UNIT – II

BUSINESS IDEAS
Introduction
Many people want to make money from home and look for innovative ways to use their
skills whilst developing a viable business. While many home business ideas develop from
providing technical skills and services, other businesses come from various arts and crafts. These
may found in hobbies you currently have in or in things you enjoy doing. Think about how you
spend your free time and of any hobbies you have enjoyed – past and present.
Meaning
A business idea is a business seed, which expands and grows into a business tree. A
business idea can emerge from technical source (within the company) or from the market source
(outside the company).

Business Ideas are generally new ideas generated with in the company

By the scientists working in the research and development department

By the engineers working in the production department
By the field staff who may get now ideas while solving problems

OBJECTIVES OF IDENTIFYING BUSINESS IDEAS

Following are the main objectives of identification of business opportunities:
 To evaluate the possibilities of developing and utilizing physical resources of a particular
region from the technical and economic point of view.
 To study and examine the small, medium and large scale industrial possibilities keeping
in mind the requirement of the region and country as a whole. These possibilities must be
technically feasible and economically viable.
 To identify those industries which are not based on local resources but they can be
established on the basis of economic consideration keeping in mind the future
requirement of the region or country as such.
 To recommend by certifying the usefulness of other possible industries for the region.
 To assess and estimate the capital, labor, transport, power, fuel, raw material for feasible
industries.
 To study the short and long run development possibilities of the region with regard to
agriculture, irrigation, forestry, fisheries, minerals and labor, etc. and recommend an
effective programme for balanced economic situations of region concerned.
 To evaluate the impact of achievement in financial resources, production, employment
and initial requirement of capital in industrial development process.

SOURCES OF BUSINESS IDEAS

 A business idea may be discovered from the following sources:
 Observing Markets: Careful observation of markets can reveal a business idea. Market
surveys reveal the demand and supply position for various products. It is necessary to
estimate future demand and to take into account anticipated changes in fashions, income
levels, technology etc.
Competition and price trends can also be found through market surveys. From the data
collected through market observation, one can identify the products / industries which are in
demand and which require increase in supply.
 Prospective Customers: Consumers knows best what he wants and the habits/tastes which
are going to be popular in the near future. Contacts with prospective customers also reveal
the features that should be built in to product / service. The business firms should conduct
survey among prospective customers before choosing the product to be manufactured.
 Development in other Nations: People in the under developed countries generally follow
the fashion trends of developed countries. So an entrepreneur can discover good business
ideas by keeping in touch with developments in advanced nations. Trade delegations of
various chambers of commerce, etc visit foreign markets to explore foreign collaborations
and other types of business idea.
 Study of Project Files: Various government and private agencies publish periodic profile of
various projects and industries. These profiles describe in detail the technical, financial and
market requirements and prevailing position. A careful scrutiny of such project files is very
helpful in choosing the lines of business.
 Government Organizations: Several government organizations nowadays assist
entrepreneurs in discovering and evaluating business ideas, development banks, state
industrial development/ investment corporations, technical consultancy organizations, export
promotion council. Government also identifies the priority sectors for investment through
five year plans, industry policy resolutions, and guidelines for industry.
 Trade fairs and Exhibitions: national and international trade fairs are a very good source of
business idea. At these fairs the producers and dealers in the concerned industry put up their
products for display and / or sale. A visit to those Fairs provides information about new
products / machines.

IDEA PROCESSING AND SELECTION

I. Preliminary Evaluation and Testing of Ideas:
Once business ideas are discovered, screening and testing of these ideas is done. The
following considerations are significant in the evaluation and testing of business ideas.

a) Technical Feasibility:
It refers to the possibility of producing the product Technical feasibility of an idea is
judged in terms of availability of necessary technology, machinery and equipment, labour skills
and raw materials. The advice and assistance of technical experts may be necessary to judge the
technical feasibility of various business ideas.

b) Commercial Viability:
A cost – benefit analysis is required to ascertain the profitability of the ideas. An
elaborate study of market conditions and prevailing situation is made to assess the viability and
prospects of the proposed project. This is known as feasibility study of the project. A number of
calculations have to made about the likely demand, expected sales volume, selling price, cost of
production, break – even point etc., The services of market analysts and financial experts may be
necessary for this propose.

II. Detailed Analysis:

The promising idea is subjected to a thorough analysis from all angles. Full investigation
is carried out in the technical feasibility of the idea are tested. At this stage a lot of information is
required. Consultations with experts in various areas of the industry may be necessary to carry
out the detailed analysis.
After the evaluation of a business idea is completed, the findings are presented in the
form of a report known as feasibility report or project report. This report helps in the final
selection of project. It is also useful for procuring licenses, finance etc., from governmental
agencies.

