Investment Needs & Funding of Business Projects

Posted on Nov 7, 2024 in Economy

The Investment Needs of Business Projects

Investment in Fixed Assets

Investment in fixed assets can be categorized into three groups: start-up and implementation expenses, intangible assets, and tangible assets.

Start-up and Implementation Expenses

We must analyze the costs associated with launching the company. Although not assets in the strict sense, these expenses must be paid. We must consider the costs the company will incur following the completion of all procedures and operations necessary to begin operations and prior to commencement, such as:

Fees of lawyers and notaries
Payments for professional and technical reports, studies, etc.
Documents, books, records, permits, etc.

Intangible Assets

We study the costs the company will incur for the acquisition or disposal of items that are part of intangible assets. The main elements of this chapter, for a company that will start a business, will come from the acquisition of patents, concessions for the exploitation of activities by the State, autonomous regions or municipalities, and especially the decision of programs and applications computer.

Tangible Fixed Assets

This includes all tangible assets that the company needs for its activity. The needs that new companies have in these items are based on their specific activities. It is necessary to study not only the necessary investments for the inception of the company, but also the investments that the firm will have to make in the medium term, particularly those which may represent a significant amount. Along with investments in fixed assets, it is also necessary to study the depreciation that will be applied to these elements and calculate and estimate their amount. It is advisable, therefore, to have a single table summarizing all these data, estimates, and estimates of investment and repayment of all project assets.

Investment in Working Capital

Working capital is a quantity that expresses the company’s net investment in short-term assets and consists of inventory, cash, accounts receivable, and accounts payable in the short term. In addition to fixed assets, companies must have adequate working capital, and within it, it is essential to have sufficient liquid mediums to develop an activity without being prevented, restricted, or excessively influenced by a lack of liquidity.

Let’s examine the various components that make up working capital:

Inventory

Companies have to acquire raw materials first, or the first articles to start the activity, i.e., the initial inventory requirements. It is also necessary to provide for subsequent purchases that will be needed to develop the same activity. Based on decisions taken, assembling, and assessing appropriately here in order to consider the investment necessary to carry out this chapter.

Accounts Receivable (Short-Term)

This component, as such, does not appear in the company’s investment because, of course, until the company starts to operate, and early sales may not exist. But to provide further investment in working capital, the enterprise should study the evolution of the main part of these accounts, i.e., the balance of outstanding invoices to charge customers the company estimates it will remain in the early years. This calculation is directly related to the sales policy the company has established in its business plan. In the initial stage, be considered that the accounts receivable that will appear as a result of the activity of the company will go becoming collections and as such will join together with others, collections and payments, the necessary study the Treasury to establish the initial requirements of the company’s liquidity.

Accounts Payable (Short-Term)

To provide further working capital, the enterprise should study the evolution of the main part of these accounts, i.e., the balance of outstanding invoices payable to vendors who are judged to the company will retain in the early years of activity. This is directly related to the purchasing policy the company has set in its business plan and can be estimated from figures for purchases and payment terms previously specified. Be considered that the accounts payable that will appear will be making payments, and as such will join together with other receipts and payments, the study of cash necessary to establish the initial requirements of the company’s liquidity.

Initial Treasury

In the initial stage of project implementation, the company must have sufficient cash to make payments in the short term, which will be due to two reasons:

Structural Payments: The acquisition of assets, expenses inherent in the constitution of the company and implementation.
Operational Payments: The first purchases of raw materials or products. The care of the needs arising from developments in the operations of the activity of the project.

Once you purchase the plant and complete the formalities of incorporation, the company must have a cash balance that allows you to meet the operational needs, taking into account the receipts and payments generated as a result of the activity. It is very important that the company can provide sufficient liquidity for its activity.

These cash requirements, which may be called working capital requirements, should be possible to cover the day-to-day operations of the company and also have an additional amount of liquidity to meet or at least cushion the contingencies that may arise.

The Cash Budget

This estimate can be obtained by preparing a cash budget, which is a document showing all receipts and payments that are to be produced in a given period of time.

An important point for the realization of these projections is to determine the total period to be covered by the forecast or cash budget and time units, or sub-periods, which will group the inflows and outflows of cash and are to be determined cash balances.

The period and the subperiods are desirable for the cash budget can be determined according to the following characteristics of each business project:

The expected size of the business: the amount of investment, amount, and frequency of operations.
The estimated volume of purchases, sales, and expenses.
The amount and estimated timing of cash receipts and payments.
The expected size of cash balances.

As subperiods to group the receipts and payments can be used as both the month of the quarter. Based on these, they will calculate for each month:

The monthly net balances, taking into account only receipts and payments will occur in that month.
The closing balances and opening balances each month, representing the total available cash that ends or begins the month respectively.

