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Management of agricultural research: A training manual. Module 7: Financial Management
CONTRACT TEXT
(1997)
EXPAND CONTENTS
DETACH Session 3. Financial management 3: Project design and
NO HIGHLIGHTING implementation
Reading note: Financial management 3: Project design and
implementation
Project design and activity implementation
Break-even analysis of projects
Financing of projects
Recurrent-cost problems
Computerization of financial functions
Electronic spreadsheets
Database management systems
Summary
Literature sources used in preparing the reading
notes

Project design and activity implementation

The design of projects, programmes and activities is critical to the future of an organization. Management has to
evaluate the financial dimensions of new projects and activities very carefully. Selection of better, financially viable
projects ensures optimal allocation of scarce long-term resources.

Each project generally requires resources in terms of land and buildings, equipment, staff and, in some situations,
foreign exchange. Most of the decisions related to initiating new projects are irreversible in nature. Resources
employed in one project cannot be put to an alternative use. In selecting new projects, management must ensure
that the new venture fits within the overall objectives of the organization. There should be a perfect match
between what the organization is currently doing and what it intends to do in future. This will also be decided in
the context of the administrative capability of the organization.

Project budgeting and monitoring

Most new projects and programmes involve investment of funds, for which estimates must be made very carefully.
A major part of these investments would involve equipment and other fixed assets.

Each project involves recurrent costs for maintaining and operating the project. The recurrent-cost implications
must be assessed carefully in advance of selecting a project. While designing new projects and programmes,
management should take into account not only current but also future commitments. A balance must be achieved
between these two commitments. During the design phase, the financial dimensions of the project must be
considered and discussed in detail. A project can lead the organization to disaster if it is based on unsound
financial suppositions.

The previous sessions in this module described aspects of budget preparation. In the same way, the organization
must prepare budgets for each proposed activity. These budgets should have a long timeframe and project details
should include information about:

· capital or development costs;

· recurrent costs; and
· sources of funds.

The capital cost of a project must be estimated very carefully. The experience of most organizations is that actual
capital costs turn out to be much higher than projected. Projections of operating and maintenance costs should
include factors such as inflation, likely growth and expansion of the activity, etc. Finally, the budget must provide
information about different sources of funds for financing the project.

Almost every project has a capital expenditure component. Once the capital expenditure phase is over, the project
requires recurrent expenses to maintain and run the project. The organization should prepare separate budgets
for capital and recurring costs because:

· there are always technical differences in financial administration of capital expenditure and recurrent-
cost expenditure;

· the bulk of capital expenditure is very often financed by external sources, whereas a more of the
recurrent costs would be financed through internal accruals, and hence the controls for the two would
 be different; and

· factors causing recurrent costs to grow are not related to capital expenditure.

The capital budget of a project should always be set relative to the recurrent expenditure budget and the rate at
which it should grow. Management should always aim to check that there is no overspending. The relationship
between recurrent and capital expenditure can be quantified as follows:

This coefficient relates the annual recurrent costs of the project to the total capital expenditure. A higher coefficient
indicates that the organization would be required to raise a larger amount of money to meet the recurrent costs.
This coefficient can be very useful in situations where the organization is in an early phase of development and
with a comparatively high dependence on external finance or loans.

To examine whether a project is going in the right direction, management can:

· lay down guidelines for recurrent costs, not just for the year for which the estimates are under
preparation, but for a longer period. While projecting the upper limit for recurrent costs, the
organization should consider real growth rates and expected inflation;

· set non-monetary ceilings for recurrent costs such as human resources employment, thus providing
an effective way to monitor whether a project is proceeding as expected;

· estimate accurately the time needed to bring the project to its operational stage; and

· examine administrative capabilities for project implementation.

Break-even analysis of projects

The organization should critically evaluate all new projects. Critical evaluation is necessary to emphasize internal
controls and justify the costs. One of the important dimensions of this evaluation is to find the operating level
which justifies the costs implicit in the activity. There will always be a scale of activity below which the costs do not
justify starting the proposed activity. The knowledge of this level of activity is necessary for decision making.
Break-even analysis is an approach which helps management to identify the critical level of activity, namely the
break-even level, which is that level of activity at which funds allocated to the project are just sufficient to cover
costs of operation. If the activity is operated below this level, the project will incur losses. In order to find this
break-even level, management requires information on:

· funding sources sanctioned for the project, which usually are

- fixed grants, such as grants received from government, and

- variable receipts, such as participation fees charged; and

· costs associated with the project, which again will be

- fixed costs, and

- variable costs.

