If DPR is prepared for the project with realistic assumptions and with the active involvement of promoters, it can help the promoters to strengthen their case to convince the potential stakeholders.
Recently I met a friend who has been very successful in an agro-based venture. He has been planning to expand the horizon his business into multiple links in the value chain to provide an integrated platform to farmers and consumers to experience superior value proposition in the transactions.
The project has significant social impact goal in its core and latest technology interface to compress the time to reach the market and make the transaction very affordable. He himself is an old hand in this segment and is valued for his viewpoints.
As a part of his plan to expand the business, he approached a financial consultant to prepare a detailed project report for securing bank financing.
Recently he contacted me to discuss securing bank finance based on that DPR. When I was going through the document, I found there many statements and assumptions which I found unrealistic for the business they are planning.
Following are three major observations which I feel required to be emphasised for all our SMEs who are planning to expand, diversify the business. They are:
- The overambitious growth rate of sales
- Unrealistic assumptions leading to exorbitant IRR estimation
- Lower working capital assessment
Let us understand the points in the context of the business proposed o be undertaken:
The overambitious growth rate of sales: The total cost of the project is little over Rs 6 crores and the plan contains a proposal to set up 50 stores to sell agri-produces. The sales number projected looks very ambitious as it expects the turnover to reach Rs 35 crores in the second year of operation.
It is well proven that the business involves setting up a retail network entails a considerable amount of time. It is unlikely that all stores will come to operations immediately and start running at decent capacity. The setting up various processes and to integrate the operations is itself a herculean task and beset with bottlenecks in the initial stage.
The blueprint did not analyse the time, effort and commitment of top management in setting new stores realistically. It is a fact that for any business in a new locality, it takes a significant amount of time to convince the consumers to turn their head and in turn building the brand.
Unrealistic assumptions leading to exorbitant IRR estimation: The faulty assumptions are not confined to sales alone but also in the rest. The profitability is so assumed high that the IRR arrived at 85%, something impossible any business let alone in the Agri venture unless they have unique selling proposition.
It is widely accepted that the project involving retailing of perishables have a high incidence of loses in the initial years till they reach a point of perfection.
Further, marketing in the retail space requires lot more imaginative schemes to attract the consumers. In such circumstances, assuming such a level of IRR in a span of seven years is extremely optimistic and unlikely to achieve.
Lower working capital assessment: Any project if it does not forecast the sufficient working capital requirement and sanction in hand at the beginning, it is fraught with danger of being deprived of the working capital when the operation starts. We had discussed the challenge in our previous blog.
Please read:Is working capital denied?: Explore options
In the instant case, the working assessment is done for second year onwards though operations start in the first year (as per the plan) and secondly, the limit assessed is less than one per cent of the turnover projected.
A fair amount of working capital needs to be in place alongside while seeking bank finance for the creation of assets. Any lopsided approach will lead to underperformance of business and the business may not yield enough cash flow to service the term debt leading to a distress situation. There are many SMEs which failed in the beginning for want of tying up working capital.
DPR is an important document:
A project report or DPR is a document which contains the details pertaining to industry, management, Business model and Financial aspects. The primary objective of preparation of project report is to assess the technical feasibility and economic viability of the project under consideration.
DPR preparation requires to be approached methodically. More elaborate the analysis, more realistic the project plan will be. It will also uncover the risks which many a time glossed over in the initial euphoria of starting a new venture.
It is important to win the confidence of stakeholders:
A well-prepared DPR conveys clarity on the purpose, mission, business strategy, business process of the venture to various stakeholders such as lenders, suppliers, investors and other stakeholders. It also embodies realistic assessment in financial terms of the venture.
It reflects upon the preparedness of the entrepreneur for undertaking the project and the ability to endure the challenges in the course of its business.
The promoters should take part actively in the process of planning and building DPR.
Many a time Detailed Project Report (DPR) is prepared for selling the proposal for a specific stakeholder. Instead, if DPR is prepared for the project proposed with realistic assumptions and with an active involvement of promoters, it can help the promoters to strengthen their case to convince the all potential stakeholders.