Assignment(PGPM 24) Finance Management and Cost Accounting

ASSIGNMENT ON FINANCE MANAGEMENT AND COST CCOUNTING (PGPM-24)

Submitted by

MD IRSHAD ALAM (Registration No: 214-05-31-50011-2163)

SUBMITTED To SCHOOL OF DISTANCE EDUCATION

NATIONAL INSTITUTE OF CONSTRUCTION MANAGEMENT AND RESEARCH CENTRE 25/1 BALEWADI, N.I.A POST OFFICE PUNE – 411045.

ASSIGNMENT An offer has been given by a Charitable Trust to develop and build a facility on a 10,000 sq.m of plot in a prime locality of Pune where 5,000 sq.m of area will be used by the trust for housing, health facilities for senior citizens. 5,000 sq.m will be given free to developer as a cost of development. Cost of land is Rs. 10,000/sq.m. Specifications for flooring: 10% Granite 40% Kota stone 50% Mosaic cement tiles R.C.C Framed structure. Aluminum sliding windows – Class A. Rest specifications as used for Class A. Constructions. Discuss the financial viability of the project and the financial planning of the project. Developer would like to have minimum 18% net profit on his investment. Developer can invest only Rs. 10lakhs as his own funds and can raise not more than Rs. 50lakhs as bank loan.

FINANANCE MANAGEMANT

Financial management is dealing with the procurement of funds to meet financial needs. Finance and capital are seen as a considerable problem for cooperative, the sources being the members and loans from banks or other institutions and individuals. The sources of capital available to any firm are quite numerous but as noted public limited companies have the greatest variety of sources available for their use and the single person enterprise. The capital structure of any firm is related to the form of the enterprise, its objectives, and the cost of capital. The cost of capital is subject to and governed by many variables, which often operate independently of each other. The firm must consider these influence and their effects on the cost of the individual types of capital to determine the most suitable capital structure. Cash budgeting will play an important role in any type of construction project also capital revenue, finance resource mobilization, cost accounting; management accounting will give proper planning of inflow as well as outflow resources in project.

PROJECT SCOPE To develop a commercial site of 10,000 sqm and in that 5000 sqm developed area will be used by the owner and the balance 5000 sqm area will be utilized by the developer to get investment and a profit of 18% on this investment. Construction should be with RCC framed structure with Aluminum sliding Window- Class A. The flooring details are 10% Granite, 40% Kota stone, and 50% Mosaic cement tiles. The other construction specification is pertaining to Class A type.

COST CALCULATION

 Manpower requirement In general without this, project cannot be run. One should know the requirements of manpower to run the show. Based on the site requirements, project will have the following categories: (i)

Management staffs.

(ii)

Professional staffs.

(iii)

Supervising staffs.

(iv)

Workers (skilled, semiskilled and un-skilled).

Selection of manpower totally depends up on the nature of work, type of work, scope of work. Based on the scope of work, the organization chart should be prepared. Work distribution should be done according to the organization chart. For workers duration of working hour, cost per hour or day, out put can do assessed based on the nature of work. For example, for labors, one labour can do the earthwork excavation upto 2-3 cubic meters for 8-hour upto the lead and lift of about 0.5-1 meter. Based on the above calculation number of manpower for certain activity can be assessed. Earthwork excavation can be done with manually as well as mechanically. Now days generally this work are carried out by mechanically since the latter will take lot of time to excavate. Moreover compared to manual work is faster and cheaper also.

Suppose we need to excavate about 5000 cubic meters of earthwork excavation. One labour can do 2 cubic meter of soil. So number of labours required to do this activity is (5000/2) = 2500nos.

According to priority of the works, within the time frame, it has to complete, suppose assume this has to be done within 25 days.

 No. of labours to be engaged/day = 2500/25 = 100 labours. Keeping labours such a longer duration for a smaller quantity of work will lead to delay in work and loss to the contractor. But the same activity with the machine, any one can do within a week times or so. One TATA Ex-200 Excavator can load min 25–30 trips/2-hours. No. of trip / day = (8 X 25 / 2) = 100 trips.

