Download Working Capital Requirement and Its Financing

MBA (Trimester)
(MBA – Finance and MBA – Banking and Finance)
Module Title : Project Finance and Management
Term V
UNIT II: – Project Market and Demand Analysis
Lesson 2.3 : Financial Estimates and Projections
Cost of Project
The cost of project represents the total of all items of outlay associated with a
project which are supported by long-term funds. It is the sum of the outlays on
the following:
• Land and site development
• Buildings and civil works
• Plant and machinery
• Technical know-how and engineering fees
• Expenses on foreign technicians and training of Indian technicians abroad
• Miscellaneous fixed assets
• Preliminary and capital issue expenses
• Pre-operative expenses
• Margin money for working capital
• Initial cash losses
Means of Finance
To meet the cost of the project the following means of finance are
available:
• Share capital
• Term loans
• Debenture capital
• Deferred credit
• Incentive sources
• Miscellaneous sources
Project Financing Decision
The key business considerations relevant for the project financing
decisions are:
•
Cost
•
Risk
•
Control
•
Flexibility
Estimates of Sales and Production
In estimating sales and production, assume that:
•
The capacity utilisation would be at 40-50 percent of the installed
capacity in the first year, 50-80 percent in the second year, and 8090 percent from the third year onwards.
•
Production and sales will be equal.
•
The selling price used may be the present selling price.
Estimates of Production and Sales
(Details may be furnished separately for each product and until the plant reaches
maximum capacity utilisation)
1.
Installed capacity (qty per day per annum)
2.
No. of working days
3.
No. of shifts
4.
Estimated production per day (qty)
5.
Estimated annual production(qty)
6.
Estimated output as % of plant capacity
7.
Sales (qty) (after adjusting stocks)
8.
Value of sales (in’000 of Rs)
Product
Product
1st 2nd 3rd 4th
yr yr yr yr
1st 2nd 3rd 4th
yr yr yr yr
Product
(i)
(ii)
(iii)
Note : Production in the initial period should be assumed at a reasonable level of utilisation of
capacity increasing gradually to attain full capacity in subsequent years.
Cost of Production
Given the estimated production, the cost of production may be worked
out. The major components of cost of production are:
•
Material cost
•
Utilities cost
•
Labour cost
•
Factory overhead cost
Working Capital Requirement and Its Financing
In estimating the working capital requirements and planning for its financing,
bear in mind the following:
•
The working capital capital requirement consists of raw materials and
components, work-in-process, finished
goods, consumable stores,
debtors, and operating expenses.
•
The principal sources of working capital finance are working capital
advances provided by commercial banks, trade credit, accruals and
provisions, and long-term sources of financing.
•
There are limits to obtaining working capital advances from commercial
banks. They relate to the maximum permissible bank finance for
working capital and the amounts that can be raised against each
individual current asset.
Profitability Projections (or Estimates of Working Results)
Given the estimates of sales revenues and cost of production, the next step is to prepare
the profitability projections or estimates of working results (as they are referred to by
term-lending financial institutions in India). The estimates of working results may be
prepared along the following lines:
A Cost of Production
B Total administrative expenses
C Total sales expenses
D Royalty and know-how payable
E Total cost of production (A+B+C+D)
F Expected sales
G Gross profit before interest
H Total financial expenses
I Depreciation
J Operating Profit (G - H - I)
K Other income
L Preliminary expenses written off
M Profit/loss before taxation (J+K - L)
N Provision for taxation
O Profit after tax (M - N)
Less Dividend on
- Preference capital
- Equity capital
P Retained profit
Q Net cash accrual (P+I+L)
Cash Flow Statement
Sources of Funds
1.
Share issue
2.
Profit before taxation with interest added back
3.
Depreciation provision for the year
4.
Development rebate reserve
5.
Increase in secured medium and long-term borrowings for the project
6.
Other medium/long-term loans
7.
Increase in unsecured loans and deposits
8.
Increase in bank borrowings for working capital
9.
Increase in liabilities for deferred payment (including interest) to machinery
suppliers
10. Sale of fixed assets
11. Sale of investments
12. Other income (indicate details)
Total (A)
Disposition of Funds
1.
Capital expenditure for the project
2.
Other normal capital expenditure
3.
Increase in working capital*
4.
Decrease in secured medium and long-term borrowings
- All India Institutions
- SFCs
- Banks
5.
Decrease in unsecured loans and deposits
6.
