Financial Blueprint: A Step-by-Step Guide to Business Viability

Introduction

In the dynamic world of business, having a brilliant idea is only the beginning. The real challenge lies in translating that idea into a viable, profitable venture. This is where a solid financial blueprint becomes indispensable. A well-executed financial study not only helps you understand the financial health of your project but also serves as a guiding framework to navigate investments, risks, and long-term sustainability.

This guide, “Financial Blueprint: A Step-by-Step Guide to Business Viability,” is designed to equip entrepreneurs and business leaders with the tools and insights needed to make informed financial decisions. From setting the right assumptions to analyzing risks, every step is crucial in building a strong financial foundation.

Here’s what we’ll cover:

• Key Financial Assumptions: Establishing the baseline for sound planning.
• Investment Costs and Capital Structure: Understanding your funding needs and sources.
• Revenue Planning and Cost Management: Balancing profitability with operational efficiency.
• Projections and Financial Statements: Creating detailed income statements, balance sheets, and cash flow forecasts.
• Viability Testing and Risk Analysis: Ensuring your business can withstand uncertainty.

By following this comprehensive approach, you’ll not only gain clarity about your project’s financial viability but also position yourself for long-term success in a competitive market. Let’s dive into the steps that will turn your vision into a thriving reality!

Set The Key Financial Assumptions

This process refers to conditions, estimates and expectations made by organizations regarding future financial variables and events. Financial assumptions that serve as foundations for financial planning and budgeting, may include estimates on the growth rate of sales and expenses, discount rate, weighted average cost of capital (WACC), interest rate, selling prices, sold quantity, operating expenses, and alike. These assumptions show the critical conditions the business will be involved in; however, such estimates shall neither replace any risk analysis nor fix the future dynamics of business influencers. These assumptions play a significant role in judging the decision-making, forecasting and budgeting, viability testing, relocation of resources, performance evaluation, and risk analysis. The more the financial assumptions are reasonable and reflect the actual business situation, the more the financial results will become accurate.

Step-By-Step Process

• Clarify the sales and marketing, technical, and organizational outcomes as per the previous steps.
• Look into best practices and obtain assumption details.
• Search the company’s internal and external conditions and anticipate variable factors that influence the viability, such as growth rate, discount rate, inflation rate, interest rate, wages and salaries, revenues and expenses, and alike.
• List all current and capital accounts and decide on the most variable accounts that impact the financial viability.
• Identify and list all financial variables relevant to the critical accounts and viability, like revenue drivers, cost components, market factors, interest rates, inflation rates, growth rates, and other factors relevant to your business or industry.
• Describe the future variability for each of the current and capital accounts critical to the financial viability and define trends and scenariosEstimate the variable factors regarding the step before, like growth rate, interest rate, operating cost as a percentage of revenues, gross margin, operating margin, net profit margin, capital structure, and so forth.
• List all financial assumptions and share them with the team and experts.

Example

Here are the financial assumptions of a pharmaceutical manufacturing facility:

• Working capital is estimated based on the third-year operation sales of ($18) million, covering (60) days for receivables, and cost of goods sold of ($7) million covering (90) days for inventory, (90) days for cash, and (30) days for payables.
• Depreciation estimates are calculated based on (5) years of depreciation schedule for the pre-investment cost and capital financing cost, (15) years for the production technology and warehouse equipment, (25) years for the building, and (5) years for the rest of the fixed assets.
• The standard growth rate for revenues, costs, and working capital is set at (5%) for the first five years of production and (3%) afterwards, except for the sales of the first ten years, which follow different paths.
• The cost of materials, packaging, wastes and other direct expenses is estimated as (20%) of factory ex-work prices (Private sales) for the production products and (25%) for the secondary-packaging products.
• The cost of marketing and sales is estimated at (45%) of the revenues.
• The cost of administration is estimated at (10%) of the revenues.
• The financial cost is based on a (75%/25%) leverage ratio (loan/equity), a (3.5%) fixed interest rate, and is repaid over ten years with a two-year grace period.
• The financial costs for the operation debts, other than the initial investment, are based on the fixed interest rate of 3.5% and are repaid over ten years with no grace period.
• The Weighted Average Cost of Capital (WACC) is estimated as 7%.
• We applied no corporate tax.
• The sales program is based on the assumption of private price as (70%) for the first generic medicine, 60% for the second generic medicine, 50% for the third generic one, and so forth of the originator factory ex-work price and (30%) of the public-tender selling prices.
• Dividend pay-outs are assumed to be (0%) for the years (1-4), (10%) for the 5^th  year, (20%) for the 6^th  year, (30%) for the 7^th  year, (40%) for the 8^th  year, and (50%) for the 9^th year and so forth.

Estimate The Cost Of Investment

It is the process of estimating the project’s investment cost and consisting of the networking capital, pre-production costs, and fixed assets. The networking capital is current assets subtracted from the current liabilities, and the pre-production costs are expenses made before creating the company; therefore, it is capitalized and considered part of the initial investment. The fixed assets, like machinery, equipment, tools, building, furniture, and vehicles, are considered a significant portion of the initial investment. The feasibility study must carefully estimate the investment cost; otherwise, it will result in cash flow issues. Understanding the investment cost allows investors to make informed decisions, allocate capital efficiently, assess risks, and evaluate the competitiveness and viability of the investment.

