Chapter I

STRATEGIC FINANCIAL MANAGEMENT

I

1. Concept of Strategy in Financial Management 1. Feasibility Study of P..rojects

·2. Functions of Strategic Financial Management 2. Contents of Project Report
3. Agency Theory 3. Project Cost Accounting
4. Strategic Decision Making Process 4. Zero Date of Project
S;. Levels of Strategic Decision Making 5. Post-Completion Audit of Projects
,:6. Financial PlanninQr-·Obi~,Adv & Disadv 6. Sooal Cost:Benefit Analysis;_~
;7. · n.~#Fmaciat~.witttQ)rporate Strategicf9tanagement: Neat;. Teelmique, U ~ . *
·g. Investing, Finanting and Dividend Decisions

,.
\ , ..

Meaning~:,111'
(a) A ~ ,is an Entity's plan of action in relation to the External Environment
(b) Strategy is the long term direction and scope of a Flffl'I, to achieve competitive advantage, by managing its
resources witllin a changing environment;. for the fulfilment of stakehofder's aspirations and expectations. · ···
(c) Strategic Financial Management is the portfolio constituent of the corporate strategic plan, that embraces the
optimum investment and financing decisions required to attain the overall specified objectives.

2. Neellfal1 ~ AU Businesses require, the roJlowing. three fundamental essential elements -

(a) A dear and realistic 5"at81¥ to provide direction to 3'Ctivities,
(b) The financial resources, controls and systems to see it through, and
(c) The right management team and processes to make it happen.

Thus, Strategy + Finance + Management = Fundamental Needs of Business.

3. Strategic Financial Management:

(a) Strategic Financial Management combines the backward looking, report focused discipline of (financial) accounting,
with the more dynamic, forward looking subject of Financial Management.
(b) It deals with the identification of the possible strategies capable of maximizing a Firm's Market Value.
(c) It involves the allocation of scarce capital resources among competing opportunities.
(d) It encompasses the implementation and monitoring of the chosen strategy, so as to achieve agreed objectives.

Strategic Financial Management involves the following functions -

1. Continual search for best investment opportunities,
2. Selection of the best profitable opportunities,
3. Determination of optimal mix of funds for the opportunities,

1.1
 Padhuka's Students' Referencer on Strategic Financial Management

4. Establishment of systems for internal controls, and I

. 5. Analysis of results for future decisioo-making. ·

As per Agency Theory (of Jenson and Meckling), Strategic Financial Management is the function by which the Management
of the Entity seeks to maximize returns to the Owners. Accordingly, Strategic Financial Management is the function of 4 ·
major components based on the concept of maximization of Expected NPV (Net Present Value) -

1: Financing Decisions: This deals with the mode of financing or mix of Equity and Debt. The objective is to obtain the
optimal financial mix, by altering Equity and Debt, such that the Market Value of the Company is maximized. An
understanding of Cost of Capital, capital Structure and Leverage Principles is a pre-requisite for these decisions.

2. Investment Decisions: This involves the profitable utilization of a Firm's funds in long-term capital projects. To
maximize the Market Value of the Company, the Finance Manager will select projects with maximum returns and
minimum risk. An understanding of Cost of Capital, and capital Budgeting are required for these decisions.

3. Dividend Decisions: Dividend Decision determines the division of earnings between payments to shareholders and
re-investment in the Company. A mature-Company having less re-investment options and idle cash can opt for higher
dividemd distribution-, while: a growtb--erientes Col:npawl,· hawng many. im,estment:. opportunities. and: need for funds
sboufd. ~ to retain its: earnillg$". Retaifffll ~ . a e oneottbe.ffllil5t~ SillUKeS of funds for financing
corporate growth, but Dividends constttute ttte: C'asll Rows· that aanie. t:o ~ ti'le Finance Manager should
t>alan.ce both growth and dividend goals.

4. Portfolio Decisions: Portfolio Analysis is a method of evaluating ilwestments based on their contribution to the
aggregate perfonnan~ ·of th~ entire Company, rather ~ .QI\ the .isolated characteristics of the inve$Jlents
themselves. Strategic Portfolio Management takes· the insights gained from P'ortfolk>- Analysis and integrates them into
the decision making process of a Company, to manage risks effectively.

~lnuberg, Raisinghani, and Theoret, provided a model of the proteSS of straregic dedsioncmaking and identified three ,
ator ohases with sub-routines or sub-ohases within each. These are -:-
Phase Description
(a) Decision Recognition Routine: To identify opportunities, problems, and crises, to commence
1. Identification decisional activity~
Phase (b) Diagnosis RDuline: To collect information refe&rt to opportunities, problems, and crises, to
identify problems more- dearly.
(a) Search Routine: To generate alternative sofutioostn problems.
2. Development
(b) Design Routine: To design new solutions to problems on hand, and to adopt or modify
Phase
previously identified ready-,nade solutions.
3. Selection _Screen Routine: This is required when the Search Routine identifies more alternatives than can be
Phase intensively evaluated. Alternatives are quickly scanned and the infeasible ones are eliminated.