III. Idea Selection:

 Products whose imports are banned or restricted by the government.
 Products, which can be exported easily and profitably.
 Products whose demand exceeds their supply so that there exists ready demand.
 Products in which the entrepreneur has manufacturing and/ or marketing experience.
 Products, which showed high profitability.
 Products based on the expansion or
diversification plans of existing firms of the
family / friends / relatives.
M ethods o
 Products, which ensured specific advantages. Generating
The advantages might accrue because of the Problem
Ideas
scale of the industry or the location of the Inventory
Analysis
factory or technology of manufacture. Brain
A m ethod
Strom ing
 Products favored by the countries industrial / A group
for
obtaining
licensing policy, e.g., delicensed industries. Focus
M ethod for new ideas
obtaining and
 Products for which incentives and subsidies are Groups
new ideas solutions by
Groups of and focusing on
available. Individual solutions problem s
s
Providing
IV. INPUT REQUIREMENTS: inform ato
n in a
Once the promoter is convinced of the feasibility Structured
Form at
and profitability of the project, he assembles the
necessary resources to launch the enterprise. He has to
choose partners, collect the required financies and acquire land and buildings, plant and
machinery, furniture and fixtures, patents, employees etc., Decisions have to be made about the
size, location layout, etc., of the enterprise.
Assembling state is an important landmark in the entrepreneur’s journey to establishment
of an enterprise. The main inputs required for launching an enterprise are as follows.

A. Information and Intelligence:

Information and intelligence has become the key input in entrepreneurial success. An
entrepreneur requires relevant data on the following aspects:
  Size and nature of demand for the product or service.
 Volume and sources of supply
 Price cost volume relationship
 Sources of raw material
 Type and suppliers of technology machinery and equipment.
 Number and type of personnel required and their sources.
 Amount and sources of funds required for the enterprise.
 Nature and degree of competition.

B. Finance:
It is the lifeblood of business and it serves as the lubricant for the wheels of business
machinery. A business enterprise requires finance for fixed assets as well as for current assets.
a) Cost Theory:
This method is relatively simple and convenient for a new enterprise. Financial
requirements of an enterprise are the aggregate of fixed assets, current assets, intangible assets
like goodwill, cost of promoting and establishing the business. The total outlay incurred on these
items constitutes the capitalization of the enterprise. But it may fail to reflect the earning power
of the enterprise.

b) Earning Theory:
This theory provides a more realistic basis but these are problems in correct estimation of
future earnings particularly for a new enterprise. The entrepreneur has to identify the sources
from which the funds are to be raised. He has also to decide the relative proportion between the
funds raised from different sources. It is a very crucial decision because it influences the real
worth of the enterprise and the return of the owners.

C. Personnel:
A Distinguishing Word,
 People are the most valuable asset of an enterprise and this asset does not Name or Symbol Used to
depreciate. An entrepreneur has to make the following decisions concerning the Identify a Product
personnel.
 Member of personnel required for management, technical and other positions in the
enterprise.
 Qualifications and experience required in the personnel to perform the jobs
Trade
effectively.
Mark
 Sources of recruitment form which the needed staff will be procured.
 Procedure and methods of selecting the best candidates Right given to prevent
 System and criteria for evaluating the performance of employees. others from Printing,
Copying or Publishing
 Policies and methods for remunerating the personnel. any original works of
authorship
 Facilities to be provided for the safety, health, welfare of the staff.
 Participation of personnel in the management of the enterprise.
Copy
rights

PROJECT IDENTIFICATION AND FORMULATION Protection against others

revealing or disclosing
information that could be
damaging to business

Trade
Secret
WHAT IS A PROJECT?
A project necessarily involves allocation and consumption of resources on the one hand
and generation of resources, goods or services on the other.

PROJECT IDENTIFICATION: Meaning

Project identification and selection also done in the process of establishing an enterprise.
The entrepreneur needs to analyze other related aspects also like raw material, potential market,
labour, capital location, forms of ownership etc. it is necessary to mention that each of these
aspects has to be evaluated independently and in relation to each other. It is searching some
resources for project.

Definition:
It may be defined as a scientifically evolved work plan devised to achieve a specific
objective within a specified period of time. The objective may be to create, expand and /or
develop certain facilities in order to increase the production of goods and / or services in the
community.

CONSTRAINTS OF PROJECT IDENTIFICATION

These are two kinds of constraints, namely
 Internal constraints.
 External constraints.
I. Internal constraints:
It arises on account of the limitations of the management system, which will eventually
be responsible for the implementation of a project. In India, the internal constraints for the
entrepreneurs while venturing the project comprise inputs, resources and outputs.
a. Project goals and objectives lay down the main purpose for which an organization
exists. Project management team is not much involved with the determination of project
objectives.
b. The availability of the necessary internal project elements and resources are physical
and non – physical resources. It includes finance, personnel, inventories and facilities. The non –
physical resources are patents, secret process, unique experience and skills. Both physical and
non-physical resources are the important constraints for the entrepreneurs to make available at a
time when the project implementation is in progress.
The limitation on the part of entrepreneurs to provide in built
project services in the form of preparing feasibility reports is an OBJECTIVES OF PROJECT
IDENTIFICATION
important internal constraint in the early implementation of the
project.
II. External Constraints:
The important external constraints are the project Specific, not general.
environments comprising things, people and situations outside a
project and also the size, nature, location and extent of the project Not overly complex.
constitute the environment of the project.
The external environment factors like nature, size, location
Measurable, tangible and
and the extent of project are the important limiting factors for the verifiable.
entrepreneurs when the project does not conform to the socio –
economic objectives of the country.
Realistic and attainable.

