Team Vector

Financial Analysis
 What is cost of project?

The cost of project represents the total of all items of outlay

associated with long-term fields.

Technical know-how
Land and Site Buildings and Civil Plant and
and Engineering
Development Works Machinery
Fees

Expenses on Foreign
Preliminary and
Technicians and Miscellaneous Fixed Pre-operative
Capital Issue
Training of Assets Expenses
Expenses
Technicians Abroad

Provision for
Contingencies
 DIRECT VERSUS INDIRECT COSTS

Direct Costs are those clearly

Indirect Costs are costs used by
assigned to the aspect of the
multiple activities, and which
project that generated the cost.
cannot therefore be assigned to
Labor and materials may be the
specific cost objects
best examples. Direct cost is
totally traceable to the production
of a specific item
 RECURRING VERSUS NONRECURRING COSTS

Recurring Costs are those that Nonrecurring Costs might be

typically continue to operate over
the project’s life cycle. Most labor,
material, logistics, and sales costs
are considered recurring
those associated with charges
applied once at the beginning or end
of the project, such as preliminary
marketing analysis, personnel
training, or outplacement services
 FIXED VERSUS VARIABLE COSTS

Fixed Costs, as their title suggests,

do not vary with respect to their
usage. It is a cost that does not
change over the short-term, even if
a business experiences changes in
its sales volume or other activity
Variable Costs are those that
accelerate or increase through
usage; that is, the cost is in direct
proportion to the usage level
 NORMAL VERSUS EXPEDITED COSTS

Expedited Costs are unplanned

Normal Costs refer to those
incurred in the routine process of
working to complete the project per
the original, planned schedule
agreed to by all project stakeholders
at the beginning of the project
costs incurred when steps are
taken to speed up the project’s
completion. For example- use of
overtime, hiring additional
temporary workers, contracting
with external resources or
organizations for support
 Means of Finance

To meet the cost of the project, means of

finance are:
• Share Capital
• Term loans
• Debenture capital
• Deferred capital
• Miscellaneous sources
 Cost of Production

Cost of production refers to the total cost incurred by a business to produce a specific

quantity of a product or offer a service.

The major components of cost of production are:

Material cost- cost of raw materials, chemicals, components and consumable stores
required for production
Utilities cost - power, water, and fuel.
Labor cost- cost of all manpower employed in the factory
Factory overhead cost- repairs and maintenance, rent, taxes, insurance on factory
assets
 Estimates of production and sales
In estimating sales revenues, the following considerations should be kept in mind:

1.It is sensible to assume that capacity utilization would be some what low in the first year and rise there

after gradually to reach the maximum level in the third or fourth year of operation.

2. It is not necessary to make adjustments for stocks of finished goods.

3. The selling price considered should be the price realizable by the company net of excise duty.

4. The selling price used may be the present selling price- it is generally assumed that changes in selling

price will be matched by proportionate changes in cost of production.

 Working Capital Requirement and Its Financing

• Working Capital Requirement is the amount of money needed to finance

the gap between disbursements (payments to suppliers) and receipts
(payments from customers).
•  The working capital requirement consists of the following: (i)raw materials
(ii)stocks of goods in process (iii) stocks of finished goods(iv) debtors
(v)operating expenses (vi)consumable stores
• The smaller the WCR, the smaller the financial resources needed.
• WCR will be negative in companies with low inventory and low accounts
receivable.
Working Capital Requirement and Its Financing
Working Capital Requirement and Its Financing
 Working Capital Requirement and Its Financing

Solution-
calculation of cost of sales
Sales(1,00,000*8) 8,00,000
less: profit(25% on sales) 2,00,000
cost of goods sold 6,00,000
Cost of goods sold per week 11,538
(6,00,000/52)
 Statement of working capital requirement
Description Amount ( ₹) Amount ( ₹)
Current assets
Debtors (11,538*8) 92,304
Stocks (11,538*12) 1,38,456
2,30,760
Current liabilities
creditors (11,538*4) 46,152
Net current assets 1,84,608
Add: contingencies (10% of net current asset) 18,461

Working capital 2,03,069

requirement
 Financial Projection

What is Financial Projection

The financial projections are a decision-making tool for the
management and creditors.  It is a concise financial model that
shows the expected revenues, expenses, and cash flows of a
business over a forecast period. 

