Unit-4

Project Cost Estimation:

1. Cost estimation in project management is the process of forecasting the financial and other
resources needed to complete a project within a defined scope.

2. Cost estimation is the process that takes various factors into account, and calculates a
budget that meets the financial commitment necessary for a successful project.

3. Estimating cost is an important process in project management as it is the basis for

determining and controlling the project budget.

4. Cost estimation accounts for each element required for the project- from materials to
labour and calculate a total amount that determines a project's budget

5. Once the project is in motion, the cost estimate is used to manage all of its affiliated costs
in order to keep the project on budget.

6. Good cost estimation is essential for keeping a project under budget. Many costs can
appear over the life cycle of a project, and an accurate estimation method can be the
difference between a successful plan and a failed one.

The elements of cost estimation in project management:

i. Labour: The cost of team members working on the project, both in terms of wages and
time.

ii. Materials and equipment: The cost of resources required for the project, from physical
tools to software to legal permits.

iii. Facilities: The cost of using any working spaces not owned by the organization.

iv. Vendors: The cost of hiring third-party vendors or contractors.

v. Risk: The cost of any contingency plans implemented to reduce risk.

Different types of project cost estimation techniques are:

1. Analogous Estimating: It assumes using the actual cost of previous or analogues projects
as the foundation for estimating the cost of the current project. This technique is usually
applied to separate segments of the project and in combination with other methods and tools.
2. Statistical Modeling: It allows using historical and statistical data to make a model of
activity parameters (like scope, budget and duration). It may provide a higher degree of
accuracy depending on the data ir.cluded in the statistical model. The technique can be used
separately as well as in combination with other approaches and tools.

3. Bottom-Up Estimating: This analysis supports the idea that the individual cost of each
activity or entire work package is of prime importance. By using the method, individual
scheduled activities, or a work package, can be estimated to the smallest detail.
4. Top-down Estimating: This technique is opposite to Bottom-up Analysis. It assumes that
the overall budget is determined at the project's beginning and the expert team needs to
identify the costs of each work item.

5. Three-point Estimate: The three-point estimation technique in used in management and

information systems applications for the construction of an approximate probability
distribution representing the outcome of future events, based on very limited information. It
comes up with three scenarios, most likely, optimistic and pessimistic ranges. These are then
put into an equation to develop estimation.

6. Reserve Analysis: Since Quality Assurance and Quality Control are integrated parts of the
cost estimation process, this technique is used to deal with uncertainties by making reviews.

Working Capital:

1. Working Capital is a part of the capital which is needed for meeting day to day
requirement of the business concern.

2. For example, payment to creditors, salary paid to workers, purchase of row materials etc.,
normally it consists of capital which is recurring in nature. It can be easily converted into
cash. Hence, it is also known as short-term capital.

3. Working capital is described as the capital which is not fixed. Working capital is
considered as the difference between the book value of current assets and current liabilities.

4. Working capital management is one of the important parts of the financial management. It
is concerned with short-term finance of the business concern which is a closely related trade
between profitability and liquidity.

5. Working capital is related to short-term assets and short-term sources of financing. Hence
it deals with both, assets and liabilities,

6. Efficient working capital management leads to improve the operating performance of the
business concern and it helps to meet the short term liquidity.

Concept of Working Capital: Working capital can be classified or understood with the help
of the following two important concepts

A Gross Working Capital:

i. Gross Working Capital is the general concept which determines the working capital
concept.
ii. Thus, the gross working capital is the capital invested in total current Resets of the
business concern.

iii. Gross Working Capital is simply called as the total current assets of the concern.
Gross Working Capital = Current Assets

B. Net Working Capital:

i. Net Working Capital is the specific concept which considers both current assets and current
liability of the concern.

ii. Net Working Capital is the excess of current assets over the current liability of the concern
during a particular period.

iii. If the current assets exceed the current liabilities it is said to be positive working capital; if
it is reverse, it is said to be Negative working capital. Net Working Capital = Current Assets -
Current Liabilities

Working capital may be of different types as follows:

a. Gross Working Capital: Gross working capital refers to the amount of funds invested in
various components of current assets. It consists of raw materials, work in progress, debtors,
finished goods, etc.

b. Net Working Capital: The excess of current assets over current liabilities is known as Net
working capital. The principal objective here is to learn the composition and magnitude of
current assets required to meet current liabilities.

