Evaluation of investment projects

The evaluation of investment projects consists of taking into account a set of structured and variable decisions to ensure that a project has a probability of success.

Evaluation of investment projects

There is no common guideline for evaluating investment projects or a perfect manual on how to generate a profitable project. However, there are a series of lines of action and evaluation that can allow a more objective vision regarding the investment decision to be carried out and that will determine throughout the development of the project whether it is successful. or not.

Stages for the evaluation of investment projects

Below are the five fundamental stages in evaluating an investment project. Although some manuals focus on economic and financial indicators, we believe that there are more important things in investing. Quantifying is important, but many things cannot be quantified and the analysis must be detailed.

In any case, the following shows the stages that, in our opinion, are essential to properly evaluate an investment project.

1. Define the investment project

This stage is qualitative in nature and in it, it is necessary to describe the cons of the investment project and the problems that may arise.

For example, in a restaurant the problem may be the growth in demand that cannot be adequately responded to with the equipment installed in the kitchen, or in a bookstore, the opening of a separate store to sell magazines and newspapers, so not to affect the positioning achieved. Thus, the investment project will consequently be a solution to the identified problem.

2. Market study

It is very important since it allows to analyze if there is potential demand so that the project is sustainable over time and gives the benefits that are expected. The depth of the analysis will be defined by the capital available to invest and the complexity of the project.

While the sale of a product (let’s imagine they are Christmas baskets) through ecommerce may not require more than a brief estimate of increases in orders based on their demand through the brand and the advertising generated. On the contrary, the opening of a wood factory with significant investments in plant and machinery will require a complete market analysis.

3. Technical analysis of the product, manufacturing and / or sales process

Based on the estimated demand in the previous point and the nature of the project, its size, where it will be used or located, what preparation or training it requires and other relevant technical aspects must be defined to determine the initial investment and estimate costs. futures.

For example, if we are evaluating a company that manufactures mobile phones, we will have to study the manufacturing process, the components, what the factory is like, how they are packaged, what is the qualification of the personnel required to work there (and its cost), how it works the device, etc.

4. Economic parameters

At this stage it is necessary to define the initial investment and quantify both the benefits (which can sometimes be savings) and the costs that the project will generate, and use this information to build a diagram of flows of funds for the useful life of the project. the investment. It is necessary to bear in mind that factors such as key cost increases or drastic changes in demand (mainly due to trends or the theory of decreasing marginal utility) can generate negative or positive scenarios for the project, which deserve to be analyzed in a way. Independent.

In addition, it will be necessary to calculate economic indicators that, based on the cash flows, allow the profitability of the project to be analyzed. These financial ratios allow you to easily compare different alternative projects. The most frequently used are:

  1. Net Present Value (NPV) , which allows the flow of funds to be equated to present value.
  2. Internal Rate of Return (IRR), which indicates the intrinsic profitability of the project.
  3. Payback or capital recovery period , which indicates how long the initial disbursement of the project can be recovered.

5. Comparison of results and analysis of expectations.

The fifth and last step, with the project defined, the estimated demand, benefits and costs analyzed, and several financial indicators calculated, it remains to compare the data obtained with the expectations about the project:

  • Are my income targets commensurate with the investment made and the demand?
  • Is there a more profitable alternative solution?

If the answers found are not what was expected, it is necessary to review the project or make adjustments before starting with it.