Description
Corporate Level Strategy is concerned with -
(a) Reach, i.e. defining the issues that are overall corporate responsibilities.

and' co-orcfimffing stair and offiijfc~ _ _ _. .:_,15; ~ces

across business units, arid using business units to c o ~ oeher corporate b!Jsine5s:activities.
(d) Management Practices; i.e. how business units- are to .be governed, e.g. *oogh · direct
corporate intervention:Ccentralizationl or ~ ~~us governance ( ~).

1.2
 Strategic Financial Management

Level Description
2. Business Here, the strategic issues deal with -
Unit Level (a) practical co-ordination of operating units
Strategy (b) developing and sustaining a competitive advantage for the Firm's products and services.
(a) Functional Level Strategies in R&D,. Operations, Manufacturing, Marketing, Finance, and Human
,3. functional Resources involve the development and co-ordination of resources through which Business Unit
Level Level Strategies can be executed effectively and efficiently.
Strategy (b) Among the different functional activities, Finance assumes highest importance during the top
down and bottom up interaction of planning. '
1. Meaning: Financial Planning is the backbone of the business planning and corporate planning. It helps in defining the
feasible area of operation for all types of activities and thereby defines the overall planning framework.

2. Components: The three components of Financial Planning are-' (a) Financial Resources, (b) Financial Tools, and' (c)
Financial Goals.

3. Financial Planning Objectives:

(a} The outcomes: of ·Financial ·Plam:nng: are:·thei RrraAdat ~ , . fiRancial dee~ing:ccmd: firiahcial;·measures
for the evaluation of the corporate performance.
(b) Financial Objectives are to be decided reasonably early, so that the other decisions can be taken accordingly.
(c) The objectives should be consistent with the corporate mission and corporate objectives.

4. Objectives of Profit ancl Value Maximisatien£ The two objectives of Financial Planning. are .,... (a) Profit ,
\ ...
Maximisation, (b) Wealth / Value Maximisation~
(a) Profit Maximisation: The basic business~ is ProfitabHity. So, the Finance Manager hasto take his decisions
irl\.ter;tQ'Ji~imise the profits of the business. Pr:oi~itmisatidn is a basic and long-terfnio~rbut has a
sfl&:t~rm.,measurement focus (say a financiatyear:) Profit Maximisation, as an ob~f',hasscffi'e following
. •"'"· ,,,·.
and limitations - ·- -·~·,,' ..
.~,.
"'"'
-···
... Advantages . Disadvantages / Limitations ·
• Must for survival of business, else capital is lost. • The term "Profit" is vague•
• Essential for growth & development of business. • Higher the profitsr higher the risks involved•
• Impact.on society through factor payments. • It ignores time pattern of returns.
• Profit-ma~ng firms· pursue social obi~. • It ignores social & moral obligations of business.
Hence, Profit Maximisation isviewedasa.limitedobjective, i.e. essential butnotsufflcient.

(b) Wealth Maximisation: The second objective of Financial Management is to maximise the Valtle of Weelth of the
Firm and that of its Investors. Wealth or Value of a Firm is represented by the Market Price of its Capital (i.e.
• Earnings
Shares and Debentures). Value of a Ftrm = - - - - - -
Capitalisation Rate
• Earnings: It takes into account, the present and prospective earnings, the timings and risk of these earnings,
the dividend policies of the Firm and other factors governing revenues.
• . Capitalisation Rate: It is the cumulative result of the assessment of the various stock-holders (Equity and
Debt) regarding the risk and other qualitative factors of a Company. This rate reflects the liking of the
investors for a Company.
• Wealth Maximization is a better objective for a business since it represents both return and risk.

1. Superiority/ Merits of Wealth Maximisation Objective:

(a) Wealth Maximisation objective takes into account, all future cash flows, dividends, EPS, etc. whereas Profit
Maximisation objective does not recognize the effect of future cash flows, dividend decisions, EPS, etc.
(b) A Firm with Profit Maximisation objective may refrain from payment of dividend to its Shareholders. However, a
Firm with Wealth Maximisation objective may pay regular dividends to its Shareholders.