 What the company going to do

 How it will start
Tells Stories about :
 How it will Grow
 Benchmarks
 Projected sales and cost of goods of a Month

Item Number Price Revenue Cost

Item 1 1000 2000 200000 20%

Item 2 600 2500 150000 20%

Item 3 800 2000 160000 20%

Total sales =510000

Labor Cost
Employee Number Salary Total
Manager 2 20000 40000
Employees 5 5000 25000
Total =65000
 Fixed Cost
Start-up Expenses Growth Rates
Rent 15000
Working capital 35000 Sales 5%
Electric 1000
Opening Supplies 1000 Labor Cost 2%
Insurance 800
Equipment 25000 2%
Legal 2000 Legal
Licenses 2000
Miscellaneous 1000 Advertisement 4%
Miscellaneous 1000 Advertisement 20000
Miscellaneous 2%
Total Start-up Total Fixed Cost 39800
64000
Expenses Electric 2%

Miscellaneous
Tax Rate 10%

Cost of Capital 6%
 Projected Profit & Loss
1st Month 2nd Month 3rd Month
Sales 510000 535500 562275
Cost of goods sold 102000 107100 112455
Gross Profit 408000 428400 449820
Less: Expenses
Labor Cost  65000  66300  67626
Rent 15000 15000 15000
Electric 1000 1020 1041
Insurance 800 800 800
Legal 2000 2040 2081
Miscellaneous 1000 1020 1041
Advertisement 20000 20800 21632
Total Expenses 104800 106980 109220

EBIT 303200 321420 340600

Interest expense - - -
EBT 303200 321420 340600
Tax 30320 32142 34060
Net Income 272880 289278 306540
 projected cash flow

A projected cash flow statement is best defined as a listing of expected cash

inflows and outflows for an upcoming period. There are two methods of cash
flow they are-
 Direct Method
 Indirect Method

Operating Activities

Three Segment of Investing Activities

cash flow are
Financial Activities
 Problem

Cash transactions expected during the upcoming 12-month period

Reference: https://www.slideshare.net/ateeqkhan09/cash-flow-statement-n-problems
Illustration 11
Projected Cash flow statement
 Projected Balance Sheet:

For preparing the projected balance sheet at the end of

year n + 1, we need information about the following:
 the balance sheet at the end of year n
 the projected income statement and the distribution of
earnings for the year n +1
 the sources of external financing proposed to be tapped in the
year n+1
 Projected Balance Sheet: (contd.)

 the proposed repayment of debt capital (long-term, intermediate

term, and short-term) during the year n + 1
 the outlays and the disposal of fixed assets during the year n + 1
 the changes in the level of current assets during the year n + 1
 the changes in other assets and certain outlays like preoperative and
preliminary expenses (which are capitalised) during the year n + 1
 the cash balance at the end of year n + 1.
 Preparing Projected Balance Sheet:

Example -
• Let’s assume X Ltd. has the following changes this year –
– Profit for the year 20000 tk
– Availing term loan 20000 tk and repayment of 5000 tk
– Increase in unsecured loans 10000 tk
– Bought machineries worth 30 and 20 depreciation charged
throughout the year
– There is an increase in the inventories by 10000 tk
– Receivables are expected to increase by 15000 tk
 Preparing Projected Balance Sheet: (contd.)
X Ltd.
Projected Balance Sheet
Account Category Opening Balance Changes During the Year Closing Balance
Assets