Determination of the Initial Project Investment

To facilitate the calculations and to make the determination on the amount of initial investment, we can produce some auxiliary tables, collecting the data we need, to help us do our job. These tables will be the following:

A table summarizing the necessary investment in fixed assets. This table will collect all tangible assets that the company needs to acquire for the start of trading.
A cash budget for the first year of project activity. This table will serve as an auxiliary tool to determine the total initial investment. Obtained it and deducted from the same investment in fixed assets, obtain the amount of investment capital. The information provided by this table is essential for projects.
A table for estimating the settlement of VAT that the company has to carry out quarterly.

Cash Budgeting

To determine the total investment needs of the project, and from these, working capital needs, we will make a cash budget. Once entered in the document all receipts and payments, we will begin to develop a first draft of the cash budget. The draft we realize the model, but from initial cash balance of 0. Typically presented negative cash balances in the first months of the year and even in some cases be maintained along the same. It also suggests that all expenditures prior to the commencement of the activity are also included in this month. Based on the data we deduce the initial investment requirements of the project from negative balances occur monthly. The investment required is given by the amount of negative balance greater amount produced and that in most cases correspond to January. Taking the amount of the deficit increased as a reference, we can set the initial investment project, which may be the same or a larger amount but not a lesser amount. Initial investment will take this amount rounded up, provided that payments exceeding structural design and also covers those that have to do so prior to the commencement of operations. Where this amount is less than the payments, we will, instead, the sum of these as initial investment amount required for the project. Once the initial investment will be made final cash budget, transferring budget data carried over a new leaf, where, as opening balance, rather than zero will the amount we have determined for the initial investment of the project. The necessary investment in initial capital obtained by discounting the amount previously fixed amount of investment in fixed assets, which have been previously ascertained and included in the cash budget.

The Funding of Projects

The Possibility of Obtaining External Financing Needed

For the chance to get outside financing for projects, it is necessary to conduct a prior review of the different sources of external financing and, thus explore the possibilities of use of each business projects. External financing for business projects start-ups can be obtained through various sources, the most common of which are listed below:

Loans to Medium and Long Term

This is going to financial institutions seeking funds through loans and credits. The possibility of funding the proportion which the same respect to the financing of the project itself, i.e., the equity of the company and, secondly, with the personal or property right that can be an entrepreneur or future employer as well as the goodness of the project and the risk that this may entail.

Funding Through the Capital Market

Financing a possibility open to all companies, but in practice is only in large, or projects of a certain economic scale. You can go to that market for external financing by issuing debt through bonds or debentures. It is also possible to seek its own financing, seeking new partners to invest in the project and make their financial contribution to it through the initial public offering of shares.

Venture Capital

A financial instrument specifically designed for small and medium enterprises and can be very interesting for them. Consists in providing temporary funding, but stable, with the aim of supporting the creation of a business or its growth or expansion. The investor or investment entity provides venture capital funding company to the company to start up and develop the business plan and the time the company has been consolidated to sell its stake thus obtaining a profit. In this reciprocal relationship, the security for the investor is found exclusively in the goodness of the project: its novelty or innovation, its expected performance, the qualities of the team that aims to bring the project into practice. The risk for the investor or investment entity for economic participation in the project is generally high so that the benefit should be seeking some relevance to the magnitude of risk involved.

Mutual Guarantee Companies

These companies are constituted precisely by SMEs and have a mutual basis of mutual support. May grant guarantees to facilitate SMEs in obtaining credits or loans by financial institutions and to facilitate access, where appropriate, a privileged credit lines and finally, provide expert advice and financial assistance to entrepreneurs.

Leasing

Leasing is a contract in which a leasing company acquires the other company that needs to yield it to rent. This company pays rent for the use of goods for a period of time and can exercise an option to purchase the same at the end of that period.

Grants and Subsidies

Government implements specific programs to support entrepreneurship. May consist, among other possibilities:

Granting direct aid and capital grants.
Bonus or subsidy in the interest rate on loans or credits granted by financial institutions.
Direct lending at a low-interest rate.
Guarantees.
Relief from taxation or reductions in Social Security contributions.

The Cost of Financing

It is necessary to calculate and analyze the costs of different alternatives and possibilities that we can obtain external financing in the project in order to choose between them and decide the most advantageous to our business. To this end, we compare the cost of borrowed funds to the expected results of the project. This comparison will help us see how our business may affect the cost of financing. In cases where the amount of the cost of financing is less than the expected results of the project, it might be necessary to take into account this circumstance to take in as much as possible the difference. In these cases, we care to increase the debt whenever possible to maintain the same profitability of our business. Thus it is said that there is financial leverage when the cost of borrowing is lower than expected profitability of the project.

