Engineers worry about finding the best product design and manufacturing process. Marketers worry about having the best pricing, distribution channels, and product features. Environmentalists consider the impact of a project on the environment. The bottom line in the project, however, is whether or not it is financially feasible.

In financial reports covering previous years using accounting standards, recommended practices, rules, and regulations, there are still judgement calls made to ensure that financial statements are fairly presented. Imagine how difficult it is to prepare financial forecasts for decades into the future for a factory that has yet to be built, a fast food chain that has not yet rented out sales outlets or a transportation company that has not imported a single vehicle. All the figures including project investment amounts, production levels, sales quantities and prices, as well as all costs, have to be forecasted based on a number of assumptions. The question is not whether to use forecasts and projections but how reasonable and sensible these figures are.

How do changes in the forecasted figures affect the bottom line? Who could independently and professionally advise prospective investors on the reasonable accuracy of the figures in the prospectuses of the newly floated companies?

This kind of sensitivity analysis is very important, as the level of demand and production has a significant impact on profit figures, particularly in the first few years of production, as the level of demand will be unpredictable, due to a lack of data and unstable macroeconomic environment. A rigorous sensitivity analysis report should be compiled in the prospectus.

One of the nearly 30 such projects that are currently floating shares to the public is presented here as an illustration for the simple reason that its prospectus was available on its website. Judging from media reports, including this newspaper, Habesha Brewery SC is conducting an aggressive marketing campaign and has managed to mobilise close to 130 million Br in shares from members of the public. Promoters of Habesha Brewery promise in their prospectus to investors earnings per share (EPS) at 113.4pc and a return on investment (ROI) of 34pc.

In simple terms, EPS at 113.4pc means that for each 1,000 Br investment made, there will be earnings of 1,134 Br per year in the factory’s third year of production. Compare this to banks which pay interest on deposits at about four per cent, an interest of 40 Br on a savings of 1,000 Br.

If the EPS of Habesha were over 100pc, as the prospectus says, one should take loans at 4.5pc in London and make an arbitrage return at over 100pc. Or profit hungry foreign investors should rush off to Ethiopia to buy Habesha’s shares and make fortunes.

Assuming the project stage is two years including raising capital and arranging bank loans as well as importing machinery, doing civil work, and hiring employees, production may begin some time in 2012. Based on the information provided in the prospectus, the first year’s (2013’s) earnings per share will be 100.6pc, while for the second (2014) and third (2015) years the figures will be 107.9pc and 113.4pc, respectively.

Why have the founders and promoters of Habesha Brewery chosen and advertised the highest EPS (2015), ignoring the others? Is this not misleading for unsophisticated investors or the financially illiterate?

In the prospectus, shortages of foreign currency, delays in the importation of raw materials, the unpredictability of the power supply, and competition from existing beer factories are identified as risk factors that could affect earnings. These risks are real and highly probable. These should have been quantified and their impacts accounted for, so that investors could be aware of the level of risk they are putting themselves into.

Even if computations of EPS and ROI are right, figures that could help a financial layman are not presented.

Where is the corporate tax of 30pc on profit or the tax of 10pc on dividends?

If less than 50pc of production is for the export market, the project is entitled to a two-year profit tax holiday, according Regulation No. 84/2003, of the Council of Ministers. Habesha Brewery probably falls into this category. Thus, profit tax will be imposed in the third production year. This is very important for investors.

All the profit cannot be distributed to shareholders, as there is a need to set aside five per cent of the profit in the form of legal reserves. Companies also need to set aside savings for future expansions. In Ethiopia, investors do not put their cash in shares expecting capital appreciation to be realised sometime in the future, as there is no exchange market. Rather, they expect cash dividends, and they need such figures from new share companies.

The investment in machinery is around 450 million Br. But where are the costs for civil work to erect machinery, offices, and other buildings; to buy infrastructure, motor vehicles, furniture, and equipment; and to cover the working capital requirements and the costs of land leases?

There are also substantial preoperational expenses. If it is assumed that the project stage will take two years, the interest cost that should be capitalised could be about 30 million Br (assuming loans of 350 million Br, phase by phase, at an 8.5pc interest rate per annum).

The project needs roughly between 100 million Br to 150 million Br additional investment in working capital (raw materials, spare parts, containers, fuels, customer credits, and cash holding), 40 million Br for motor vehicles, 20 million Br for office buildings, 30 million Br for infrastructure, 20 million Br for preoperational expenses, and 35 million Br for land leases. These additional investment requirements could come either from banks or investors.Whichever way it is preferred; this has an impact on the ROI.

The level of initial investmentrequired is up to 600 million Br, and this is confirmed by the new Raya Brewery project, which has the same production capacity as Habesha. It seems Habesha has seem this black hole in their initial investment and increased their share offerings to 250.2 million Br.

Strangely enough, the prospectus has not been revised accordingly.

Habesha analysed the level of current consumption (2.9 million hectolitres) and the production capacity (3.35 million hectolitres) of factories in the brewery industry. It projected demand to grow by 11pc for 10 years, based on the growth rate of the industry during the last three years. The 11pc growth projection is a very simplified one, as it takes into account only three years of data. A realistic and long-term demand projection should take into account prices of the product, population growth, disposable income, age composition, levels of education, cultures, religions, and lifestyle changes over a long period of time.

The company projected the first year production level at 85pc to increase to 95pc in the second year and 100pc in the third year, whereas the average current production level of well-known existing brands is only about 86pc.

How is it realistic for a new venture to produce and sell at 85pc capacity in its first year of operation? How is it possible to produce at 100pc capacity considering severe shortages in electricity, limited foreign currency availability, increased competition, and maintenance issues?

