When assessing an investment proposal, it is crucial to analyze the key data provided to determine the viability and risks involved. This includes closely examining cash flow projections, required investments, expected returns, and risks. By conducting thorough due diligence on the numbers, one can make an informed decision on whether the proposal is sound. In this article, we will explore the key data investors should look at when evaluating investment proposals and how to interpret them. Proper analysis of cash flows, investment requirements, returns, and risks is essential for making wise investment choices.
Analyze Projected Cash Flows and Returns
One of the most important pieces of data for an investment proposal is the projected cash flows and returns. This allows you to see how much cash the investment is expected to generate each year and the projected return on your capital. Be sure to look closely at the underlying assumptions used for the projections. Are the revenue growth rates realistic? Have costs been properly estimated? Small changes in assumptions can greatly impact projections so understand the rationale behind them. Also look at the timing of cash flows. Is there negative cash flow in early years followed by positive cash flow later? This may require external financing to fund initial losses. Analyze cash flow projections in both absolute dollar amounts and from a ratio perspective to see if returns meet your requirements.
Examine Required Upfront and Ongoing Investment
An investment proposal should clearly state the upfront capital required as well as any ongoing investments needed. This includes hard costs like equipment purchases and working capital as well as soft costs like permitting and professional fees. Be sure to include a contingency buffer in your analysis as projects often run over budget. You also need to consider financing costs if leveraging debt. Look at ongoing investments like maintenance capital expenditures or marketing costs required to sustain revenues. A project may generate positive cash flows but still require hefty continual reinvestment of those flows.
Assess Business and Market Risks
In addition to analyzing projected financial returns, you need to thoroughly assess the underlying business and market risks involved. What risks could prevent customers from materializing or revenues from coming in as forecasted? These could include execution risks in unproven markets, new technologies, competition, regulation, or inadequate access to resources. Stress test key assumptions and cash flow projections to see impact if major risks emerge. Also look at options to mitigate risks like insurance, contracts, diversification, and staged investments. Understanding downside risks and upside potential is key.
Scenario Analysis for Different Conditions
Conduct scenario analysis modeling projected returns under different business conditions. Best case scenarios allow you to see the full upside if everything goes better than planned. Downside scenarios help gauge risks and returns if key assumptions prove overly optimistic. Scenarios could include economic expansion or slowdown, changes in customer demand, increased competition, higher input costs, etc. This analysis provides a clearer picture of potential outcomes across a range of conditions the investment could face.
Careful analysis of projected cash flows, required investments, expected returns, and risks provides critical insights into the viability of an investment proposal. Looking beyond surface level projections to understand the rationale behind them allows for an informed decision on whether the opportunity truly aligns with your requirements and risk tolerance. Stress testing assumptions and modeling different scenarios enables you to make investment choices with full knowledge of the potential risks and rewards involved.