Chapter 4

Project Formulation and Report

1. Meaning of Project Formulation

Project formulation is the process of systematically developing a project idea into a workable
and investment worthy plan. It involves evaluating the idea at each step, enabling scientific and
rational decision making.

Definition

"Project formulation is the technique by which a project idea is converted from an intuitional
base to a rational base for all round benefit."

2. Significance of Project Formulation

Project formulation is crucial for:

• Making effective project decisions.

• Securing financial assistance.
• Optimal allocation of scarce resources.
• Obtaining government clearances.
• Independent feasibility assessment.
• Ensuring smoother project implementation.

3. Stages / Elements of Project Formulation

1. Feasibility Analysis

Checks if the project is viable within the entrepreneur’s constraints.

Forms the basis for sanctioning financial aid.

Alternatives:

Project is feasible → proceed.

Not feasible → drop the idea.

Data insufficient → collect more info.

2. Techno Economic Analysis

• Studies demand potential and chooses optimal technology.

• Helps decide project size and methods.
• Ensures economies of scale.

Involves:

• Determining max feasible output.

• Selecting optimal strategies.

3. Project Design and Network Analysis

• Prepares detailed work plan using network diagrams.

• Ensures efficient time/resource management.
• Aids in identifying and quantifying project inputs.

4. Input Analysis

• Identifies required resources (material & human).

• Determines nature, quantity, and supply reliability.
• Forms basis for cost estimates and financial analysis.

5. Financial Analysis

Assesses financial viability and profitability Includes:

• Financial requirement assessment.

 • Breakeven analysis.
• Cash flow needs.
• Capital efficiency.
• Supports investment and commercial decisions.

6. Social Cost Benefit Analysis

• Measures social profitability using imputed prices.

• Evaluates the project’s broader impact on society and national development.
• Helps in national level project justification.

7. Project Appraisal

• Final evaluation of project feasibility.

• Examines technical, financial, managerial, and social aspects.
• Determines the project’s role in economic equilibrium.

4. Feasibility Study Types

a) Prefeasibility Study

Initial study to decide if the idea warrants a detailed analysis.

Helps:

• Identify promising investment opportunities.

• Decide if deeper analysis is needed.
• Spot feasibility constraints.
• Evaluate information adequacy.

b) Feasibility Study

Detailed analysis covering:

• Economic
• Technical
• Managerial
• Organizational
 • Commercial
• Financial aspects

Helps finalize project structure by comparing alternatives.

Suggests changes or adjustments if the initial plan is nonviable.

5. Network Analysis

• Network: Sequential diagram of all project activities.

• Used to prevent delays and excess costs through project scheduling.
• Helps complete the project with minimum time, cost, and resources.

Economic Aspects of Project Appraisal – Pointwise Notes

Meaning:

• Focuses on the overall contribution of a project to national and regional economic

development.
• Evaluated from a social viewpoint, not just private financial gain.

Objectives:

1. To determine if the project benefits the national economy.

2. To assess the optimum utilization of scarce economic resources.

3. To examine potential for import substitution or export promotion.

4. To evaluate the contribution to GDP.

5. To conduct a Social Cost Benefit Analysis (SCBA) for economic justification.

Tools Used:

1. Shadow Pricing – Adjusts market prices to reflect true economic value.

 2. Economic Rate of Return (ERR) – Measures returns using economic values.

3. CostBenefit Ratio (CBR) – Compares economic benefits to economic costs.

Key Factors Considered:

1. Employment generation potential.

2. Use of domestic vs. imported technology.

3. Impact on foreign exchange (imports/exports).

4. Contribution to poverty reduction and rural development.

5. Environmental and social impact of the project.

6. Effect on regional imbalances and income distribution.

1. Economic Viability

• Economic viability is crucial for project evaluation.

• Profit is the main motive behind implementing a project.

Factors affecting viability:

▪ Raw materials
▪ Capacity and utilisation levels
▪ Anticipated sales, expenses, profits

Areas of economic appraisal:

▪ Compatibility with macroeconomic environment & government policies

▪ Demandsupply gap analysis
▪ Stability of demand
▪ Potential market share
▪ Competitor analysis
▪ Availability of necessary resources
▪ Government incentives like tax exemptions, subsidies, etc.
2. Financial Aspects

Finance is essential for mobilising production factors.

Two types of capital:

▪ Fixed Capital (for fixed assets)

▪ Working Capital (for daily operations)

Financial appraisal includes:

▪ Total project cost

▪ Means of financing (owned/borrowed)
▪ Production cost and profit potential
▪ Cash flow projections
▪ Projected balance sheet
▪ Accurate cost estimation and funding source identification are vital.