Established within resource

bounds.
 Government may delay in giving approval to the entrepreneurs in the medium of
industrial licensing foreign collaboration approval, foreign exchange permit, capital goods
approval and import goods clearance.
Financial institutions, banks are the important external financial source for the
entrepreneurs while financing their projects. The financial institutions and commercial banks
cumbersome procedures and documentation system are important external constraints for the
entrepreneurs in the form of delay in financing the projects.
PROJECT LIFE CYCLE
 The Pre-investment phase:
It is primarily concerned with objective
formulation, demand forecasting, selection of
optimal strategy, evaluation of input characteristics,
projections of the financial profile, and if necessary
cost benefit analysis and ultimately the pre-
investment appraisal.
 The Construction Phase:
Resources are invested during this phase in building
the basic assets of the project, which can in due
course be utilized to achieve the project objectives.
In projects not involving the use of plant and
machinery, the construction phase may merely
consist of developing necessary manpower
resources. Thus, the construction phase consists
mainly of developing the infrastructure for the project.

 The Normalization Phase:

This phase starts after the trial run of the project framework developed during the
construction phase. It involves routine procedure, which are performed in a cyclic order. These
can be determined by analyzing the process cycle identifying the sequence of process operations.
Projects, which do not involve production of goods, do not require raw materials but only
supplies or supporting goods needed to sustain the project process.

PROJECT FORMULATION

MEANING
It is the systematic development of a project idea for the final objective of arriving at an
investment decision. Project formulation involves a step – by – step investigation and
development of project idea.
The aim of project formulation is to achieve the project objectives with minimum
expenditure in a short span of time. It is a process involving the joint efforts of a team of experts.

NEED OF PROJECT FORMULATION

 A well-formulated project is the best passport for obtaining the required assistance from
financial institutions.
  Project formulation will also be of great assistance for obtaining necessary government
clearances. The project report submitted by the entrepreneur will establish his bonafides
in the eyes of the bureaucracy and obtain the due government sanction without much
difficulties.

STAGES / PHASES / PROCESS / ELEMENTS OF PROJECT FORMULATION

I. FEASIBILITY ANALYSIS:
The future of a project idea is examined in the context of internal and external
constraints. It is undertaken to determine the desirability of investing in further development of
project idea.
Firstly, the project idea seems to body can proceed to invest further resources in pre-
investment studies.
Secondly, the project idea is not a feasible one and therefore, further investment in the
project idea is ruled out.
Thirdly, unable to arrive at a conclusion about the feasibility for want of adequate data. In
this case, additional information must be collected and the investment decision is postponed
temporarily. Projects identified are normally analyzed in order to assess their viability from
different angles such as technical, marketing, financial, etc., It is classified two stages namely.
i) Pre-feasibility study.
ii) Feasibility Study.

i) Pre-feasibility Study:
Before assigning funds for techno-economic study, a preliminary assessment of the
project idea must be made through a prefeasibility study. It examines broadly the economic
alternatives of market capacity, Production programme, overheads, manpower, project
implementation and financial analysis.

ii) Feasibility Study:

It will define and analyze the critical elements that relate to the production of a given
product together with alternative production methods.
It provides a project of a defined production. Capacity at a selected location, using a
particular technology in relation to defined materials and inputs, at identified investment and
production cost and sales revenues yielding a defined return on investment.

II. TECHNO – ECONOMIC ANALYSIS:

This analysis is primarily concerned with estimation of the project demand potential and
the choice of optimal technology suitable for achieving the project objectives. The choice of
technology used and size of the project are based on the demand potential. This analysis
produces necessary information for detailed project design development.

III. PROJECT DESIGN AND NETWORK ANALYSIS:

It is the heart of a Project entity. It identifies the sequence of events of the project. The
interrelationship between various constituent activities of a project is generally depicted in the
form of a network diagram.
 A detailed work plan of the project is prepared with time allocation for each activity and
presented in a network drawing.
Network analysis is carried out to identify the optimal course of action in order to execute
the project within the minimum time keeping in view of the available resources.

IV. INPUT ANALYSIS:

It assesses the input requirements during the construction of the project and also during
the operation of the project. This analysis is concerned with identification, qualification of inputs
requirements of several activities of a project. Inputs include materials and human resources.

V. FINANCIAL ANALYSIS:
It involves estimating the project costs, estimating its operating costs and funds
requirements some analytical tools like discounted cash flow, cost volume project analysis and
ratio analysis are used in financial analysis. The information from this analysis can be used for
commercial profitability analysis.

VI. SOCIAL COST – BENEFIT ANALYSIS:

Social costs and social benefits of a project are estimated and presented for computation
of social profitability of the project.
The purpose of this analysis is to ascertain all social costs and secondary benefits with a
view to find out the impact of a project on the society.

VII. PRE – INVESTMENT PLAN / PROJECT APPRAISAL:

The project proposal gets a formal and final shape at this stage. All the results obtained in
the above six steps are consolidated and various conclusions arrived at to present a clear picture.
The sum total of the pre-investment appraisal is to present the project idea in a form in
which an entrepreneur can take an investment decision regarding the project.

PROJECT REPORT
MEANING
It is a written Statement of what an entrepreneur proposes to take up. It is defined as a
well evolved course of action devised to achieve the specified objective with in a specified
period of time. It gives a complete analysis of the inputs and outputs of the project.