1.3
 Padhuka's Sttldents' Referencer on Strategic Financial Management

(c) Shareholders prefer an incr~seJrlthe Firm's wealth as against mere increaseJn_flow of profits. ,
{d) Shareholders prefer a Firm to:use its funds effectively, e.g. a Firm which is •Ito generate a higher rate of return .
on its own- retained funds, may be able to ~ its Wealth / Value. If the Firm had distributed its profits by way
o f ~ the rate o f ~ ~ .not be ffllb. . ·. .
' . " '' ' ''. ' '

2. Limitations/Demerits of Wealth or Value Maximisation Objective:

(a) Timing: The timing or duration of expected returns is-not specified. So, one cannot be sure whether an investment
fetching , 1.0 Lakhs return after 5 years is more or less valuable than an investment fetching , 1.50 ~khs per year
for the next five years.
(b) Risk: The risk factor of projects to be undertaken is not considered properly. A Firm with a higher Debt Capital
may have the same EPS as a Firm having a lesser Debt Capital in the capital structure. However, the Market Price·
per Share of the two Companies shall b~ different.
(c) · Dividends: The effect of dividend policy on Market Price per Share is not fully considered. To maximize EPS,
Companies may not pay any dividend. In such cases the EPS may increase but the Market Price per Share may go
down due to adverse reactions from the Shareholders.

However, for routine decision-making purposes, the Finance Manager views Profit Maximisation as a short-term objective
and Value Maximisation as a medium / long-term objective.

The areas of difference of Profit Maximisation and Wealth Maximisation are:

Profit Maximisation
Does· not. consider the effect of Future. cash Flows, Dividend Recognises the effect of all Future cash Rows, Dividends,
Decisions, EPS, etc.. ,.
A Arm with Profit Maximisation objective may refrain from
payment of dividend to Its Shareholders.
· -.. ,Jpres time pattern of returns.· ,,.,;,,-,,-f-·'·'"··
·on Short·::-Ter.m;
·Does not consider the effect of uncertaitity / risk.
Comparatively easy -to· determine the· relationship between
financial decisions and profits.
Wealth Maximisation
EPS, etc.
A Firm with Wealth .Maximisation objective may pay regular
dividends to its Shareholders. · · ·
Recognises the:iffle 13attet'9:itd returns.
Focus.on Medium,4,1,;ong,::,I•m.
Recognises the risk-return'felatlonships.
Offers no dear or specific relationship between financial
decisions and share market prices.

The interface of Financial Planning with Corporate ~ Management is based on the idea that the starting. point and
end poinfof every. Firm is "money': No Firm can rm ttJe aisting business and pro, note a new expansion project without a
suitable internally mobiliied financfat base or both internally anct externally mobilized financial base. Accordingly, the
following dimensions/interfaces emerge -
1. Sources of Finance and Capital Structure:
(a) Funds may be raised by 't'ay of Own capital (Equity and Preference Shares) and Borrowed capital (Debt).
(b) Along with the quantification of funds required, the policy makers should decide on the capital structure, to
indicate the desired mix of Equity capital and-Debt capital.
(c) The ideal Debt-Equity Ratio varies from industry to industry, and also depends in the planning mode of the Firm.

2. Effective Fund Allocation/ Capital Budgeting:

(a) A Planner has to frame policies for regulating investments in Fixed Assets, and for restraining of Current Assets.
Investment Proposals originated by different Business Units may be divided into three groups namely -
• Addition of a product to the existing product portfolio.

• c.t·-...... ano.effic:fent ~ o t resomces-through a new approach· and or -closer manitO~ng of the

different crittcal activities: f.o, improvements. .· ·
(b) Project Evaluation .and P~oject Selection are the two most important jobs under Capital. Budgeting:. The Planner's
task is to make the best_ possibfe allocati9n under resautce constraints. ·

1.4
 Strategic Financial Management

3. Dividend Policy: Dividend Policy decision deals with the extent of earnings to be distributed as Dividend, and the
extent of earnings to be retained for future expansions of the Firm. From the viewpoint of long-"-terrri funding of
business growth, Dividend can be considered as that part of Total Earnings, which cannot be profitably utilized by the
Company. [Note: The various Dividend Policies are described in Chapter 10]

Inter-relationship:
(a} The Anancial Policy of q Company cannot be worked out in isolation of other Functional Policies. It has a close link with
the overall organizational performance and direction. f
(b) The nature of interdependence of the policies is· the crucial factor to be studied and modelled, by using an in depth
analytical approach.
(c) At certain times, Corporate Strategy is the cause and Financial Policy is the effect, whereas at other times Financial
Policy is the cause and Corporate Strategy is the effect.

1. Objective: The underlying objective of all the three decisions viz. - Investment, Financing and Dividend deciSions is
"maximization of Shareholders' wealth". The Finance Manager has to consider the joint impact of these,three decisions
on the market price of the Company's Shares.

