When developing investment projects, analytical work is always carried out in advance, aimed at assessing their prospects, that is, potential profitability and possible risks. One of the most important stages of project assessment is the development of a feasibility study. Let us further consider what a feasibility study is and how to draw it up.
Feasibility study - what is it and how does it differ from other similar documents
Drawing up a feasibility study is the result of studying the possible economic benefits of an investment project, calculation and analysis of its main indicators. It is an official document containing all the necessary research that makes it possible to make a reasonable preliminary conclusion about the feasibility of investing in a specific project.
A feasibility study is usually carried out only for part of a company’s business; it allows one to evaluate the result of qualitative or quantitative changes in its activities. Based on the results of the study, it is concluded that:
- the effectiveness of investments in existing or new areas of work;
- the need for additional lending;
- acquisition or merger opportunities;
- introduction of new technologies;
- choosing the right equipment;
- changes in the organization of enterprise management.
There are other documents developed to assess the feasibility of investing money, such as a business plan and investment memorandum. Feasibility study has a number of similarities and differences with them.
The investment memorandum substantiates the feasibility of investing in the undertaking and is directed outward, to potential investors who are ready to invest in its implementation. Feasibility studies have a more utilitarian function: to determine the feasibility and feasibility of the project, i.e. this document is used more internally within the company.
The main difference between a business plan and a feasibility study is the level of elaboration of all indicators. The business plan describes all processes in interaction with environmental factors, for example:
- analysis of markets and trends therein;
- marketing strategies;
- descriptions of services and goods;
- risk analysis.
It is most often compiled to open a new business. The feasibility study is more focused on the internal needs of the company, it is less detailed. Often, a feasibility study becomes an integral part of a business plan.
Rules for drawing up a feasibility study
The feasibility study for each individual project may differ depending on its scale, complexity and focus. The structure of the feasibility study and the content of its parts are determined by the developer, who is responsible for the objectivity of the final results.
The justification for a large-scale undertaking is divided into several successive stages:
- The first is a general understanding of the feasibility of the project. Here, the proposed initiative is briefly described, using well-known analogies and generalized assessments. This stage does not require significant investment of money and time. If, based on the data received, management decides that the proposal has prospects, then they move on to the next stage.
- The second is called “preliminary selection”, since it offers an approximate justification with an accuracy of estimates within +(-) 20%. Its cost is usually within 1% of the total cost of the undertaking.
- The third is final. The calculation of the feasibility study (full) at this stage is worked out to an accuracy of +(-) 10%, and on its basis the final decision is made.
A complete technical and economic report consists of the following sections:
The specified components of the project feasibility study are a sample applicable to the production of products at the enterprise. If we are talking about construction or the service sector, then the internal content of the sections may have a different look.
Different types of projects and features of justification for them
Depending on the goals of the undertaking, the calculations for them differ, sometimes quite significantly. Let's look at them in more detail:
If the question concerns a large undertaking with the need for significant financial resources, then they use the services of specialized organizations that have experience in creating such documents and the necessary specialists. If the project is of an intra-company nature and is small in volume, then you can get by using your own financial and economic unit.
Feasibility study in the construction industry
The construction feasibility study has its own characteristics. For the construction of a facility, this is the main document at the design stage. On its basis, tender documentation is developed, tenders are organized between contractors, contracts are concluded with the winners, working documentation is prepared and financing is opened.
The main decisions displayed in the feasibility study for construction are:
- space-planning;
- technological;
- environmental protection;
- constructive.
Also important are the safety aspects of the future facility from the operational, sanitary-epidemiological, and environmental points of view. In addition to economic efficiency, we should not forget about the social consequences. The completed feasibility study is agreed upon and approved by the supervisory and executive authorities in the prescribed manner.
As an example, we can give an approximate feasibility study for the construction of a residential multi-storey building. In this case, the document will contain the following sections:
- A general explanatory note about the proposed structure. It will include information about the location, purpose of the building, its area and number of floors, the total estimated cost of all premises, networks and equipment, and a list of project participants. The source of financing is funds from home buyers and a bank loan. The dates for the start and completion of construction work are indicated.
- Information about the land plot intended for construction and data from geological, hydrological, meteorological and geodetic surveys.
- A master development plan, including the house itself, the surrounding area and social infrastructure facilities (if any), as well as transport accessibility.
- Technological solutions used in construction, for example, the material from which it is planned to construct the building (concrete, brick).