C. Positive Working Capital: This refers to the surplus of current assets over current
liabilities.

d. Negative Working Capital: Negative working capital refers to the excess of current
liabilities over current assets.

e. Permanent Working Capital: The minimum amount of working capital which even
required during the dullest season of the year is known as Permanent working capital.

f. Temporary or Variable Working Capital: It represents the additional current assets

required at different times during the operating year to meet additional inventory, extra cash,
etc.

Fund:

1. Funding refers to the money required to start and run a business.

2. Funding for projects may be via a single source or through multiple investors. The
governance of the project will vary to meet the needs of the investors in the project and the
life cycle option chosen.

3. It is a financial investment in a company for product development, manufacturing,

expansion, sales and marketing, office spaces, and inventory.

4. Many startups choose to not raise funding from third parties and are funded by their
founders to prevent debts and equity dilution.
5. However, most startups do raise funding, especially as they grow larger and scale their
operations.

Different types of funds for starting a project are:

1. Governmental Grant: A grant is a sum of money given by a government or other
organisation for a particular, purpose.
2. Fund by Partners: Partnerships can help manage costs by sharing buildings, equipment,
expertise and workloads.
3. Borrowed Money: Borrowing money can be an option if your project can repay the loan.
4 Investor Funds: Investors are looking for opportunities to put their funds into, providing
this private equity returns a profit.
5. Donation: If a project is appealing to the community people like to show support for a
good cause by giving a donation.
6. Crowd Funding: Crowd funding uses the internet to connect with potential funders.
7. Revenue Fund: Growing revenue and conserving cash are effective ways to improve a
bank balance that support the project financially.
8. Selling up: Selling up a project might sound drastic, but when the time is right sometimes
it is better to let go of a project and allow someone else to take control.

Source of Funds (SOF): Source of Funds refers to the origin of the particular funds or any
other monetary instrument which are the subject of the transaction between a Financial
Institution and the customer.
Classification of Source of funds:

1. On the basis of the period, sources of funds can be classified into three types:

i. Long-term sources: These sources fulfill the financial requirements of a business for a
period more than 5 years. Such financing is generally required for the procurement of fixed
assets such as plant, equipment, machinery etc.
ii. Medium-term sources: These are the sources where the funds are required for a period of
more than one year but less than five years.
iii. Short-term sources: Funds which are required for a period not exceeding one year are
called short-term sources.

2. On the basis of ownership, the sources can be classified into two types:

i. Owner's funds: funds which are procured by the owners of a business, which may be a
sole entrepreneur or partners or shareholders of a business. It also includes profits which are
reinvested in the business.
ii. Borrowed funds: The funds raised with the help of loans or borrowings. This is the most
common type of source of funds and is used the majority of the time.

3. On generation bases sources funds are of two types:

i. Internal sources of funds: These are type of funds that are generated inside the business.

ii. External sources of funds: These are the sources that lie outside an organization, such as
suppliers, lenders, and investors.

Capital Budgeting :

1. It is the process of making investments decisions in long term assets. It is the process of
deciding whether or not to invest in a particular project as all the investments possibilities
may not be rewarding.

2. Process of capital budgeting ensure optimal allocation of resources and helps management
work towards the goal of investor profit maximization.

3. Capital budgeting also refers to the total process of generating, evaluating, selecting and
following up on capital expenditure alternatives.

4. Thus, capital budgeting is a decision making process through which a business concern
evaluates the purchases of various fixed assets for expansion and replacement.

5. Capital budgeting is also known as investment decision making, capital expenditure

decisions, planning capital expenditure and analysis of capital expenditure.

6. Capital budgeting techniques are invariably used in all types of investment opportunities
from the purchase of a new piece of machinery to whole factory.

