date: 2021-06-14 11:40:47
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.
It is considered the first step in understanding whether your business idea is financially viable / feasible or not. In order to do so, it is important to understand the key metrics used to understand whether your idea is worthwhile or not. This is because sometimes a business idea could be feasible (i.e. profitable), however, you would be better off if you just invest your cash in a passive investment.
For more information on what a financial feasibility study is, please refer to this article.
The results of the financial feasibility study comprise of the following key metrics:
Internal rate of return (IRR) (The higher the better): 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 higher the better): 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 (The lower the better): Payback period refers to the number of years it takes to recoup the equity investment
Cash conversion cycle (The lower the better): The cash conversion cycle (CCC) measures how long it would take a company to convert its inventory to cash. It lets you figure out how long it takes you to sell inventory, how long it takes you to collect on accounts receivable, and how soon you have to pay your accounts payable. Refer to this article for further details about the CCC.
It is vital to understand the opportunity cost and the returns estimated in any other investments in order to assess the above metrics. For example, if you are currently working a full-time job and taking a 50,000 USD$ annual salary and your estimated NPV equates to almost that figure on an annual basis, then is it worth it actually starting the business? That is your opportunity cost.
Another example, if investing in a defensive sector (for example, healthcare or education) generates an IRR figure close to your riskier business idea, then again, is it worth the risk?
Of-course, sometimes there are other factors that could make the answer for the above questions a “Yes”, but that is usually a decision that should be taken by the potential founder of the business.
An important note is that your assumptions should always be conservative but realistic. For details, check out our article on 5 Methods to Make Realistic Financial Estimates.
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.