Step-By-Step Process

• Clarify the marketing, technical and organizational studies, collecting more precise information about the projected sales, plant assets, staff costs, building and more that will be input into the process of estimating the investment costs.
• Estimate the networking capital of the project by assuming the number of coverage days as sales and cost of goods sold to use it in estimating the initial balances of the account receivables, inventories and payables. The networking capital is the net current assets (e.g., receivables, inventories, and cash) after covering the current liabilities (payables).
• Estimate the pre-production costs by obtaining information about the expenses made before creating the company to prepare, for instance, the feasibility study, marketing surveys, travels, etc.
• Estimate the fixed assets of the project like, machinery, equipment, tools, building, furniture, vehicles, and alike.
• Validate investment cost estimates by sharing them with your teams, experts, and supply chains.

Example

Here is the investment cost of a pharmaceutical manufacturing facility:

Accounts	Sub-accounts	Cost ($)
Current Assets	Receivables	2,914,517
	Inventories	1,689,489
	Cash	4,371,776
	Sub. Total	8,975,782
Current Liabilities	Payables	563,163
	Other Payables	381,615
	Sub. Total	944,778
Net Working Capital	Sub. Total	8,031,004
Pre-Investment Costs	Sub. Total	250,000
Capital Financing Costs	Sub. Total	175,000
Fixed Assets	Secondary Packaging Lines	500,000
	Solid Production Plant	5,566,000
	Construction	4,208,200
	Civil and Electrical Works	210,410
	Licensing Fees	100,000
	Product Formula and Profiling	8,000,000
	IT Systems and PCs	350,000
	Furniture	100,000
	Vehicles	350,000
	Other Fixed Assets	581,538
	Sub. Total	19,966,148
Total Investment		28,422,152

Describe The Capital Structure

This process refers to the source of funds to finance the investment cost, and capital structure typically consists of share equity, loans, and grants. For example, investment costs can be financed by (50%) of loans and equity. Many determents influence the decision of the capital structure, including the cost of money, management control, and risk tolerance. Loans incur interest expenses, and share equity promises investment returns to investors. The weighted average cost of capital (WACC) results from the weighted cost of loans and equity. (WACC) impacts the project viability as it is oppositely correlated to profitability.

Step-By-Step Process

• Evaluate the components of the investment costs (e.g., net working capital and fixed assets), founders’ risk tolerance, expected profit returns, and business plans and objectives.
• Clarify the investment costs and explore options for financing.
• Using multi-methods to fix a capital structure, including the cost of capital, profitability, cash flows, and WACC might be considered a key determent for the capital structure.
• Collect information about credit conditions and costs from lending houses.
• Explore the returns and risk tolerance potential investors claim to invest in the business.
• Set the ideal capital structure, and calculate the WACC and expected return on investment.
• Test and validate the capital structure options regarding capital cost, returns, risk, control, cash flows, and overall profitability.
• Share a discussion of the capital structure with your team and experts and obtain advice.

Example

Here is the capital structure projection of a pharmaceutical manufacturing facility:

Capital	Construction Yr. 1	Yr. 1	Yr. 2	Yr. 3
Loans	21,316,614	21,316,614	21,316,614	21,316,614
Additional loans	–	–	1,000,000	1,000,000
Accumulated repayments of loans	–	–	–	(2,231,661)
Net Loans	21,316,614	21,316,614	22,316,614	20,084,953
Paid-up capital (Equity)	7,105,538	7,105,538	7,105,538	7,105,538
Additional paid-up capital	–	–	–	–
Net profit/loss	–	(4,702,848)	(5,488,660)	(435,382)
Retained profit	–	(4,702,848)	(10,191,508)	(10,626,891)
Pay-out dividends %	–	–	–	–
Pay-out dividends $	–	–	–	–
Sub. Total	7,105,542	2,402,694	(3,085,966)	(3,521,349)
Total	28,422,168	23,719,320	19,230,660	16,563,615

Estimate The Cost Of Capital

The cost of capital is the price of the cash (or money) the company pays to get, and it is a rate from the invested costs (loans and equity). Businesses get funds through loans, equity shares, or grants, and every source of funds has a different level of risk and return (or cost) that funders ask for from borrowers or investors. The company’s cost of capital is the weighted average cost of capital (WACC) sourced through loans and equity shares. The cost of loans is usually referred to as the interest rate and return on equity for the equity shares that shareholders claim from the company due to associated risks (e.g., credit, default, finance, and investment). Management strives to achieve a return on investment, which is higher than the cost of capital, to allow company profitability and sustainability. The importance of estimating the capital cost includes evaluating investment decisions (i.e., viable opportunity shows returns higher than the cost of capital), determining the value of assets and the company by discounting its future cash flows, directing the company to set financial targets, and guiding the management to decide on the optimum capital structure that supports maximizing profitability.

