What is a Financial Feasibility Study?

date: 2021-06-13 15:18:26

 

Usually Company owners conduct financial feasibility studies when they have an idea about a new project. They first conduct a simple market research and a financial feasibility study in order to determine the idea’s viability. This avoids wasting both time and money on that project before actually committing to it.

 

The purpose of a financial feasibility focuses specifically on the financial aspects of a project. It assesses the financial viability of a proposed project by evaluating the initial investment cost, operating expenses (including salaries), cash flow and as a result have a forecast of future performance of that project. 

 

The results from the feasibility study mainly includes the Net Present Value (NPV) and Internal rate of return (IRR). In simple terms, IRR indicates the return on investment of your invested capital.

 

Now in order to perform a financial feasibility study, some preparations are required to identify the feasibility of that project:

  • Initial investment cost (which includes real estate cost, software cost, equipment and pre-operating costs). Additionally, it is critical to test out the debt to equity ratio to understand the most convenient and profitable structure, if applicable.
  • Revenue (it is always recommended not to forecast as a bulk figure but understand the metrics behind that figure. For example, if you are a subscription-based company, you can forecast your number of annual recurring subscribers and then after the expected annual payment per customer. This method will enable you to understand the accuracy of that assumption as opposed to just stating your budgeted revenue figure that you wish to generate)
  • Variable expenses that fluctuate with revenue
  • Fixed expenses that are paid regardless of your revenue, which could include, rent, salaries and utilities.
  • Cash conversion cycle (This is essential to understand that any given time, your company could have a cash deficit that potentially might impact its operations during a given period)
  • Capital expenditure estimated to be paid to purchase additional tangible/intangible assets.

An important note is that your assumptions should always be conservative but realistic. Check out our article on 5 Methods to Make Realistic Financial Estimates.

 

The results of the financial feasibility study are then broken into three important metrics:

Internal rate of return (IRR): The internal rate of return is a measure of an investment’s rate of return based on its equity investment. It is used evaluate the attractiveness of a project or investment.

Net Present Value (NPV): The NPV of a project represents the change in a company's equity resulting from the acceptance of the project over its life. It equals the present value of the project net cash inflows minus the initial investment cost. It is considered one of the most reliable methods used in capital budgeting because it is based on the discounted cash flow approach

Payback period: Payback period refers to the number of years it takes to recoup the equity investment

The above results will then illustrate the financial viability of that project. It is important to note that some projects will have a positive IRR and NPV, however, the project owner’s job is to assess if the IRR and NPV of your results are worth your time and money, or maybe alternatively you could be better off just putting your money into another investment altogether. 

 

Do you need to value your company or find out the financial feasibility of your new idea? Check out Front Figure. It is quicker and more cost effective compared to other traditional methods.

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