labourcost,andfactoryoverheadcost.Thematerialcostcomprisesthecostof
rawmaterials,chemicals,components,andconsumablestoresrequiredfor
production.Thecostofutilitiesisthesumofthecostofpower,water,andfuel.
Thelabourcostincludesthecostofallmanpoweremployedinthefactory.The
expensesonrepairsandmaintenance,rent,taxesandinsuranceonfactory
assets,andsoonarecollectivelyreferredtoasfactoryoverheads.

Inestimatingtheworkingcapitalrequirementandplanningforitsfinancing,the
followingmustbeborneinmind:thebuildupofcurrentassetstilltheratedlevel
ofcapacityutilisationisreached,themaximumpermissiblebankfinanceasper
thesecondmethodoflendingrecommendedbytheTandonCommittee,andthe
marginrequirementsagainstvariouscurrentassets.
Theprofitabilityprojectionsorestimatesofworkingresults(astheyarereferred
tobyterm-lendingfinancialinstitutions)arepreparedalongthefollowinglines:
(i)costofproduction,(ii)totaladministrativeexpenses,(iii)totalsalesexpenses,
(iv)royaltyandknow-howpayable,(v)totalcostofproduction(vi)expectedsales,
(vii)grossprofitbeforeinterest,(viii)totalfinancialexpenses,(ix)depreciation,
(x)operatingprofit,(xi)otherincome,(xii)preliminaryexpenseswrittenoff,(xiii)
profit/lossbeforetaxation,(xiv)provisionfortaxation,(xv)profitaftertax,(xvi)
dividend,(xvii)retainedprofit,and(xviii)netcashaccrual.
Thecashflowstatementshowsmovementofcashintoandoutofthefirmand
itsnetimpactonthecashbalancewiththefirm.
Thebalancesheet,showingthebalanceinvariousassetandliability
accounts,reflectsthefinancialconditionofthefirmatagivenpointoftime.