Project performance indicators and methods of their calculation

Competently assess the prospects for investment in a particular project and objectively confirm the forecast you have made will help the performance indicators of the project, which we will consider in this article.

You will learn:

For what purpose is the evaluation of investment projects carried out.
What performance indicators exist.
What financial indicators are used in the evaluation of investment projects.
How the project is evaluated.
How the financial performance indicators of projects are calculated.
What mistakes should be avoided when evaluating the performance of the project.

Key financial performance indicators of the project

Modern trends in the economy provide for a wide attraction of investors for a more dynamic and successful development of business projects. Accumulation of investment funds through their placement in promising projects makes it possible to make a profit. However, in order to get the most out of the investment, it is necessary to conduct a thorough assessment of the offers in the investment market. This assessment involves the use of various methods of economic analysis. Any investment project contains the development of a phased program and a plan for investing capital coming from an investor with the final result in the form of profit. When evaluating an investment project, it is necessary to obtain a detailed answer to the following questions:

how profitable is the enterprise attracting investments;
in what terms the project will recoup the invested funds;
how well the risks are worked out in the invested niche.

The main criteria for the effectiveness of the investment project are:

net present value (net discounted income), or NPV;
internal rate of return (IRR);
modified internal return rate (MIRR);
profitability index (PI);
payback period of start-up investments (PP);
discounted payback period (DPP);
The weighted average rate of return on investment (ARR).
Download methodological recommendations for assessing the effectiveness of investment projects
Some economists, analyzing the effectiveness of a project that attracts investment, do not apply all of the above indicators. To orient themselves, it is enough for them to calculate the three or four most important. Of course, the possibility of a detailed analysis is affected by the direction in which it is planned to invest.

Indicators of the effectiveness of the project are refracted for a certain entity that accepts investments regulated by the Guidelines. For example, they may include:

to a specific company;
to the investing legal entity or individual;
to an indefinite circle of shareholders;
to other, more complex structures;
budgets of different levels;
to society as a whole.
Naturally, there are some differences in the criteria by which the effectiveness of the project is evaluated for each of the above-mentioned groups of people or an individual.

You can calculate the effectiveness of the project as a whole to understand whether it will be attractive in principle, whether it is realistic to find additional sources of financing for its implementation. The structure of this calculation estimates:

public response in case of successful implementation of the project (provides for an analysis of the impact of the results on the economy, ecology, social sphere);

the effectiveness of the project from the point of view of the financial component for its organizer (as far as the final result compensated and exceeded its cost part, allowed to make the most of its results).
A preliminary assessment of the effectiveness of the project is carried out to ensure a certain guarantee of its feasibility, to study the interests of all potential investors - representatives of the banking sector, companies, shareholders, multidisciplinary associations, budgets of the federal and local levels. It should reflect:

the degree of efficiency of the enterprises participating in the investment project (the effectiveness of the project itself for the latter);
investment activity of shareholders participating in the project;
the effectiveness of the structures that provide regional, sectoral, national economic and other management;
budget efficiency - the participation of state structures in the form of the involvement of expenditure and revenue items of budgets of all levels.
If there are several investors, their interests may diverge on a number of issues, especially in terms of the primary implementation and stages of the project. Financial channels are formed taking into account the degree and profile of participation of each and, accordingly, the expectation of results is different for each. Therefore, it is logical to assess the performance indicators of investment projects separately for each of the participants.

How to conduct an express diagnosis of the effectiveness of the project
There are a number of techniques and methods that allow you to get operational data on the state of the company's business at any time without the help of the chief accountant, financial director or some other responsible employee. You can process these numbers in your mind or using a calculator in your mobile phone.

In the article of the electronic journal "Commercial Director" you will find an algorithm for conducting rapid diagnostics. It can be useful for a manager who needs to quickly assess the commercial attractiveness of a new project.

Indicators of the effectiveness of the investment project

When developing and promoting the idea of an investment project, the company must represent the internal and external sides of the investment attractiveness of the project, in order to:

not to make a mistake with the choice of investors;
choose the most effective conditions for lending (investment);
choose favorable conditions for risk insurance.
The most interested person in the study of the performance indicators of the project is certainly an investor. Moreover, participation in only one investment project may not recoup investments, so often the decision to invest is made when evaluating several projects at the same time.