- Architectural and construction solutions that take into account the entire range of functional, social, fire safety, artistic, sanitary and hygienic and other requirements sufficient for the comfortable living of residents.
- Characteristics of engineering systems, networks and equipment. Let's take this example. It is planned to install 9 elevators, a modular boiler room, centralized water supply and sanitation in the house. There is no provision for gas supply; it is planned to use electric energy for domestic needs, so electric stoves are installed in the apartments.
- Issues of managing a complex of construction and installation works, ensuring working conditions and worker safety.
- Organization of the construction process (availability of a calendar plan broken down by process).
- Activities aimed at compliance with environmental protection standards, as well as at preventing emergency situations and organizing civil defense.
- Estimate documentation.
- Economic and marketing calculations (plan for the sale of apartments by year, calculations for a loan taken from a bank, payment for the services of contractors and suppliers).
- Expected financial results. Here all cash flows, the structure of sources of money, all possible losses and profits are calculated. The level of return on investment, NPV, and IRR is calculated. All cash flows are discounted based on the duration of the project.
Each feasibility study is unique in its own way. Despite the general points, the final document for the construction of, say, a hospital will be radically different from the modernization of a mining and processing plant or the expansion of an auto repair shop. It is important that the organization that prepares the documentation understands the current situation in a specific market segment and is able to draw correct conclusions regarding the relative success of the proposed initiative.
The economic justification is the reason that motivates an organization to undertake a specific project. This concept includes consideration of the benefits that the enterprise will receive as a result of the project. In addition, the business case examines various alternatives and also analyzes the project from a financial and economic point of view. The latter allows you to assess the investment attractiveness of the project. How to write a business case? An example is in this material.
The essence of the concept
The economic justification is reminiscent of the analysis that we conduct when planning some kind of serious purchase. For example, your own car. Let's assume that we can allocate 35 thousand US dollars from the family budget for this purchase. The first step is to find out which automobile concerns produce cars of the class we are interested in. Then we determine the main technical characteristics and agree on the final price with the company that sells these products. But that's not all. How to write a business case? An example in the matter of choosing a payment scheme.
At the same time, there may be another situation when the buyer is primarily interested in the total amount that will have to be paid for a new car. This is especially true in a situation where the final price is affected by the amount of interest if we are talking about buying on credit. In this case, it is advisable to choose the option that provides the lowest interest rate. Another way is to look for an offer with the lowest monthly payment. Such an acquisition will allow you to stretch out payments for as long as possible. At the same time, the monthly amount of such a payment will not hit your pocket too much. When carrying out a financial and economic feasibility study, attention is paid to similar aspects.
Components of a business case
There are no clear rules for documenting a business case. Its main task, as in the case of a feasibility study of a project, is to determine the material or intangible results of its implementation. Tangible results mean those that can be measured.
Below is a list that gives an idea of those material components that are important in the process of preparing the financial and economic feasibility study of the project. It would be useful to say that not all of them require mandatory documentation. The need to record them on paper depends on the complexity of the project, cost and number of risks for the enterprise.
Material elements of the business case
So, the main tangible components of the business case include savings, cost reduction, the likelihood of generating ancillary income, an increase in the enterprise's market share, customer satisfaction and cash flow assessment. In addition to the material components of the business case, it must also contain intangible components.
Intangible elements of the business case
These may include probable, but not pre-planned, company costs. Among the main intangible elements of the business case are transition costs, operating costs, transformation of business processes, as well as reorganization affecting company employees. In addition, the intangible components of the business case include recurring benefits. How else can you write a business case? Example below.
Other components of the business case
It should be emphasized that along with the benefits and assessment of cash flow in the EO, it is necessary to pay attention to alternative approaches and methods for implementing a specific project in practice. How to write a business case? An example in the following situation.
It is known that there are a large number of manufacturers of different products on the market. However, each of them sets its own price for its own products. What to choose? An option that is a turnkey solution costing $2 million. Or an alternative solution that involves partial purchasing from a third-party manufacturer and, to some extent, using its own resources?
In fact, aspects of precisely this nature often have to be considered when drawing up an economic feasibility study for an enterprise. Any of the proposed options must include the previously listed tangible and intangible components. At the end of the business case, proposals and conclusions must be stated. In addition, you can add additional materials to it.
