Types of Valuations and Investment Risk Management
Management and types of evaluation of investment projects
Project investments are capital investments, funds, or costs used to develop and expand production, bringing benefits, benefits, or profits in the long run.
Investments are cash, securities, other property, including property rights, other rights having a monetary value, invested in objects of entrepreneurial and (or) other activities in order to make a profit and (or) achieve another beneficial effect.
The identical relationship between "investment" and "financial investment" is traced in this definition.
Investment project management is a methodology for organizing, planning, managing, coordinating labor, financial and, material, and technical resources throughout the project cycle, aimed at effectively achieving its goals through the use of modern methods, techniques, and management technologies to achieve the results defined in the project in terms of composition and scope of work, cost and time, quality and satisfaction of project participants.
The business enterprise investment management process is forming, planning, promoting, and controlling investment resources and projects. The first step to effective investment management is to find the investment solution that best suits the company and has the best chance of success. Difficulties in the process of determining the degree of attractiveness of the project are due to several factors:
the costs of implementing an investment project can be incurred either at a time or over a sufficiently long period;
in practice, in the implementation of investment projects, there is a risk of time since the period for achieving the results of the investment project may be higher than the calculated indicators;
the implementation of long-term investment projects leads to an increase in uncertainty in the assessment of all aspects of investments, that is, to an increase in investment risk.
Although economic reforms have had a detrimental effect on many areas of activity, it is becoming increasingly clear that the investment activity of a business enterprise is the engine that pushes the economy forward. If the momentum of this engine fades, the economy will be in a challenging position.
The essence of the decision taken by the investor is to solve the problem of choice. When making an investment decision, an investor has many alternative options. The investor will have to choose only one investment option (or an investment portfolio) that best suits the goals of the investment project or refuse all options, that is, prefer the zero option.
To select the investment option that best suits the project's objectives, it is necessary to evaluate the project. Investment project evaluation analyzes a proposal's technical and economic feasibility and costs. Evaluation can be considered a private function of project management.
Types of project evaluation:
1) Technical Evaluation
determines the compliance of technical parameters with expectations, their realism, and technical feasibility. List of technical evaluation criteria:
the complexity of implementation;
type of equipment and suitability conditions;
realistic implementation schedule;
necessary raw materials and inputs;
the cost of operation and maintenance;
assessment of engineering development costs;
the potential impact of the project on humans and the physical environment.
2) Financial assessment.
To determine whether the financial costs and benefits are correctly estimated and whether the project is financially viable, the following indicators should be determined at the baseline:
operating and maintenance costs;
institutional assessment of IRR;
net present value;
return on investment over the life of the project.
3) Commercial (entrepreneurial) valuation
The commercial appraisal includes an assessment of the current demand/market scenario that allows the project to become sustainable in the future. The following should be assessed:
customer-facing process and preferences
demand and desired scope of the project from the point of view of the beneficiaries
availability of up-to-date information in all areas
reliability of business relations with suppliers and consumers
state control measures, etc.
4) Environmental assessment
An environmental assessment allows you to see any harmful environmental impacts and ways to minimize them.
5) Legal assessment
The investment project requires a legal assessment to determine whether the project satisfies legal regulations and other regulatory requirements related to land acquisition, acquisition of property rights, environmental cleanup, etc.
6) Estimating social costs
Social cost-benefit analysis is an evaluation system that helps to select socially significant projects for implementation. The costs used to implement a social project constitute the project's social value. At the same time, it is essential to consider that each project uses resources, preventing their use for other purposes.
7) Economic evaluation
The final economic analysis and evaluation of the financial efficiency of investment projects are carried out using various models that allow structuring and identifying the relationship between the leading indicators. Visual models of analysis are descriptive models (models of a descriptive nature), including:
structural and dynamic analysis of reporting;
presentation of financial statements in various analytical sections based on the principles of planning and retrospective data;
coefficient and factor analysis;
building a system of reporting and forecast balances.
Economic analysis and evaluation of the financial efficiency of investment projects are carried out using various models that allow structuring and identifying the relationship between the leading indicators. At the same time, it should be noted that the most acceptable and illustrative models of analysis are descriptive models (models of a descriptive nature), including:
building a system of reporting and forecast balances;
structural and dynamic analysis of reporting;
coefficient and factor analysis.
All these models are based on the use of information and accounting data.
The assessment may be preliminary (forecast). Such an assessment is usually carried out during an investment project's development and feasibility study. Measuring costs and benefits at the preliminary assessment stage is difficult, as they are spread over a long period with high uncertainty. The preliminary appraisal relies primarily on forecast or historical data, most of which can be derived from experience with other similar projects.