Objectives of Capital Budgeting:

1. To ensure the selection of the possible profitable capital projects.

2. To guarantee the effective control of capital expenditure in order to achieve by forecasting

the long-term financial requirements.

3. To make estimation of capital expenditure during the budget period and to see that the
benefits and costs may be measured in terms of cash flow.

4. Determining the required quantum takes place as per authorization and sanctions.

5. To expedite co-ordination of inter-departmental project funds among the competing capital

projects.

6. To guarantee maximization of profit by allocating the available budget.

Process of Capital Budgeting:

i. Capital Budgeting process is the process of planning which is used to evaluate the potential
investments or expenditures whose amount is significant.

ii. It helps in determining the company's investment in the long term fixed assets such as
investment in the addition or replacement of the plant & machinery, new equipment, research
& development, etc.

iii. It is the process of deciding whether or not to invest in a particular project as all the
investment possibilities may not be rewarding.

iv. While capital budgeting several phases are involved in the process. These processes are
given below in sequence.

Phases of capital budgeting:

1. Planning: The planning phase encompasses investment strategy and the generation and
preliminary screening of project proposals. The investment strategy offers the framework that
shapes and guides the identification of individual project opportunities.

2. Analysis: If the preliminary screening proposes that the project is worth investing, a
detailed analysis of the marketing, technical, financial, economic, and ecological aspects is
conducted.
3. Selection: The selection process addresses the matter whether the project is worth
investing. Several appraisal criteria are used to judge the value of a project.
4. Financing: After choosing a project, proper financing must be made. Flexibility, risk,
income, control and taxes are the vital business considerations that influence the capital
structure decision and the choice of specific instruments of Financing.

5. Implementation: The implementation phase has following stages:

i. Project and engineering designs

ii. ii. Negotiations and contracting

 iii. Construction

iv. Training

v. V Plant commissioning

6. Review: Once the project is commissioned, a review phase has to be done. Performance
review should be done occasionally to compare the actual performance with the projected
performance.

Risk:

1. A risk is an unplanned event that may affect one or some of the project objectives if it
occurs.
2. The risk is positive if it affects the project positively, and it is negative if it affects the
project negatively.
3. Risk is any unexpected event that can affect the project for better or for worse.
4. Risk can affect anything including people, processes, technology, and resources involve in
a project.

Uncertainty

1. Uncertainty is a lack of complete certainty. In uncertainty, the outcome of any event is

entirely unknown, and it cannot be measured or guessed.

2. Uncertainty is ability to predict outcome of parameters or foresee events that may impact
the project.

3. Uncertainties have a defined range of possible outcomes described by functions reflecting

the probability for each outcome.

4 In uncertainty, you completely lack the background information of an event, even though
it has been identified.

The following are differences between risk and uncertainty:

S.No. Risk Uncertainty

1. In risk, you can predict the In Uncertainty, you cannot predict

possibility of a future outcome. the possibility of a future outcome.
2. Risk can be managed by several Uncertainty cannot be controlled by
tools and techniques. any means.
3. Risk can be measured and Uncertainty cannot be measured
quantified. and quantified.
4. Probability can be assigned to risk Probability cannot be assigned on
events. any type of uncertainty.
Risk management:

Risk management is the act of identifying, evaluating, planning for, and then ultimately
responding to threats to the business or a project.
Process of risk Management involves following given steps:

1. Identify the Risks:

i Being able to identify the type of risk is vital to the risk management process.

ii. Organizations can identify their risk through experience and internal history, consulting
with an industry professional and external research.

iii. Risks management is an important process because it empowers a business with the
necessary tools so that it can adequately identify and deal with potential risks.

2. Analyze the Risk:

i To determine the severity and seriousness of the risk it is necessary to see how many
business functions the risk affects.

ii. When a risk management solution is implemented one of the most important basic steps
is to map risks to different policies, procedures, and project processes.

iii. This means that we already have a mapped risk framework that will evaluate risks and let
us know the far-reaching effects of each risk.