Estimating and Calculating Quantities for Evaluation

The Cash-Flow as a Measure for Investment Analysis

For return on investment studies, profit is not the best variable that can be used. Profit is an accounting concept that is used to measure overall business achievements as getting involved in the observation of agreements and standards. The company’s profit is obtained by the difference between revenue and expenditure estimates. The economic performance of the company may be different in a business project, according to the rules that apply and depreciation policy has been decided to follow.

Revenues – Expenses = Profit

Formula in which, if we subtract the amount of expenses of depreciation, they can be decomposed into depreciation and other expenses. Substituting in the formula above, we have:

Income – Depreciation – Other Expenses = Profit

To eliminate the aforementioned inconvenience, we may not take into account depreciation and then be used to study the profitability of projects and magnitude, instead of profit, only the difference between revenue and expenses. If we solve the above formula we have:

Revenues – Other cost = (Profit + Depreciation) → Cash flow

This figure represents one of the meanings of what we call cash-flow, which translates the English expression for “cash flow” or “cash flow” and also by movements of the enterprise fund. The cash-flow is the most appropriate size for the study of investments and that therefore the most used. Use of this magnitude has the advantage, as we have seen before of not taking into account depreciation, so these will not affect profit unlike the cash-flow represents a much simpler concept is also the difference between receipts and payments. However, this term is used in various acceptances, sometimes being able to generate some confusion about its meaning:

It is sometimes used the term cash-flow to designate only the funds generated from operations and therefore an expression of the company’s ability to finance itself. This is the meaning of cash flow that represents the above formula we’ve seen. Cash flow = Profit + Depreciation
Also used in the term for cash flow statements arising from the current color of receipts and payments. This meaning is also cash-real name, and cash and financial. Is to consider not only the funds generated by the business but also the funds absorbed by it. To this must be taken into account as investment flows.

Investment Appraisal Methods

The Net Present Value (NPV)

The net present value method of investment appraisal is to reduce the current number one cash flow is estimated to build the project. This is achieved by discounting each amount of the cash flows at a discount rate and discount rate determined by the time between now and the year that will get them. The net present value is obtained by subtracting the initial investment of the sum of the current values of the flows. The interpretation of the value obtained is as follows:

If the NPV is zero or negative, the project will not be advisable.
If the NPV is positive, the project is justified from the economic point of view and is therefore advisable, representing the value obtained the extent of its expected performance.

The NPV represents current monetary values, the total return you’ll get a project over the time horizon has been considered, after recovering the initial investment itself. The main difficulty for the correct application of this method is to determine the discount rate to be used to calculate the NPV and we can provide an adequate measure of the profitability of the project.

Considerations for Determining the Discount Rate

The discount rate we choose to calculate the NPV should represent the returns you can expect from alternative projects for the investor, provided that they behave in a similar risk level. That is, should be fixed taking into account the opportunity cost of that money represents for the future entrepreneurial projects with similar risk.
If the project requires financing, the discount rate should cover the cost of financing.
The discount rate must take into account the effect of inflation.
The discount rate must take into account the risk assumed by the project.

Internal Rate of Return (IRR)

The internal rate of return (IRR) is another measure to evaluate the profitability of projects. Can be defined as the interest rate that produces the money invested in the project. The internal rate of return is the discount rate that makes the NPV of a project is zero. If you want to calculate the IRR to a normal calculator is the most appropriate method of trial and error. Is to calculate the NPV formula by substituting a value that can be considered to approximate the value of the TIR and performing calculations. Depending on the result, returns to try another value than the previously used internal or discount rate, and compares the new result. If we use the IRR as a measure for the selection of business projects, those projects will be advisable to offer an IRR above the opportunity cost of capital for investors. Be especially careful with this as it may have some disadvantages for the analysis and lead to elections sometimes not very successful project. Another problem with the IRR is that when there are more of a turnaround in cash flow may lead to the emergence of several TIR reason in these cases meaningless the application of this method.

Payback Period

Through this method is to calculate the length of time it takes for a project to recover the initial investment. One of the things that you can roll back to the investor when investing in a project is more risk in the recovery times of risk may arise.

Recovery Period = Initial Investment / Annual Cash Flow

When flows are obtained each year are not equal, will have to cash them until the sum total amount equal to the initial investment, with the recovery period the number of years needed to produce this equality. If Dad is achieved as a period between two years, to be calculated using a ratio fraction of the year corresponding to the same.