3. Commercial Aspects (Market Analysis)

Marketing is key to generating revenue.

Market analysis involves:

▪ Anticipating demand, customer base, timing and location of sales

▪ Market size and its growth
▪ Demand supply gap

Competitor data: capabilities, share, strengths/weaknesses

▪ National/international market scope

▪ Export potential or import substitution feasibility

Marketing strategy should cover:

▪ Product quality
▪ Pricing
▪ Packaging
▪ Promotion
▪ Distribution
4. Organisational Aspects

Lenders assess organisational structure and management.

Bank may require:

▪ Shortterm help (e.g., staff recruitment)

▪ Longterm measures (e.g., management consultancy)

Emphasis on:

▪ Effective execution
▪ Locally staffed institution
▪ Training for responsible roles

5. Technical Aspects

Technical feasibility ensures that the plant/equipment meet required norms.

Consider:

▪ Location suitability
▪ Availability of basic inputs: water, power, transport
▪ Access to service facilities
▪ Size of the plant and production process
▪ Availability of skilled labor and raw materials
▪ Factory layout
▪ Compliance with pollution control and government regulations
▪ Technical knowhow (internal or external) should be confirmed.

6. Managerial Aspects

Managerial competence determines project success/failure.

Factors considered:

▪ Promoter’s education and experience

▪ Integrity and entrepreneurial skill
▪ Lack of managerial ability is a key reason for business failure.
7. Modern Quantitative Techniques of Project Appraisal

1. Systems Analysis:

▪ Evaluates alternatives with systematic procedures.

▪ Supports consistent, clear analysis using technology.

2. Operations Research:

Applies mathematical models (e.g., linear programming, inventory control) for decision making.

3. Sensitivity Analysis:

Assesses project risk by evaluating NPV under:

▪ Optimistic
▪ Most likely
▪ Pessimistic scenarios

4. Probability Analysis:

▪ Estimates expected cash flows using assigned probabilities.

▪ Calculates expected monetary value and NPV.

5. Decision Tree Analysis:

▪ Graphical representation of decisions and future events.

▪ Helps visualize outcomes and choose the best alternative.

6. Standard Deviation Method:

▪ Compares risk of projects with equal NPV.

▪ Higher standard deviation = higher risk.
Project Report

Meaning:

▪ A project report is a plan of action or a roadmap for execution.

▪ Contains all essential details to guide the entrepreneur.

Importance:

Highlights viability in terms of economy, finance, technology, and social factors.

Two perspectives:

A. Entrepreneur’s Perspective:

1. Assess demand for proposed product.

2. Estimate total investment and operational costs.

3. Forecast expected profitability.

4. Minimize project execution risks.

5. Aid in final project decisionmaking.

6. Convince investors of project viability.

7. Guide in resource allocation decisions.

8. Explore opportunities in investment.

9. Understand technical, commercial, and financial feasibility.

10. Compare and select from multiple project options.

B. Financial Institution’s Perspective:

Helps in evaluating the feasibility and credibility of the proposed project.

Why Banks and Financial Institutions Insist on a Project Report

1. Avoid waste of scarce investable funds.

2. Prevent misuse of funds by fraudulent entrepreneurs.

3. Prevent emergence of sick (nonperforming) industrial units.

4. Enable wise decisions on loan applications.

5. Prevent financial loss by avoiding unviable projects.

6. Decide the extent of financial assistance.

7. Assess project’s internal fund generation capability.

8. Evaluate technical feasibility of loan repayment.

Scope of a Project Report

1. Economic Aspects

Justifies the investment.

Analyzes:

▪ Market conditions
▪ Demand supply gap
▪ Expected market size and growth
▪ Share of the market to be captured

2. Technical Aspects

Provides:

▪ Technology details
▪ Machinery and equipment info
▪ Source of machinery
 4. Financial Aspects

Includes:

▪ Financial requirements
▪ Funding sources
▪ Fund mobilization methods

4. Production Aspects

Describes:

▪ Product to be manufactured
▪ Reasons for product selection
▪ Product qualities, design, and nature

5. Managerial Aspects

Includes:

▪ Top level management details

▪ Qualifications and experience
▪ Entrepreneur's suitability to manage the project

6. Marketing Aspects

Describes:

▪ Marketing plan and strategy

▪ Distribution channels

Contents / Requirements of a Project Report

1. General Information

a. Biodata of Promoter: Name, address, qualifications, experience.

b. Industry Profile: Industry background, performance, trends.

 c. Constitution & Organization: Legal structure and organization setup.

d. Product Details: Utility, design, variety, and features.