3. Evaluate or Rank the Risk:

i. Risks need to be ranked and prioritized from most severe to lowest level of risk.

ii. Risks that can be catastrophic to the organization are ranked highest while risks that
cause an inconvenience are ranked lower on the list.
By knowing the level of the risk and the impact it will have on the project, management
knows how best to intervene if a risks occur.

4. Treat the Risk:

1. When the organization has identified the risks and ranked them in order of high to low,
each risk needs to be eliminated or contained as much as possible.

2. This is usually done by connecting with the experts in each department or field to which
the risk belong, to discuss the risk and solution is the key to understanding how to eliminate
or contain the risk.

5. Monitor and Review the Risk:

1. There are some risks that cannot be completely eliminated and risk management isn't
something that has a start and finish, or end result. It is an ongoing process within a project
that is constantly changing.

2. The project, its environment, and its risks are constantly changing, so the process should
be consistently revisited

3. If an organization gradually formalizes its risk management process and develops a risk
culture, it will become more adaptable in the face of change.

Project Risk Analysis:

1. Project risk analysis is a process which enables the analysis of risk associated with a
project.

2. Properly undertaken it will increase the likelihood to successful completion of a project to

cost, time and performance objective.

3. All projects are prone to some kind of risk or the other. All projects are appraised making
certain assumptions.

4. Assumptions in project appraisal are unavoidable since no two projects are unique in all
respects and hence a new project cannot be compared with old one.

5. The assumptions being made can be listed as:

i. Project cost estimates.

ii. Life of project.

iii. Estimate of demand, production, sales and prices.

iv. Political and social development.

v. Change in technology, price and productivity

B. Techniques of Project Risk Analysis:

1. Breakleven analysis,

2. Sensitivity analysis,

3. Decision tree analysis,

4. Monte-Carlo analysis, and

5. Game theory.

C. Types of Project Risk:

a. Project Completion Risk:

1. Completing the project in time and within estimated cost is a major achievement.

2. Project time overrun results in cost overrun.

3. If additional funds are not pumped in, the project may come to grinding halt.

4. Project overrun can be due to bad management or technological obsolescence during

implementation of project of long gestation period.

b. Resource Risk: Shortage of raw material, power fuel, skilled manpower will jeopardize all
profitability calculation as there will be reduction in capacity utilization, increase in
production cost and reduction in estimated return.

C. Price Risk:

1. Price fluctuation of both input and output can have adverse effect on performance of the
project.

2. The government intervention in price fixation and capability of competitors to sell the
product at a lower price will affect the project performance.

d. Technology Risk:

1. Use of non-proven technology.

2. Obsolescence of technology due to larger time spent on project.

e. Political Risk:

1. Levying and regulating taxes.

2. Regulating monopolistic trade practices.

3. Imposing import duties.

4. Promoting expert.

5. Price control.

6. Nationalization.

7. Prohibiting export of certain products.

f. Interest Rate Risk:

1. Fluctuation of interest rate on long term borrowing can adversely affect the project.

g. Exchange Rate Risk:

1. Company exposed to international economy is adversely affected by volatile exchange

rate.

D. Break Even Analysis in Project Risk Analysis:

1. The cost of inputs and price of output are decided by influence of market forces.

2. The only thing that is under the control of project promoter is the level of output.

3. It is very essential to know the level of operation below which the project will incur losses.
Breakeven point (BEP) refers the level of operation at which the project neither earn profit
nor incur losses.

4. Therefore, analysis of BEP becomes important to decide the level of operation to avoid
the possibility of loss.

Income Statement:

1. An income statement is one of the three (along with balance sheet and statement of cash
flows) major financial statements that reports a company's financial performance over a
specific accounting period.

2. Net Income (Total Revenue + Gains) - (Total Expenses + Losses)

3. Total revenue is the sum of both operating and non-operating revenues while total
expenses include those incurred by primary and secondary activities.

4. Revenues are not receipts. Revenue is earned and reported on the income statement.
Receipts (cash received or paid out) are not.
5. An income statement provides valuable insights into a company's operations, the
efficiency of its management, under-performing sectors and its performance relative to
industry peers.