Step-By-Step Process

• Clarify the investment cost and capital structure outcomes.
• Obtain the loan interest rates from potential lenders.
• Review the average (WACC) for the industry.
• Work out the expected return on equity in your company using multi-methods like the capital asset pricing model (CAPM) (free return plus risk-premium return), dividends discount model (DDM), collecting the equity returns of similar businesses, or searching industry benchmarks. As a rule of thumb, the equity return is higher than the loan interest rates as the equity investment risk is much higher than credit risks.
• Use the weighted average cost of capital (WACC) to estimate the project’s capital cost. The formula is WACC = (Cost of Debt x Weight of Debt) + (Cost of Equity x Weight of Equity).

Example

If the company’s capital structure reveals (60%) loans and (40%) equity shares, the loan interest rate is (7%), and the expected return on equity is (14%), then the weighted average cost of capital becomes (9.8%).

Plan Revenues

Revenues are sales and a significant source of operating funds for a business, and it is measured as sold quantities multiplied by prices. Projecting revenues enables estimating the income statement, operating cash flow, breakeven point, and viability measurement. Revenue serves as a critical measure of a business’s financial performance and is vital for assessing the feasibility, profitability, growth potential, and investment attractiveness of a venture.

Step-By-Step Process

• Clarify the project sales and marketing strategy discussed in the sales and marketing section above.
• Set sales assumptions, e.g., market size, growth rate, market share, selling prices, and competition, and the projection timeframe, e.g., (5-10) years.
• Search the target markets and customers and judge the project market share, sales, and growth rate.
• Understand competition and work out a competitive pricing strategy and marketing positioning.
• Estimate the first-year sales and project them as per the approved growth rate for, e.g., (5-10 years).
• Judge the sale projections with your team and experts before finalising.

Example

Here is the summary of the sales projection for a new business:

Details	Yr. 1	Yr. 2	Yr. 3	Yr. 4	Yr. 5	Yr. 6	Yr. 7	Yr. 8	Yr. 9	Yr. 10
Revenues ($ Mil.)	–	1.2	18	31	42	51	58	64	69	71

Set Depreciation, Amortization, And Provision Costs

This process refers to breaking down the business’s non-cash expenses over the useful lives of assets. They are accounting terms related to the allocation of costs and the recognition of future liabilities. Depreciation costs are typically the summation of the net cost of fixed tangible assets, like machinery and building, (after deducting residual values) divided over each asset life expectancy period (e.g., usually counted in years).

Amortization is the same as depreciation, but it is for non-physical assets like goodwill, patent, copyrights, trademarks, pre-production costs or capital financing fees. It represents the gradual write-off of the cost of intangible assets over their estimated useful lives. Like depreciation, amortization helps match expenses with the revenue generated from the use of intangible assets.

Provisions are expenses resulting from impairment (i.e., potential losses or liabilities before assets are materialised) of investment sub-accounts like account receivables, inventories, or fixed assets.

These costs depend on the purchasing costs or initial investment estimates and life expectancy period (e.g., (5) years for the pre-production costs, (15) years for machinery, and (25) years for the building).

The importance of estimating these non-cash expenses includes allocating associated expenses of sales for each financial reporting period (e.g., a year), maintaining the accurate values of fixed assets, revolving cash equivalent to investment costs for future replacement, and enabling assets growth. These expenses play crucial roles in financial reporting by accurately reflecting the consumption of assets, the value of intangible assets, and potential future obligations.  

Step-By-Step Process

• Clarify the investment cost and identify each sub-account, including the nature of the account, classification (e.g., depreciation, amortization, or provision), beginning balance, and useful life.
• Check industry benchmarks on asset useful lives.
• Choose the method of depreciation (e.g., fixed, accelerating, or decelerating method).
• Prepare a table showing the investment account, its beginning balance, and useful life, and conclude every asset’s depreciation, amortization or provision expenses over its useful life period.
• Spread the depreciation, amortization, and provision expenses over a period of years equivalent to asset useful lives.
• Share findings with your team and experts for finalization.

Example

Here is the table of the depreciation costs for a pharmaceutical manufacturing facility:

Accounts	Sub-accounts	Initial Investments	Dep. Period	Yr. 1 ($)	Yr. 2 ($)	Yr. 3 ($)
Current Assets	Receivables	8,026,714	1%	40,134	40,134	40,042
	Inventories	3,022,278	1%	15,111	15,111	23,602
	Cash	12,040,071	–	–	–	–
	Total	23,089,063	–	55,245	55,245	63,645
Current Liabilities	Payables	1,511,139	–	–	–	–
	Other Payables	445,887	–	–	–	–
	Total	1,957,026	–	–	–	–
Pre-investment costs	Pre-Investment Costs	500,000	5	100,000	100,000	100,000
Fixed Assets	Production Technology	58,933,000	15	3,928,867	3,928,867	3,928,867
	Warehouse Equipment	1,270,000	15	84,667	84,667	84,667
	lab. Instruments and Facilities	2,000,000	5	400,000	400,000	400,000
	Spare Parts and Consumables	1,624,975	5	324,995	324,995	324,995
	Other Tools and Equipment	1,700,000	5	340,000	340,000	340,000
	Freight, Testing, Installation, and Commissioning	10,214,000	15	680,933	680,933	680,933
	Stage 1- Manual Secondary Packaging Lines	500,000	15	33,333	33,333	33,333
	Stage 1- Pilot Plant	5,566,000	15	371,067	371,067	371,067
	Construction	39,697,000	25	1,587,880	1,587,880	1,587,880
	Civil and Electrical Works	1,984,850	15	132,323	132,323	132,323
	Registration & Licensing Fees	2,600,000	5	520,000	520,000	520,000
	Product Formula and Profiling	21,620,000	10	2,162,000	2,162,000	2,162,000
	IT Support + PCs	1,400,000	5	280,000	280,000	280,000
	Furniture	400,000	5	80,000	80,000	80,000
	Vehicles	1,400,000	5	280,000	280,000	280,000
	Other Fixed Assets	4,527,295	5	905,459	905,459	905,459
	Depreciation costs for the fixed assets	155,437,120	–	12,111,524	12,111,524	12,111,524
Capital Financing Costs	Capital Financing Costs	925,000	5	185,000	185,000	185,000
Total		177,994,157		12,451,769	12,451,769	12,460,169