2. 1Jnlrap1
(a} A new• project (investment) needs finance. Alsa, a Company may hiwe to expamt· / develop its operatkms# which
require funds. Hence, Investment Decisions are based on the Anancing Decisions. ·
(b) The Financing decision is influenced byr and influences the Dividend decision, since retained earnings used in
internal financing means reduction in d'Mdends paid to Shareholders. _ .
(c) So, the inter-relationship between the three types of decisions should be analysed jointly; in hrcter to'm~ize the ,.
\
Shareholders' wealth.- · · ·

3.
a) y - ' , : ~.....
:.,.. -~scan berinkedtomaxi~:s~~~wealthrinthefolfowing~ay;... ·,\,;{~~j{,,".ifr,
( &JllJc.:tUl·n:;t:.~ .. j_',.,_,,c<;;'.'-/-o._; _
__ .,.,o·,.-::_-.:"., _ :·,;,_ :·-":···?!~;,_~:·:_:i\':"T ,;,;.7 , , ,

• · ~ in ~ Term Projects should.be made after capital Budgeting and Uf!Certainty analysis. .J"
• Projects· which Qive reasonable returns (higher than cost) in order to add to the surplus 'of the Shareholders',
should be selected. The returns should be high enough as to distribute reasonable .dividends and also retain
adequate resources for the Company's growth prospects.
{b) financing Decisions:
• Proper balancing between long-term and short-term funds, as well as own funds and loan funds, will help the
Arm to minimize its overall cost of capital and increase its wealth / value.
• Low cost• of funds wm mean higher profit margins, which can be used for· clMdemi ctistfib\mon. as well as
internal financing of new projects: l growth plans.
(c) Dividend Decisions:
• The optimum dividend pay~ut ratio ensures that shareholders' wealth is optimized.
• Where the funds at the disposal of the Company earn a higher return than if distributed to shareholders,
wealth maximization can be achieved by retaining the funds, rather than declaration of dividend.

Investment Decisions Maximum Return Dividend Decisions

{i.e. investing fundsfor maximizing i.e. Distribution of Profits
returns)
Business Operations resulting in
Surplus i.e. Profit
Funds Invested
= Returns Less Cost
F'mancing Decisions
Retention in Business.
(i.e. procuring funds from various Minimum Cost
sources at minimum cost) i.e. Internal Fund Generation

1.5
Padhuka's Students' Referencer on Strategic Financial Management

The three types of Feasibility Study for a Project are - (1) Market Feasibility, (2) Technical Feasibility, and (3) Financial
Feasibility.

1. Market Feasibility: For an existing product, Market Feasibility Study consists of -

(a) Demand Estimation: Projection of Demand includes -
• End-User Profile - classification of customer groups, market segments, their inter-linkages, etc.
• Study of Influencing Factors - whether direct or derived demand for product, causes, etc.
• Market Potential - evaluation of Regional, National and Export Markets, economies of export, cost and
quality of product, etc.
• Infrastructure Facilities facilitating or continuing demand, and
• Demand Forecasting.

(b) Supply Estimation based on -

• Past trends,
• Projects undertaken in the economy,,,
" Import Possibility as governed by I'flllllOrt Policy~ Import Tariff amt international: prtcesr
• Government Licensing Policy,
• Availability of required input like Materials, Skilled Labour, etc.

(c) Identification of Critical Success Factors:

• Some examples of Critical Success Factors are availability of Raw Material, Supplies, Cost of Power,
Transportation Facilities, Supply of Skilled Manpower, etc. They are product and region specific.
• If some- crucial fyictors are ~td>ject to volatile, changes, then the impact of their ',(ariability O.ll the ne.L
profitability of a project hasJo :be separately evaluated. ·· ··

(d) Estimation of Demand-Supply Gap: A multiple point forecast gives the most adverse, most likely and most
favourable forecast of demand and supply.
To find Demand Supply-:-Gap,
Demand Surplus: Minimum = Minimum Demand(-) Maximum Supply
Likely = Likely Demand(-) Likely Supply
Maximum = Maximum Demand(-) Likely Supply.
2. Tedmical Feasibility: Technical Feasibility Analysis of a project can vary w~th the size and complexity involved
in setting up the project. Establishing a large scale project for manufacturing will require the evaluation of the
followin as ects -
Aspect Points to be evaluated
• Site Access - (i) by road, (ii) by rail, and (iii) by Telecom lines.
• Issues related to 'Seismic Zone' and risk thereof.
(a) Plant • Soil Structure Analysis •
Location • Program for preparation of Construction Site.
• Civil Engineering and Construction Capabilities - piling, roads, ports, pipelines, transmission, etc.
• Facilities for reception of Equipment.
Facilities for erection and/or assembly of Machinery.
• Raw Material Availability - both in terms of quaiity and quantity .
(b) Resources • Components Availability - Vendor capabilities.
f\yaJlaQ!lity ... • . V!i!iti~,tl\Y~U€i~m!Y :-{il pg~~r {Y.,itry ~~~--llQ}, {i!} Vyat~r (g~~Iity and 9.uantity)r (iii) s.anitation
·~/~}'~~·'"· ''""'?f"iJ*i :;."i"l;\l~(;0~,, ·' ••• ,i,:.:. :.,<, ;, · .•...• · · · ·. -•· · ··. .
• · Research & Development - Inputs and Capabifity · · · ·

(c) Technology
• Proposed Technology,versus available alternative technologies.
• Details of present operation of the chosen technology if already in operation .
• Ease of Technology Absorption, Leaming Curve Analysis, etc..