The break-even level of activity would be identified by equating the two revenue and two cost components. This is
an important tool in project analysis. One can also find break-even levels under different revenue levels.

Financing of projects
Financing is an important component of project design. When designing a project, the organization must make a
realistic assessment of both the fiscal requirements and the probable availability of funding.

Sources of funds include:

· internal sources, such as

- government grants,
- plan expenditure, and
- non-plan expenditure;

· aid flows, including

- domestic agencies, and

- international agencies; and

· borrowing from national and international agencies, including

- interest-free loan sources,

- interest-bearing loans, but at less than commercial rates (i.e., soft loans), and
- commercial loans at market interest rates.

When assessing resource availability, the organization should consider all relevant factors. For example,
availability of funds from internal sources depends upon the internal capability of the organization. In general,
internal funds would in part cover recurrent cost. For large funding requirements, the organization cannot depend
on internal generation. Support from government would depend on priorities and allocations.

It is important that deficits are closely monitored, and it also very important to be aware of inflation, as it can play
havoc with budget management and can easily render a project non-viable by rapidly shifting the break-even
premises.

Recurrent-cost problems
Management has to ensure that activities or programmes operate in the ways and at levels that were initially
planned. In general, programmes or activities are more likely to face problems as the project progresses. A
common major problem area is recurrent-cost expenditure, as grants are often insufficient cover all aspects. Some
effects of insufficient funds include:

· inability to produce output because of lack of staff or equipment;

· shortages of consumable supplies;
· no qualified staff to operate equipment or machinery;
· poor maintenance of buildings, equipment, facilities, etc.;
· transport constraints; and
· a large number of positions unfilled due to recruitment freezes.

One can immediately visualize the consequences: reduced efficiency, reduced service quality and quantity,
reduced utilization of facilities, reduced equipment life due to poor maintenance, and low staff morale.

Factors contributing to recurrent-cost problems include:

· dramatic changes in the environment;

· overall budgetary constraints;
· poor budgetary planning; and
· imbalances in resource allocation.

Revenue mobilization efforts can redeem the organization from recurrent-cost problems arising from changes in
external factors. If the problem arises because of poor budgetary planning and mis-allocation of resources,
management has to identify ways and means to redeploy all resources to optimize efficient and effective
utilization.

Computerization of financial functions

Financial management involves recording and analysis of large number and wide variety of transactions. Timely
use of information generated by various reports and statements is critical to the success of the finance function.
Manual systems of recording transactions and producing reports are very time consuming, with numerous
shortcomings. As the number of transaction increases, the recording and processing system may be affected
because of errors arising from overloading. The major disadvantage of a manual system is that, because of
interdependencies in financial and accounting variables, a small revision or a minor change may involve lot of
work. Conducting sensitivity analysis of various programmes or activities may prove to be a Herculean task.

In recent years, information processing technology has developed enormously in capacity and sophistication.
Computerization of financial functions and accounting is no longer restricted to big organizations: even small
organizations can profit from use of a small personal computer. The widespread use of computers for financial
functions is the outcome of the low prices of commonly available, standard software packages. Software
packages which have really made the use of computers easy for financial purposes are electronic spreadsheets
and database management systems.

Electronic spreadsheets
Using an electronic spreadsheet, one can do detailed analysis of accounting and financial information. The word
spreadsheet - also called a ledger sheet or worksheet - derives from the standard accountancy sheets of paper
printed with several columns for recording financial transactions, keeping track of funds and commitments, and
performing some computations. Just as on paper, the spreadsheet has rows and columns. Each row-column
intersection forms a cell into which numbers can be entered and further processed by specifying the relationships
between various individual and groups of cells. This type of electronic spreadsheet is useful for doing financial
analysis, creating budgets, etc., which require a tabular form of presentation of information. Each piece of
information can be accessed easily and further computations carried out. Verifications and revisions are simple.
The spreadsheet will not produce accounting reports automatically as it does not understand accounting
procedures and rules: it is merely a tool to perform calculations, but optimized for calculations typical of an
accounting environment.