Plan Operating Costs

This process refers to planning all annual expenses of the project for, e.g., (5-10) years, and they are the day-to-day expenses that a business incurs to maintain its regular operations and generate revenue. Operating costs encompass all business activities to generate revenues, including production, marketing and sales, administration, and general expenses. The product costs show the cost of production activities like raw materials, labour, depreciation, utilities, maintenance, and more. The sales and marketing expenses include, for instance, workforces, promotions, and more, and the administration costs include staff costs, depreciation, utilities, rents, financial cost, and more. Costs are cash-outs to acquire services and materials, and they are a significant determent for financial reporting, product costing, pricing, and performance evaluation. 

Step-By-Step Process

• Clarify the project’s costing details, including sales and marketing, administration, production, organisation, and plans.
• Research the key costing indicators of the concerned industry. These indicators may include gross margin, operating margin, net profit margin, sales and marketing expenses as a percentage of revenues, administration and general expenses as a percentage of sales, etc.
• Set costing assumptions based on evidence.
• Clarify the staff costs.
• Clarify the depreciation, amortization, and provision costs.
• Identify all associated activities with revenues and estimate their realization costs.
• List, estimate, and group all costs ($/year) into production, sales and marketing, administration, and general.
• Reclassify costs as direct (e.g., relevant to the cost centre of production) and indirect costs, or variable and fixed costs.
• Add contingency margin as a percentage of the total estimated costs to meet any unseen costing condition. 
• Evaluate and analyse cost estimates, yearly and classified per the main section, by comparing them with industry benchmarks and similar businesses before finalization.
• Share these costing assumptions and findings with your team and experts.

Example

Here are the operating costs of the pharmaceutical manufacturing facility:

Operating Costs- Production

Accounts	Year 1 ($/Yr.)	Year 2 ($/Yr.)	Year 3 ($/Yr.)
Cost of raw materials, packaging and waste	18,100	180,998	2,562,556
Factory staff costs	751,797	1,552,254	1,603,347
Utility costs	359	3,586	50,775
Maintenance costs	552	5,517	78,116
Communication costs	138	1,379	19,529
Travelling costs	225	2,248	31,832
Machine and tool calibration costs	414	4,138	58,587
Insurance costs	138	1,379	19,529
Office supply costs	138	1,379	19,529
Cleaning costs	276	2,759	39,058
Safety and fire service costs	276	2,759	39,058
Staff development costs	138	1,379	19,529
Factory- Internet and IT support services costs	276	2,759	39,058
Hospitality costs	207	2,069	29,294
Factory depreciation cost	1,986,450	1,986,450	1,986,450
Royalty cost	–	–	–
Factory transportation	207	2,069	29,294
Other factory costs	55,194	75,063	132,511
Total	2,814,883	3,828,188	6,758,052

Operating Costs- Marketing and Sales

Sub-accounts	Year 1 ($/Yr.)	Year 2 ($/Yr.)	Year 3 ($/Yr.)
Sales & distribution staff costs	74,160	153,120	158,160
Communication costs	675	6,747	95,520
Travelling costs	1,667	16,672	236,047
Office supply costs	556	5,557	78,682
Staff development costs	278	2,779	39,341
Marketing- Internet and IT support services costs	1,111	11,115	157,365
Promotion costs	13,894	138,937	1,967,061
Event management costs	3,890	38,902	550,777
Distribution costs	9,448	94,477	1,337,601
Vehicle fuels and maintenance	706	7,058	99,927
Printing costs	1,667	16,672	236,047
Advertising costs	5,557	55,575	786,824
PR costs	2,779	27,787	393,412
Hospitality costs	556	5,557	78,682
Sales & marketing  transportation	1,111	11,115	157,365
Goods transportation	9,521	95,205	1,347,906
Other sales & market costs	3,827	20,618	231,622
Total	131,403	707,897	7,952,341