 Assume qty. / trip = 8 m3.  Total qty. executed / day = 8 X 100 = 800 m3.  Number of days required to excavate = 5000 / 800 = 6.25 days. Say = 7days. Suppose here if we do the cost analysis: Labours: We have to keep the labours for 25 days to complete this activity. Assume rate of excavation = Rs. 80 per m3. Total amount = (100 X 25 X 80) / 2 = Rs. 100000 m3.

Machine: But if we do this activity by machine, Assume rate of excavation = Rs. 25 / m3.

 Total amount = 5000 X 25 = Rs.125000.

By seeing the above comparison, machine oriented work can be done fast and economically in term of days and with less manpower. Now a day’s world is very fast, ones do not have time to do this type of work for longer duration. If the project duration increases, we have the following deficiencies: i. Profit will decrease. ii. Manpower will be blocked. iii. Further planning hampered. iv. Slow work more overheads. v. Loss in profit.  Design adequacy The considerations given while designing and checked with alternative design were also checked. Provide weather and sun protection, such as overhangs, awnings, canopies, and etc. to mitigate climate and solar conditions. The building’s, not the parking lots has been designed to establish the image and character for the development along street frontages. Short-term parking has been provided in close proximity to office check in area. Delivery and loading areas should be screened to minimize adverse visual and noised impacts to adjacent uses. Recreational facilities should be designed to offer privacy to facility users. The scale of buildings should be compatible with the surrounding development patterns. Walkway, stairway and balcony railings and other similar details are stylistically. Consistent with the building design minimize impacts on adjacent uses. Air conditioning units are not visible from public streets. Structures have been incorporated for interior access to guestrooms. Room entrances directly adjacent to parking lots or exterior

walkways were not provided. Articulate fades to provide a visual effect that is consistent with the community’s character and scale.  Free standing accessory structure Enclosed service areas and covered parking should be designed to be an integral part of the building architecture. The forms, colors, textures and materials used on the main building should be applied to all sides of these structures generally visible to the public.

ENVIORNMENTAL SENSITIVITY While not specifically guideline items, the following measures that promote environmental sensitivity are offered for consideration by the development community: 

Orient and design new structures and addition for minimum solar gain, reflectivity and glare.

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Shelter entries and windows and use architectural shading devices and landscaping to minimize cooling losses.

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Use energy efficient materials in doors and windows.

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Use energy efficient lighting.

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Mitigate urban heat island effects.

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Reference national programs for environmentally sensitive development methods such as Leadership in Energy and Environmental Design (LEED), Energy Conservation Code (IECC) and Energy Star Labeled.

FINANCIAL AND ECONOMIC ELEVATION Basically financial and economics is dependent upon two important parameters and these are:

PROPSED CAPITAL STRUCTURE AND FINANCE PLAN The net approach suggests that each asset would be offset with a financial instrument of the same approximate maturity i.e. short term or seasonal variations in Current Assets would be financed with short-term debt. On the other hand permanent component of current assets would be financed with long-term funds. It is indicated that a profitable firm may not be in a position to meet its costs obligations if funds borrowed on a short-term basis have become tied up in permanent assets. Larger the percentage of funds obtained, from long-tern sources, the more conservative the firms working capital policy. There are three primary factors determining the use of longterm versus short-term funds for financing current assets flexibility, cost and risk. It is desirable to have a balance between working capital and the cost differentials of various sources of capital forming part of working capital. The financial executive has to balance various costs in an effort to keep the total cost of working capital as low as possible. These costs may consist of: 

Cost of having trade credit.



Cost of extending liberal credit terms to debtors.

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Cost of letting or allowing cash to remain idle.

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Cost of managing cash in off periods, and

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Cost of borrowing money from lenders or lending institutions.

The planning of sources of working capital can be: 

Net gains from operations.



Sale of fixed assets.

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Raising long-term debt.