CONTENTS OF PROJECT REPORT

1. General Information: Information on product profile and product details.
2. Promoter: Education qualification, work experience, project related experience.
3. Location: Exact location of the project, lease or freehold, locational advantages
4. Land and Building: Land area, construction area, type of construction, cost of construction
detailed plan and estimate along with plant layout.
5. Plants and Machinery: Details of machinery required, capacity, suppliers various alternatives
available, cost of miscellaneous assets.
6. Production Process: Description of production process, process chart. Technical know how,
production programme.
7. Utilities: Water, power, steam, compressed air requirements, sources of utilities.
8. Transports and Communication: Mode, possibility of getting costs.
9. Raw Material: List of raw material required by quality and quantity, sources of procurement,
cost of raw material, tie-up arrangements, if any, for procurement of raw material alternative raw
material if any.
10. Man Power: Manpower requirement by skilled and semi skilled, sources of manpower
supply, cost of procurement, requirement for training and its cost.
11. Products: Product mix, estimated sales, distribution channels, competition and their
capacities, product standard, product substitute.
12. Market: End users of product distribution of market as local national, international, trade
practices, sales promotion devices.
13. Requirement of Working Capital: Working capital required, sources of working capital
need for collateral security, nature and extent of credit facilities offered and available. It shows
the cost of production and profitability of first ten years, break-even analysis, and schedule of
implementation.

COMMON ERRORS IN PROJECT FORMULATION

1. Product Selection:
It is noticed that some entrepreneurs commit mistakes by selecting a wrong product for
their enterprises. They select the product without giving due attention to product related other
aspects such as size of the product markets, its future demand, competitive position, raw material
and technology.

2. Market Study:
Product production is ultimately meant for eventual sale. Market study continues to be a
grey area. But these are some entrepreneurs who pass by this component of their business plan
completely. Based on their nebulous ideas and scanty and scattered information on demand and
supply of their proposed product, they conclude that market is just there waiting to be tapped.
This is a wrong attitudinal block.

3. Technology Selection:
The requirements for technology differ from product to product depending upon the
nature of products. The entrepreneur sometimes plans for a technology not possible to setup
within limited financial resources.

4. Location Selection:
They are completely swayed by the government offer of financial incentives and
concessions to establish industries in a particular location. This becomes overriding concern
completely disregarding other factors like market proximity, availability of raw materials,
manpower and infrastructural facilities. Moreover the entrepreneurs select a location for their
enterprises merely because it is their hometown or they own ancestral land there, which is,
however, not an appropriate location.

5. Selection of Ownership form:

Many enterprises fail merely because the ownership form of enterprises is not suitable.
Hence, select a suitable form of ownership taking a comprehensive view of the factors affecting
the selection of a form of ownership.
CLASSIFICATION OF PROJECTS
Projects are generally classified in the following ways:
1. Quantifiable and Non-Quantifiable Project: Quantifiable projects are concerned with
quantification of targets and development of particular project is made to produce particular
product/service in terms of units, quantity etc. E.g. Physical production, Power generation,
Mineral production. Non-Quantifiable Projects are those projects where quantitative
assessment is not possible. E.g. Health, Education, Social Welfare, Rural development.

2. Sector Projects: Economy is generally divided among different sectors to ensure effective
project development. E.g. planning commission identifies different sectors and allocates
resources for project development accordingly. The sectors are I) Agriculture, Irrigation,
Food Security and Nutrition, II) Industry & Minerals III) Energy IV) Transport &
Communication V) Environment and Forest VI) Special area Programmes VII) Science &
Technology.

3. Techno-Analysis Projects: These projects include Factor intensity oriented projects,

causation oriented projects, and magnitude oriented projects.
i. Factor intensity oriented projects: It deals with capital intensive projects or labor
intensive projects. Investment in plant & machinery, R&D programmes and HR is
the basis for deciding that what type of project is a capital intensive project or
labor intensive projects.
ii. Causation oriented projects: If a particular product or service is not available to
meet out growing demand is treated as Causation oriented projects.
iii. Magnitude oriented projects: In case of Magnitude oriented projects, level of
investments generally used as a deciding criteria. E.g. Classification of project in
different scales – large scale, medium scale or small scale project is totally
governed by the level of investment required.

4. The objective-wise projects: All India financial institutions generally extend financial
support to meet out the objectives for which funds are required. These projects are classified
as New projects Expansion projects, Modernization projects , Diversification projects.

5. Service oriented projects: These projects include welfare projects, service projects, R&D
projects , Educational projects

SIGNIFICANCE /IMPORTANCE OF PROJECT REPORT

The project report is like a road map. It describes the direction the enterprise is going in,
what its goals are, where it wants to be and how it is going to get there.
It enables the entrepreneur to understand, whether the project is sound on technical,
commercial, financial and economic parameters.
The banks and financial institutions take decision to render / financial assistance on the
basis of a project report.
It serves as a main instrument in convincing the investors about the profitability of the
venture at the time of public issue of shares.
 Other development institutions, which provide various assistance such as work shed, raw
material etc., also require project report.
A project report enables the entrepreneur to know how much money; manpower and
material would be required to setup the enterprise.
It also helps the entrepreneur to know the type of machine and technology required to the
project and the economic gains from the project.
A well-drawn project report minimizes the failure of the project. It ensures the optimal
utilization of scarce resources.