Income Statement Components:

1. Revenue:

Revenue is the money an entity receives from the sale of goods or services. Other terms
frequently used for revenue are sales, net sales, or sale revenue

2. Cost of Goods Sold:

Cost of goods sold are the direct costs of producing the goods being offered by the entity.
This would include the materials, labor, and other resources required for production.

3. Gross Profit:

Gross profit is the difference between the revenue received for the product less the cost of
goods sold.

4. Operating Expenses:

Operating expenses are the amount an entity expends to maintain and operate the general
business. Operating expenses include research and development, marketing, general and
administrative, amortization of intangible assets etc.

5. Operating Income:

Operating income is equal to revenues minus cost of goods sold and operating expenses.

6. Other Income/Expenses:

To obtain net income, further adjustments must be made to account for interest income
and expense, income tax expenses, and other extraordinary and miscellaneous items.

7. Profits:

Revenues minus all expenses equal net income (profits or losses).

Importance of an income statement:

1. An income statement helps business owners decide whether they can generate profit by
increasing revenues, by decreasing costs, or both.

2. It also shows the effectiveness of the strategies that the business set at the beginning of a
financial period.
3. The business owners can refer to this document to see if the strategies have paid off.
Based on their analysis, they can come up with the best

Funds Flow Statement:

1. Funds Flow Statement is a method by which we study changes in the financial position of
a business enterprise between beginning and ending financial statements dates. It is a
statement showing sources and uses of funds for a period of time.

2. Fund flows are a reflection of all the cash that is flowing in and out of a variety of financial
assets.

3. Fund flow is usually measured on a monthly or quarterly basis.

4. The performance of an asset or fund is not taken into account; only share redemptions, or
outflows, and share purchases, or inflows.

5. Net inflows create excess cash for managers to invest, which theoretically creates
demand for securities such as stocks and bonds.

Importance of fund flow statements are:

1. The financial statements reveal the net effect of various transactions on the operational
and financial position of a concern.

2. It throws light on many questions of general interest which otherwise may be difficult to
be answered, such as:

i. Why were the net current assets lesser in spite of higher profits and vice-versa
ii. Why more dividends could not be declared in spite of available profits?

3. Sometimes a firm has sufficient profits available for distribution as dividend but yet it may
not be advisable to distribute dividend for cash resources. In such cases, funds flow
statement helps in the formation of a realistic dividend policy.

4. The resources of a concern are always limited and it wants to make the best use of these
resources. A projected funds flow statement constructed for the future helps in making
managerial decisions,

5. A projected funds flow statement also acts as a guide for future to the management

6. A funds flow statement helps in explaining how efficiently the management has used its
working capital and also suggests ways to improve working capital position of the firm

7.It Helps Knowing the Overall Creditworthiness of a Firm.

Cash flow statement:

1. A cash flow statement (CFS) is a financial statement that summarizes the amount of cash
and cash equivalents entering and leaving a company.

2. The CFS measures how well a company manages its cash position, meaning how well the
company generates cash.

3. The CFS complements the balance sheet and the income statement.

4. The main components of the CFS are cash from three areas: operating

activities, investing activities, and financing activities.

5. The two methods of calculating cash flow are the direct method and the indirect method.

i. Direct Cash Flow Method:

The direct method adds up all of the various types of cash payments and receipts, including
cash paid to suppliers, cash receipts from customers, and cash paid out in salaries.

This method of CFS is easier for very small businesses that use the cash basis accounting
method.

ii. Indirect Cash Flow Method:

With the indirect method, cash flow is calculated by adjusting net income by adding or
subtracting differences resulting from non-cash transactions.

Non-cash items show up in the changes to a company's assets and liabilities on the balance
sheet from one period to the next.
Objectives: The main objectives of cash flow statement are:

1.Measurement of Cash:

Inflows of cash and outflows of cash can be measured annually which arise from operating
activities, investing activities and financial activities.

2. Generating inflow of Cash:

Timing and certainty of generating the inflow of cash can be known which directly helps the
management to take financing decisions in future.