Fixed assets 180,000 + 30,000 (Additional outlay) 190,000

 - 20,000 (Depreciation)

Investments -

Current asset's 180,000 215,000

Cash 20,000 30,000

Inventories 80,000 +10,000 (Proposed increase) 90,000

Receivables 80,000 +15,000(Expected increase) 95,000

360,000 405,000
 Break Even Point:
Accounting BEP: Financial BEP:
Accounting BEP is the break Financial BEP is the break even
even point, where a company’s point, where the NPV of an
revenues and expenses were investment is zero at a certain
equal within a point of outcomes.
specific accounting period. • Focus is on the point where
• Focus is on the point where NPV is Zero
profit is Zero
Cash flow projection from X Ltd.

Tax rate = 33.33%

 Accounting Break Even Sales:
Tax rate = 33.33%
• Focuses on the Sales
amount at which profit is
Zero.
• Formula:

• Break even sales of X Ltd:

=
= 9 million dollar of sales.
 Financial Break Even Sales: Tax rate = 33.33%

• Focuses on the Sales amount at

which NPV is Zero.
• Profit after tax of X Ltd.:
= (1-T)(Sales*CMR –
Expenses)
= (1-.333)(Sales*0.333 – 3 million)
= 0.667*(Sales*0.333 – 3 million)
 Financial Projection:
• Profit after tax of X Ltd = 0.667*(Sales*0.333 – 3 million)

• Cash flow after tax = 0.667*(Sales*0.333 – 3 million)+ 2 million®

= 0.222 sales - 2 million + 2 million

= 0.222 sales
• PV (cash flows) = 0.222 Sales * PVIFA (10 years, 12%)

= 0.222 Sales * 5.650

= 1.254 Sales
 Financial Projection: (contd.)
So, the financial breakeven occurs when –

PV (cash flows) = Investment

or, 1.254 Sales = 20 million

Sales = 15.95 million

• So, the sales for X Ltd. must be 15.95 million per year for the investment to have a zero
NPV.

• Note that this is significantly higher than 9 million which represents the accounting
break-even sales.
Creating a project Budget :
The project budget is a plan that identifies the allocated resources, the projects goals,
and the schedule that allows an organization to achieve those goals. Effective
budgeting always seek to integrate corporate level goals with department specific
objectives, short - term requirements with long – term plans, and broader strategic
missions with concise, needs- based issues. Useful budgets evolve through intensive
communication with all concerned parties and are complied from multiple data
sources.

Several important issues go into the creation of the project Budget, including the
process by which the project team and the organization gather data for cost estimates,
budget projections, cash flow income and expenses, and expected revenue streams.
The ways in which cost data are collected and interpreted mainly depend upon
whether the firm employs a top- down or a bottom – up budgeting procedure. These
approaches involve radically different methods for collecting relevant project budget
information, and can potentially lead to very different result.
Top – down budgeting:

Top- down budgeting refers to a budgeting method where senior management prepares a
high – level budget of the company. The company’s senior management prepares the
budget based on its objectives and then passes it on to department managers for
implementation. At each step down the hierarchy, the project is broken into more detailed
pieces, until project personnel who will be performing the work ultimately provide input on
specific costs on a task- by- task basis.

The approach can create a certain amount of friction within the organization, both between
top and lower levels and also between lower level managers competing for budget money.
When top management establishes an overall budget at the start, they are saying, “this is
all we are willing to spend. “ Thus, all successive levels of the budgeting process must make
their estimates fit within the context of the overall budget that was established at the
outset. The positive side of the top down approache is that top management estimates of
project costs are often quite accurate, at least in the aggregate.
Bottom – up Budgeting :

Bottom – up Budgeting takes a completely different approach than that pursued by Top-
down methods. The bottom – up budgeting approach begins inductively from the work
breakdown structure to apply direct and indirect costs to protect activities.