Even if it is presumed that there is a substantial demand gap, a new entrant into the market cannot fill this gap immediately as customers have strong emotional and geographical ties to existing products and brands. The industry is dominated by five breweries with strong financial resources, highly experienced professionals, and well-established distribution networks.

The process of entering into this market, developing a new brand, and creating loyal customers needs huge investments in promotion and a long period of time, as it takes time for consumers to develop a new taste for something.

There are new brewery projects in the pipeline and further expansions as well. Kangaroo Group plans to produce 300,000hl per year with further expansion after a year to 500,000hl, Raya Brewery is planning to produce 300,000hl, Meta Brewery is planning to expand its capacity from 450,000hl to 750,000hl within three years, and Dashen is to expand its capacity to 750,000hl from its current capacity of 300,000hl per year.

The largest operator in the brewery industry, BGI, has up to nine expansion projects planned between 2005 and 2009 with a total investment of 70 million dollars. It is planning to set up a new factory in Hawassa, which plans to start production in 2011. These expansions and new projects will inevitably increase the competition in the industry. As a result, they are bound to have implications on prices, production, and market shares.

Have promoters of Habesha taken into account these facts in their demand projection, or do they simply base production capacity on possible demand?

The demand projections would have made sense had they been between 50pc and 80pc in the first three years of production. For instance, the demand forecast is 60pc in the first year (2013), 70pc in the second year (2014), 80pc in the third year (2015), and between 80pc and 100pc during the rest of the project’s life.

The current selling prices of bottled beer and draught are 11 Br and 5.5 Br per litre, respectively. Habesha’s projected selling price of bottled beer is 13.76 Br and draught beer at 9.50 Br. Considering the increase in inflation in two years, the forecasted price for bottled beer makes sense, whereas the projected price of draught beer does not seem reasonable. As the contribution of draught beer to the profits of the project is small, this matter is not of deep concern.

The prospectus claims a profit margin for bottled beer at 41.2pc, a reasonable estimate. However, the 26.2pc margin for draught beer came out at 18pc after independent calculations. Habesha’s computed production cost of bottled beer and draught beer is 8.09 Br and 7.01 Br, respectively.

The breakdown of production costs into fixed and variable components is important as fixed costs do not vary with the level of production. About 30pc of production costs are fixed in nature. At a 100pc production level, Habesha would have fixed production costs of about 71.8 million Br, variable production costs of 5.66 Br per litre of bottled beer, and 4.91 Br per litre of draught beer.

The most understated figure covers sales and administration expenses. It is assumed to be 0.25 Br per litre. The total amount at a 100pc production level would be 7.5 million Br. It is unclear how promoters of Habesha have reached this figure.

Where is the financing cost on loans of 350 million Br? It may be estimated to be about 30 million Br a year, assuming that there is an annual interest rate of 8.5pc,as mentioned previousiy.

How much are the annual depreciation costs on motor vehicles, administration buildings, and infrastructures? How much are they planning to spend on salaries and benefits; promotions; fuel and lubricants; packaging and labelling; machinery, building, and car insurance; distributions; communications; supplies; and repairs? Where are the promoters’ and founders’ remunerations of 10pc of profit after tax for the first three years to come from?

My review of four years of financial data of a factory of similar size, taking into account some differences, shows that administration, sales, and distribution costs represent between 27pc and 31pc of sales or 1.9 Br per litre. This figure does not include interest costs. Whereas Habesha says its administration, sales, and distribution costs represent 1.9pc of sales or 7.5 million Br on sales of 400 million Br. How miraculous Habesha is to achieve such a level of efficiency!

Considering the huge financing costs, depreciation of new buildings, founders’ and promoters’ initial remunerations, huge brand development expenses, initial inefficiencies, and increases due to inflation, Habesha’s sales, distribution, and administration costs, excluding interest, could be about 30pc of sales or abute four Birr per litre based on the assumption that there will be full capacity utilisation. As a significant component of administration, sales and distribution expenses are fixed. A 10pc reduction in the production level could result in these expenses going up 4.50 Br per litre.

If the demand level is worked out to be 60pc, 70pc, and 80pc in the first (2013), second (2014), and third (2015) years of production, respectively, the loss  figures would be 34.2 million Br in 2013, 22.9 million Br in 2014, and 11.7 million Br in 2015. Prospective investors could only expect profit after three years of the production cycle.

If we take a very optimistic assumption of demand at 70pc, 75pc, 80pc, 85pc, and 90pc between the first and fifth years of production, respectively, together with sales, distribution, and administration expenses at 20pc of sales, the profit before tax figure would be 5.09 million Br, 12.71 million Br, 20.33 million Br, 28 million Br, and 35.63 million Br, respectively. In terms of return ROI, the figures would be 5.8pc, 7.1pc, 8.3pc, 9.6pc, and 10.9pc, respectively, while EPS would be 17.9 Br, 44.6 Br, 71.3 Br, 98.3 Br, and 125 Br, respectively.

If we compute the cash dividends, it could be well below the EPS figures stated in the prospectus.

All these inconstancies, anomalies, and unrealistic figures are due to the rush to lure prospective investors. Achieving a tenth of the EPS mentioned above by the third year of operation would be a remarkable performance. Pledging over 100pc in EPS is an utterly senseless proposition and not a realistic projection.

Members of the public take for granted information provided in the prospectuses they are handed by promoters and their designated sales agents. It is the role of the promoters to verify that their prospectuses are not misleading and to advise investors thereon. However, promoters are not doing their job properly but are imposing a big chunk of non-refundable service charges that is little deserved for the services they are currently providing.

Those participating in forming and promoting share companies should take responsibility for any unprofessionally authored prospectuses. What if the proposed projects fail or significantly underperform? Their reward mechanism needs to be linked with the creation of wealth for shareholders. It is unreasonable and unjustifiable for them to reward themselves just for raising capital and then get away with it.