A significant part of the financial analysis with a special impact assessment form shows how to write a business case. An example of the use of such a form, tracing the process of changes in net financial flows that arise as a result of the implementation of measures, will be presented in this article. In such a plan, the assessment of cash flows in corporate programs should be aimed at positive changes in the socio-economic sphere.
Law
Russian legislative practice has clearly outlined how to write an economic justification, an example of which is presented in Article 105 (Rules of the State Duma of the Russian Federation), and it concerns financial feasibility when introducing bills that require certain material costs for implementation. The government reviews relevant materials before submitting the bill.
First of all, an explanatory note is prepared, which sets out the concept of the bill with all the subjects of legislative regulation. The second document demonstrates how to write a business case. This example is not universal, since it is designed for a specific project and respects the interests of a specific customer. Naturally, each case requires an individual approach - each time with different calculations and plans, since financial justifications are written everywhere and by everyone - from legislators in the State Duma to students in technology lessons in high school.
FEO
How to write a business case? You can see an example below. It all depends on the object to which it is dedicated: whether it is technical regulations, organizations with their own standards, or even a national economy looking for financial ways for economic recovery. Let's take, for example, technical regulation, which requires clearly defined financial justification for changing norms or technical regulations.
When implementing a project, the costs, benefits and risks of each subject of the state, enterprise or community will inevitably be redistributed. Not many people know how to write a business case. A pattern exists for every type of activity, but it cannot be called universal. The implementation of such a procedure is required at the initial stage - during design, which allows you to avoid many mistakes and gain a lot of opportunities.
Advantages of the business case
First of all, when writing a justification, changes in costs are predicted, risks and benefits of all economic entities are identified. This is due to an accurate assessment of the financial and economic effect in connection with changes in certain norms. Costs are optimized by adjusting the direction of economic development, and the development of new standards will help fulfill this task.
Concrete modeling of the ensured impact of these developed standards will tell you step by step how to write a business case. The sample hardly reflects the actual situation of a given enterprise, industry, or society. Only a person inside the situation can identify the winning and losing sides. The demands for change must be effectively harmonized with all systems subject to technical regulation, taking full advantage of the implementation of any project.
Bills
Regulatory legal acts also require material or financial costs, and therefore the legislator proposing a new project must write an economic justification, that is, provide specific financial calculations. These justifications, directly related to the introduction of a new norm or change in a legal act, must indicate the income and expenses of budgets at all levels, the costs of each economic entity, the costs of society (or third parties), tax revenues, and budget efficiency.
This is how all reforms in the state are made: management mechanisms are changed, self-regulatory organizations are introduced, the rules of trade and production are changed, and certain new services are provided by members of associations and associations. In truth, the effectiveness of the introduction of any bill can rarely be directly and accurately calculated, as society is now witnessing with its own eyes - many errors and inaccuracies accompany them. Apparently not all legislators know how to write an economic justification for ongoing operations. When carrying out reforms, the forecast of socio-economic consequences and effects is especially important.
How is it necessary?
The financial and economic assessment of any innovation should be as accurate as possible and identify political, administrative, economic and other effects and consequences in advance. The “young reformers” know best how to write an economic justification for the alienation of property from the state, but society is now overcoming the consequences of this knowledge - with great difficulty, pain and losses. But it was necessary to evaluate in monetary terms not only our acquisitions, but also our losses (this is from the section of the economic justification called “additional costs”). Has the impact of such changes on the finances of all stakeholders and budgets at all levels been identified? And this is an indispensable condition for the correct preparation of an economic justification.
No, nothing was revealed, it’s just that a huge number of the country’s citizens “didn’t fit into the market.” How to write a business case for a lack of wages that people have not seen for several months? It was necessary to conduct a thorough analysis of all changes in the structure of income, expenses and risks of economic entities, the entire society, that is, third parties, and this is an unshakable rule for drawing up economic justifications. A detailed analysis of everything related to changes in control mechanisms was needed. In this financial calculation, it was necessary to honestly evaluate (monetize!) the redistribution of benefits, and for absolutely all parties interested or affected by the changes.
About feasibility
It is an honest and impartial analysis of the situation even before the start of any changes that can help in assessing the feasibility of any project, primarily in monetary terms. Then recommendations are given on its compliance with this state of affairs. Economic justification procedures should be carried out at the very first stage, when the project is still in the development stage. Designing changes to legal regulations requires fairly strong justification, since only then can the risks, benefits and costs of a variety of economic entities be predicted. Only a business case can outline costs based on expected revenue increases or cost reductions. Money is spent in order to earn much more in the future or spend less.