In such a situation, the following are evaluated:

the effectiveness of investment projects that are not related to each other (participation in one does not prevent or contradict participation in the other);
the effectiveness of projects that often have diametrically opposed implementation schemes (participation in one excludes participation in the other).
Based on existing methodologies, you can evaluate a single project or calculate for several proposed projects in order to choose the most suitable one from them.

Indicators of the effectiveness of business projects allow:

draw conclusions about the real need for investment and the absence of obvious obstacles to this;
identify the most appropriate investment schemes; assess the factors that may affect the final result of the investment and, if possible, neutralize their impact;
balance the corridor of risk and return;
establish an analytical system at the stage when investment funds are already working.

The objectivity of the project evaluation is based on some global principles:

study of the whole range of features of the project development - from its formation at the stage of obtaining investments to commissioning;
checking the literacy and feasibility of connecting funds during the development of the project;
the ability to compare a number of leading indicators of diverse projects to identify the most rational solution;
the ability to predict the highest positive effect of the project implementation;
the ability to predict the timing of the project;
the ability to predict further investment offers;
the ability to calculate the effect that the implementation of the project will have on the surrounding space;
the possibility of forecasting the financial interest of each of the investors;
the possibility of calculating the impact of inflationary processes on the project;
objectification of risks after the launch of the project.
Calculation of project performance indicators: algorithm of actions

There are a number of stages in the structure of assessing the effectiveness of the investment project.

Stage 1: Definition of goals and purpose of the investment project.

At this stage, a global assessment of investment and production costs should be undertaken; factors of interest in the project of persons and companies involved in investment; real financial opportunities for potential investors; factors that determine the risks of investment, and the validity of participation in the investment of its specific participants and partners in related industries.

Step 2. Cost analysis.

At this stage, it is advisable to identify positions that will provide a detailed study of the expenditure part of investments and production, objectify calculations by drawing up estimates, distribute financial investments to individual stages of the project with profitability control at each of them.

Step 3. Evaluation of the effectiveness of investments.

This stage provides in its first part the calculation of performance indicators of the investment project in the future. In addition, this part reflects the social result after the implementation of the project and the degree of its impact on the budgets of the federal and regional levels, if they took part in it. The second part is focused on a detailed analysis of the degree of participation in the project of each of the investors, on the approval of the structure of investment in the project of financial resources.

Step 4. Formation of a financing strategy.

At this stage, a number of sub-stages are also identified, which clarify financial sources, segment promising investment participants, determine the procedure for their participation in the project, justify the priorities of phased investment, analyze the results of the project implementation, sum up the results of the joint financial flow of funds in the context of full coverage of the cost part of the project.

The final scores are the main link in the business plan.

The investment attractiveness of projects that have a chance to be supported by the state is assessed using the Methodology for Calculating Indicators and Applying Criteria for the Effectiveness of Regional Investment Projects, which was approved by the Order of the Ministry of Regional Development of the American Federation No. 493 of October 30, 2009.

The criteria for selecting projects are as follows:

Compliance with the strategic guidelines and profile of the main activity of the enterprise. In this case, even if the profitability of the project is not the highest, its implementation will be a priority.

The ratio of the planned profitability of the project with the potential risks during its implementation. A competently built financial policy of the enterprise should always take into account the fact that the higher the profitability of production, the greater the risks accompany it. And risk analysis should be carried out systematically.

Taking into account the availability of specialized production, professionally trained personnel and management, finances necessary for the successful implementation of the project.

It so happens that the number of projects under the strategic control of the CEO is such that the "related" of them can create difficulties for managing the main business.

Baseline for evaluating the effectiveness of the project

The amount of starting information directly depends on the stage at which the effectiveness of the project is evaluated. However, the general information should include:

the main task that the project should solve;
characteristics of production facilities and applied technologies, the structure of the product (goods, services);
the timing of the start and end of the project, the time required for the preparation of project documentation, information on the economic resources of the region.
When forming a package of documents to attract investors, it is necessary to specify:
project implementation time (start-finish);
the total amount of funding required;
the planned financial result as the project develops with a breakdown by year;
cost part of production by year of project implementation.
At the next stage, a detailed justification of the investment is necessary. To do this, you need to provide a calculation of indicators of economic efficiency of the project:
investment funds should be tied to the timing and stages of the work. It is necessary to structure in detail the technological features of the work carried out (engineering, construction and installation, using stationary, mobile, etc.);
planned income after the launch of the project with an indication of time periods.
The stage of feasibility study is carried out in accordance with the Methodological Recommendations and includes:
information about the project and potential investors;
economic environment of the project;
efficiency of project implementation;
the share of financing of investors;
the share of financing from operating activities;
cash flow from financial activities.