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Additional issue of shares.

Net profits constitute a potential permanent source of working capital funds from current operations since funds accruing to the depreciation are usually expected to be reinvested at some later date in replacements and additions of fixed assets. This is the most desirable source of working capital, as it does not burden the business with external obligations. All other sources of funds are irregular and temporary Capital borrowing is a source of working capital that can be planned with certainty but these funds eventually have to be returned to the creditors and the only source of funds for replacement is working capital. Funds raised from the sale of shares may be a potential and permanent source of working capital in addition to net profit. These share issues may not add to interest burdens like long term debt but they exert a potential demand for dividends and the use of this source implies sharing of ownership in the business with new investors. When depreciation deductions from earnings are not balanced by new investment in fixed assets there may be an increase in working capital provided such funds are not used to pay back loans or to distribute dividends.

FINANCING WORKING CAPITAL The net approach suggests that each asset would be offset with a financial instrument of the same approximate maturity i.e. short term or seasonal variation in Current Asset would be financed with the short-term debt. On the other hand permanent component of current assets would be financed with long- term funds. It is indicated that a profitable firm may not be in a

position to meet its costs obligations if funds borrowed on a short- term basis have become tied up in permanent assets. Larger the percentage of funds obtained from long term sources, the more conservative the firm’s working capital policy. There are three primary factors determining the use of long term versus short-term funds for financing current assets, flexibility, cost and risk.

BANK OVERDRAFTS A bank overdraft is a process whereby a customer of a commercial bank is permitted to overdraw on that account up to an agreed limit for a prescribed period. This is rather similar to a bank loan expected that interest is payable on the amount overdrawn only for the period it remains overdrawn and the account is usually repayable on demand or upon the termination of the overdraft period. Overdraft facilities are, however, commonly renewable and so, in practice, ma constitute a continual source of short-term capital or liquidity ‘insurance’ facility. An overdraft is a relatively cheap from of finance due to its being a short- term facility and with interest payable only on the loan actually taken up. Overdrafts are thus very suitable for firms with a fluctuating financial requirement, such as building contractors. It is a widely held belief that almost all building firms operate on an overdraft. The real estate industry, all financing grouped into two generic categories debts and equity. All financing follows this formula, by which equity must make up the gap between total project costs and the amount of loan money that can be raised. Equity + debt = total financing Total financing = total development cost

In real estate development projects, conventional leaders will lend up to a maximum of only 60 to 70 percent of the projects market value. Thus, in bigger projects massive amounts of equity investments may be required. Many project sponsors do not have sufficient equity, so that they form partnerships or corporations with two, twenty or even hundreds of investors.

In ordinary partnerships, all partners share income and risks in proportion to their investments. If the project goes sour, every partner could lose their original investment, or in the worst case, may even have to make up further losses. In special kind of partnership called syndication, a general partner plans and oversees the project and is fully liable for all financial obligations. Limited partners buy shares of a project’s ownership much as stock certificates are sold. As with stocks, the investor’s liability is limited to the amount of the investment. But unlike stocks, syndications pass through tax losses and tax credits to the investors. LOAN / BORROWINGS PLANNED Short-term capital provision and management is vital to the firm. It is this type of capital, which is required for the day-to-day activities. The sources of short-term capital are both internal and external, the main internal sources being accrued expenses and tax provisions and the main external sources being trade creditors, bank overdrafts, and short-term loans. It is short term finance, which provides the circulating capitals for the firm and assists with overcoming potential cash flow problems due to market fluctuation notable the most important source for construction firms is that of bank overdraft.

OPERATING EXPENSES The actual costs associated with operating a property including maintenance, repairs, management, utilities, taxes and insurance. A landlord’s definition of operating expenses is likely to be quite broad, covering most aspects of operating the building. The following are some of the strategies that can make buildings healthy, comfortable and productive and reducing the operating expenses. 