Financial subtleties
How to write a business case for a bank to convince it to invest in a project? First, we need to understand some hard truths about borrowing. Does the written rationale take into account that money is generally worth more today than it will be in even the shortest time? After all, the bank will give them, of course, at interest. But even if there are personal available funds that can cover expenses, has the justification calculated the percentage on the deposit that will inevitably be lost when investing money in the project?
How to write an economic justification for an agreement with a bank so that it proves that all expenses will be effectively and more than repaid, that is, future income will pay off the interest on the loan or exceed the interest on the deposit? You need to find the most promising aspects of a given project and prove in your justification that all proposed expenses will actually bring savings or revenues equal to those planned. And you don’t need to look for ready-made forms and printed forms. It must be remembered that there are simply no hard and fast rules for documenting a financial or feasibility study.
The form of the economic justification should be the simplest and must indicate the reason that influenced the decision of the organization to carry out this project. But the discussion of the expected benefits should be very detailed, with the application of alternatives, which may be useful, and a detailed financial analysis that will determine the investment attractiveness of the project. In practice, usually no one knows how to write a feasibility study, especially for projects where significant risk is involved. Most often, it is drawn up as a separate document and serves as an annex to the exact form of initialization of this project. If, in fact, the project is small, then all the benefits can be listed directly in the initialization form.
Individual elements
Typically, the results of the project are determined and indicated in its material aspect, that is, all parameters are measurable: cost savings, increased capacity or productivity, increased market, increased income, and the like. Before writing a justification, it makes sense to talk with people interested in investing in the project, or with licensing authorities, about what exactly they want to see in the justification, what is most important to them.
And yet, some material elements must be kept in mind when writing justifications. And the more complex the project, the greater the number of such elements will be present in it: cost reduction, savings, the possibility of generating additional income, increasing the company’s market share, complete customer satisfaction, directions of cash flows. The latter is documented as a major part of the project's business case.
Cash flows
This analysis aims to help committees or individuals reviewing projects to select the most suitable ones for implementation. The measurable elements are already listed above, but the business case does not end with them. There are also intangible ones, and there are many of them. For example, the main ones include the transition period and its costs, operating costs, business process changes, personnel replacement, and the like.
It is necessary to give due credit to alternative solutions in the economic justification, listing all available methods for implementing the project in practice. For example, among thousands of suppliers with millions of identical products offered, almost no one has the same price.
How to make the acquisition profitable? The economic justification will have to answer many, often inconvenient or simply difficult questions. It is more profitable to buy a ready-made solution or find an alternative, your own option. Or you can partially buy and partially sell it yourself. There should be many such answers in the economic justification.
Guardianship
Depending on the culture of the organization, the business case is written by the trustee or the project manager himself. But in any case, the trustee, that is, the investor, is responsible for the project; it is he who is responsible for financial efficiency, while the manager plans, carries out and practically implements it. The leader is the form, and the guardian is the content, that is, the investment. And therefore, the main thing is to convey to the investor the exact amount of costs for the entire project, indicate the correct payback period and predict attractive results.
There is an opinion on the Internet that a feasibility study (TES) is a shortened version of a business plan in which the marketing section is missing (or greatly compressed). This is wrong. A feasibility study is a document that proves that a project is technically feasible and economically viable. In my opinion, this definition is the only and complete one. A feasibility study is an idea document.
To make it completely clear, I will also give the definition of a business plan (BP). The BP is a document that provides detailed information about who is going to implement the project, how, in what time frame and in what market. Naturally, part of the BP is necessarily a feasibility study, because any project begins with a technical and economic analysis. A business plan is an implementation document (see How to write a business plan).
Main sections of the feasibility study
1. Name
2. Project goal
3. Basic information about the project
4. Economic justification
4.1. Project implementation cost
4.2. Profit calculation
4.3. Economic performance indicators
5.Additional
6. Applications
Here we have given the approximate contents of the feasibility study. Naturally, these are only the main sections of the feasibility study; there may be more sections if they are not enough to implement your project.
Feasibility Study Sections - Description
1. Name
Laconic (short but insightful) name of the project. For example: Center for Precision Engineering.
2. Project goal
As briefly as possible about what the main idea of the project is. After reading this, the investor should be interested, but remember, if there is a lot of text here, the investor will not read it at all - he will simply tell you: “I don’t find this interesting.”