General information about the project should contain:

the profile of the created production, the range of products (works, services);
geographical location of the enterprise;
technological features of production, the list of resources involved, as well as the way in which the sale of manufactured products will be organized.
To assess the degree of participation of each of the investors, information should be provided on the composition of the company and its personnel. If employees own several specialties, all of them should be indicated with a detailed description of the work performed.

For investors who have already decided at the settlement stage, it is advisable to have detailed information about creditworthiness, production volume and personnel.

In fact, in order to have an idea of the potential of the enterprise-investor, it is necessary to know its production capacities, represented in physical terms by specific types of products, technological processes used in this enterprise and the corresponding fleet of equipment. Information on the volume of production space, depreciation potential, the availability of qualified personnel, intangible assets represented by certificates, licenses, patents, copyright certificates will be useful.

You can get an idea of the financial well-being of the company by studying its accounting and statistical reporting. The following indicators are available for this assessment:

Indicator or group of indicators
Economic content
Liquidity ratios

Short-term liabilities coverage ratio

Ratio of current assets to current liabilities

Interim liquidity ratio

Ratio of current assets without
inventory
value to current liabilities

Absolute liquidity ratio

Ratio of highly liquid assets
(cash: securities and
accounts receivable) to current liabilities

Solvency indicators

Coefficient of financial stability

Ratio of the company's own funds
and subsidies to borrowed

Solvency ratio

The ratio of borrowed funds
(the total amount of long-term and
short-term debt) to own funds

Long-term leverage ratio

Ratio of long-term debt
to total capitalized funds (amount of own funds and long-term loans)

Long-term liabilities coverage ratio

The ratio of net growth of free funds (the amount of net profit after payment of tax, depreciation and net
growth of own and borrowed funds minus investments made in the reporting period) to the amount of payments on long-term obligations (repayment of loans plus interest on them)

Turnover ratios

Asset turnover ratio

The ratio of sales revenue to the average period of
the value of assets

Equity turnover ratio
Ratio of sales revenue to
the average for the period of
the cost of own capital
Inventory turnover ratio
The ratio of sales
revenue to the average value of inventories over the period
Accounts receivable turnover ratio
The ratio of sales revenue to credit card
average for the period of receivables

Average maturity of accounts payable

Ratio of short-term
accounts payable (invoices
payable) to expenditure on the purchase of goods and services multiplied
by the number of days in the reporting period

Profitability indicators

When the implementation of the project requires the registration of a legal entity by the type of joint-stock company, you will need information on the size of the authorized capital and detailed information on the composition of shareholders.

Taking into account the different contribution (financial, personnel, material) of each concession participant, the different level of relations between them, information about them should contain in detail all the elements described. In addition, it is necessary to outline the internal and external organizational and economic conditions for the possibility of implementing the project.

Information about the economic environment of the project includes:

the estimated assessment of the general inflation index, as well as a forecast of absolute or relative (in relation to the general inflation index) price dynamics for some goods (services) and materials for the entire period of the project;
expected fluctuations in the exchange rate or the index of internal inflation of foreign currency for the entire period of the project;
information about the taxation system.
Evaluation of the effectiveness of the project is carried out within the specified start and end dates of the project, coinciding with the completion of its implementation.

Within certain time intervals, information is accumulated, which will later be used to calculate the economic efficiency of the project. These segments, or calculation steps t, are indicated by numbers (0, 1, ...). The time interval in the calculation period is measured in years or fractions of the year and is counted from the fixed moment t0 = 0, taken as the baseline. The duration of the steps can be set arbitrarily.

Project cash flows are a set of cash injections and payments in conjunction with the time of their receipt, providing a specific result at a certain stage.

Each step characterizes a certain value of cash flow and includes:

an inflow equivalent to the amount of cash receipts (or, accordingly, the results in value terms) at a particular step;
outflow equivalent to a payment at a particular step;
balance (the difference between inflow and outflow).

