Abstract
Many of the papers submitted to Small-scale Forestry contain financial analyses of forestry investments. Unfortunately, both the method of analysis and the reporting of the analysis in initial submissions are often inadequate, and result in manuscripts being rejected or requiring major revision prior to acceptance. This paper discusses some of the common deficiencies in financial analyses in research papers, and presents a simplified financial analysis of a forestry plantation development to illustrate key points. Simple guidelines are presented to overcome common major weaknesses, for example in identifying relevant cash flows, confusion between financial and economic analysis, dealing with capital outlays, and determining an appropriate discount rate.
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Notes
The authors are founding editors of Small-scale Forestry (previously known as Small-scale Forest Economics, Management and Policy) and co-authors of Capital Budgeting, by Dayananda et al. (2002).
Depreciation is an accounting concept whereby the initial cost of a long-life capital asset is allocated over a number of accounting/tax periods. Normally depreciation would not be included in financial appraisal as it is already captured by including the capital cost of the asset. However, where a tax deduction is allowable for depreciation, this deduction results in a cash flow through savings on tax paid and this saving in cash outflows is included as a relevant cashflow for the financial analysis, e.g. see Dayanandra et al. (2002).
The land expectation value (LEV) or site value as described in Dayananda et al. (2002) is the appropriate criterion to compare the addition to the firm’s wealth of two projects with differing project lives.
Mathematically, calculating the IRR involves solving a polynomial equation with respect to the discount rate. Sometimes no solution (no IRR) exists, or the solution is not unique, or the estimated rate is meaninglessly high. These problems arise mainly when the initial project outlays are small relative to project revenue and when there are multiple changes in the sign (positive and negative) of net cash flows during the project life.
A CBA would include allowance for social benefits such as watershed protection and flood mitigation, wildlife habitat and employment creation. Notably, there are also private benefits (e.g. plantation amenity value, seed source and land security) which could be taken into account in the CBA.
References
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Dayanandra D, Irons R, Harrison S, Herbohn J, Rowland P (2002) Capital budgeting: financial appraisal of investment projects. Cambridge University Press, Cambridge
Harrison S, Venn T, Sales R, Mangaoang EO, Herbohn J (2005) Estimated financial performance of exotic and indigenous tree species in smallholder plantations in Leyte Province. Ann Trop Res 27(1):67–80
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Pearse PH (1990) Introduction to forestry economics. University of British Columbia Press, Vancouver
Weiskittel AR, Hann DW, Kershaw JA, Vanclay JK (2011) Forest growth and yield modelling. Wiley, Chichester
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Harrison, S., Herbohn, J. Financial Evaluation of Forestry Investments: Common Pitfalls and Guidelines for Better Analyses. Small-scale Forestry 15, 463–479 (2016). https://doi.org/10.1007/s11842-016-9334-1
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DOI: https://doi.org/10.1007/s11842-016-9334-1