Assignment No 4-Construction Finance Management and Cost Accounting

NICMAR CONSTRUCTION FINACE MANGEMENT & COST ACCOUNTING

ASSIGNMENT

ON

MODULE NO: 19

COURSE NO : NCP 29

SEMESTER : 02

NUMBER OF PAGESS: 22

SUBMITTED BY:

RAJESH M. R

REG NO: 210-12-14-8895-2112

Assignment 4 1


I N D E X PAGE

INTRODUCTION 03

FINANCE MANAGEMENT 04

PROJECT SCOPE 04

ENVIRONMENTAL SENSETIVITY 08

FININCIAL WORKING CAPITAL 11

FININCIAL EVALUTION BASED ON THE ESTIMATE 14

FININCIAL AND ECONOMICAL EVELUTION 16

AREA STATEMENT AND PROJECT DETAIL 19

RECOMANDATION AND CONCLUSION 21

BIBLOGRAPHY 22

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1. INTRODUCTION:-

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 rise not more than Rs. 50lakhs as bank loan.

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2. FINANCE MANAGEMENT:-

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.

3. 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

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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:

Management staffs.

Professional staffs.

Supervising staffs.

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, output can do assessed based on the nature of work.

For example, for labours, one labour can do the earthwork excavation up to 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

labor can do 2 cubic meter of soil.

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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, anyone 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.

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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: -

Profit will decrease.

Manpower will be blocked.

Further planning hampered.

Slow work more overheads.

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

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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.

4. ENVIORNMENT SENSITYVITY

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.

Shelter entries and windows and use architectural shading devices and landscaping

to minimize cooling losses.

Use energy efficient materials in doors and windows.

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Use energy efficient lighting.

Mitigate urban heat island effects.

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 ECONOMICA 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-term sources, the more conservative

the firms 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. 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:

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Cost of having trade credit.

Cost of extending liberal credit terms to debtors.

Cost of letting or allowing cash to remain idle.

Cost of managing cash in off periods, and

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.

Raising long-term debt.

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

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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.

5. FINANCE 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.

THE 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

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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

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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 EXPENCES

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

Narrow floor plans to optimize natural daylight

High benefit lighting upgrades

Under floor air distribution and displacement ventilation

Occupant control of heat, light and air

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.

6. 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

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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:

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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.

7. FINANCIAL AND ECNOMIC 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

Liquidity

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

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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

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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 average investment

3. Discounted cash flows techniques

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

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K = cost capital

N = life of the project

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.

Payback period

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

8. AREA STATEMENT AND 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.

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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 as 400X5000X12 = 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)

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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.

Ideally, this choice should be clear well in advance so they have sufficient warning and

details can be agreed. Detailed planning and resourcing for the following phase should be

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performed well in advance. Where team members will be leaving, their next role or assignment

should be identified

9. 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.

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BIBLIOGRAPHY

TEXT BOOKS PROVIDED BY NICMAR

GUIDE LINES OBTAINED FROM SENIORS.

PERSONAL SITE EXPERIENCE

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Assignment No 4-Construction Finance Management and Cost Accounting

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