Day lighting

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Properly commissioned and maintained HVAC systems

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Narrow floor plans to optimize natural daylight

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High benefit lighting upgrades

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Under floor air distribution and displacement ventilation

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Occupant control of heat, light and air

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Operable windows and mixed mode HVAC

Buildings consume 40 percent of the world’s total energy, 25 percent of wood harvest and 16 percent of water consumption, according to the U S Department of Energy’s Center of Excellence for Sustainable Development. FINANCIAL EVALUATION BASED ON THE ESTIMATES: Several methods are available for evaluation of the proposal on expenditure. These methods ascertain the profitability of capital projects and are invaluable aids to the management in the process of making decisions about capital expenditure. All these methods or techniques claim to have certain merits but they have certain limitations too. The choice of a method should

be carefully made. ‘Various techniques have been introduced’, observe Brown and Howard, to help management take decisions, but the choice still remains. It is the responsibility of the management accountant to see that management is presented with useful information about each project, so that decisions are based not on guesswork but on reasoned calculations.

PROFITABILITY Profit is defined as the return rightly accruing to the entrepreneur for enterprise and use of funds. It is also useful to consider the accountants concepts of profit. Gross profit is total sales revenue minus production and sales expenses. Net profit is gross profit minus depreciation and interest on loans. Profit after tax is net profit minus tax payable on that profit. Thus profit represents the earnings available as a surplus, which may be used as a source of capital or may be distributed among owners. The basic profit (or less) = Revenues in terms of sale proceeds and rental income − Expenses in terms of hard land and construction costs and other soft costs such as professional fees and interest payments.

PAY BACK OF INVESTMENT This is widely used technique of assessing proposals on capital expenditure. This method, also known as pay-of-method, tends to ascertain the period in which the cost incurred on a capital project and there from is equated. It determines the period in which the investment is recovered. The period of repayment is popularly known as ‘pay-back period’. ‘Earnings’ here

means profits, arising out of the use of assets before deducting depreciation but after deducting income tax. Only then the cost generated to ‘pay-off’ the cost of the asset can be known. Thus: Earnings= Sale of the products − its cost of production − Income Tax payable. In case of annual earnings are fairly uniform, the payback is determined as:

Pay-back period =

cost of asset i.e. investment

= No of years

Earnings or Net cash flow per year If there are alternatives proposals of investment in different models or makes of an asset, say machines, the choice would fall on the model that pays for itself the earliest of all i.e. with the shortest pay-back period. To quote Keller and Ferrara. Those proposals with shortest pay-back periods, would considered the most desirable and those with the longest pay-back periods would be considered least desirable cash flow.

FINANCIAL AND ECONOMICS EVALUATION Generally the construction project depends on the financial activities i.e. capital input capital output of the project. There are certain types of projects depending probability and productivity. Those projects, which have been found feasible, have to be ranked from two points A. Liquidity B. Profitability The different methods of capital investment proposals we need top management accords its approval or notes its rejection. For the accepted projects, necessary sanction is accorded for its financial outlay and orders are passed for their execution following are some proposals 

Pay-back method



Average rate of return



Net present value method



Internal rate of interest method

PAY-BACK METHOD This is widely used technique of assessing proposals on capital expenditure. This method is also known as pay-off-method, tends to ascertain the period in which the cost incurred on capital project and earnings there from are equated. It determines the period in which the investment is recovered. The period of repayment is popularly known as pay-back method.

If there are alternative proposals of investment in different models or makes of an asset, say machines, the choice would fall on the model that pays itself the earliest of all i.e. with the shortest pay-back method. Those proposals with shortest pay-back periods would be considered the most desirable and those with the longest pay-back periods would be considered least desirable. Pay-back method = cost of asset i.e. investment /earnings or net cash flow per year = no of years

AVERAGE RATE OF RETURN Rate of return is the ratio of investment. Basically there are two principal variations in approach 1)

Original investment approach It refers the total cost of the project till its commissioning minus any salvage value divided.