FEASIBILITY STUDY
MEANING
Feasibility of a business means viability of the business. A feasibility study is the
evaluation of a business idea. The evaluation can be done by an entrepreneur himself or by
professional consultants appointed by him. After project identification, project appraisal, is done.
For such an appraisal marketing research tool is largely used by the entrepreneur or by his
consultants to check or re-check a business idea. Information is collected through primary or
secondary sources of information for determining market feasibility.

DIFFERENT CLASSIFICATION OF PROJECT FEASIBILITY STUDIES

1. Technical Feasibility:
It refers to the adequacy of the proposed plant and equipment to produce the product as
per the required norms. This aspect requires a careful examination and a thorough assessment of
the various inputs of the project like land, machineries, trained labor, power etc., It also requires
the analysis of the know how necessary to run the project and whether the entrepreneur possesses
that knowledge or whether he is going to procure from outside. Incase of foreign technical
collaboration the legal provisions prevailing in the country in relation thereto should also be
analyzed, on the whole, technical analysis deals with the following aspects.
a) Availability of land and site.
b) Location of the Project.
c) Size and adequacy of the plant and factory layout.
d) Availability of inputs like, water, power, transport, communication facilities etc.,
e) Types of technology to be adopted.
f) Suitability of the technology.
g) Availability of servicing facilities like machine shops, repair shops etc.,
h) Availability of skilled labor and raw material.

2. Financial Feasibility analysis:

It is the most important prerequisite to establish an enterprise. Hence, the appraisal of the
financial viability of the projects assumes much importance in a project appraisal. This requires
the scrutiny of the following:

Cost of the Project and Means of Financing:

Assessment of the financial requirements both for fixed and working capital should be
carefully made. The cost of the project normally included the following items:
i) Cost of land and site development.
ii) Cost of building plant, and machinery.
 iii) Technical know how fees including consulting and engineering fees.
iv) Preliminary and pre-operative expenses.
v) Interest during construction.
vi) Other fixed assets.
The tendency to underestimate the cost of production should be avoided. Having
estimated the cost of the project the sources of finance should be identified. The usual sources of
finance are:
a) Owned funds
b) Share Capital
c) Issue of debentures
d) Reserves and surplus and retained earnings.
e) Term loans and long term borrowings.
f) Public deposits.

II) Cash Flow estimates:

It is nothing but a projection of the future sources of cash and their application. It
estimates are necessary to ascertain as to when the project will need money for different
purposes and from different sources.
Profit is the most important source of inflow and this profit actually depends on how
accurately the costs of production and sales estimates have been made. It also depends upon the
management policies.

III) Projected Balance Sheet:

The projected balance sheet will reflect the financial position of the concern in the future
years during the entire period of the term loan. The lending institution should pay a special
attention to the following:
 The procedure adopted for the valuation of assets.
 The depreciation policy adopted
 The impact of term loan on the assets and liabilities.
After sanctioning the term loan, the lending bank has to make a post- sanction inspection to
ensure:
 Whether the loan has been actually utilized for the purpose for which it was borrowed?
 Whether the value of the security is adequate?
 Whether there is any default in repayment?
To ascertain the financial feasibility, two more popular methods are used they are:
i) Simple rate of return method
ii) Pay back period method

3. Market Feasibility:
The success of any enterprise depends upon its ability to market its products/services, the
lending institution should first of all pay meticulous attention to this aspect. The survival of any
business depends upon its earning capacity, which in turn depends on the volume of sales.
Marketing is the only activity which brings revenue while all other activities involve
expenditures. Possible future changes in the volume and pattern of supply and demand should
also be estimated to assess the long run prospects of the unit. On the demand side, the following
factors should be taken into account:
 a) The potentialities of the export market.
b) The multiple use of the product.
c) The probable market share of the product.
d) The effect of advertisement and sales promotion measures to be launched etc.

On the supply side also, the following factors should be taken in to accounts:
a) The type of distribution channel proposed.
b) Provision for after sales service.
c) The proposed designing and packaging.
d) Economic feasibility analysis:
It is absolutely essential to see that the project is economically viable. The economic
viability depends upon its profitability.
A project without adequate profits cannot be commercially viable. Hence, the economic
viability can be assessed through projections of profitability for a period ranging from 3 to 10
years. The profitability of a project should be established on a long- term basis.

4. Managerial feasibility analysis:

The appraisal of the management is indeed considered as the touchstone of term credit
analysis. The managerial competence can be judged with reference to the following:
a) Educational background of promoters.
b) Previous experience in the field and managerial competence.
c) Possession of entrepreneurial talents.
d) Honesty, integrity and reputation of promoters
e) Possession of adequate know – how of the business

5. Social feasibility analysis:

Any business should be socially responsible. It must accept its obligation to be
socially responsible and to work for the larger benefit of the community. It has a lot of
responsibility to the community around its location and to the society at large. The social
feasibility analysis includes the following:
a) Whether the project offers large employment potential?
b) Whether it is located in a backward and less developed area?

PROJECT APPRAISAL

MEANING
It means the assessment of a project. It is made for both proposed project and executed
project. It is a crucial and multi- dimensional analysis of the project, that is completes scanning
of the project. It helps the entrepreneur select the best project among available alternative
projects.

