Guide to

Financial Analysis

Contents

Purpose of this Guide

Financial Analysis defined

Defining Costs

Capital Costs

Operating Costs

Benefits

The Financial Calculator

The value of money

NPV

Payback period

Sensitivity Analysis

Further assistance

The Purpose of this Guide

The purpose of this guide is to provide assistance in
completing the financial components of the business
case, namely the costs and benefits and in using the
financial calculator to obtain a financial assessment of
a project.
The guide also provides explanations of the financial
indicators: NPV, payback period and sensitivity
analysis.

Financial Analysis Defined:

Comparing the costs and benefits over time to
determine whether a project is profitable or not.
To achieve this the following financial indicators
are used:
Net Present Value (NPV)
Internal Rate of Return (IRR)
Sensitivity Analysis

Steps in conducting a Financial

Analysis:
1. Identify the costs
2. Identify the benefits
3. Enter the costs and benefits into the financial
calculator
4. Assess the financial indicators to determine if the
project is financially favourable.

Defining Costs
There are different ways of defining costs:
By type:

By function:

Capital costs

Development costs

Operating costs

Operational costs
Maintenance costs

By behaviour:

By time:

Fixed costs

Recurring costs

Variable costs

Non-recurring costs

Capital Costs
Capital costs are the expenses incurred in purchase of
items that are recorded as assets; their value is
depreciated over time and they are recorded in the
Balance Sheet.
Identify the capital costs for the project for the following
items:
Equipment
Non-consumable Materials*
Infrastructure
*Non-consumable materials are capital costs because
these are materials that persist (eg. furniture, bricks)

Operating Costs
Operating costs are expenses incurred in the execution of
the project or in the operation of the business (after the
project) They are not depreciated over time and are
recorded in the profit and loss statement.
Identify the operating costs for the project for the following:
Internal business resources
Internal IT resources
External resources
Office accommodation
Licenses
Support

Training
System administration
Equipment hire
Consumable materials*
Travel
Accommodation

*Consumable materials are operating expenses because

they are materials that are used up by the project (eg.
stationery, batteries)

Identifying the Benefits

Identify the benefits that the project will
provide, and the value that can be assigned to
each benefit.

Refer to the guide to benefits analysis

Enter the costs and benefits into the

Financial Calculator
For each year enter the anticipated capital and operating
expenses into the financial calculator spreadsheet.
For each year enter the anticipated benefits into the
spreadsheet.
Adjust the discount rate if appropriate.
Enter sensitivity values (% cost increase and % revenue
decrease values)
The spreadsheet will automatically calculate the financial
indicators

Assess the Financial Indicators

Financial indicators used in the spreadsheet are:
Net Present Value (NPV)
Internal Rate of Return (IRR)
Sensitivity Analysis

The value of Money

The value of money changes over time.

With most projects, the financial benefits are realised at a different

time to the costs.

Net present value (NPV) provides a means to compare these by

adjusting the value to todays value.

This is achieved by modifying the future value by a factor that

represents the change in value of money from todays value.

This factor is called the discount factor.

It is calculated as: 1 (discount rate / 100)

Investment Analysis
Year 1

Benefits
Less Costs
Cash Flow
X Discount factor
Present Value
Net Present Value

Year 2

Year 3

Year 4

Year 5

9250 21000 21000 21000 21000

23570 15320 15320 15320 18320
-14320 5680 5680 5680 2680
0.87 0.756 0.658 0.572 0.497
-12458 4254 3737 3249 1332
$154

If the Net Present Value is less than zero then this indicates
the project is not financially worthwhile.
Note: The discount factor is based on a discount rate of 13%.
Hence at the end of the first year $1 is worth 87c, drops to
75.6c in the second year, 65.8c in the third year etc.

Internal Rate of Return

Is defined as the discount rate at which an investment has a
zero net present value.
The internal rate of return equates to the interest rate,
expressed as a percentage, that would yield the same return if
the funds had been invested over the same period of time.
Therefore, if the internal rate of return for the project is less
than the current bank interest rate it would be more profitable
to put the money in the bank than execute the project

Sensitivity Analysis
Projects do not always run to plan. Costs and benefits
estimated at an early stage of a project may indicate a
profitable project, but this profit could be eroded by an
increase in costs or a decrease in the value of the
benefits (the revenue).
Sensitivity analysis provides a means of determining the
financial impact of this type of fluctuation.
By entering an anticipated percentage increase in costs
or decrease in revenue the financial impact on the project
can be identified by looking at the change to the NPV or
IRR measures.

Further Assistance
For additional supporting guides refer to:
Guide to Benefits Analysis