Agroindustrial project analysi

THE PROCUREMENT FACTOR 103firm's profitability as unimportant, they drained the dairy of itsretained earnings; it was unable to maintain or modernize its equipmentand, consequently, fell into disrepair and financial difficulty.BACKWARD INTEGRATION. Instead of buying from farmers, theagroindustrial enterprise should consider integrating backward toproduce some or all of its raw material. For some products this ishighly economical and will reduce raw material costs. The earlierexample (see "Logistical services," above) of a sugar mill that organizedits own transport fleet illustrates effective backward integration.Cost, however, is not the only consideration in deciding onintegration; others will be discussed in the section "Organization ofthe Procurement System," below.Sensitivity analysisThe cost of raw material varies according to several marketfactors. Because raw material costs are uncertain yet are the dominantproduct cost for an agroindustry, it is necessary that the project'sfinancial analysis include a "sensitivity analysis of raw materialcost" to determine the effect of variations in raw materialprices or profits and investment returns.The analysis should be analogous to the "price sensitivity analysis"illustrated in chapter 2. The example of the spice manufacturerfrom that chapter (see the subsection "Data assumptions") illustratesthe financial implications of changes in raw material costs. Ofthe plant's total annual costs of $300,000, 82 percent, or $246,000,was attributable to the raw material. Thus, if the price of raw materialincreases 10 percent, total costs rise 8.2 percent and profitsdrop 12.5 percent. A 20 percent increase in raw material priceswould consume one-quarter of the firm's profits. Conversely, if rawmaterial prices drop, profits would increase. The analyst can assessthe effect of such variations and calculate an expected cost for rawmaterial. A full sensitivity analysis would integrate the variationsin both the sales of finished goods (see table 2-4) and the cost ofraw material. A combined sensitivity analysis of this kind is shownin table 3-7.Salient points for project analysisEven if an agroindustrial firm can obtain an adequate quantityof quality raw material, the firm will not be profitable unless the