Financial Management

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PROJECT FINANCIAL

MANAGEMENT

SHENAL RAJAKARUNANAYAKE
DEPARTMENT OF INDUSTRIAL MANAGEMENT
FACULTY OF BUSINESS
UNIVERSITY OF MORATUWA
LEARNING OUTCOMES

• Explain different structures of finance


• Identify different sources of finance
• Explain Break-even point and its significance.
• Prepare basic financial statements.
PROJECT FINANCE STRUCTURES

• Project funding can be obtained from various sources


• Some of the main sources are explained using an example of a water
treatment project.
• Public Finance
• Corporate Finance
• Project Finance
PUBLIC FINANCE

• For years, many governments including the Sri Lankan government, funded projects by using
existing surplus funds or issued debts (T/bonds) to be repaid over a specific period.
• However, governments worldwide have increasingly found this funding mechanism/structure
to be less attractive, as it strained their own balance sheets and therefore limited their
ability to undertake other projects.
• This concern has stimulated the search for alternative sources of funding.
PUBLIC FINANCE
CORPORATE FINANCE

This is a mechanism where private sector participant uses its own credit for
raising the funds due to its capacity and the limited size, and nature of the
project.
This option is used for shorter, less capital-intensive projects that do not
warrant outside financing.
CORPORATE FINANCE
PROJECT FINANCE

Project financing uses the project’s assets and/or future revenues as the basis
for raising funds.
Generally, the sponsors create a special purpose, legally independent company
in which they are the principal shareholders.
PROJECT FINANCE
PROJECT FUNDING ALTERNATIVES

There are different types of long-term securities that a project may issue in
raising funds.
They are listed in order of seniority from the most risky, requiring the highest
level of return, to the least risky, requiring the lowest returns.
PROJECT FUNDING ALTERNATIVES

Common Equity: This represents ownership of the project. The sponsors usually hold a significant
portion of the equity in the project.
Preferred Equity: This also represents the ownership of the project. However, the sponsors have
priority over the common equity holders in receiving dividends and funds in the event of liquidation.
Unsecured Debt: This could be short-term or long-term, and although not secured by specific
assets, is senior to equity in dividends and repayment of principal.
Secured Debt: This could also be short-term or long-term. However, this is secured by specific
assets or sources of revenues.
Lease financing: This can vary in terms of structure and duration, although the lessor always retains
the rights to the leased assets. Tax issues and the strength of the collateral are usually the driving
forces behind a lease strategy. A lessor may be able to depreciate an asset for tax purpose, or the
lessee may be exempt from taxes or expect losses in the early stages of the project.
PROJECT FUNDING ALTERNATIVES

Banks generally offer short-term funding options;


Construction financing: Used for construction purposes
Bridging financing:
Line of credit:
ESSENTIALS OF PROJECT FINANCIAL
MANAGEMENT

• Types of cost
• Direct, Indirect
• Fixed, variable, total
• Relationship between Revenue/Profit and cost
• P & L account
• Break Even Analysis
• Calculation
• Chart
TYPES OF COSTS

• Direct Costs – cost’s that can be identified with a particular product or


process eg. raw materials, packaging and direct labour
These are normally variable costs
• Indirect Costs or overheads – affects the whole business e.g. rent, insurance,
salaries of office staff
These are normally fixed costs
FIXED COSTS

1200

• Fixed Costs: 1000

Costs that stay the same for all levels 800

of output e.g. Rent, insurance, heating


FIXED
COSTS 600
(£000)

400

200

0
100 200 300 400 500

OUTPUT UNITS
(£000)
VARIABLE COSTS

1200

• Variable Costs: 1000

Costs of production which increase 800

directly as output rises


VARIABLE
COSTS 600
(£000)

400

200

0
100 200 300 400 500

OUTPUT UNITS
(£000)
TOTAL COST = FC + VC

1400

1200

1000

800
VARIABLE
TOTAL COSTS
COSTS 600
(£000)

400

FIXED
200 COSTS

0
100 200 300 400 500

OUTPUT UNITS
(£000)
EXERCISE

Abrams and Lyons are a small manufacturer which assemble electric kettles. They
lease a factory in Southampton and employ 38 workers. Their fixed costs are
£100,000 and variable costs are £2.50 per kettle.
a) Draw a table showing output, fixed costs, variable costs (use a range from 0 -
100,000 in divisions of ten thousand) Plot your figures on a graph
b) If variable costs rise to £3.50,what will happen to total cost if output is :
(i)Zero
(ii)50,000
EXERCISE

EXAMPLE part (a)

OUTPUT FIXED VARIABLE TOTAL


(units) COST COST COST
0 100000 0 100000
10000 100000 25000 125000
20000 100000 50000 150000
30000 100000 75000 175000
40000 100000 100000 200000
50000 100000 125000 225000
60000 100000 150000 250000
70000 100000 175000 275000
80000 100000 200000 300000
90000 100000 225000 325000
100000 100000 250000 350000
`

EXERCISE
350

300

250

TOTAL
COSTS
200
(£000)
VARIABLE
COSTS
150

100

FIXED
50 COSTS

0
10 20 30 40 50 60 70 80 90 100

OUTPUT UNITS
(£000)
EXERCISE

EXAMPLE part (b)- variable cost £3.50

OUTPUT FIXED VARIABLE TOTAL


(units) COST COST COST
0 100000 0 100000
10000 100000 35000 135000
20000 100000 70000 170000
30000 100000 105000 205000
40000 100000 140000 240000
50000 100000 175000 275000
60000 100000 210000 310000
70000 100000 245000 345000
80000 100000 280000 380000
90000 100000 315000 415000
100000 100000 350000 450000
EXERCISE

