Investment appraisal for everyone especially non financial managers part one

Investment appraisal involves all those steps taken by an organization or an individual to determine the worthwhile-ness of an investment. It is a scientific approach to choosing a project to pump in money into. The importance of investment appraisal cannot be overemphasized. This is one of the functions of a financial manager; others include: financing, dividend and risk management function.

Calculated steps needs to be taken to ensure that every penny invested by investors/owners of the business is well put to work for return that will at least maintain the purchasing power of the invested fund.

This article and the subsequent ones on this series (3 series) will attempt to explain the steps to be taken to carry out a meaningful investment appraisal in such a way that non-finance managers will understand the concept.

STAGES OF INVESTMENT APPRAISAL

1. Search for investment opportunities. This is mostly done by the R&D research and development) team. A better term to use is marketing (marketing in this context is defined as a “conscious effort made by team of people or an individual to find out what the people want and research on the best possible solution(s) to that problem.
2. Enquiry into the possible outcome(s). Here, an informed and almost reliable estimate is made about the outcome of the project(s). Note that both financial and non-financial factors will be taken into consideration at this point. Though some people will argue that you don’t bring in non-financial factors at this point; but the only question I have for them is; how do you carry out further investigation on a project that is highly probable to tarnish the image of a company (you can think out an example for yourself)
3. Identification of the best possible outcome. Based on the analysis above, outcome(s) that is/are more convincing to the company or the individual (a product of so many factors) will be identified.
4. Capital budgeting. This is the stage where some appraisal tools (sophisticated and simple) will be used to decide whether to continue with the investment decision or not. The techniques used are: Payback period (Both discounted and non-discounted), ARR (Accounting rate of return), PI (Profitability Index), IRR (Internal rate of Return), ROI (Return on Investment), ROCE (Return on capital Employed) and NPV (Net Present Value). The next two articles on this series will be based on the explanation of these techniques.
5. Selection of the most viable project. Based on the decision criteria, project that proves to be the most viable in monetary term will be selected subject to availability of cash. Note the non-financial criterion has been taken care of during the enquiry stage.
6. Implementation of the selected project(s). Action is the only difference between a well written plan and a well executed project. The actual investment needs to be done here.
7. Monitoring, Feedback and correction. Control is one important aspect of every project. Through monitoring and feedback, corrective actions are made when this don’t work out according to plan. So many things can go wrong and will need to be corrected for the project to see the light of the day. This is one area where many non-financial managers tend to apportion a lot of blame on the Accountants and other financial professionals of a company. In as much as due care is taken, things can still go wrong.

Please note at this point that investment appraisal is not a one stop thing (i.e. activities needs to be going on from time to time). A lot of companies are at the verge of bankruptcy today because they considered their investment function as one time stuff.

Read more on Payback and Return on investment