1.6
 Strategic Financial Management

Aspect Points to be evaluated

• Details of Technical Collaboration, ifany, Details of Collaborator, etc.
• Technical Collaboration Agreement Review to assess extent to Support from Collaborators -
Supply vs Supply, Installation and Commissioning, etc.
• Availability of right labour for the technology selected, and adequacy of training/skilling of
manpower by Collaborators at their workplace.
• Availability of Patents / Licences to use certain. external processes.

(d) Plant and

• Technical Specifications of Plant and Equipments.
• Plant Design anctlayout
• Selection process for supply of Plant and Equipments.
• Lead times for delivery of Plant and Equipments.
'
Machinery • Back to Back Liability (Liquidated Damages (LO)) Clauses with Suppliers of Equipments.
• Support from Plant & Equipment Suppliers in case of downtime, with· respect ter (i} availability
of Service Level Agreements (SLAs), and (ii) availability and cost of machinery spare parts:
Installation
Aspects • Localization Programme (PMP- Phased Manufacturing Program).
• Present Installed capacity, future capacity build-up - possibilities and constraints.
• Type of Buildings (Oass 1, 2 or 3) and appropriateness of the Buildings for the Machinery
installed.
• Technical Drawings, Blueprints
.. PractuctMix:.iWl:i~.on~ty,1:Jtit~
• Seate of Operations an<:i:Line Bafancingl
• Production· Botttenedcs,
(e) Production
• Flexibility in Production Lines.
Aspects
• By-Products, Use and Disposal
• Effluents and Disposal of Effluents.
• Process losses and pmsibilities to airest the losses.
• Possibilities for future Manufacturing / Operating Cost Reduction.
{f) Control
Aspea:s:';/:'"'. • ,,,11, ~re of Project ~ n g Systems -r:ew~ng and F§Yiew of reports.
• :·.:~Technical Obsolescence Possibi(tties. ·· V ' > , "

(g) Backup
• :Nature of Safety Standards. WorkpJace;frfazards.
Plans
• Evaqration in case of Disaster. ' . ·,
• Disaster Recovery Possibilities and Back-up options
3. Financial Feasibility: Financial Feasibiliy Study requires detailed finandaf analysis based on certain ·assumptions,
workings and calculations such as -.
{a) Projections for prices of products,. cost' of various resources for maoofacturing goods, capacity utilization. The
actual data of comparable projects are. ii'Jduded in the estimates.
(b) Pedoct: of !stimatiM is determinett orr. the: basis of product llfeeyde, bt.Jsiness;·cycle, penoo, of debt ~ etc.
and the Value of the Project at the terminal period of estimation are furecastect,
(c) Financing. Alternatives are. considered. and a choice of financing mix made with regard to cost of funds and
repayment schedules. " · · · · · · ·
(d) Basic calculations like Interest and Repayment Schedule, Working ·Capital ·Schedule, Working capital Loan,
Interest and Repayment Schedule, Depreciation Schedule, etc.
(e) Financial Statements prepared in the Project Feasibility Report, viz. Profit and Loss Account, Balance Sheet and
cash Flow Statements for the· proposed project.
(f) Financial Indicators. and Parameters like Interest Coverage Ratio, Debt-Service .Coverage Ratio (DSCR), Net
Present Value (NPV) or Internal Rate of Return {IRR).
(g) Specific Requirements of Lending Institutions, when a Project is set up with Debt, especially with Loans from
Banks and Financial Institutions.
Thus, Financial Feasibility Study in twerfold -
(a) Risk Assessment: Basic indicators of financial viability use Profit and cash Flow Estimates subject to risk or
uncertainty. Evaluation of risk isnecessarythrough the adoption of various analyses.
(b) Financial Projections: In assessing the financial viability of a Project, it is necessary to analyse the forecasts of
financial condition and flows, viz. - (i).Projeded Income Statement, (ii) Projected B1:dance Sheet, and (iii) Projected
Cash Flow Statement.