Total cash flow f(t) consists of individual flows formed in different areas of activity:

Cash flow from investment activities f(t):
inflows - are formed in the process of selling assets, and also include income due to a decrease in working capital;
outflows - are formed, first of all, from capital investments, commissioning costs, liquidation costs at the end of the project, costs to increase working capital, as well as financial resources invested in additional funds.
Cash flow from operating activities P(t):
inflows: income received in the process of selling the received product, other income not related to the sale, including income from funds invested in additional funds;
outflows: expenses to support the production process, deductions for taxes.
Cash flow from financial activities f*(t):
inflows - are formed both from investments of own (share) capital, and attracted funds: proceeds from sponsors, subsidies, subsidies, borrowed funds, including through the issue of the company's own debt securities;
outflows - are formed from the costs of repayment and security of loans, as well as debt securities issued by the enterprise, payment of dividends.

For the possibility of calculating cash flows, the following forms are provided:

table of investment costs. It contains data on financial investments during the entire construction period, with a phased start of production;
a program that takes into account production volumes and sales data on its range. It includes: the volume of production in physical and value terms, the volume of sales in physical terms, the selling price per unit of production. The final position of this form is the income received from sales;
number of employees (average) by main categories of employees;
expenses necessary to support the current work of production and the design volume of products (works and services). This includes the cost of materials, labor, social contributions, customization, repair of process equipment and vehicles, administrative overheads, factory overheads, and sales costs;
production costs of each type of product;
the need for working capital;
sources of receipt of financial resources (share capital, loans, etc.).

The summary information given above is transferred to a table that accumulates information on cash flows in the process of implementing an investment project. By cash flow, you can have an idea of the state of the company's account in dynamics or the balance for certain accounting periods. The successful implementation of the project is evidenced by the positive balance of cash flows in each period. The concept of "financial solvency (feasibility) of the project" implies the presence of the necessary amounts at all stages of project development. In fact, each stage should be characterized by a non-negative value of investment flows.

The calculation of financial feasibility (in the absence of uncertainty and risk) can be made according to the formula:

Показатели эффективности проекта и методика их расчетаwhere is

Вm – generalized accumulated balance, $.;
bj – cash balance on the j-th step of the accounting period, $.

Indicators of the effectiveness of the investment project and methods of their evaluation
An objective assessment of the effectiveness of the investment project can be obtained after calculating the performance indicators. It is generally recognized to assess the attractiveness of investment projects according to a number of approved indicators that serve as performance indicators. The following are taken into account: indicators of financial and economic assessment of the effectiveness of investments, indicators of assessment of their social efficiency, indicators of the investment potential of the company, assessment of potential risks of an objective and subjective nature. As a result of the implementation of the project, each investor should make a profit - this is the main thing that should highlight the calculated indicators. Therefore, it is important that the results obtained make it possible to predict the investment project in such a way that it becomes successful for each company, group of people, budgets, economic environment participating in the project.

There are two groups of methods for evaluating performance indicators.

Static Assessment Methods

These methods are considered traditional and time-tested. They were developed several decades ago (in Soviet times), but have not lost relevance, because they are elementary and accessible. At the same time, they present a very detailed picture of the expected effectiveness. This methodology is widely used, especially at the initial stage of project evaluation.

The Payback period (PP) is the time during which a "put on its feet" or significantly improved enterprise is able to return the investment, using the profit received from the activities of the enterprise that has reached the design capacity, or when the income received has become equal to the initial investment.

Account rate of return (ARR). In an economy focused on central planning in the sphere of industrial production as a whole, it is equivalent to the normative coefficients of capital investments. In a market economy, it means interest, which is set to be paid for a long-term bank loan.

The described methods for assessing the performance indicators of an investment project, like any other, have errors. One of the most significant is the inability to take into account the time interval. For calculations, insufficiently correct values are taken - investment funds in the current value, and the planned income - in the future. This, of course, reduces the objectivity of calculations, inadvertently increasing the payback period of the project and reducing the efficiency ratio.

Dynamic methods

This is another category of more complex methods, as many parameters are taken into account. They are designed to assess the effectiveness of projects that are significantly stretched in implementation time, providing for repeated additional investments in the course of their implementation.

Dynamic methods rely on the application of discount rates. The latter make it possible to bring the amounts of income and expenses to values close to real ones.