Operating Costs- Administration & General

Sub-accounts	Year 1 ($/Yr.)	Year 2 ($/Yr.)	Year 3 ($/Yr.)
Management, administration, and inventory staff costs	346698	658416	680088
Communication costs	442	4,421	62,596
Travelling costs	617	6,175	87,425
Office supply costs	370	3,705	52,455
Staff development costs	247	2,470	34,970
Adm.- Internet and IT support services costs	1,113	11,127	157,540
Rent costs	864	8,645	122,395
Insurance costs	642	6,422	90,922
legal costs	494	4,940	69,940
Utility costs	741	7,410	104,910
Auditing costs	220	2,198	31,123
Financial costs	746081	781081	702973
Hospitality costs	417	4,168	59,012
Inventory administrative costs	1,235	12,350	174,850
Administration transportation costs	547	5,471	77,458
Non-Factory depreciation cost	604633	604633	604633
Other administration costs	51161	63709	93399
Total	1,756,523	2,187,342	3,206,689

Estimate The Cost Of Products

Product costing refers to estimating the cost of products and includes the direct costs (e.g., materials and labour) and indirect costs like production overheads. For the sake of the study, the cost of products results from dividing the total costs by the produced quantity annually. Estimating the direct costs of products is straightforward and can be done by calculating the cost of materials, packaging, waste and other direct costs (e.g., labour costs) for a product (or a job order); however, the problematic issues rely on the mechanism of allocation of production overheads (e.g., utilities and depreciations) over the produced quantity. Resolving this issue includes the simple average method when the total production overhead of the specific period (e.g., one year) is divided by the produced quantity. Other ways include using the percentage of the man-hours spent on every job order from the total man-hours or machine-hours consumed from the total machine-time spent on production over the year. Another way to estimate the production overheads of products is to apply a computer system called activity-based cost, which creates cost centres relevant to production job orders and assumes production overheads allocation percentages over job orders. Activity-Based Costing (ABC) is a method that assigns costs to specific activities or cost drivers within the production process, identifying the activities that consume resources and allocating costs based on the usage of those activities. Before choosing the method of cost accounting, set the costing assumptions about, for instance, the standard consumption criteria of direct costs for production job orders, the overhead allocation method, the system of cost accounting (e.g., job order or continuous system of accounting), cost of inputs, inventory costing system (FIFO, LIFO, or average costing), and more. The significance of product costs is driven by the results of allowing the management to accurately estimate the costs, set pricing, and plan profitability.

Step-By-Step Process

• Clarify the operating costs, production capacities, and sales projections illustrated in the previous sections of this study.
• Set cost accounting assumptions about the direct and indirect costs of production.
• Determine the various cost components of the overall product cost, including direct and indirect production costs, indirect sales and marketing, and indirect administration and general.
• Collect all necessary data and information related to each cost component.
• Estimate the direct cost of a product that includes the cost of materials, packaging, waste and other direct expenses (e.g., labour costs).
• Estimate the production overheads of a product, including costs like depreciation, utilities, maintenance, cleaning, equipment calibration, etc.
• Estimate the cost of marketing and sales of a product by dividing the total cost of sales and marketing by the quantity produced or sold over a year.
• Estimate the cost of administration and general of a product by dividing the total cost of sales and marketing by the quantity produced or sold over a year.
• Use a computer system to handle the cost accounting processes.
• List the product cost, judge them with your team, and consult experts.
• Evaluate and test costing results.

Example

Products	Unit	Cost of Raw Materials ($/Unit)	Cost of Packaging ($/Unit)	Cost of Waste ($/Unit)	Other Factory Direct Costs ($/Unit)	Factory Indirect Costs ($/Unit)	Cost of Production ($/Unit)	Cost of Marketing ($/Unit)	Cost of General Adm. ($/Unit)	Total Cost ($/Unit)
Diabetic agent	30	0.15	0.08	0.01	0.22	0.09	0.55	1.23	0.31	2.00
Diabetic agent	30	0.12	0.06	0.01	0.17	0.07	0.44	0.99	0.25	1.60
Diabetic agent	30	1.03	0.52	0.08	1.44	0.63	3.71	8.26	2.06	13.40
Diabetic agent	30	1.03	0.52	0.08	1.44	0.63	3.71	8.26	2.06	13.40
Diabetic agent	60	1.11	0.56	0.09	1.56	0.68	4.00	8.90	2.23	14.45
Diabetic agent	30	0.91	0.46	0.07	1.28	0.57	3.28	7.29	1.82	11.82
Diabetic agent	60	0.99	0.49	0.08	1.38	0.61	3.55	7.89	1.97	12.80
Diabetic agent	30	1.09	0.55	0.09	1.53	0.68	3.94	8.76	2.19	14.21

Project Income Statement

This process refers to planning the net profit or loss of the business over (5-10) years, and it involves estimating revenues, cost of goods sold, gross margin, operating expenses, financial costs and net profit or loss balances. An income statement shows the efficiency of managing resources, and net profits increase the equity and net worth of the company. Profit results from the surplus of revenues after covering all expenses, and it is a source of cash flows from operating which is the source of value for the project. The income statement provides rich information about the business performance over a specific period (e.g., one year) and enables performance evaluation and analysis. There are many ways to project an income statement, including assuming a fixed growth rate of revenues or planning a market share growth based on evaluating the target markets. The cost of goods sold (COGS) and operating expenses are usually assumed as fixed percentages of revenues. These percentages, such as gross margin, percentage of sales and marketing expenses to revenues, operating profit margin or net profit margin, are taken from the industry benchmarks.