2. Project Description

a. Site: Location details.

b. Physical Infrastructure: Availability of raw materials, labor.

c. Utilities: Power, fuel, water requirements.

d. Communication: Access to communication facilities.

e. Transport: Modes, routes, bottlenecks.

f. Machinery & Equipment: Type, size, cost, suppliers.

g. Common Facilities: Repair shops, machine shops, etc.

3. Market Potential

a. Demand & Supply: Expected demand and gap in supply.

b. Expected Price: Sale price estimation.

c. Marketing Strategy: Sales arrangements.

d. After Sales Service: Service plans post sale.

e. Seasonality Factor: Inventory/storage plans for seasonal items.

4. Capital Cost and Sources of Finance

Estimates for:

▪ Land, building, machinery

▪ Installation costs, preliminary expenses
▪ Working capital margin
▪ Sources: Owner’s funds, bank loans, institutional finance.

5. Assessment of Working Capital Requirements

 ▪ Details working capital needed.
▪ Lists sources of short term funds.
▪ Presented in bank prescribed formats.

6. Other Financial Aspects

Profitability projection:

▪ Projected P&L Account

▪ Cash flow statement
▪ Projected Balance Sheet

7. Economic and Social Variables

Environmental Considerations: Cost of pollution control, treatment of emissions.

Social Benefits:

▪ Employment generation
▪ Import substitution
▪ Ancillarisation
▪ Export potential
▪ Use of local resources
▪ Area development

8. Project Implementation

Timetable/schedule for:

▪ Land acquisition
▪ Unit registration
▪ Bank loan sanction
▪ Building construction
▪ Power connection
▪ Machinery order & installation
▪ Worker recruitment & training
▪ Raw material procurement
▪ Start of commercial production
9. Simplicity

The report should:

▪ Be simple and direct

▪ Justify claims with facts
▪ Quantify dimensions (size, volume, amount)

Requisites of an Ideal Project Report

1. Should be prepared with the help of an expert team.

2. Based on proper surveys and systematic preliminary studies.

3. Assumptions must be realistic—avoid extreme optimism or pessimism.

4. The report is a means, not an end—it's a tool for decisionmaking.

5. Accurate estimates must be made regarding:

▪ Product demand
▪ Raw material availability
▪ Capital resources
▪ Labour resources

6. Discussions with subject experts should be held before finalizing the report.

Problems Faced in Preparation of a Project Report

1. Time overrun is common, which leads to cost overrun.

2. Working capital assessment may be inaccurate due to faulty assumptions.

3. Lending institutions require strict specifications (e.g., land/building size).

4. Excessive documentation is demanded by financial institutions before credit approval.

5. Multiple government department clearances cause delays and stress.

Planning Commission of India – Guidelines for Industrial Project Reports

1. General Information

Analyze the industry background (past performance, public sector role, priority status).

Include information on the enterprise submitting the report.

2. Preliminary Analysis of Alternatives

Data on demand supply gap.

Details of existing plant capacities.

Lists of:

▪ Existing plants
▪ Projects with letters of intent
▪ Proposed projects
▪ Comparison of profitability and return on investment across alternatives.

3. Project Description

Describe the chosen technology/process.

Justify the location of the project.

Provide environmental impact data:

Population, water, air, land, flora, fauna

Pollution effects

Include:

▪ Operational requirements
▪ Personnel and organizational structure
▪ Transport costs
▪ Construction schedule and influencing factors

4. Marketing Plan
Data on:

▪ Demand and supply in targeted areas

▪ Domestic supply estimates
▪ Criteria for market selection
▪ Price trends and analysis

5. Capital Requirements and Costs

Provide a complete estimate of capital costs, ensuring accuracy in:

▪ Land, buildings
▪ Machinery
▪ Installation and preliminary expenses

6. Operating Requirements and Costs

Postproduction costs including:

▪ Raw materials
▪ Fuel and utilities
▪ Labour
▪ Repairs and maintenance
▪ Selling and other expenses

7. Financial Analysis

Measures to assess financial viability:

▪ Proforma Balance Sheet

▪ Depreciation (as per Bureau of Public Enterprises)
▪ Foreign exchange needs clearance

Consider:

▪ Tax rebates
▪ Area based incentives
▪ Accelerated depreciation

Include sensitivity analysis (e.g., effect of product price changes on returns).

8. Economic Analysis

Adjust data to reflect true costs of inputs like foreign exchange, labour, and capital.

Assess:

▪ Impact on foreign trade

▪ Indirect costs and benefits
▪ If unquantifiable, still analyze and highlight their importance.