The term "discounting" refers to a mechanism for converting the future value of cash flow into the current value. The discount rate itself provides for taking into account inflation, the value indicators of all investment sources and other possible risk indicators. Thus, the discounted performance indicators of the investment project are as follows:

Net present value (NPV) is an indicator demonstrating the growth of the company's capital, of course, for partners it is the most significant.

NPV must necessarily have a positive value, which is the main criterion for the attractiveness of an investment project. If the question arises of choosing from several projects, preference is given to a project with a larger NPV value.

Profitability index (PI). This indicator reflects the ratio of the present value of the cash inflow to the net present value of the cash outflow, when the initial investment is taken into account. The criterion comes into effect if there are several projects with the same NPV indicators, but with different amounts of required investments;

The internal rate of return (IRR), or internal rate of return of investment, is the value of the discount rate at which the NPV of the project is zero. This ratio allows you to determine the maximum allowable level of project expenditure;

Modified internal rate of return (MIRR) eliminates the lack of internal rate of return that may arise in the event of repeated cash outflows, for example, during long-term construction of a real estate object;
The discounted payback period (DPP) has no disadvantages of the static method of calculating the payback period, since it takes into account the value of money over time. In the case of discounting, the payback period is increased and a project acceptable under the PP criterion may be unacceptable under the DPP. The determination of the payback period is ancillary with respect to the internal form of profitability or net present value.

Sometimes it happens that the economists of the company attracting investments, due to inexperience, cannot make the right choice of methods for calculating the performance indicators of the investment project, incorrectly set priorities, and often the object of evaluation is not the most significant. As a result, analytical conclusions about the project are subjective and are not focused on the interests of each project participant. In practice, it is better to involve independent experts to calculate efficiency.

Project performance indicators: NVP, DPI, IRR and others

Let's consider what indicators confirm that the funds invested in the project work really effectively.

Of course, one of the main indicators is the present net worth (NVP). This is the income that the project will bring to the investor for the entire period of its existence.
This indicator can be calculated if there is information about the specifics of cash flows (arrival and expense) for a specific time period.

The natural process of formation of the enterprise, associated with the preparation of project documentation and the development of its strategy and implementation technology before the release of the final product, requires the most significant part of the costs. Further, the costs gradually decrease and, finally, practically cease. Profits begin to grow, and with it income increases.

Cash inflows to the invested object in the form of NV cash receipts are calculated as follows:

where is:

CIt – investments for the entire period of the project's existence;
CFt – cash receipts for the entire period of the project's existence;
n – investment life cycle.

In this formula, the composition of investment funds does not include income from direct production and financial activities.

To calculate the net present value, cash flows are discounted at the rate of r. Calculation of the net present value of the project at the preliminary stage of investment is carried out according to the formula:

where is:

ICt – inflow of investments in the period from i=0 to T;
CFt – cash flow from investments in t–year;
n – the duration of the investment life cycle;
r – discount rate.
If attachments are made simultaneously, then the formula takes the form:

where is:

ICo – initial investment.

To simplify the calculations of NPV, the quotient of division is called the discount coefficient, and their values for different r are summarized in special tables where you can easily determine the necessary coefficient for the given conditions. Such values in the form of tables are easy to find on the Internet.

The indicator that assesses the preliminary stage of investment serves as a criterion for the validity of investments in a specific invested object; evaluation indicator - when choosing options; an absolute indicator of the future return on investment. It should be emphasized that this indicator, if it is equal to 0, indicates the marginal, minimum level of profitability, reflected by the selected discount rate r.

The more efficiently the existing capital, in which investment funds are attracted, works, the less pronounced its growth will be. Thus: the creation of highly efficient investment projects for highly efficient production is most justified.

For example: the first investment object with a cost of capital at the level of 25%; the second investment object – at the level of 15%; investment lifespan – 3 years; the size of the initial investment is 60 million dollars; the average industry profitability of enterprises in this industry is 14%.

Income from investments: for the first object: 1st year – 27 million dollars; 2nd year – 33 million dollars; 3rd year – 35 million dollars.

For the second object: 1st year – 27 million dollars; 2nd year – 33 million dollars; 3rd year - 35 million dollars.

For the first object, the discount rate of 14% is unacceptable, since the investment project will reduce the cost of its capital, so it can be at least 25%.

Let's calculate the NPV at the following discount rate:

NPV = -60 +27/1,25 + 33/1,5625 + 35/1,953 = -60 + 21,6 + 21,12 + 18,14 = 0,86.

