3. Financial Estimates and Projections

Subject - Project Management (62001)
Branch - Common for all Branches (CS,CE,ME,EE)
Semester - 6th Semester

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3. Financial Estimates and Projections 💰📊

Financial estimates and projections are a crucial part of the capital budgeting process. They provide insights into the financial aspects of a project, including its cost, financing, profitability, and cash flow. These projections help in evaluating the feasibility of a project and its expected financial performance. Let’s explore each aspect in detail.

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3.1. Cost of Projects 💵

Cost estimation is the process of determining the total expenditure required to complete a project. It involves assessing all the direct and indirect costs involved in setting up and running the project.

• Direct Costs: These are costs directly associated with the project, such as raw materials, labor, equipment, etc.

  • Example: For a manufacturing unit, direct costs would include materials for production, wages for workers, and the cost of machinery.

• Indirect Costs: These are overhead costs like rent, utilities, administrative expenses, and other costs that support the project but aren’t directly tied to production.

  • Example: Office rent, electricity, and general administrative staff salaries.

Cost estimation helps in creating a budget for the project and provides a foundation for financial projections.

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3.2. Means of Financing 💳

When it comes to financing a project, there are several options available. The choice of financing method depends on the type of project, its size, and the company's financial situation.

1. Equity Financing 📈:

   • This involves raising funds by selling shares of the company to investors. The investors gain ownership in exchange for their investment.
   • Example: A startup raising capital by issuing shares to angel investors or venture capitalists.

2. Debt Financing 💳:

   • This involves borrowing funds that need to be paid back with interest. Common sources include loans from banks, bonds, or other financial institutions.
   • Example: A company taking out a bank loan to fund its expansion.

3. Internal Financing 💡:

   • This involves using the company’s own funds, such as retained earnings, to finance the project.
   • Example: A company using profits from previous years to finance a new branch opening.

4. Hybrid Financing 💼:

   • A combination of debt and equity financing, which reduces the risk associated with relying solely on one source.
   • Example: A company might take a loan for a portion of the project cost and issue shares for the remaining amount.

Choosing the right method of financing is critical for the project's financial health and its future growth.

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3.3. Estimates of Sales and Production - Cost of Production 📉🔧

Sales Estimates: These are projections of the revenue a company expects to generate from selling its products or services over a certain period.

• Example: A company estimates it will sell 50,000 units of a new product at ₹500 each in the first year, generating ₹25,000,000 in revenue.

Cost of Production: This refers to the total cost incurred in producing goods or services. It includes the cost of raw materials, labor, overheads, and manufacturing expenses.

• Example: A company estimates that the cost to produce each unit of the product is ₹200, so the total cost of producing 50,000 units is ₹10,000,000.

The difference between sales revenue and the cost of production gives the company an estimate of the gross profit.

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3.4. Working Capital Requirement and Its Financing 💼💵

Working Capital refers to the funds required to manage the day-to-day operations of a business. It is the capital needed to cover the gap between current assets (like inventory and receivables) and current liabilities (like payables).

• Formula: $$\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$$
  

Working Capital Requirements depend on the type of business and its operational cycle. It can be used for purchasing raw materials, paying employees, or covering short-term expenses.

Financing Working Capital: Working capital can be financed through:

1. Short-term loans: Borrowing money to cover short-term operational needs.

   • Example: A company borrows ₹2,00,000 from a bank to cover its working capital gap for the next quarter.

2. Trade Credit: Getting credit from suppliers for purchases, where the company can pay later.

   • Example: A company purchases inventory on credit and pays the supplier in 60 days.

3. Internal Funds: Using retained earnings to fund working capital needs.

   • Example: Using the company's profits to cover short-term operational costs.

Proper working capital management ensures that the company maintains liquidity and can meet its financial obligations.

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3.5. Profitability Project, Cash Flow Statement, and Balance Sheet 📈📑

Profitability Project: This refers to the overall profit a company expects to generate from its project. It is typically evaluated by analyzing the Return on Investment (ROI), Net Profit, and other profitability ratios.

1. Net Profit: The total profit after all expenses, taxes, and costs are subtracted from revenue.

   • Formula: $$\text{Net Profit} = \text{Total Revenue} - \text{Total Expenses}$$
     
   • Example: A company expects a net profit of ₹5,00,000 after covering all its costs and expenses.

2. Return on Investment (ROI): A profitability ratio that measures the return on a specific investment.

   • Formula: $$\text{ROI} = \frac{\text{Net Profit}}{\text{Investment}} \times 100$$
     
   • Example: If the company invested ₹1,00,000 and generated ₹25,000 in profit, ROI = (25,000 / 100,000) * 100 = 25%.

Cash Flow Statement: A cash flow statement tracks the inflow and outflow of cash within a company during a particular period. It is used to assess the liquidity position and ensure that the company can meet its short-term obligations.

• Operating Activities: Cash inflows and outflows from core business operations.
• Investing Activities: Cash flows related to investments in assets, such as purchasing equipment or selling property.
• Financing Activities: Cash flows from borrowing, repaying debt, or issuing stock.

Balance Sheet: A balance sheet provides a snapshot of a company’s financial position at a specific point in time. It lists all of the company’s assets, liabilities, and equity.

• Assets: What the company owns (cash, inventory, property).
• Liabilities: What the company owes (debts, loans).
• Equity: The owner’s share of the business (assets minus liabilities).

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3.6. Breakeven Analysis ⚖️

Breakeven Analysis helps determine the level of sales at which a project or business will cover its total costs, with no profit or loss. It identifies the point where Total Revenue = Total Costs.

• Formula:

  $$\text{Breakeven Point} = \frac{\text{Fixed Costs}}{\text{Selling Price per Unit} - \text{Variable Cost per Unit}}$$

• Example: If a company has fixed costs of ₹200,000, sells a product for ₹500 per unit, and has variable costs of ₹300 per unit, the breakeven point would be:

  $$\text{Breakeven Point} = \frac{200,000}{500 - 300} = 1,000 \text{ units}$$
  

  This means the company needs to sell 1,000 units to cover all its fixed and variable costs.

Breakeven analysis helps in decision-making, pricing, and assessing the risk involved in a project. It’s crucial for determining how much a company needs to sell to become profitable.

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Summary 📑

• Cost of Projects: Estimating all costs involved in the project, both direct and indirect.
• Means of Financing: Identifying whether the project will be funded through equity, debt, or internal resources.
• Sales and Production Estimates: Projecting future sales and calculating the cost of production.
• Working Capital Requirements: Determining the funds needed for daily operations and how to finance them.
• Profitability and Financial Statements: Evaluating profitability through financial statements like cash flow and balance sheets.
• Breakeven Analysis: Identifying the sales level required to cover all costs and achieve zero profit/loss.