Decrease in bank borrowings for working capital
7.
Decrease in liabilities for deferred payments (including interest) to machinery
suppliers
8.
Increase in investments in other companies
9.
Interest on term loans
Multi-Year Projections
Having learnt the basics of projections, we shall now look at an illustration
wherein financial projections are made over a longer time frame.
A new firm, ABC Limited, is being set up to manufacture alloy steel. The
expected outlays and proposed financing during the construction and the first
two operating years are shown in Exhibit 6.9.
The projected revenues and costs for the first two operating years are shown
in Exhibit 6.10. It may be assumed that (i) the tax rate for the firm will be 60
per cent, (ii) no deductions (reliefs) are available, (iii) preliminary and preoperative expenses will not be written off during the first two operating years,
and (iv) no dividend will be paid in the first two operating years.
Based on the above information, the projected profit and loss statements,
projected cash flow statements, and projected balance sheets may be prepared
as shown in Exhibits 6.11, 6.12, and 6.13.
Exhibit 6.11
Projected Profit and Loss Statements of ABC Limited
Exhibit 6.12
Projected Cash Flow Statements for ABC Limited
Exhibit 6.13
Projected Balance Sheets of ABC Limited
SUMMARY
• To judge a project from the financial angle, we need information about the
following : (i) cost of project, (ii) means of financing, (iii) estimates of sales and
production, (iv) cost of production, (v) working capital requirement and its
financing, (vi) estimates of working results (profitability projections), (vii) breakeven point, (viii) projected cash flow statements, and (ix) projected balance sheets.
• The cost of project represents the sum of all items of outlay associated with a
project which are supported by long-term funds. It is the sum of outlays on the
following:
(i) land and site development, (ii) buildings and civil works, (iii) plant and
machinery, (iv) technical know-how and engineering fees, (v) expenses on foreign
technicians and training of Indian technicians abroad, (vi) miscellaneous fixed
assets, (vii) preliminary and capital issue expenses, (viii) pre-operative expenses,
(ix) provision for contingencies, (x) margin money for working capital, and (xi)
initial cash losses.
• To meet the cost of project, the following sources of finance (referred to commonly
as the means of finance) may be available: share capital (equity capital and
preference capital), term loans (rupee term loans and foreign currency term loans),
debenture capital (non-convertible debentures and convertible debentures), deferred
credit, incentive sources (seed capital assistance, capital subsidy, and tax deferment
or exemption), and miscellaneous sources (unsecured loans, public deposits and lease
and hire purchases finance)
• To determine the specific means of finance for a given project, the following
should be borne in mind:(i) norms of regulatory bodies and financial institutions,
and (ii) key business considerations, namely cost, risk, control, and flexibility.
• Typically, the starting point for profitability projections is the forecast for sales
revenues. In estimating sales it is reasonable to assume that capacity utilisation
would be somewhat low in the first year and rise thereafter gradually to reach
the maximum level in the third or fourth year of operation.
• The major components of cost of production are: material cost, utilities cost,
labour cost, and factory overhead cost. The material cost comprises the cost of
raw materials, chemicals, components, and consumable stores required for
production. The cost of utilities is the sum of the cost of power, water, and fuel.
The labour cost includes the cost of all manpower employed in the factory. The
expenses on repairs and maintenance, rent, taxes and insurance on factory
assets, and so on are collectively referred to as factory overheads.
• In estimating the working capital requirement and planning for its financing, the
following must be borne in mind: the build up of current assets till the rated level
of capacity utilisation is reached, the maximum permissible bank finance as per
the second method of lending recommended by the Tandon Committee, and the
margin requirements against various current assets.
• The profitability projections or estimates of working results (as they are referred
to by term-lending financial institutions) are prepared along the following lines:
(i) cost of production, (ii) total administrative expenses, (iii) total sales expenses,
(iv) royalty and know-how payable, (v) total cost of production (vi) expected sales,
(vii) gross profit before interest, (viii) total financial expenses, (ix) depreciation,
(x) operating profit, (xi) other income, (xii) preliminary expenses written off, (xiii)
profit/loss before taxation, (xiv) provision for taxation, (xv) profit after tax, (xvi)
dividend,(xvii) retained profit, and (xviii) net cash accrual.
• The cash flow statement shows movement of cash into and out of the firm and
its net impact on the cash balance with the firm.
• The balance sheet, showing the balance in various asset and liability
accounts, reflects the financial condition of the firm at a given point of time.