In this budgeting approach, each project manager is required to prepare a project Budget
that identifies project activities and specifies funds requested to support these tasks. Under
these first – level budget requests, functional managers develop their own carefully
documented budgets, taking into consideration both the requirements of the firms projects
and their own departmental needs. This information is finally passed along to top managers,
who merge and streamline to estimate overlap or double counting. They are then
responsible for creating the final master budget for the organization.
 Bottom – up budgeting emphasizes the need to create detailed project plans, particularly
work breakdown structures, as a first step for budget allocations. It also facilitates
coordination between the project managers and functional department heads and because
it emphasizes the unique creation of budgets for each project, it allows top managers a
clear view for prioritization among projects competing for resources. On the other hand, a
disadvantage of bottom – up budgeting is that it reduces top management’s control of the
budget process to one of oversight rather than direct initiation, which may lead to
significant differences between their strategic concerns and the operational – level
activities in the organization. Also, the fire- tuning that often accompanies bottom – up
budgeting can be time consuming as top managers adjust and lower level managers
resubmit their numbers until an acceptable budget is achieved.
 Developing budget contingency :
A budget contingency is the allocation of extra funds to cover future uncertainties and
improve the chances that the project can be completed within the time frame originally
specified. The contingency is calculated as an extra cushion on top of the calculated
cost of the project. There are several reasons why it may make good sense to include
contingency funding in project cost estimates. Many of these reasons are given below
—
 Project scope is subject to change : Many projects aim at moving targets. That is, the
project scope may seem well articulated and locked in, but the project moves through its
development cycle, external events or entertainmental changes often force us to modify
or upgrade a projects goals.

 Murphys Law is always present : Murphys Law suggests that if something can go wrong, it
often will. Budget contingency represents one important method for anticipating the
likelihood of problems occurring during the project life cycle. Thus contingency planning
just makes prudent sense.
 Cost estimation must anticipate interaction costs: It is common to budget project
activities as independent operations. Thus, in a product development project, we
develop a discrete budget for each work package under product design, engineering,
machining and so forth. However this approach fails to recognize the often “ interactive”
nature of these activities.

 Normal conditions are rarely encountered: project cost estimates usually anticipate “
normal conditions “. Some of the ways in which the normal conditions assumption is
routinely violated include the availability of resources and the nature of environmental
effects. When resources are missing or limited, the activities that depend upon their
availability are often delayed, leading to extra costs. While project teams naturally favor
contingencies as a buffer for project stakeholders, particularly clients, is less assured.
 Some clients may feel that they are being asked to cover poor budget control
on the part of the project firm. Other clients object to what seems an
arbitrary process for calculating contingency. Despite these drawbacks, there
are several benefits to the use of contingency funding for projects, including :

 It recognizes that the future contains unknowns, and the problems that do arise are
likely to have a direct effect on the project Budget. In providing contingency, the
project allows for the negative effects of both time and money variance.

 Provision is made in the company plans for an increase in project cost. Contingency
has sometimes been called the first project fire alarm. Allowing contingency funds to
be applied to a project is a preliminary step in gaining approval for budget increases,
should they become necessary. It recognizes that the future contains unknowns, and
the problems that do arise are likely to have a direct effect on the project Budget. In
providing contingency, the project allows for the negative effects of both time and
money variance.
 Application to the contingency fund gives an early warning signal of a potential
overdrawn budget. In the event of such signal, the organizations top management
needs to take a serious look at the project and the reasons for its budget variance, and
begin formulating fallback plans should the contingency prove to be sufficient to cover
the project overspend.

Although we can not possibly anticipate every eventuality, the more care that is used
in initial estimation, the greater the likelihood that we can create a budget that is a
reasonably accurate reflection of the true project cost. Cost estimation challenges us to
develop reasonable assumptions and expectations for project costs through clearly
articulating the way we arrive at our estimates. Budgeting is the best method for
applying project expenditures systematically, with an eye toward keeping project costs
in line with initial estimates.