Step-By-Step Process

• Clarify sales plans, operating cost details, capital structure and the cost of finance, and overall growth rate of revenues and expenses.
• Search the market and decide on the market share targets and growth rate.
• Obtain industry benchmarks and performance indicators, especially regarding the financial percentages associated with revenues.
• Project revenues over (5-10) years, assuming a fixed or variable growth rate.
• Project the cost of goods sold, assuming a fixed percentage of revenues.
• Calculating the gross profit/loss by subtracting the cost of goods sold from revenues.
• Project operating overheads, including sales and marketing, administration, and general expenses, assuming a fixed percentage of revenues.
• Project the financial costs, if any, by obtaining the bank interest rate on loans.
• Project the net profit/loss statement for (5-10) years as per the above assumptions.
• Share the income statement projection with your team and experts for finalization.
• Evaluate, test, and decide on the income statement projection.

Example

Here is the projection of the income statement for a pharmaceutical manufacturing facility:

Details	Yr. 1 ($)	Yr. 2 ($)	Yr. 3 ($)	Yr. 4 ($)	Yr. 5 ($)
Net revenues	–	1,235,149	17,487,103	30,862,800	41,934,667
Cost of goods sold	2,814,883	3,828,188	6,758,052	9,468,665	11,495,931
Gross profit/loss	(2,814,883)	(2,593,039)	10,729,051	21,394,135	30,438,736
Marketing and sales expenses	131,403	707,897	7,952,341	13,982,685	18,922,412
Administration expenses	1,010,480	1,406,642	2,509,118	3,919,235	4,706,717
Net operating profit/loss	(3,956,766)	(4,707,578)	267,591	3,492,215	6,809,607
Financial expenses	746,082	781,082	702,974	624,866	546,757
Net profit/loss before tax	(4,702,848)	(5,488,660)	(435,382)	2,867,349	6,262,850
Tax expense	–	–	–	–	–
Net profit/loss	(4,702,848)	(5,488,660)	(435,382)	2,867,349	6,262,850

Project Balance Sheet

This process refers to planning the business’s balance sheet over (5-10) years, and it involves estimating current assets, fixed assets, current liabilities, loans and equity balances. A balance sheet shows the networking capital, capital structure, and company’s net worth on a specific date. The net equity, which is the company’s net worth, is the residual asset value of the firm after covering the loans and current liabilities. The balance sheet provides rich information about the net worth value, short-term and long-term capital structure, working capital, and overall liquidity levels, along with analysing cash flows and performances. The balance sheet is a dynamic net balance document that changes due to variability of, for instance, working capital, depreciation costs, net profit/loss, investment decisions, and capital structure. You can estimate the initial balances of the working capital by assuming the days of coverage for account receivables, inventory, and payables, whilst the fixed assets are recorded by the historical purchasing values. Loans and equity’s initial balances are recorded as per the assumed leverage ratio, e.g., 50/50% or 60/40% loans to equity.

Step-By-Step Process

• Clarify income statements, fixed assets, depreciation expenses, capital structure, and capital budgeting.
• Obtain industry benchmarks and performance indicators, especially regarding the working capital coverage ratios, capital structure, and fixed assets.
• Estimate the networking capital, i.e., current assets minus current liabilities, by working out the initial balances of account receivables, inventory, and account payables.
• List out the balances of the fixed assets, including machinery, building, equipment, furniture, and vehicles, and project their values over (5-10) years by assuming variable factors like depreciation expenses, capital budgeting (e.g., additional capital), profitability/loss, and capital structure.
• List the initial balances of the capital structure accounts(% as loans and equity) and projection for (5-10 years) by considering repayment of loans, obtaining additional loans, issuing equity shares, and net profit/loss.
• Draft the initial balance sheet and projection of (5-10 years) for discussion with your team and experts.
• Evaluate and test the outcomes of balance sheet projection.

Example

Here is the projection of the balance sheet for a pharmaceutical manufacturing facility:

Details	Yr. 1 ($)	Yr. 2 ($)	Yr. 3 ($)	Yr. 4 ($)	Yr. 5 ($)
Current Assets	6,841,021	4,920,424	4,840,523	8,290,191	14,453,132
Net Pre-Investment Costs	200,000	150,000	100,000	50,000	–
Net Capital Financing Costs	140,000	105,000	70,000	35,000	–
Net Fixed Assets	17,483,085	15,000,022	12,516,959	10,033,896	7,550,833
Total Assets	24,664,106	20,175,446	17,527,482	18,409,087	22,003,965
Current Liabilities	944,786	944,786	963,867	1,209,786	1,399,761
Net Loans	21,316,626	22,316,626	20,084,964	17,853,301	15,621,638
Equity	2,402,694	(3,085,966)	(3,521,349)	(654,000)	4,982,565
Total Liabilities and Equity	24,664,106	20,175,446	17,527,482	18,409,087	22,003,965