2)

Average investment approach It means the original cost divided by 2, and where there is some salvage value recoverable at the end of the life the asset, it would be ½ (original cost − salvage value) + salvage value. The average investment approach is more realistic than the original investment. Approach, since the investment gradually decreases over the number of years.

Average annual earnings after = average depreciation and taxes × 100 Rate of return

3)

average investment

Discounted cash flows techniques A. Net present value method (N P V) The net present value of the project is equal to the some of the present value of the all cash flows associated with the project.

NPV = CF1 /(1+K) + CF2 /(1+K)*2 + CFN /(1+K)*N-L CFN = cash after occurring at the end of year N L = initial investment K = cost capital N = life of the project

B. Internal Rate of return (I I R) IRR of a project is the discount rate, which notes its net present value equal to zero. It is value of K in the equation.

L = CF1 /(1+K) + CF2 /(1+K)*2 + CFm /(1+K)*m IRR method also takes into account the time value of money. It makes sense to businessmen who want to think in terms of rate of return and not in terms of absolute quantity such as net present value.

C. Payback period This is the period by which initial investment is entirely recovered.

AREA STATEMENT & PROJECT DETAILS To develop a commercial site 10,000sqmt and in that 5,000sqmt developed area will be used by the owner and the balance 5,000sqmt area will be utilized by the developer to get back investment and a profit on his investment. The cost of land is Rs. 10,000/sqmt. Developer is going to get 5,000sqmt at the rate of 10,000/sqmt, which will give him an asset of 5000 x 10000 = 50000000 (5 crore) Developer will get the area to develop for the trust is 5000 square meter at the rate of 10000/sqmt. within this area total usable area will be 85%. Thus developer has to develop the total area is 5000 X 0.85 4250sqmt. Generally construction rate is varying with area to area. We can assume the construction cost at this prime locality is 750Rs/sqft. that is we can say 7000/sqmt. Thus total cost of construction will be 4250X7000=29750000Rs. (say 3 crore)

Developer is going to generate the amount of 1000000Rs on his own and 5000000Rs from the bank. This total 6000000Rs is not at all sufficient to develop the proposed development therefore he is going to use the land which he got as a development cost for generate the amount. Thus developer can generate the amount by giving this land for rents to private authorities. Developer is going to get the rent of 400Rs/sqmt/mount, which will generate the amount for the year as400X5000X12 = 24000000Rs. Developer is going to generate the total amount of 30000000Rs. We can say the amount generated from bank is having the rate of interest 14% i.e. at the end of the year we have to return total amount of 5000000X1.14=57000000Rs. Thus the total investment of the developer will be 30700000Rs. within the year. NET PRESENT VALUE METHOD: - (NPV) NPV = (CF1/(1+K)) + (CF2/(1+K) * 2) + (CFN/(1+K) * N –L) Life of the project is one year NPV = 50000000 / (1+0.14) - 30700000 = 13159649 Thus the investment is most beneficial to developer INTERNAL RATE OF RETURN: - (IIR) L = (CF1/(1+K)) + (CF2/(1+K)*2) + (CFm/(1+K)*m) 30700000 = 50000000/(1+K)*1 K = 0.628 i.e. 62% Thus the investment is most beneficial to developer because he is getting net profit more than 18% i.e. developer is getting 62% net profit on his investment.

PAYBACK PERIOD This is the period by which initial investment is entirely recovered. Developer is going to invest the total amount for development within one year is 30700000Rs. at the same time he is going to make an asset of 50000000Rs. in terms as a land property, this shows the developer is going to recover his investments made in the development within a year.

RECOMMENDATION Particularly during periods of economic recession construction firms are exceedingly conscious of the problem of survival and seek to predict, monitor and control costs and revenues with diligence far surpassing that employed during more buy-ant time. Hence considering real estate value is going up it is recommended to take up the project financial term in the project.

BIBLIOGRAPHY: 1. Financial Management by M Y Khan. 2. Financial Management by Prassanna Chandra. 3. Finance Management by Khan and Jain. 4. Construction Finance Management by NICMAR (text book).