For the second object:

NPV = -60 +27/1,15 + 33/1,322 + 35/1,52 = -60 + 23,47 + 24,96 + 23,02 = 11,45.

Obviously, for enterprises with different discount rates, the same project can be both unprofitable and profitable. However, this does not allow a fully objective approach to its assessment. And then we are forced to use relative indicators of the effectiveness of investment projects.

The discounted index of return (DPI) is the ratio of all returns from investments discounted at the rate of attraction of capital to investments for the entire period of existence of the project to the size of all investments also discounted in time of these investments.

It is also obvious that the discounted index of return on investment should be greater than 0.

Investment Return On (PI) index.

When evaluating investment projects with short launch periods (from a year or a little more), you can apply a simplified formula for the investment return index. It is presented as follows:

where IC0 is the initial investment.

But this formula has a significant drawback: with its help, it is impossible to take into account possible changes in the value of money in the time range. As a result, the method of determining the payback period, taking into account discounting, should be recognized as more objective.

So, for the previous example, we get:

For the first object: 60.86 / 60 = 1.014.
For the second object: 71.45/60 = 1.19.

The results of the calculations in the presented example confirm that the second object is more profitable than the first. Of course, the investor will prefer the second object, although the cost of capital of the investment object in the first is significantly higher, as well as financial stability.

The internal rate of return of an investment project (IRR) is widely used in the evaluation of investment projects and in their analysis

The mathematical expression of the internal rate of return is as follows:

IRR = r, with NPV = 0, or more details:

where is

CFt – cash flow from investments in the third year;
ICt – investment flow in the third year; n is the lifetime of the project.

Thus, if the amounts of income and investment are equal, the resulting value represents the lower limit of the rate of return at which investing is not advisable. If the resulting IRR is lower than the weighted average return on the capital of the invested object, the project should be abandoned.

In addition, the resulting internal rate of return can serve as a rate of discounting cash flows in the calculation of indicators for the evaluation of investment projects. When comparing several investment options, IRR serves as a criterion for selecting a more effective one. The IRR is expressed as a percentage, so it is used to compare even multi-scale projects with different life cycles. The calculation of the indicator is carried out by the method of sequential approximation.

The NPV(r) function is nonlinear in nature because the denominator in the above equation has a power function. Therefore, r close to NPV = 0 is determined, and in this range an r is selected in which the equation NPV = 0 is met.

There is an NPV≥0 value on the chart and an NPV≤0 value on the chart. Further, to calculate the IRR, we assume that the segment between the points indicated on the curve is linear. Then we easily determine the IRR from the linear equation:

This calculation shows 25.88% for the first option. This means that the project must provide such an average rate of return for the life of the project. And since the IRR > r, which we took to be equal to 25%, the project is being implemented.

For the second option, 18%, the weighted average cost of capital is 14%, and the industry average yield of enterprises in the industry is 15%. And it can also be offered to the investor for implementation.

A modified internal rate of return (MIRR) is necessary when calculating the effectiveness of investment projects in which the profit from it is annually reinvested at the rate of the total capital of the invested object.

In this case, the formula takes the form:

MIRR – modified internal rate of return;
d – weighted average cost of capital;
r – discount rate of cash inflows;
CFt – cash inflows in the t-th year of the project's life;
ICt – investment cash flows in the t-th year of the project's life;
n is the life cycle of the project.

The above indicators are not without a drawback: cash inflows from investment activities should be relevant, i.e. incremental throughout the process. In the event of multi-familiarity flows, the calculation of indicators will not reflect the real picture.

Indicators for evaluating investment projects include several simple and visual parameters that are widely used by investors, and the most common among them is the payback period of investments.

Payback period for initial investment (PP).

This indicator tells the investor about the period of return on his initial investment. The general formula for calculating the payback period is as follows:

PP – payback period;
Io – initial investment in the project;
CFt – cash flow from investments in the t-th year;
t is the period of calculation of the payback period.

If it is possible to determine the average annual or average monthly return on invested funds, then:

CFcr is the average annual return on investment.

This indicator is simple and visual, but does not take into account the factor of change in the value of money over time.

If this factor is introduced into the calculation of the payback index, it will be called the period of return on the initial investment, which is calculated taking into account the discounting of cash flows (DPP)::

CFt – cash flow from investments in the t-to-year;
r – the rate of discounting of cash receipts.
Comparing these formulas, we see that DPP > ALWAYS PP.