1.7
Pndhuka's Students' Referencer on Strategic Financial Management

Market Feasibility Analysis involves deriving answers to the following queries -

1. What is the Product/Service and what Customer need does it/they address?
2. . What is the Market Size?
3. What is the Demand-Supply Gap for the product/service?
4. What is the nature of the product, i.e. Intermediary Product or End-User Product?
5. Whether any Market Research/survey has been conducted and, if so, the results of the survey?
6. What is the demand pattern / potelrtial in DomesticMarket and Overseas Market?
7. Is Customer Segmentation possible? If yes, what are the various segments?
8. What is the initial Market Share and Growth in Market Share projected?
9. Who are the Competitors and the competitive forces in the industry?
10. Are there possibilities of reverse engineering of the product by competition?
11. What is the Price and Income Elasticity for the product(s)?
12. What are the Imports, Exports, Import/Export Restrictions and Tariff Protection to the product?
13. What are the additional analysis aspects in case of B2C, viz.
(a) Demographic Factors, such as Age, Sex, Family Status, Education, Income, Class, Occupation, Education, and, if
relevant, Religion and Race.
(b) Beh~ Factors sudr a s ~ · of produtt purchase1 s~behaviour, etc
14. What are the barriers to entry into indtisby· and exit?
15. What are the larger forces that define the market- e.g. cultural changes, government pofiries, innovation, etc.?
16. What is the sale Process?
17. What. is the Overall Marketing and Sales strategy?
18. What is the proposed channel and distribution policy?
19. What are the strategic.distribution alliances proposed?
20. How much Commissi~ is proposed to be ofter~ to the sflannel?
Wha! is the proposed Pricing Policy and C()l!'parison of.prices with competition?
· 22. What is the 5ales Promotion Budget rl}~q~ in financial proj~ctions? . . ...
23. If significant part of the output is proposed to be· exported, what are the selling arrangements?
24. What are the Gross Profit and Net Profit Margins and how do they compare with competition?
25. What are the payment terms proposed?
26. What are the product standards, specifications and certifications available?
27. If the Project has Collaborators, how to leverage on Collaborator Brand Value?

Items to be included in Project Report

1. Promoters Experience of Promoters, their past performance records.
2. Industry Brief description and prospects of general industrial environment outside and within the country.
Analysis
3. Economic Demand and Supply position of the product under consideration, Competitor's market shares and
Analysis marketing strategies, export potential of the product, consumer preferences, etc.
4. Technical Technical Know-how, Plant Layout, Production Process, Installed and Operating Capacity of Plant and
Machinery
Availability of Raw Materia1s within and outside the home country, reliability of Suppliers, Job Work
5. Inputs facilities available, Cost Escalations, Transportation Charges, Manpower Requirements, Effluent Disposal
Mfchf~i~m~: .·. .. .. · ·..··...... ·. ·. . . .. .... .. ... . ............... · · ., N •

6. #~ ; , · ~ ~ . . ., ~ « ~ ~ , . i , ~ y ) f ~ ;.. ·•••·
Ut.ttities e.g .. Power, .. Fuet, . Wtlt~r•.. Vehicles, . 1'echriltal Koow----Hbw,
Cost Preliminary/Pre-Operative Expenses, Provision for Contingencies.
Estimates of Production Costs, Revenue, Tax Liabilities, Profitability and Sensitivity of Profits to different
7. Finandat
elements of Costs and Revenue, Financial Position and Cash Flows, Working Capital Requirements,
Analysis
Return on Investment, Promoter~ Contribution, Debt and Equity Financing, etc.

1.8
 Strategic Financial Management

Aspect Items to be included in Project Report

SCBA= Social Cost Benefit Analysis. Ecological Matters, Value Additions, Technology Absorptions, Level
8. SCBA
of Import Substitution, etc.
Strengths and Weaknesses in handling environmental opportunities and threats, viz. Liquidity / Fund
SWOT constraints in Capital Market, limit of resources available with Promoters, Business/Financial Risks,
Analysis micro/macr0;-economic considerations subject to Government restrictions, role of Banks/Financial
Institutions in project assistance, Cost of Equity and Debt Capital in· the Financial Plan, etc.
io. Imple-
Date of Commencement (i.e. Zero Date), Duration of the Project, Trial Runs, Cushion for Cost and Time
I
mentation
Overruns, Date of Completion of the Project, using Network Analysis techniques:
Schedule

1. Meaning: Project Cost Accounting is the process of recognizing, measuring, recording and reporting the project
cost data (MIS} to its Stakeholders, about the Project Milestones and Costs. It is a service that supports the
Ptoject Management function.