The current assessment is based on data from direct observation. The ongoing assessment relies on the data and information generated in the monitoring system (aggregated data) and control (non-aggregated data). It acts as a way to analyze trends during project implementation. Monitoring the project's progress can identify questions that the evaluation will answer.
The final evaluation combines these two approaches and allows not only to evaluate the project's results at the final stage but also to compare the evaluation data with the planned and final indicators of other projects, thereby determining its relative effectiveness. In general, this gradation corresponds to the concept of the project life cycle.
Thus, although economic reforms have had a detrimental effect on many areas of activity, it is becoming increasingly clear that the investment activity of a business enterprise is the engine that pushes the economy forward. If the momentum of this engine fades, the economy will be in a very difficult position.
Most of the business decisions made by investors are based on the results of a predictive assessment of the consequences of a particular decision option. Investment management has a set of time-tested methods for evaluating and weeding out unwanted investment decisions with a very low probability of success.
Within the investment decision evaluation methodology framework, technical, economic, commercial, financial, organizational (institutional), social, environmental, and other types of investment project evaluation are distinguished.
In each case, the final assessment of the effectiveness of the project under consideration is implemented through a set of economic methods. At the same time, non-commercial criteria are also considered, such as the social effect, the impact of the project on the image of the territory, etc.
Investment project risk management. Risk classification
Risk management is an important area of project evaluation, which relies on various ways of structuring internal and external relationships in a project.
The definition of "uncertainty" in investment as the possibility of changing the environment of an investment project has received the widest distribution in the economic literature. V. R. Evstigneev believes that uncertainty is any probability distribution of the results of an investment project.
Although uncertainty and risks are often associated, investment risks are understood as the possibility of not receiving the planned profit while implementing investment projects. In this case, the object of risk is the property interests of a person - an investor who invests his funds in one form or another in the project.
Investment risk is associated with the specifics of investing funds by an entrepreneurial firm in various projects. However, in the domestic economic literature, often under the investment means the risks associated with investing in securities. In our opinion, this concept is much broader and includes all possible risks when investing money.
Investment risk characterizes the probability of unforeseen financial losses. The level is the deviation of expected income from investment from the average or calculated value. Therefore, the assessment of investment risks is always associated with an assessment of expected income and losses.
At the same time, risk assessment is a subjective process. No matter how many mathematical models for calculating the risk curve and its exact value are used, in each specific case, the investor himself must determine the risk of investing in this enterprise.
The relationship between the type of investments and the level of their risk is determined by the degree of danger - not to guess the possible reaction of the market to a change in the results of the enterprise's work already at the operational stage of the investment project. From this point of view, the organization of a new production, which is going to produce a product unfamiliar to the market, is associated with a maximum degree of uncertainty; at the same time, increasing efficiency by reducing costs in the production of a product already accepted by the market contains minimal risk of negative consequences of an investment.
There are many types of investment risks. Here is the classification of risks given by I. A. Blank (“Investment Management”):
I. by spheres of manifestation:
economic - the risk associated with changes in economic factors (investment activities are carried out in the economic sphere. Therefore, they are most exposed to economic risk);
political includes various types of emerging administrative restrictions on investment activities associated with changes in the political course of the state;
social - the risk of strikes, the implementation of unplanned social programs;
environmental - the risk of environmental disasters and disasters (floods, fires, etc.) that adversely affect the activities of invested objects;
others (racketeering, theft of property, fraud by investment or economic partners, etc.).
II. by a form of investment:
the risk of real investment - associated with an unsuccessful choice of the location of the facility under construction, interruptions in the supply of building materials and equipment, a significant increase in prices for investment goods; the choice of an unqualified (unscrupulous) contractor, other factors that delay the commissioning of the investment object or reduce profits during its operation;
the risk of financial investment - associated with an ill-considered selection of financial instruments for investment; financial difficulties or bankruptcy of issuers; unforeseen changes in investment conditions; direct deception of investors, etc.
III. By origin:
systematic (or market) - occurs for all participants in investment activities and forms of investment; it is determined by the change in the stages of the economic cycle of the country's development or the economic cycles of the development of the investment market; significant changes in tax legislation in the field of investment and other similar factors that the investor cannot influence when choosing investment objects;
non-systematic (or specific) - characteristic of a specific investment object or activity of a specific investor; may be associated with the low qualification of the management of the company - the object of investment; increased competition in a separate segment of the investment market; irrational structure of invested funds and other similar factors. The adverse effects of these factors can largely be prevented through effective investment process management.
