Financial preparation is a critical part of any business expansion project. Talking about financial preparation, three aspects that come to the forefront are the financial liability that will arise from a new project, financial ability to execute the project and financial feasibility of carrying out the project.
A business expansion project shall increase the financial liabilities (increased costs) which have to be sourced internally and/or externally (revenue generation, loans and borrowings) reflecting the financial ability of the business enterprise to support expansion. The third aspect is determining the financial feasibility (profitability, healthy ROI) of executing an expansion project. The three financial pillars (liability, ability and feasibility) and project financial management are elaborately discussed here to help businesses effectively prepare on the financial front for their expansion projects.
Costs of business expansion are of two types – capital expenditure and direct and operating costs. The capital expenditure includes investments in machinery, equipment, furniture, space, set-up and establishment costs etc. The direct and operating costs include the expenditures to run the new project. This includes the purchase of inventory and raw materials, wages and salaries, rent and bills, repair and maintenance, insurance and legal expenses etc. Capital expenditure and direct and operating costs associated with a project constitute its financial liabilities and have a direct bearing on its profitability. Therefore, it becomes important that a business enterprise makes a detailed assessment of these costs. These costs have to be recovered to create surpluses. While the investment in capital assets may be recovered in a phased and indirect manner, the direct and operating costs have to be covered on the go. Through cost accounting, a business enterprise can get a clear picture of the financial liabilities of a proposed project based on approximate figures and prices.
The financial ability of a business reflects its knack to procure additional capital funds required to establish a new project and generate sufficient revenue to cover the direct costs and operating expenses. Some of the pertinent questions that arise in capital funding decisions are –
- What is the amount of fresh capital required (cost of new assets, other long-term establishment costs)
- What will be the composition of capital (debt-equity ratio, proportion of self-funding etc)
- What the potential sources of capital (loans, credit, angel investors, mortgage etc)
- What are the costs associated with procuring capital from various sources (interest rates, collateral, ease of acquiring funds etc)
The second part is revenue generation from the new project to cover its direct costs and operating expenses. A business enterprise needs to prepare realistic revenue projections which will reflect the quantum and frequency of cash flow. Liquidity is a crucial element of financial management in business. Businesses need to maintain a healthy working capital ratio to ensure smooth flow of operations in any of its projects or business units. In the event of liquidity crunch, which may happen because of poor revenue collection resulting from poor sales, credit policies, bad debts etc, operations may come to a halt leading to further revenue losses.
The financial ability of a business reflects its knack to procure additional capital funds required to establish a new project and generate sufficient revenue to cover the direct costs and operating expenses.
The financial motive behind every business venture or a project is to generate profits. After ascertaining the costs and revenue generation capabilities of a project, a business enterprise would be in a suitable position to determine the financial feasibility of a proposed project. Financial feasibility of a project determines its fate as to whether it should be executed or not. If a project is not able to able to generate a healthy and steady flow of revenue, it would not be able to cover its costs. ROI also indicates as to how soon the project will be able to reach its breakeven point. There are hosts of financial metrics used in the financial analysis which includes profit margins, return on equity, returns on assets etc. Ascertaining the financial feasibility involves preparation of various financial statements like profit and loss account, income and expenditure account, balance sheet, statement of sources and application of funds etc based on approximate figures and prices.
Financial feasibility of a project determines its fate as to whether it should be executed or not
Project Financial Management
Once a project is financially approved, the next step is laying down the base of its financial management. Financial planning has been broadly discussed above. The other important areas are identifying the key financial processes, structuring of the finance department/team and design for control measures.
For a new project, the primary financial processes are procurement and investment or allocation of capital funds, regulatory compliances, accounting record keeping and information system, processing of receivables and payables, cash flow and credit management, liaisoning with other departments and audit. Each of these processes comprises of several operations and activities which have to be streamlined and documented. This can be done by developing Standard Operating Procedures or SOPs that serves as a guide map for employees to execute their routine duties while maintaining the rules and standards.
Finance is a sensitive area for any organization or project. Apart from prudence and professionalism trustworthiness and integrity are essential competencies in the members of the finance and accounts team.Adequate control measures are crucial to the functioning of the finance department. Authority, accountability and responsibilities must be clearly defined leaving no room for any sort of ambiguities. Along with finance SOPs, periodical audits must be conducted to ensure that rules and regulations pertaining to accounting, reporting and other processes like regulatory compliance and cash handling are being diligently followed.
Authority, accountability and responsibilities must be clearly defined leaving no room for any sort of ambiguities.
Financial preparedness and vision are vital for any economic venture. Without the financial ability, a business enterprise will not be able to establish a new project and cover its financial liabilities. And even if they can, doing so without sound financial feasibility will render the whole project unworthy or loss-making causing it to become a financial burden on the existing business and operations.