2. Different from Financial Accounting: Project Cost Accounting, inter-alia, seek,s to estimate the ."Cost to
Completion", and, therefore, differs.from 'Financial or Corporate Accounting' significantly, which solely reflects on the
past[transacttiotlS,.
' !. . ·Repadi9As,eds:
(a)' Project' Cost Accounting starts with a Budget, a Benchmark, with which the current performance is continuously
measured.
(bl· Reporting on Cost Overruns, Physical Overruns and Time Overruns is the.essential part of Project Costing.
4. T•elfness vs Precision: Timeliness in reporting on Project Costs and Milestone.Overruns is mere important than :. ".
\ - ...
. predsion in reporting. In large projects involving huge investments (say in Oores), a delay of couple of days in
reporting can cause more problems, than an error in reporting of a few thousands or even few _Lakhs of Rupees. . ,
·,~- ".J;;"f/t:JCf";'.3-'-',' .,
._-,· ~N:,_~~:~~:-\
,._\ . ·
:r~·-_, .;~_·', '"s~i"'-1':'/'1,';F:l:Y· .

<l. Meaning: The Zero Date of a project represents the effective starting point of the project This is the starting, point for
operations of the project.
2. Sitlnifkance:
{a} Project Performance, including monitoring and completion of the Project will be counted from the Zero Date.
(b} IAVeSting Entity should. ensure that alt activities for ensuring_ project performance such as regulatory CQmpliance
amt.approval-, arrangementfor Project Finance (Working Capital and t=ixea£apital), infrastrud;urat facilities; etc. are,
put into place by this date.

1. Meaning:
(a) Post Completion Audit seeks to evaluate actual performance with projected performance, by verifying both
revenues and costs.
(b) Post Completion Audit involves effort and cost. So, it should be conducted only for Investments/ Projects above a
certain size.
(c) It should be performed by an independent group consisting of Economists, Engineers, Accountants, and Executives
who have adequate training in Capital Budgeting. ·

2. Advantages:·
(a) It highlights mistakes and errors that can be avoided, and areas of improvements to be brought about.in future
decision-making.
(b) It helps to identify individuals with superior abilities in planning and forecasting.
(c) It helps in discovering biases in judgment.
(d) It induces healthy caution among the Sponsors of Projects, as Project Sponsors make over-optimistic projections
for their proposals.

1.9
Padhuka's Students' Referencer on Strategic Financial Management

(e) It serves as a useful training ground for promising Executives needing experience 9n~texposure, int.o a wide range
of factors, like market behaviour, pricing, G~t structure, input availability, proouctlVity, regulatory environment,
financial system and industrial relations. ·

3. Tuning:
(a) Post-Completion Audit may be conducted when - (i) the Project is commissioned, or (ii) the operations of the
Project stabilizes, or (iii) the Project is terminated, or (iv) at any other time in the Ufe of the Project.
(b) If conducted too early, the review data may not be meaningful, and if conducted towards end of project life utility
of the lessons drawn is not useful.

4. Reasons for Neglect: Post Completion Audit is the most neglected aspect of Capital Budgeting, since -
(a) It is difficult to isolate the Cash Flows attributable to individual investments, from Financial Accounts compiled as a
whole and based on accrual principle.
(b) Apprehension that it may be used for punitive purposes and fault-finding.

1. Meaning:
(a) Since scarce resources available with the Society are used in Projects, the social impact of investment proposals
should be considered along with regular Finallciat Evaluation of Projects~ Such analysis of gains / losses to the
Society as whole from the acc~eofa ~ i s caUed SedacestleM:lt.-..,u fscaA}.
(b) Social Gains / Losses (quantifiable/ ~ } arre regarded as ~ m and subtradions from something that
the society desires. Sometimes, Aggregate Qmsumption may be used as a unit of measurement under SCBA.
(c) Use of Uncommitted Social Income in the hands of the Government may also be used as yardstick of
measurement, since consumption has both time dimension (present / future) and distributional dimension
(consumption by group / region of the country}.

2. Feature of/ Need for Social.Cost Benefit Analysis (SCBA):

(c1) Market . Prices used to measure co~ anct ~pefits in Project Analysis, do not represent social. values due to
imperfections in market. They hay ?o l>e ~itably adjusted to reflect social valuations,
7 J "·
(b). Monetary Cost Benefit Analysis f~llito corislaer the external effects of a project, .;;ihich n,ay be. positive like
development of infrastructure, training of worl<ers, or J1egative like polfution and imbalance in environment.
(c) Taxes and Subsidies are "monetary costs and gains", but these are only transfer payments from social point of view
and therefore irrelevant. For the Society as a whole, Taxes are merely transferred from the Project in hand to
Government and does not involve Real Cost.
(d) SCBA is essential for measuring the re-distribution effect of benefits of a project as benefits going to poorer section
are more important than one going to sections which are economically better off.
(e) Projects manufacturing life necessities like medfcines, or creating infrastructurelikee!ectricity generation are more
important than projects for mat11.J.fad:ure of liquor and cigarettes. Thus Merit wants are an important appraisal
criterion for SCBA.
(f) If savings are inadequate, money going into investment is regarded more valuable than money going into current
consumption. There is a need for evaluating the proper use of the money used for investment.
(g) Relative valuation placed on future consumption compared to current consumption is different for the society. Also
effect of perceived uncertainties may be different.
(h) There is a need for analysing the external effects that exist on the consumption side, e.g. a person getting
inoculation against infectious disease will be conferring some benefit to society by preventing the spreading over of
the disease.