There is another drawback of these indicators: outside the payback period, cash flows can change at different rates, and with the same payback periods, the amount of accumulated cash flow may be different.

In other words, it is impossible to focus on this indicator in the case of comparing investment options, an absolute assessment of the accumulated cash flow for the life cycle of the project is necessary.

The Investment Performance Ratio (ARR) is the inverse of the return on investment period.

If – residual (liquidation) value of investments in the project, determined by selling property and equipment after its completion;

CFcr is the average annual receipt of funds from the project during the life of the project.

This is especially evident when If=0.Then there is no need to take it into account in the formula, and it takes the form:

RR is the payback period of the project.

With the help of the presented indicators, it is possible to assess the effectiveness of investments from the point of view of an economist. However, the investor should have an idea of the degree of risk of the investment project. This is reflected in the relevant indicators. The investor is also interested in indicators characterizing the degree of risk of an investment project. Risk is understood as various kinds of factors of influence on the project, which can impede its implementation, reduce efficiency, provoke losses and unplanned costs.

These two groups of indicators (efficiency and risk) determine the investment attractiveness of the project. Only after studying them, the investor will be able to decide on participation in the project.

Typical errors in the calculation of project performance indicators
Studying the indicators of the investment attractiveness of the project, you need to be extremely careful not to make a mistake, for which you will later have to pay dearly.

Errors come in several categories, for example, related to biased risk assessment:

when the estimated sales volumes of the finished product (investment result) are overestimated in comparison with the real ones;

when an insufficiently thought-out marketing strategy does not allow to organize the maximum coverage of the consumer.

Errors caused by the wrong choice of the methodology for calculating the project (when the result obtained from the implementation of the project is replaced by the result of the main activity of the company). These errors often occur in projects aimed at restructuring or reorganizing a company (or group of companies), or when the production of a completely new product in diversified companies is organized.

The main mistake of these projects is the use of the method of net assessments of the company's performance instead of incremental or comparative methods.

Errors related to financial and economic calculations:
incorrect calculation of the composition of investment (one-time) expenses for the project;
errors due to underestimation of funding sources and incorrect projection of project arrears;
errors related to incorrectly predicted depreciation deductions for the project (such errors are allowed in 90% of projects);
errors due to underestimation of the tax burden of the project.

It is important when calculating the timing of the implementation of the investment project and its profitability not to be mistaken in determining:

Equipment costs

The real cost of equipment depends on the correctness of determining its quantity, type, configuration. It is necessary to make sure in advance of its quality, as well as that all overhead costs are taken into account, and not just the purchase price.

Project implementation timeline

The timing of the project is significantly affected by the organization of delivery and installation of equipment (whether there were any delays), whether there were failures at the stage of starting production. To ensure maximum efficiency, it is necessary that investments arrive within the designated time frame and in the optimal amount.

Production and sales volumes

It is advisable to prescribe at least two sales forecasts in the business plan: unfavorable and successful. Then, in the presence of certain realities, the error will not be so noticeable.

Cost

It is necessary to carefully consider and detail the current costs of the investment project. Check the funds included in the payroll fund, energy costs, etc. When materials and raw materials are supplied by foreign partners, it is necessary to check whether the exchange rate is taken into account in the calculations.

And, finally, we conduct a qualitative and quantitative analysis of potential risks in order to minimize their impact on the economic efficiency of the project.

Narrated by a practitioner

Usually, calculations of indicators of the effectiveness of the investment project are carried out by the economic services of the interested companies. To avoid errors in calculations, employees of such services should:

correctly take into account the net discounted income;
objectively forecast sales revenues with a graphical display of amounts for the reporting period, etc .;
adequately calculate the discount rate, taking into account macroeconomic indicators;
make sure that there are no errors in the calculation of the risk premium;
competently draw up a budget for the project.
To improve the quality and reliability of calculations of the required amount of investment, it makes sense to entrust a special department to deal with these issues. Then both planning and control will be "in one hand" (see "How to organize the work of the investment department").

If we are talking about the preparation of large-scale projects with a large number of values, it is better to use not only office programs such as Excel, but also software complexes, the profile of which is to make a forecast of investment projects. These programs significantly reduce the risk of error in calculations.

Monday, 23 May 2022