Lotus 1-2-3 and Excel are two well-known spreadsheet software packages for personal computers. Others include
MultiPlan, SuperCalc, Paradox and Quattro.

Database management systems

Another important category of software is that used to manage databases. One very well known database
management software package is dBase IV, the latest in a series of increasingly sophisticated packages. This
programme uses data files in highly structured formats so that sorting, updating, indexing, accessing selected
records, locating data, generating reports, adding or deleting information, etc., are easy and quick.

Major advantages of using such software include:

· the ability to identify and exploit a large number of interdependencies;

· the timely availability of information, as the processing of transactions is very fast;

· reliability of information as, assuming the input data are correct and the interrelationships established
are valid, the results are reproducible;

· lower costs in terms of human resources training; and

· the ability to perform sophisticated analyses and to do sensitivity analysis.

However, the effective use of computers for financial functions requires a more sophisticated and specialized form
of database management system, namely a management information system (MIS). MIS is an integrated human-
machine system that can provide information in support of planning and control functions. MIS provides support to
largely structured planning and control tasks through routine reports.

Summary
Management of resources plays a critical role in the growth and development of an organization. The organization
should strive for effective and efficient utilization of financial resources. The organization should also be
concerned about the effectiveness of the control system in achieving its objectives and fulfilling its mission.

Preparation of financial statements, such as balance sheets and income and expenditure accounts, is important
as they provide insights into the operating and financial performance of the organization. In preparing these
statements, the organization should use an accrual system of accounting. Financial functions include analysis,
planning and budgeting, control, and project and activity planning. Analysis involves preparing statements of the
sources and uses of funds, developing diagnostic indicators, preparing cost of service statements, and deriving
common-sized ratio statements, other coefficients and indices. Analysis of cost information can provide many
insights into the performance of various programmes and activities. It also becomes the basis of planning and
controlling. The classification of cost information into variable, fixed, capital and recurring costs helps the analysis
a great deal. Planning of activities is important and is done by preparing budgets. For successful implementation
of budgetary control, certain conditions have to be fulfilled. These are preparing statements of goals and
objectives, creating budget centres, developing accounting controls, communication, coordination and budget
administration. Control ensures that plans are achieved. Variance analysis and internal and external audits
strengthen the control process.

The designs of projects, programmes and activities are critical to the future of an organization. Since most new
projects and programmes involve significant investments, estimates must be arrived at very carefully. Each project
involves recurrent costs for maintaining and operating the project, and so the recurrent-cost implications of a
project must be assessed well before the project's approval. One of the important dimensions of new project
evaluation should be to determine the operating level of activities which justify the costs incurred. This can be
done by performing a break-even analysis. Financial management involves the recording and analysis of a wide
variety of transactions. Timely use of information generated by various reports and statements is critical to the
success of the finance function. Computerization of the finance function should ensure timely availability of
reliable and accurate information.

Literature sources used in preparing the reading notes

Anthony, R.N., & Herzlinger, R.E. 1975. Management Control in Non-Profit Organizations. Homewood, IL: Irwin.

Anthony, R.N., & Reece, J.S. 1977. Management Accounting Principles. Bombay, India: D.B. Taraporevala.

Horngren, C.T. 1977. Cost Accounting: A Managerial Emphasis. 4th ed. Englewood Cliffs, NJ: Prentice-Hall.

Dearden, J. 1973. Cost Accounting and Financial Control Systems. Reading, MA: Addison-Wesley.

Gross, M.J., & Warshauer, W. 1979. Accounting Guide for Non-Profit Organizations. New York, NY: John Wiley.

Henke, E.O. 1971. Accounting for Non-Profit Organizations. Belmont, CA: Wadsworth.

Howell, J. (ed.) 1985. Recurrent Costs and Agricultural Development. London: Overseas Development Institute.

Pandey, I.M. 1992. Financial Management. New Delhi: Vikas Publishing House.

Turk, I. 1984. Accounting Analysis of the Efficiency of Public Enterprises. Lublijiana: International Centre for Public
Enterprises in Developing Countries.

Vargo, R.J. 1977. Readings in Governmental and Non-Profit Accounting. Belmont, CA.: Wadsworth.

Welsh, C. 1976. Budgeting, Profit Planning and Control. New Delhi: Prentice-Hall of India.