1s: ·what are the factors used in Social Cost Benefit'Analysis? . · .· .. .

, .•~ Wf~f :ShQrt;ngtQ&,_Ql,l th~ ,fes~Qi()UA;~!\d;con_~~'8J~~Gf;~~IQ-~;~~ ,}:;\,:' ;J~ :· ·"' r \ < ··.~::,. < ;; ' </.!k
:~~~===;ices form the coreof SCM H~y. ·
• A Shadow Price (which may or may not be equal to the Market Price) reflects the social evaluation of the input
or output.
• It is also called Social Cost, and does not have an existence apart from its use in social evaluation.

1.10
 Strategic Financial Management

In SCBA, the concept of Shadow Price is used for evaluation in the following economic resources -

Goods & Services:

(a) Social Gains/ Losses from outputs and inputs of a project are measured by the willingness of the consumers to
pay for the goods.
(b) Generally, such Gains / Losses are reflected by the Market Price, if - (i) Perfect Competition exists in all relevant
markets, and {ii) Project is unable to make substantial additions to or withdrawals from existing supply of goods.
(c) In case of specific conditions like presence of rationing/ controls for consumer goods, monopoly power in case of I
industriaf goods, etc. suitable adjustment of Market Price is necessary to derive. Shadow Price / Social Gains.

Labour:
(a) Social Cost of Labour is generally lower than Market Wages because of massive un/under employment along with
traditions, changes in lifestyle, etc.
(b) Shadow Price of Labour has to be evaluated considering factors such as -
• Seasonal Un/under employment,
• Full time withdrawal of labour,
• Labour migration .from rural to urban areas, and leading to urban unemployment, lack of minimum basic
overheads / amenities to a higher urban popufation, etc.

POl!eigJt ~ Elfisteflce' of ettensive·trade: com:ros leads: to official undervaluatiorT of Foreign. Exchange.. The:
official Exchange Rate understatesc the' benefit of e,q,orts:. amt cost& of imports in termS: of domestic resources;. Hence,
an upward adjustment is necessary.

Shadow Price of Investment: Society as a whole gives importance to future generations than that accorded by
private dedsion-makers. Imperfections of Capital Markets lead to less than Optimal Total Investment. Hence, Money
devoted to investment in terms of immediate consumption is much more than money itself. Thus, the Shadow Price of
Investment vis-a-vis. Consumption, has to be determined carefully. ·

5. Social Rateo(O~~;j,'• . •::,.~f'>I:"''"""· ·.,;;'.'"''

(a} Social R~~;5~{9!SC9ij~\;epresents the Shadow Pri~ ofFuturftonsumption vis-a-vis Present Cons~QO.·
(bl Choice of ·Soda! Discount Rate (as opposed to Market JAteiest. Rate),is based on value judgment about weights to
be ~ed to the welfare of future generations compared to that of present generations. This is treated. as a
parameter and computations are carried out for a number of values within a certain range.

1. Dependability: Successful application of SCBA depeflds, upon reasonable accuracy and dependability of the underlying
forecasts as well as assessment of intangibles'.
2. Inconclusive: SCBA does not indicate whether given project evaluated on socio-economic considerations is the best
choice to reach national goals or whether same resources if employed in another project would yield better results.
3. Cost: SCBA involves very high cost, and is not ~uited for all projects.
4. Intangibles: SCBA takes into consideration those aspects of social costs and benefits which can be quantified. Other
aspects like happiness, satisfaction, aesthetic pleasure, better quality of life cannot be quantified.
5. Subjective: Certain amount of re-distribution benefits flow to different groups in certain proportions. Costs may not be
borne by same people or not in proportion to benefits they receive. Policy makers place different weights on net
benefits flowing to different sections of population, leading to a highly subjective anatyyis.
6. Double Counting: Employment is always into the analysis by low Shadow Wages, and distributional consideration
does not warrant further weight to be attached.
7. Exclusion of' many factors: Income generated in a region through Multiplier Effects of direct expenditures on the
project, Intangibles like increased pollution, destruction of wild life, scenic beauty, etc. are not analysed. Moreover,
certain long run effects, e.g. effect on rainfall in an area due to heavy exploitation of forests for a paper mill, are not
quantifiable.
8. Uncertainty: Uncertainty about future outputs, inputs, timely execution, etc. is to be considered. Some expected
Value Maximization is resorted to for incorporation of quantifiable uncertainties.

1.11
Padhuka's Students' Referencer on Strategic Financial Management

· STUDENTS1 NOTES

1.12