3. Basic information about the project
Depends on the specific project, may include sections:
- Types of activity of the enterprise / Types of products.
- Production capabilities and volumes.
4.1. Project implementation cost
Here it is necessary to present an enlarged list of works necessary for the implementation of the project and their cost.
4.2. Profit calculation
Here are calculations of the income and expenses of the project enterprise at its planned production workload, as well as the calculation of profit.
I draw your attention to the fact that depreciation charges must be shown separately; investors can consider depreciation charges as profit from the activities of the enterprise.
4.3. Economic performance indicators
Basic investment performance indicators:
- Amount of investment
- Annual net profit
- Discount rate
- Payback period
- Break-even point (per year)
5.Additional
A variety of information that is important for revealing the idea of the project and its economic efficiency.
6. Applications
Be sure to include additional materials with your feasibility study. Firstly, your document will look more solid, and secondly, additional material will not overload the main sections of the feasibility study. However, remember that there is no need to include material of little use even in the application - any material should have value for the investor.
The feasibility study must briefly and unambiguously reflect the pure idea of the project. A feasibility study should not be loaded with implementation details. This document is needed in order to get the investor's attention. When an investor becomes interested in a project, then a business plan is needed.
There is a common misconception that a feasibility study is nothing more than a condensed version of a business plan with a significantly reduced or missing marketing section. This is actually not true. What then is a feasibility study for a project? An example in this article.
The essence of the term
A feasibility study, or feasibility study, is a printed confirmation of the technical viability of a project and its feasibility from an economic point of view. This formulation seems logically complete and understandable. A feasibility study is an idea reflected on paper.
For clarity, the term “business plan” can also be defined. A business plan is a detailed document containing the following information: who will implement the project and with what tools, in what period of time and in what markets the goods or services will then be presented. At the same time, the feasibility study is a component of the business plan, since the implementation of any project is preceded by its technical and economic assessment. In other words, if a feasibility study is a document that contains a business plan, it is a step-by-step plan for its implementation.
When creating a feasibility study for the construction of an enterprise, it is necessary to take care of its maintenance. This will be the basis of the project. The content of a feasibility study usually includes the following items: name, project goals, basic information about the project, economic justification, additional data and applications. In this case, the economic justification is supported by subparagraphs, namely: the cost of the project, calculation of the expected profit, as well as economic efficiency indices.
The given content of the feasibility study for production is indicative and includes only the main sections. If they are not enough, then you can use other additional ones that will help in the implementation of the project.
Title and goals
The title should be short but informative. In addition, an attractively formulated title of the feasibility study of the project will help to hook the investor. Example - “Center for Precision Instrumentation”. The purpose of the project should also be stated concisely. The main goal of these two parts of the feasibility study sample is to make a good impression and interest the investor. Too much text can discourage you from reading the project.
Basic information. Project cost
A feasibility study of a project, an example of which includes the types of activities of the company, as well as a list of manufactured products, is considered successful. In addition, a description of production capabilities and planned production volumes must be included in the basic information. The section on the cost of implementation should contain a list of works that will be required to complete the project, as well as their cost.
Next, you should indicate the expected amount of income and expenses, provided that the project enterprise will operate at the planned load. Based on this data, profit is calculated. It should be noted here that depreciation deductions should be a separate item. Investors often regard this indicator as one of the sources of profit.
A feasibility study of a project, an example of which includes the main indicators of investment efficiency, is competent. These include the amount of investment, net profit for the year, internal rate of return (IRR), (NPV), payback period of the project and BEP for the year - break-even point.
Additional information and applications
The additional information section should include any materials that will help enhance the impression of the project and highlight its positive and beneficial aspects. In addition, such information should be aimed at revealing the main objectives of the project, as well as emphasizing its economic efficiency and benefits for the investor. Additional information, also appropriately formatted, will add weight and solidity to the project. In addition, these materials will not overload the main points of the feasibility study, as they are presented in a separate section. But at the same time, it should be emphasized that there is no place for unhelpful information here. Any information and data must be of value to the investor.
In conclusion, I would like to remind you that a good and competent example of a feasibility study is a document that is concise and specific. The main idea should be clearly understood from it. A feasibility study does not require a detailed description of the project implementation process itself, but is intended only to attract the attention of the investor. But after achieving this goal, you will need a business plan.