METHODS OF PROJECT APPRAISAL

1. Pay back period:
The payback period measures the length of time required to recover the initial outlay in the
project or the period in which the project will generate the necessary cash to recoup initial
investment.
Even Cash flows: Example
Assume that a project requires an outlay of Rs 50,000 and yields annual cash inflow of
Rs. 12,500 for 7 years. The payback period for the project is:
Rs 50,000
PB = ------------------ = 4 Years
Rs 12,500

PAYBACK PERIOD = INITIAL INVESTMENT ÷ ANNUAL CASH FLOWS

The annual cash flow is calculated by taking into account the amount of net income on
account of the asset/ project before depreciation but after taxation. The income earned, if
expressed on percentage of initial investment is termed as “Unadjusted rate of return”
UNADJUSTED RATE OF RETURN= ANNUAL RETURN ÷ INITIAL INVESTMENT × 100

Un Even Cash flows:

In even cash inflows the annual cash inflow is uniform. However, it may not always be so. The
cash inflow each year may be different. In such case cumulative cash inflows are calculated and
by interpolation, the exact payback period can be calculated.
2. Average rate of return method:
Average profit, after tax and depreciation, is calculated and then it is dividend by the total
capital outlay or total investment in the project. This method establishes the ratio between the
average annual profits to total outlay.

Average rate of return = Average Annual profit X 100

Outlay of the project
3. Net present value method:
This method is the modern method of calculating investment proposal. This method
takes into consideration the time value of money and attempts to calculate return on investment
by introducing the factor time element. It recognizes the fact that a rupee earned today is worth
more than the same rupee earned tomorrow. The NPV is the difference between the total present
values of future cash flows. While selecting in between the mutually exclusive projects, it is
ranked in the order of NPV having the maximum positive point.

The net present value of an investment proposal is defined as the sum of the present
values of all future cash inflows less the sum of the present values of all cash outflows associated
with the proposal. Thus, NPV is calculated as under, NPV= Discounted Cash Inflows –
Discounted Cash Outflows (or) Initial Investment

4. Benefit cost ratio:(BCR)

It is the ratio of gross discounted benefits to gross discounted costs. T his may be used as an
extension of NPV and expressed in coefficient, or in percentage. It is particularly useful for
ranking the projects on the basis of their profitability. However, it also suffers mostly from the
same weaknesses as the net present value technique.
5. Internal rate of return method :( IRR)
This method is popularly known as time adjusted rate of return method of discounted rate
of return method. The internal rate of return is defined as the interest rate that equates the present
value of the expected future receipts to the cost of the investment outlay. The internal rate of
return is found by trial and error.
PROJECT DESIGN
MEANING
It is the heart of the project entity. It defines the individual activities, which go into the
corpus of the project and their interrelationship with each other. It enables to identify the flow of
events, which must take place for the successful completion of the project.

NETWORK ANALYSIS
MEANING
Network analysis is concerned with the evaluation of time and resources profile of
project activities. It also deals with identification process of optimizing the particular course of
action in terms of available time and resource constraints.

TECHNIQUES OF NETWORK ANALYSIS

 Network diagram and scheduling computation enable the project formulation team to
identify the longest series of the work by the project implementation, which determines
the project period.
 It is investigated in elaborate manner.
 It is utilized to complete narration of the constituent activity of a project.
 It is accomplished with set of symbols linked with each other.

OBJECTIVES OF NETWORK ANALYSIS

1. Helpful Planning:
It is a powerful tool, which helps in planning, scheduling and controlling the activities of
the project.
2. To develop inter-relationship:
It intends to create interrelationship and inter dependence of various activities of a
project. It s very useful in bringing out the technological inter dependence of various activities. It
also helps in integrating project planning.
3. To Control the Cost:
This cost can be compared to the cost of the resources required to carryout the various
activities at varying speed. Thus the total cost can be calculated and steps can be taken to
minimize and control the project cost.
4. To Minimize the Maintenance Time:
It enables management to minimize the total maintenance time. If the cost of production
overhead is very high, there arises a need to minimize the maintenance time, which is possible
with network analysis.
5. To Reduce Project Time:
 Sometimes available resources have to be arranged with a view to reduce the total time
for the project rather than reducing the cost of the project.
6. To Control Idle Resources:
Network analysis helps to control the idle resources. A provision for effective utilization
of limited resources can be made with network analysis. The entrepreneur can stick to budgeted
costs and scheduling time for the effective execution of the project.
7. Avoiding Delays and Interruptions:
It develops discipline and systematic approach in planning, scheduling etc., It helps the
managers avoid delays and interruptions in production and exercise effective control over
complex projects.
8. To delegate the responsibilities:
It enables the delegation of responsibilities on different supervisors. Supervisor of an
activity is aware of his time schedule and also activities of other supervisors. It facilitates proper
co-ordination amongst supervisors.

UTILITIES OF NETWORK ANALYSIS

 The network analysis helps the management in achieving the objectives with minimum of
time and least cost and also in predicting the probable project duration and the associated
costs.
 It clearly designates the responsibilities of different supervisors. Supervisor of an activity
knows his time schedule precisely and also the supervisors of other activities with whom
he has to coordinate.
 The flexibility of the networks permits the management to make the necessary alterations
and refinements as and when needed. These alterations may be made during development
of resources.
 It provides a number of checks and safeguards against going astray in developing the plan
for the project and thus there are little chances of oversight of certain activities and
events.
 It helps the management in planning the completed projects, controlling the
implementation of the plan and keeping the plan up to date. It also helps in locating the
potential trouble spots and in taking corrective measures.