3. Classification of activities:

All the activities are classified into operating activities, investing activities and financial
activities which help a firm to analyse and interpret its various inflows and outflows of cash.
4. Prediction of future:

A cash flow statement, no doubt, forecasts the future cash flows which helps the
management to take various financing decisions since synchronisation of cash is possible.

5. Assessing liquidity and solvency position:

Both the inflows and outflows of cash and cash equivalent can be known, and as such,
liquidity and solvency position of a firm can also be maintained as timing and certainty of
cash generation is known i.e. it helps to assess the ability of a firm to generate cash.

6. Evaluation of future cash flows:

Whether the cash flow from operating activities are sufficient in future to meet the various
payments (eg. payment of expense/debts/dividends/ taxes).

7. Supply necessary information to the users:

A cash flow statement supplies various information relating to inflows and outflows of cash
to the users of accounting information in the following ways:

To assess the ability of a firm to pay its obligations as soon as it becomes due;

To analyse and interpret the various transactions for future courses of action;

ii. To see the cash generation ability of a firm;

Detailed Project Report:

1. After the planning and the designing part of a project are completed, a detailed project
report is prepared.

2. A detailed project report is a very extensive and elaborative outline of a project, which
includes essential information such as the resources and tasks to be carried out in order to
make the project turn into a success.

3. DPR (Detailed Project Report) is the primary report for the formulation of the investment
proposal. Investment decisions are taken based on the details incorporated in the study.

4. The first step in feasibility study is the needs analysis. The purpose is to define overall
objectives of the system proposed to be designed.

5. After the preparation of feasibility study report, it is being reviewed by experts in the
concerned department. In case of any differences, the report is modified as discussed with
experts.
6. Preparation of Detailed Project Report is further step in firming up the proposal. When an
investment proposal has been approved on the basis functional report and the proposal is a
major proposal.

Contents of a detailed project report must include the following information:

i. Brief information about the project

ii. Experience and skills of the people involved in the promotion of the project

iii. Details and practical results of the industrial concerns of the promoters of the project

iv. Project finance and sources of financing

V. Government approvals
vi. Raw material requirement
vii. Details of the requisite securities to be given to various financial organizations
viii. Other important details of the proffered project idea include information about
management teams for the project, details about the building, plant, machinery, etc.

Objectives of Detailed Project Report (DPR):

1. The report should be with sufficient details to indicate the possible fate of the project
when implemented.

2. The report should meet the questions raised during the project appraisals, i.e. the various
types of analyses be it financial, economic, technical, social etc. should also be taken care of
in the DPR.

Various steps for project financing:

1. Pre-Financing Stage:

i. Identification of the Project Plan: This process includes identifying the strategic plan of
the project and analysing whether its plausible or not. In order to ensure that the project
plan is in line with the goals of the financial services company, it is crucial for the lender to
perform this step.
ii. Recognising and Minimising the Risk: Risk management is one of the key steps that
should be focused on before the project financing venture begins. Before investing, the
lender has every right to check if the project has enough available resources to avoid any
future risks.

iii. Checking Project Feasibility: Before a lender decides to invest on a project, it is

important to check if the concerned project is financially and technically feasible by
analysing all the associated factors.

2. Financing Stage:
i. Arrangement of Finances: In order to take care of the finances related to the project, the
sponsor needs to acquire equity or loan from a financial services organisation whose goals
are aligned to that of the project.

ii. Loan or Equity Negotiation: During this step, the borrower and lender negotiate the loan
amount and come to a unanimous decision regarding the same.

iii. Documentation and Verification: In this step, the terms of the loan are mutually decided
and documented keeping the policies of the project in mind.

iv. Payment: Once the loan documentation is done, the borrower receives the funds as
agreed previously to carry out the operations of the project.

3. Post-Financing Stage:

i. Timely Project Monitoring: As the project commences, it is the job of the project manager
to monitor the project at regular intervals.

ii. Project Closure: This step signifies the end of the project.

iii. Loan Repayment: After the project has ended, it is imperative to keep track of the cash
flow from its operations as these funds will be, then, utilised to repay the loan taken to
finance the project.