Essay on Financial Parameters

Published: 2021-06-25 02:49:48
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The decision on where a company should invest its resources to achieve its goals have a great impact on the companys future based on competition. Therefore, being involved in the right project is worth considering, both to avoid wastage of the companys time and resources. However, for a continuous improvement, there is need to prioritize change ideas and projects to (or intending to) addressing all scenarios of the project.

Financial evaluation of the project will tell the management whether the project is yet to contribute to the overall goal of the company or whether it will drain the resources instead. While the purpose of the financial analysis is to help the management in making decisions, there are various financial parameters that should be considered. The most common parameters include; net present value, internal rate of return, profit to investment ratio, multiple rate of return, payback period, rate of return on investment, accounting rate of return, social cost and benefits analysis, profitability index, economic rate of return, benefit-cost ratio, average rate of return and technical cost.

Financial Parameter Reason for its use by the Management

Net Present Value (NPV) This would be the net cash flow of the company, either on a monthly or yearly basis. After using a specific discounting method, the management should recommend the companys average investment opportunity rate which is the interest rate that represents the future investment opportunity returns for the company [6].The management would use this parameter for project screening whereby, if there is a positive NPV at the average investment opportunity rate of the company, then the project is accepted.

Internal Rate of Return (IRR) This is the interest rate which when used to calculate NPV, the NPV becomes zero. This parameter can also be used to easily screen the project. If the average investment opportunity rate is lower than the IRR, then the project is worth implementing [6].If IRR is used to compare two different scenarios, then IRR should be calculated for the per capita used for the scenario with a larger investment. This will finally lead to a correct decision by the management.

Discounted Profit to Investment Ratio This parameter is touted by R.D. Seba [6] as the only financial parameter that management would ever need. It is calculated by dividing the sum of the net operating income of the project by the sum if its investments. If the value of the project is greater than 1.0, then the management would select it. This parameter will ensure that the project has a treasury that grows at the fastest rate.

Payback Period This is the period that the company would require to recover the cost of the project. The management would consider this parameter in that it would help them whether to undertake the project since longer payback periods may not be desirable for an investment.

Benefit-cost ratio This parameter uses the simple thumb rule to estimate cash flow. It would tell the managers to accept the project if only it has an index value of greater than or equal to 1.

It would also allow the managers to rank the project since values that are high are considered to be more profitable.

Social cost and benefits analysis This parameter will evaluate whether the project will add benefits or cost to the society [5].The management would use this parameter as an aid to evaluating the project within a planning framework which clearly states the national economic objectives and allocation of resources.

Technical cost This parameter is used to compare the benefits of the project and its total cost and as a result, ensures that the technical cost is associated with the project [4].

The managers would use it at the start of the project when two different scenarios are being compared, as a parameter for choosing the best approach.

Accounting Rate of Return (ARR)/Average Rate of Return This is the amount of profit that the company would expect base on the investment that they would make [3].The management would use this parameter to recognize the profitability factor of the project.

Profitability Index This index will attempt to identify the relationship between the cost of the project and its benefits. The managers would use this parameter to determine the financial attractiveness of the project.

Any value of less than 1.0 would indicate that the profitability value of the project is less than the initial investment [2].

Return on Investment This parameter is used to evaluate the efficiency of a project or to compare its efficiency with other different scenarios [1].The managers would use it to measure a number of returns of the project relative to the initial cost of investment.

In conclusion, these financial parameters would help the managers to decide whether to proceed with the project or not. Before then, they would need to establish overall goals and determine how the project would be more profitable compared to other projects they would undertake. These financial parameters would give them the financial results to evaluate their goals and decide whether the project meets their requirements.

REFERENCES

[1]I. Staff, "Return On Investment - ROI", Investopedia, 2017. [Online]. Available: http://www.investopedia.com/terms/r/returnoninvestment.asp. [Accessed: 28- Apr- 2017].

[2]I. Staff, "Profitability Index Rule", Investopedia, 2017. [Online]. Available: http://www.investopedia.com/terms/p/profitability-index-rule.asp. [Accessed: 28- Apr- 2017].

[3]"Accounting Rate of Return (ARR) Formula | Examples", Accountingexplained.com, 2017. [Online]. Available: http://accountingexplained.com/managerial/capital-budgeting/arr. [Accessed: 28- Apr- 2017].

[4]2017. [Online]. Available: http://www.betterevaluation.org/en/evaluation-options/CostBenefitAnalysis. [Accessed: 28- Apr- 2017].

[5]r. pathak, "SOCIAL COST-BENEFIT ANALYSIS: A STUDY OF POWER PROJECTS", Academia.edu, 2017. [Online]. Available: https://www.academia.edu/3848594/SOCIAL_COST-BENEFIT_ANALYSIS_A_STUDY_OF_POWER_PROJECTS. [Accessed: 28- Apr- 2017].

[6]"Evaluating Cash Flow Results", Money-zine.com, 2017. [Online]. Available: http://www.money-zine.com/investing/investing/evaluating-cash-flow-results/. [Accessed: 28- Apr- 2017].

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