CLASSIFICATIONS OF NETWORK ANALYSIS/ TECHNIQUES

1. Critical path Method: (CPM)
It is a deterministic network. It has two time – cost estimates for each individual activity.
One time – cost estimate is concerned with normal situation and the other estimate is meant for
the crash situation.
2. Programme Evaluation and Review Technique: (PERT)
The Programme Evaluation and review technique deals with the likelihood that the
single value given as the estimated time for completion of activities is going to have a degree of
error associated with it.
3. GERT:
 The Graphical Evaluation And Review Technique is the most complex network, treats both
activity and time as probabilistic factors. It presents a project as a set of processes of operations
called activities which are generally available in certain sequential order.
4. LOB:
Line of Balance uses graphic techniques to show the progress achieved on the project
with respect to key events
4. WASP:
The British Atomic Energy Authority developed a networking system called Workshop
Analysis Scheduling Programme.

MAIN FEATURES OF CRITICAL PATH METHOD

 It determines the pattern of allocation of available limited resources.
 It is a deterministic model.
 It assumes both times to complete the activity as well as cost of doing activity, which is
known with certainty.
 It gives importance to critical path and critical activities.
 It gives the most economical schedule for a fixed duration.
 It determines the complicated activities and critical path on which the project duration
depends.
 The scheduling of activities is done in such a manner that critical activities do not cause
any delay to project completion time.

IMPORTANCE / ADVANTAGES OF CRITICAL PATH METHOD

 It helps in ascertaining the time schedule and activities having sequential relationship.
 It makes control easier for the management.’
 It identifies the most critical elements in the project. Thus, the management is kept alert
and prepared to pay due attention to the critical activities of the project.
 It makes better and detailed planning possible

LIMITATIONS OF CRITICAL PATH METHOD

 It operates on the assumption that there is a precise known time that each activity in the
project will take. But it may not be true in real practice.
 CPM time estimates are not based on statistical analysis.
 It cannot be used, as a controlling device for the simple reason that any change
introduced will change the entire structure of network. It cannot be used as a dynamic
controlling device.

ADVANTAGES & DISADVANTAGES OF PERT

Advantages:
 It determines the expected duration of activities and consequently of the project duration.
 It incorporates risk analysis in project network.
 It determines critical activities of the project, which helps in efficient allocation of
resources to complete the project early.
 It determines the most economical schedule for fixed project duration.
  It helps in optimal allocation of limited resources.

Disadvantages:
 It does not consider the resources required at different stages of the project.
 It is mainly based on time estimates required for each activity. On account of wrong time
estimates , the network is bound to become highly unrealistic.
 It requires frequent updating and revising the PERT calculations. But, this proves quite a
costly affair for the organization.

STEPS INVOLVED IN PERT

The following are the steps involved in PERT technique:
1. The activities involved in the project are drawn up in a sequential relationship to show
what activity follows what.
2. The time required for completing each activity of the project is estimated and noted on
network.
3. The critical activities of project are determined.
4. The variability of the project duration and probability of the project completion in a
given time period are calculated.

DISTINGUISH BETWEEN THE CPM AND PERT

PERT - PROGRAM M E
C P M - C R IT IC A L P A T H
E V A L U A T IO N R E V IE W
M ETHOD
T E C H N IQ U E
I t s o r ig in is in d u s t r y . I t s o r ig in is m ilit a r y .
I t is a n a c t iv it y o r ie n t e d I t is a n e v e n t o r ie n t e d
ap p roach . ap p roach .
I t d o e s n o t a llo w I t a llo w s u n c e r t a in t y .
u n c e r t a in t y . I t is p r o b a b ilis t ic m o d e l.
I t is a d e t e r m in is t ic m o d e l. I t is t im e - b a s e d .
I t is c o s t - b a s e d . It d o e s n o t d e m a rc a te
I t m a r k s c r it ic a l a c t iv it ie s . b e t w e e n c r it ic a l a n d n o n
I t d o e s n o t a v e r a g e t im e . c r it ic a l a c t iv it ie s .
I t is s u it a b le w h e n I t a v e r a g e s t im e .
r e a s o n a b le p r e c is io n is I t is s u it a b le w h e n h ig h
r e q u ir e d e .g . C iv il p r e c is io n is r e q u ir e d in
c o n s t r u c t io n p r o je c t s , t im e e s t im a t e s e .g ., d e fe n s e
in d u s t r ia l e x p a n s io n p r o je c t s .
s c h e m e s , e t c .,