EXAMPLE part (b)- variable cost £3.50


500 Variable cost rise
to £3.5
OUTPUT FIXED VARIABLE TOTAL
(units) COST COST COST 400

0 100000 0 100000 50,000 units


Variable cost £2.5

TOTAL
10000 100000 35000 135000 COSTS 300
20000 100000 70000 170000 (£000)
30000 100000 105000 205000 No of units
zero
200
40000 100000 140000 240000 VARIABLE
50000 100000 175000 275000 COSTS
60000 100000 210000 310000 100
FIXED
70000 100000 245000 345000 COSTS
80000 100000 280000 380000
90000 100000 315000 415000 0
10 20 30 40 50 60 70 80 90 100
100000 100000 350000 450000
OUTPUT UNITS
(£000)
BREAK EVEN ANALYSIS

• Break even point - ‘The level of sales or output, where total costs are
exactly the same as total revenue’
• Companies often want to know how much they want to produce or
sell to break even
• It is possible to calculate the ‘break even’ point if a firm knows the value
of its costs and the price it can charge in the market place
BREAK EVEN ANALYSIS

Why calculate the break even point?


• Know in advance the level of output needed to ‘break even’
• See how changes in output affect profit
• See how changes in cost affect the break even point and profit
• Calculate the level of output needed to reach a target rate or profit
EXERCISE

• A small producer makes wrought iron park benches in a foundry. The fixed costs (FC)
are £60,000 and variable costs are £40 per bench. He sells the benches for £100.
Calculate the breakeven output.

Let q= quantity of benches needed to break even

Total cost (TC) = Fixed cost + variable cost

Total Cost (TC) = £60,000+£40q …………….. eq. 1

Total Revenue (TR) = £100 x q = £100q …….. eq.2


EXERCISE

TR = TC

selling price * quantity = FC + Vaiable cost * quantity


Breakeven occurs when TC=TR

£60,000 + £40q = £100q

£60,000 = £60q

q = £60,000 = 1000 units


£60
EXERCISE

180
TOTAL
160 REVENUE
140 BREAK EVEN
POINT Profit
COST
120
REVENUE
PROFIT
100
VARIABLE
(£000) 80 COSTS
60
Loss
40 FIXED
COSTS
20

0
200 400 600 800 1000 1200 1400 1600

BENCHES
(000)
PRACTICE QUESTIONS

• A company wishes to introduce a new product. In order to do this, it must invest in some new
manufacturing equipment. The choice is between Machine A and Machine B. Costs and income
associated with each machine are as follows in Table 01 .

Costs / Income Machine A Machine B


Fixed Costs 71,500 81,200
Variable Cost per Product Produced 12 11
Selling Price for each Product 25 25

Plot a graph which shows the break-even point for each machine in terms of the number of
products produced. Which machine would you recommend for purchase? Explain your choice.
REVENUE AND PROFIT

Total Revenue - ‘The amount of money a company receives from selling its product’

Total revenue = Quantity sold x Price

Profit - ‘The difference between revenue and costs’

Profit = Total revenue – total costs


EXAMPLE

Revenue JAN
Sales £1,980,000
Net Sales £1,980,000
Cost of Goods Sold
Direct materials 1,359,000
Direct labour 300,000
Manufacturing overhead
Indirect labour
Net cost of goods sold £ 1,659,000.00
Gross Profit £ 321,000
Period Expenses JAN
Salaries & Wages £ 40,000
Depreciation 0
Rent 5,000
Office Supplies 150
Utilities 1,000
Telephone 800
Insurance 300
Travel 250
Maintenance 54,000
Advertising 3,000
Direct Marketing 500
R&D 3,000
Total Expenses £ 108,000
Income From Operations £ 213,000
Total Expenses £ 108,000
Income From Operations £ 213,000
Interest Income (Expense) 0
Income Before Income Taxes 213,000
Income Tax Expense 42,600
Net Income(Profit) £ 170,400.00
C ASH FLOW STATEMENTS

AUG SEPT OCT NOV DEC JAN FEB MAR


Sales 4000 4400 2200 3000 3000 5000 3600 2800
estimates
(units)

• Sales prices per unit 65. Customers are given two month’s credit before they pay you.
• Material price per unit 20. Suppliers give you one month’s credit before you pay them.
• Labour costs are 15 per unit. Labour is paid for in the month of use.
• Overheads are 4,000 per month.
• There is a scheduled loan repayment of 15,000 per month for the duration of this
project.
C ASH FLOW STATEMENTS

October November December January February March

B/F £12,000

Sales Income
Total Available

Expenditure

Materials
Labour
Overheads
Loan
Total Expenditure

Closing Balance
C ASH FLOW STATEMENTS

CASH FLOW STATEMENT OCT NOV DEC JAN FEB MAR

Brought forward £12,000 161700 339700 453200 638200 750200


INCOME 260000 286000 143000 195000 195000 325000
Total Available 272000 447700 482700 648200 833200 1075200

COSTS
Overheads 4000 4000 4000 4000 4000 4000
Materials 88000 44000 60000 60000 100000 72000
Labour 3300 45000 45000 75000 54000 42000
Loan 15000 15000 15000 15000 15000 15000
TOTAL EXPENSES 110300 108000 29500 100000 83000 133000

CLOSING BALANCE 161700 339700 453200 638200 750200 942200

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