Project Cash Flow Statements

This process refers to planning the cash flows (i.e., cash-in and out) of the business over (5-10) years, and it involves cash flows from operation, investment, and finance. It represents the inflows and outflows of actual cash, rather than accounting profits or losses, and provides a more accurate picture of the financial health and performance of the entity. Cash flow from operation reveals the cash flows from the business’s core activities, and it results from the net profit or loss after adding non-cash expenses (e.g., depreciation, amortization, and provision expenses) and financial expenses (e.g., interest expenses of loans), and considering changes in the balances of the networking capital accounts. Cash flows from the investment result from buying or selling fixed assets and are estimated by considering the changes in the fixed-assets balances over accounting years. Cash flows from finance are cash received or paid from loans and equity and are estimated by considering the changes in the balances of loans and equity over accounting years. Positive net cash flows indicate healthy cash flow positioning and performance efficiency. Cash flows are critical to the value of the business, liquidity assessment and budgeting, and show the efficiency of managing resources. The cash flow statement provides rich information about the business performance over a specific period (e.g., one year), liquidity, sources and uses of cash, and enables performance evaluation and analysis. Project cash flows result from the income statement and changes in capital accounts of the balance sheet over consecutive years.

Step-By-Step Process

• Clarify the projection of the income statements and balance sheet.
• Estimate and project the cash flow from the operation, from investment, from finance, along with the free cash flow from investment (i.e., the surplus of cash flow from operation after covering the cash flow from investment), and equity (i.e., free cash flow from investment subtracted from the cash flow from loans).
• Draft the initial cash flow statements and projections of (5-10 years) for discussion with your team and experts.
• Evaluate and test the outcomes of cash flow projection.

Example

Here is the projection of the cash flow statements for a pharmaceutical manufacturing facility:

Details	Yr. 1	Yr. 2	Yr. 3	Yr. 4	Yr. 5
Cash Flow from operating	(5,001,907)	(2,093,475)	2,900,775	3,474,370	7,314,149
Cash flows from investment	(20,391,148)	–	–	–	–
Free cash flows- investment	(25,393,056)	(2,093,475)	2,900,775	3,474,370	7,314,149
Cash flows from finance	20,570,544	218,918	(2,934,636)	(2,856,528)	(2,778,420)
Free cash flow equity	(4,822,511)	(1,874,557)	(33,861)	617,842	4,535,729
Cash flows from equity	7,105,542	–	–	–	(626,285)
Net cash flows	2,283,031	(1,874,557)	(33,861)	617,842	3,909,444

Test Viability 

This process refers to measuring and evaluating the profitability of the project, and it involves estimating viability indicators like the present value (PV), the net present value (NPV), internal rate of return (IRR), payback period (PBP), the breakeven point, and collective financial ratios. The viability test of a project shows the profitability based on specific assumptions. The (PV) results from the discounted future cash flows, whilst (NPV) shows the net (PV) after covering the initial investment (a proxy of investment cash flows). The (IRR) is the investment’s overall return that makes (NPV) equal to zero; in other words, it is the discount rate that makes the (PV) equal to the initial investment. The (IRR) varies depending on the type of cash flows used to figure out the net present values and can be (IRR- Investment) (i.e., the present value of future free cash flows from the investment- operating cash flows minus cash flows from investment or initial investment), or IRR-equity- free cash flow from investment minus cash flows from loans. The IRR-Investment shows the net cash flows that can be used against cash flow from finance (Loans and equity), while IRR-Equity represents the net cash flows against equity (net worth of the company). The breakeven point indicates the level of revenues (as values or quantity) that the company starts at, making a profit, and is calculated by dividing the fixed costs (e.g., marketing and sales, administration, and general expenses a year) by the contribution margin or amount. The investment decision, whether to approve or reject an investment opportunity, typically lies in aligning its viability results with the industry indicators. As a rule of thumb, healthy (PV), (NPV), (IRR), and (PBP) results are positive if they are positive and above the average industry benchmarks. The significance of profitability indicators shows the profitability measurement and enables the decision-making about the investment opportunity.

Step-By-Step Process

• Clarify the study’s details on the income statement, balance sheet, and cash flow statements.
• Decide on the weighted average cost of capital (WACC) or the discount rate.
• Prepare the table of cash flow statements for (5-10 years), including the cash flows from operation, investment, free cash flow investment, cash flow from loans, equity, and free cash flow equity.
• Calculate the terminal value of the project at the end of ten years as net operating cash flows (free cash flows from investment and equity). The terminal value is cash flow at the end of the year (10) multiplied by (1+ growth rate) divided by capital discount (discount rate minus growth rate).
• Obtain industry benchmarks and performance indicators, especially regarding the viability indicators like (PV), (NPV), (IRR), (PBP), and (ROI), to validate your investment viability.
• Draft the viability results for discussion with your team and experts.
• Evaluate and test the outcomes of the viability results.

Example

Here are the viability results of a pharmaceutical manufacturing facility:

Details	PV ($ Mil.)	NPV ($ Mil.)	PBP (Year)	IRR-Investment (%)	IRR- Equity (%)	ROI- Accounting (%)	Break-even Point ($)
Results	243	215	7.11	32	41	37	26,712,442

Analyse Financial Ratios 

This process refers to calculating the financial ratios of projects, relating two or more account balances to indicate meaningful ratios. Financial ratio analysis is a method used to evaluate a firm’s financial performance by comparing various ratios derived from its financial statements. Financial ratios can analyse different aspects of the business performance, including, for instance, liquidity, efficiency, profitability, and leverage (or solvency) ratios.

