CHAPTER FIVE

5. Financial Analysis
 Core contents of the Chapter
5.1. Objectives of Financial Analysis
5.2. Market Analysis
5.3. Pricing Project Costs and Benefits
5.3.1. Finding Market Prices
5.3.2. Change in prices
5.3.3. Financial export and import parity price
5.4. Farm Investment Analysis
5.5. Computing Debt service
5.5.1. Simple interest rate
5.5.2. Compound interest
 [Link] Analysis (FA)

✓ Focuses on the profitability of a project, from an investor's perspective

(business prospects)

✓It refers to cash flow analysis from which present and future expenditure
and income are used to determine financial feasibility;

✓All analysis is done using market prices;

❖ For public projects, FA provides an indication of the pressure the project

will place on the treasury
 Cont’d

❖Financial analyses answer questions such as:

✓ Is the project financially profitable to the interested parties?

✓Do the interested parties (particularly private ones) have a

sufficiently strong financial incentive to participate?

✓What will be the costs and benefits to private investors or to

participating farmers and landowners?

 5.1. Why Financial Analysis in project?

I. Assessment of financial impact:

o Financial effect on farmers, public and private firms and any other
participating agencies.

o For each, examine the current financial status against the projection of future
financial performance.

II. Efficiency of resource use:

✓Return of project investment and repayment of loans capacity

✓Profitability of individual enterprises should be large enough to be self-

financing
 Cont’d

III. Assessment of incentives:

o Assess incentives for farmers, managers, and other participators and

beneficiaries to participate;

o For farmers, is incremental income enough to justify change?

o For private firms, is it profitable enough for them to make the required
investments?

o For semipublic enterprises, is the return large enough to be self-financing?

 Cont’d
IV. Financial plans:

✓Identify sources of funds - amount, timing, repayment terms and conditions of

credit for individual entities; and

✓Effect of inflation.

V. Financial contributions:

➢Coordinate contributions from various sources and match investment

requirements.
 Cont’d
VI. Assessment of financial management competence:

➢Assessment of complexity of financial matters and therefore managerial

requirements

➢Assess any changes in organization and management that are necessary

➢Identify any special training required.

 5.2. Marketing Analysis
❖ Marketing analysis embraces two sides of market; i.e. demand & supply

❑ Key steps in this analysis are:

1. Situational analysis and specification of objectives

2. Collection of secondary information

3. Conduct of market survey

4. Characterization of the market

5. Demand forecasting

6. Market planning
Steps 1. Situational analysis
➢ Project analysts should communicate with stakeholders to understand the relationship
between products and its marketing.

➢ Project analysts also consider the preference and purchasing power, consumer’s , actions
and strategies of competition and practices of the middlemen.

➢Furthermore, objectives of the project should be structured as queries.

Examples;

Suppose a given project aims at producing wheat in a given locality. The project
initiator and implementer need information about where and how to market their
product. The objective of the market and demand analysis in this case may be to
answer some of the following questions.
 Cont’d
✓Who are the buyers of this product? (Consumers)

✓What is the total current demand for wheat?

✓ How is the demand distributed temporally /pattern of sale over the year and
geographically?

✓ What price will the consumers be willing to pay for the product?

✓How can consumers be convinced that wheat could be substituted for other
foodstuffs?

✓ What channels of distributions are most suited for the product?

✓ What trade margins will induce distributors to carry it out?

 Steps 2. Collection of secondary information
➢Information might be grasped form either primary or secondary sources in order to
address objectives of the market study

➢Secondary information is information that has been gathered in some other context
and is already available.

➢It provides the base and the starting point for market and demand analysis.

➢It includes what is known and often provides clues for gathering primary
information required for further analysis.

➢Examples: Census data, national sample survey reports, plan reports, statistical
abstracts, industry specific sources of data etc.
 Steps 3. Conduct of market survey
➢ It is a census or sample survey which provide a comprehensive basis for market and demand
analysis.

✓ Total demand and rate of growth of demand

✓ Demand in different segments of the market

✓ Income and price elasticity of demand

✓ Motives for buying

✓ Purchasing plans and interventions

✓ Satisfaction with existing products

✓ Attitudes towards various products

✓ Socio economic characterization of buyers

 Step 4. Characterization of the market
❖ Based on secondary and market survey, the market of certain product can be described
as;

o Effective demand in the past and present

o Breakdown of demand

o Prices

o Methods of distribution and sales promotion

o Consumers

o Supply and competition

o Government policy
 Step 5. Demand Forecasting
✓It refers to estimation of future demand on the product and services.

✓Forecasting methods might be divided into three categories; Namely,

o Qualitative methods

i. A jury of executive opinion methods: it involves the soliciting opinion of grouping

managers on expected future sales and combing them into the sales estimation

ii. Delphi methods: it is used to eliciting the opinion of group of experts with the
helps of a mail survey

o Time series projection methods and

o Causal methods
 Time series forecasting methods

o A time series is a set of observations taken at specific time, usually at equal time

interval Example:

✓Daily price of coffee at the auction floor

✓Monthly rainfall

✓Total annual production of wheat in Ethiopia

Step 6. Market planning
 [Link] project
✓Here, we should clearly understand the time value of money. So, project analysts
most probably follow the principles of “Bird-in- the hands”

✓Additionally, project analysts follow some steps while searching for market price;

i. Identifying the technical aspects of the project.

ii. Costs and benefits of both inputs and outputs should be valued

iii. Based on monetary value of inputs and outputs, find market prices and

iv. Make an adjustment for obtained market prices.

 Cont’d

o Furthermore, market prices of certain product could be sought at;

a. First point of sales price

b. Farm gate price: this prices can be used for agricultural commodities in

which their pattern are cyclical and seasonal.

c. Prediction of future prices. This pricing mechanisms depend on the

trends of agricultural commodities or industrial products prices of a few

years patterns.
 5.4. Financial export and import parity price

o Brainstorming Queries

oWhen do we need financial export and import parity price ?

oWhy we need Export and Import parity prices?

 Import and Export parIty prIcEs (cont…)

Definition:

o“Estimated prices at the farm-gate or project-boundary, which are

derived by adjusting the CIF or FOB by all the relevant charges
between the farm-gate and the point where the CIF or FOB is quoted”

•Export PP "The price that a producer gets or can expect to get for its
product if exported, equal to the FOB price minus the costs of getting
the product from the farm or factory to the border.
 Cont’d

• Import parity price or IPP is defined as, “The price that a purchaser

pays or can expect to pay for imported goods;

• Thus the CIF import price plus tariff plus transport cost to the

purchaser's location.

• These are the prices we need for doing the economic analysis.
Elements of CIF (Import) and FOB (Export)
 Cont’d
✓ The possible reason why do we used financial export and import parity prices are;

o All in all inputs of certain project product couldn’t be obtained from domestic.

o Outputs of specific projects cannot be consumed at domestic level due to

purchasing power / Access / of consumers

o Therefore, both parity prices usually used at a time of inputs and outputs of the

firm are sourced and freight to abroad / foreign