FINANCIAL ANALYSIS
MEANING
It refers to the process of obtaining relevant economic information about a project in
order to establish its financial viability. It primarily deals with the interpretation of the financial
data incorporated in the pro- forma financial statements and the presentation of the economic
facts in such a form as to make a comparative evaluation of a project but also with its operational
aspects.
Advantages and Disadvantages Of Pay Back Period
Advantages:
 It is easy to understand.
 It is simple to operate.
 This method makes it clear that there is no profit on any project unless payback period is
over.
 The business unit can judge the period for which its funds will remain tied up if the
project is approved.
 It is particularly suitable in industries where risk of obsolescence is high. In such cases,
Projects having short payback period shall be preferred.
 This method is preferable where funds are in very short supply. They may be invested to
yield more by selecting project having shorter pay back periods.
Disadvantages:
 It is delicate and rigid.
 It treats each asset individually in isolation with other assets, while assets, in practice,
cannot be treated in isolation.
 It ignores capital wastage and economic life by restricting consideration to the project’s
gross earnings.
 It overplays the importance of liquidity as a goal of capital expenditure decisions.
 It overlooks the cost of capital, which is the main basis of sound investment decisions.
 It overstates the worth of flows within the payback period in that it assigns implicit equal
importance to cash flows at the end of year 1.
 It ignores the earning beyond the payback period while in many cases these earnings are
substantial. This is true particularly in respect of research and welfare projects.

METHODS OF AVERAGE RATE OF RETURN

This method is also known as Accounting rate of return method or return on investment
or Average rate of return method. According to this method, various projects are ranked in order
of the rate of earnings or rate or return. Projects, which yield the highest earnings, are selected
and others are ruled out. The return on investment can be expressed in several ways as follows:

a) Average rate of return method:

It takes into account, the accounting concept if profit (i.e.,) profit after depreciation and
tax and not the cash inflows. The project, which yields the highest rate of return, is selected. The
rate of return means the average annual return on a project.

b) Return per unit of investment method:

In this method, the total profit after take and depreciation is divided by the total
investment. This gives us the average rate of return per unit of amount invested in the project.

Return per unit of Investment = .

c) Return on Average Investment method:
The percentage return on average amount of investment is calculated. To calculate the
average investment, two divides the outlay of the project.

Return on average Investment = .

d) Average return on Average Investment Method:
Under this method, average profit after depreciation and taxes is divided by the average
amount of investment. This is an appropriate method of rate of return on investment.

Average return on average investment =

Advantages & Disadvantages of Average Rate On Return Method

Pros / Advantages:
 It is simple and easy to understand like payback method.
 It takes into consideration the total earnings from the project during its entire economic
life.
 This approach gives due weight to the profitability of the project.
 Investment with extremely long lives, the simple rate of return will be fairly close to the
true rate of return. Financial analysts to measure performance of a firm often use it.

Cons / Disadvantages:
 It is simply an averaging technique, which does not take into account the various impacts
of external factors on overall profits of the firm.
 This method also ignores the time factor, which is very crucial in business decisions as
the amount of interest, and discount is powerfully affected by it.
 This method does not determine the fair rate of return on investment. It is left to
discretion by the management. So use of this arbitrary rate of return may well cause
serious distortions in the selection of capital projects.
 Once apparent disadvantage of this approach is that its results by different methods are
inconsistent.

NET PRESENT VALUE METHOD

The net present value method is a modern method of evaluating investment proposals.
This method takes into consideration the time value of money and attempts to calculate the
return on investments by introducing the factor of time element. It recognizes the fact that a
rupee earned today is worth more than the same rupee earned tomorrow.
The net present value method is based on the fact that the cash flow arising at different
periods of time differs in value and is not capable of comparison unless their equivalent present
values are found.
The present values of all inflows and out flows of cash occurring during the entire life of
the project is determined separately for each year discounting these flows by the firm’s cost of
capital or a pre-determined rate.
The following are the necessary steps to be followed for adopting the net present value
method of evaluating investment proposals:

 The rate should be a minimum rate of return below which the investor considers that it
does not pay him to invest. The discount rate should be either the actual rate of interest in
the market on long term loans or it should reflect the opportunity cost of capital of the
investor.
 Cash outflows are ascertained at the determined rate. If the total investment is to be made
in the initial year the present value shall be the same as the cost of investment.
 Cash inflows at the above determined discount rate.
 The net present value of each project by subtracting the present value of cash inflows
from the present value of cash outflows for each project.
 If the net present value is positive or zero (i.e.,) when present value of cash inflows
exceeds or is equal to the present values of cash out flows, the proposals may be
accepted. But in case the net present value is negative (i.e.,) when the present value of
cash inflows is less than the present value of cash flows, the proposals should be rejected.
 To select between mutually exclusive projects the projects should be ranked in order of
present values. i.e., the first preference should be given to the project having the
maximum positive net present value.

ADVANTAGES AND DISADVANTAGES

Merits:
 It considers the time value of money.
 It considers income over the entire life of the project.
 It is helpful in comparing the two projects in which the same amount of investment is
required.
 Conclusions drawn by this method are not affected by decisions regarding various
accounting policies (e.g.) regarding valuation of stock, depreciation etc.,
Demerits:
 This method is too difficult to use.
 It is note helpful in comparing projects in which different amount of investments are
required.
 It may be misleading in comparing projects of unequal lines.
 This method is based on the estimates of future earnings unless we know the life of the
project accurately, estimates of future earnings cannot be made.

[UNIT – II COMPLETED]
REFERENCE BOOKS:
Entrepreneurial Development C.B.GUPTA, N.P.SRINIVASAN
Entrepreneurial Development – ANIL KUMAR