Liquidity ratios that analyse the business’s short-term liquidity include current liquidity (i.e., current assets divided by the current liabilities) and quick liquidity (i.e., current assets without inventory divided by current liabilities).

Efficiency ratios aim at measuring the efficiency of performance and include assets turnover (net revenues divided by net assets), fixed assets turnover (net revenues divided by fixed assets), equity turnover (net revenues divided by equity), loans turnover (net revenues divided by loans), inventory turnover (net of purchasing divided by inventory), receivable turnover (net revenues divided by receivable), payable turnover (purchasing divided by payables), days to cover the inventory (365 days divided by inventory turnover), days of customers’ credits (average collection period) (365 days divided by receivable turnover), days of suppliers’ credit (average payment period) (365 divided by payable turnover). 

Profitability ratios measure the project’s profitability and include gross margin (gross profit/loss divided by net revenues), net profit margin (net profit divided by the net revenues), profitability index (present values divided by initial investment), return on investment (net profit divided by net assets), return on capital invested, and return on equity (net profit divided by the equity).

Leverage ratios measure the project’s capital structure and long-term financing, especially regarding debt and equity financing. These ratios include debt/equity ratio, debt/asset ratio, interest coverage period (operating profit before interest and tax divided by interest expenses), and debt coverage period (operating profit before interest and tax divided by loans).

The significance of financial ratios evaluates the project’s financial performance and efficiency, and they must be looked at in the context of the industry’s performance to make decisions.

Step-By-Step Process

• Clarify the study’s details on the income statement, balance sheet, and cash flow statements.
• Obtain industry benchmarks, especially regarding financial performance ratios.
• Arrange the financial ratios and share them with your team and expert for discussion.
• Evaluate the project’s financial ratios in line with the industry benchmarks and ensure compatibility.
• Evaluate and test results.

Example

Here are the financial ratios for a pharmaceutical manufacturing facility:

Purpose	Ratio Name	Ratio Analysis (7th Yr.)
Liquidity	Net working capital ($)	27,795,936
	Current ratio	1903%
	Quick ratio	1700%
	Operating cash flow ratio	22%
Efficiency	Asset turnover ratio	161%
	Fixed asset turnover ratio	904%
	Inventory turnover ratio	410%
	Account receivable turnover ratio	612%
	Account payable turnover ratio	1200%
	Average collection period (Days)	59.60
	Average payment period (Days)	30
Profitability	Gross margin ratio	78%
	Operating margin ratio	23%
	Net profit margin ratio	23%
	Return on asset ratio	37%
	Return on equity ratio	57%
	Return on capital invested ratio	38%
	Profitability index ratio  (Overall-business profitability ratio)	855%
Financial leverage	Debt ratio	31%
	Debt to equity ratio	48%
	Interest coverage ratio	3445%
	Debt coverage ratio	121%

Measure Viability Under Risk Conditions

This process refers to measuring profitability under different scenarios like increasing costs, decreasing sales, or increasing the discount rate. Like the viability test shown in the previous section, measuring viability under risk conditions will run measurements like the (PV), (NPV), (IRR), and (PBP), but with different variable conditions from the base-case conditions. The significance of this process reveals viability measurement under different risk scenarios and ranges the level of profitability fluctuating due to various variable causes.  

Step-By-Step Process

• Clarify the study’s details on the income statement, balance sheet, cash flow statements, and base-case viability results.
• Decide on the variable conditions from the base case, like increasing the costs by 10%, decreasing the sales by 10%, increasing the discount rate, reducing the growth rate, and so forth.
• Run the viability testing for each variable condition case and compare results with the base-case results.
• Obtain industry benchmarks and performance indicators, especially regarding the viability indicators like (PV), (NPV), (IRR), (PBP), and (ROI), to validate your investment viability.
• Draft the viability results for discussion with your team and experts.
• Evaluate and test the outcomes of the viability results.

Example

Here is the sensitivity analysis for a pharmaceutical manufacturing facility:

Scenarios	PV ($ Mil.)	NPV ($ Mil.)	Payback Period	IRR Investment (%)	IRR Equity (%)	Breakeven point- Sales ($ Mil.)
Decreasing in revenues: 10%- Quantity	168	140	9 years & 1 months	27	34	–
Decreasing in revenues: 10%- Price	145	117	9 year & 9 months	25	30
Increasing discount rate to 12%	89	60	7 years & 4 months	27	32	–
Increasing operating costs by 10%	160	131	9 years & 6 months	26	31	–
Decreasing growth rate to be 2% (after 10-year operation)	144	172	7 years & 11 months	30	38	–
Base situation	243	215	7 years & 11 month	32	41	$26.7 mil. @ 87% of 4th year sales

The author: Munther Al Dawood

This article is derived from my book- Your Guide for Preparing an Industrial Feasibility Study

Get your copy here: https://growenterprise.co.uk/book-your-guide-for-preparing-an-industrial-feasibility-study/

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