In addition, the following risks are identified:
the risk associated with the industry of production (for example, investments in the production of consumer goods are, on average, less risky than in the production of equipment);
management risk (associated with the quality of the management team at the enterprise);
time risk (the longer the period of investment in the enterprise, the higher it is);
commercial risk (associated with the development indicators of this enterprise and the period of its existence).
There are other classifications of investment project risks.
Depending on the event, there are:
I. Pure risks
This means receiving negative or zero results:
natural-natural (associated with the manifestations of the elemental forces of nature: earthquakes, floods, storms, fires, epidemics);
environmental (possibility of losses associated with the deterioration of the environmental situation);
socio-political (political upheavals, unpredictability of the economic policy of the state, changes in legislation);
transport (associated with the transportation of goods by transport: road, sea, rail, etc.);
commercial (actually entrepreneurial) - the risk of losses in the process of financial and economic activities, which means the uncertainty of the results from this commercial transaction; there is property (probability of loss of the entrepreneur's property), production (loss from stopping production due to loss or damage to fixed and working capital; from the introduction of new equipment and technology into production), trade (loss due to delayed payments, refusal to pay during the period transportation of goods, non-delivery of goods).
II. Speculative risks
means getting both a positive and a negative result: all types of financial risks that are part of commercial risks. Financial risks are associated with the probability of loss of financial resources (cash) and are divided into those associated with the following:
the purchasing power of money;
capital investment (proper investment risks).
III. Purchasing power risks:
inflationary (when inflation rises, the received cash incomes depreciate in terms of real purchasing power faster than they grow; the entrepreneur incurs actual losses);
deflationary (with the growth of deflation, there is a fall in the price level, a deterioration in the economic conditions of entrepreneurship, and a decrease in income);
currency (danger of currency losses associated with changes in foreign exchange rates in the course of foreign economic, credit, and foreign exchange transactions);
liquidity risks (the possibility of losses in the sale of securities or other goods due to changes in the assessment of their quality and use value).
IV. Risks associated with capital investment, investment:
lost profits (occurrence of indirect financial damage (lost profit) as a result of non-implementation of any event);
decrease in profitability (may arise as a result of a decrease in the amount of interest and dividends on portfolio investments, deposits, and loans);
direct financial losses:
exchange (the risk of losses from exchange transactions - the risk of non-payment for commercial transactions, the risk of non-payment of commission fees of a brokerage firm);
selective (risks of incorrect choice of the type of capital investment, type of securities for investment);
bankruptcy (danger due to the wrong choice of capital investment of a complete loss of equity capital and inability to pay off obligations assumed);
credit (associated with the loss of funds due to non-compliance with obligations on the part of the issuer, borrower, or its guarantor); mainly inherent in banking activities; can be divided into deposit, leasing, factoring, and loan default risk.
V. Classification of risks according to the degree of damage caused:
partial (planned indicators, actions, and results are partially fulfilled, although without loss);
acceptable (planned indicators, actions, and results are not fulfilled, although without loss);
critical (planned indicators, actions, and results are not fulfilled, and there are inevitable losses);
catastrophic (non-fulfillment of the planned result entails the destruction of the subject - the project, the enterprise).
VI. Classification of risks depending on the possibility of reducing the degree of risk through diversification:
diversifiable (can be eliminated or smoothed by diversifying the investment portfolio - the right choice and combination of the investment object);
non-diversifiable (they cannot be reduced by changing the structure of the investment portfolio; most often, this group includes all types of systematic risks).
VII. Classification of risks by time of occurrence:
arising at the preparatory stage (remoteness from transport hubs, availability of alternative sources of raw materials, preparation of title documents, creation of a dealer network, repair, and maintenance centers);
related to the creation of the facility (insolvency of the customer, unforeseen costs, shortcomings in design and survey work, untimely delivery of components, dishonesty of the contractor, untimely preparation of engineers and workers);
VIII. related to the operation of the object:
financial and economic (instability of demand, the emergence of an alternative product, price cuts by competitors, tax increases, consumer insolvency, rising prices for raw materials, materials, transportation, dependence on suppliers);
social (the attitude of local authorities, insufficient wages to retain staff, insufficient qualifications of personnel);
technical (instability of the quality of raw materials and materials, novelty of the technology, insufficient reliability of technology, lack of power reserve);
environmental (harmfulness of production).