3 Project Costs and Budgeting: 3.

1 Objectives: The objectives of this unit is to understand the concept of costs of the project, their components and the process of project budgeting which deals with the process of spending money to complete the project. 3.2 Project Costs: Project cost is the total outlay on a project. If this amount is spent, the project can be completed without any cost over-run. Once the project is completed, it can commence the commercial operations. Now let us identify the project costs for a Project ABC: Capital Cost Estimates (Figures are left blank) Item Particulars Cost of SubItems 3 Item Costs

1 I

2 Advance expenditure (a) Prep, of prospect sheet (b) Survey of raw materials (c) Techno-economic survey (d) Project formulation costs Total advance expenditure

II

Cost of land (a) Cost of land (b) Cost of site development Total cost of land

III

Cost of buildings and civil works (a) Cost of project premises (b) Cost of administrative buildings (c) Cost of ancillary buildings (go downs) (d) Cost of residential buildings and civic amenities (e) Cost of services and other civil works Total building costs

IV

Plant and machinery costs (a) Cost of imported P and M (b) Cost of spares (c) Freight and insurance charges (d) Duties and taxes (e) Cost of indigenous P and M (f) Cost of spares (g) Freight and insurance charges (h) Local taxes and duties (i) Installation costs (j) Erection charges (k) Overhead expenses Total plant and machinery costs

Costs of ancillary and miscellaneous assets (a) Cost of ancillary plant (b) Installation and costs of ancillary plant (c) Erection charges for ancillary plant (d) Costs of ancillary equipment (workshop, fire fighting) (e) Costs of miscellaneous asset Total costs of ancillary and miscellaneous asset

VI

Invisible expenses (a) Costs of patents, licenses, copyrights, technical know-how, trade marks, etc. (b) Consultants fees for engineering services Total invisible expenses

VII

Special items not listed above (a) Registration fees (b) Pre-operation interest changes Total special items costs

VIII

Standing resource requirement costs

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(a) Overheads Total standing resource requirement costs

IX

Provision for escalation/Contingencies (a) Escalation on a/c of land costs (b) Escalation on a/c of building costs (c) Escalation on a/c of plant machinery (d) Escalation on a/c of ancillary assets (e) Escalation on a/c of other items Total provision for escalation Provision for contingencies and unforeseen item@-%of items I-IX

Total capital cost estimates for the project (I to x)

3.3 Means of Finance Financial Matrix for project ABC

S.No. 1. 2.

Means of Financing Promoters equity Share capital (a) Ordinary shares (b) Preference shares (c) Total

Repayment Rate of Amount schedule interest

3.

Secured long-term loans (a) Borrowings from financial institutions (b) Borrowings from others

4.

Unsecured long-term loans (a) From institutional sources (b) From others Government subsidies Other sources

5. 6. Total

3.4 Project Budgeting: Budgeting is a plan of spending. Budget is a very good tool for control of funds. It gives reasons for deviation in spending more than what has been budgeted. The management will be able to know, in time, when things are expected to go wrong so that a corrective action can be taken. In project budgeting, the main focus is on the process of estimation of the cost of a project and its pricing in detail.
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 Approximate Estimate: This is made without engineering data and is estimated by interpolating the expenditure on similar projects undertaken earlier. Their variations will be 15% on either side. Definitive Estimates: These are most accurate and are based on detailed engineering data. Their accuracy will be most and variation will be only 5% on either side. Based on Top-down or Bottom-up of the Work Breakdown Structure: Top-down budgeting: In this, the amount of resources to be allocated to the project as a whole is first estimated by the top level people in the organization. Their estimate is given to their immediate subordinates to be broken down into individual tasks and their costs. People at each level do the same until it reaches the last level of the organization, at which level the project is broken down at the smallest tasks possible. One advantage in this method is that the overall budget constraint is fixed at the top level and only essential activities will be funded. The disadvantage is that higher level executives may not like the lower level employees revising the figures. . Bottom-up budgeting: This is the reverse approach to the top-down budgeting. The estimation in this approach starts at the smallest work element, at the lowest level in the organization. Estimates are first made in terms of machine and man hours and are then converted into currency (rupee) and then resolved or revised through discussions with
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the seniors. The rupee estimates at each level are aggregated to get the estimates for the next higher level, starting from the lowest level on the work breakdown structure. The sum obtained at the higher level gives the total direct cost for the project. To this, the project manager adds general and administrative expenses, contingency margin, and also the profit margin if required. The advantage with this method is that the individuals who are in regular touch with technical activities will make a better estimate of the costs. The disadvantage lies in the higher level people not believing in the capabilities of the lower level people. 3.8 The Budgeting Process: The main steps involved in the budgeting process are as follows: The Kick-off Meeting: This is the first meeting of people from all departments concerned with budgeting to discuss WBS for providing dependable estimates. This meeting may be followed by several other meetings for clarity and follow up action. Estimation of Labor Requirements: All the line departments estimate the labor requirements for each task assigned to them in man-hours with justification thereof, and the estimation of wages and salaries based on the above. Then the project manager and the line managers call a meeting and finalize the same and will submit the estimates for approval by the top management or the sponsors. Estimation of Overheads:

Overhead costs are estimated based on overhead rates derived from three factors viz. direct labor rates, business base and the overhead expenses projected. Project manager exercises control over direct costs and overhead costs. Estimation of Materials and Support Services These are estimated on the basis of engineering standards. They are communicated to the project office called bill of materials, which contains the description of the materials required, the name of the supplier, expected cost, duration of shelf life, and estimated scrap value. Cost of supporting services like traveling, transportation of materials, etc is also estimated as a percentage of total direct cost. Pricing the Project The aggregate of all the costs viz. labor, overheads, materials and support services will give the total project cost. 3.8.1 Budgeting Techniques: Zero Based Budgeting System: Under this, each project or activity is evaluated, ranks are assigned, on the basis of relative importance and funding is first made to the projects considered most important, in the descending order of importance. This technique advocates against basing on past, while taking decisions for future (i.e. starting on zero basis). Planning-Programming-Budgeting System: This system is designed to assist in identifying and planning projects that maximize the achievement of an organizations long time goals.
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It involves planning for identifying the goals and objectives, programming i.e. analysis of each of the programs to be undertaken, budgeting i.e. estimating the total cost for each of the programs and choosing the portfolio i.e. selection of one of the projects based on comparison of costs, benefits etc. ___________________________________________________________________ Exercise: Arun Labs is a Pharma company which has purchased 4 acres of land near Hyderabad at a cost of Rs.15 lakhs. Site development is Rs.6 lakhs. The details of the project are given below. Central Subsidy is 15% and Debt:Equity Ratio is 2:1. A contingency provision has to be made on buildings at 15% and on plant & machinery at 10% Cost of the Project Land Site development Plant & Machinery: Imported 180.00 Import Duty 8.00 Freight from Port 3.00 Buildings & Civil works Other Fixed Assets Preliminary Expenditure Pre-operative Expenditure Working Capital Margin Rs.Lakhs Means of Finance Re.Lakhs 15.00 Promoters 70.00 Contribution 6.00 Term Loan from FI 200.00

191.00 50.00 40.00 32.00 30.00 26.00

Required: To find the Cost of the Project and Means of Finance. --------------------------------------------------------------------------------------------------------------------------------------3.12 Solution to the Self-check Exercise: Contingency 5% on Buildings Building Estimate: Contingency 5%: Rs.50.00 lakhs Rs.2.50 lakhs

Contingency on P&M 10% on landed cost of Rs.191 lakhs: Rs.19.10 lakh Total Contingency: Rs.2.5 lakhs + Rs.19.10 lakhs =Rs.21.60 lakhs Subsidy 15% on fixed investment of Rs.323.60 = Rs.48.50 lakhs approx. Cost of the Project Rs. Means of Finance Lakhs Land & Site 21.00 Promoters Development Contribution Plant & Machinery 191.00 Central Subsidy Buildings 50.00 Term Loan Other Fixed Assets 40.00 Contingencies 21.60 Pre-operative Expenses 30.00 Preliminary expenditure 32.00 Margin on Working 26.00 Capital Total 411.60 Total Means of Cost: Finance: Workings: Total Cost of the Project: Rs.411.60 lakhs Debt-Equity Ratio: 2:1 Equity: Rs.137.20 lakhs
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Rs. Lakhs 88.70 48.50 274.40

411.60

Promoters Contribution: Rs.88.70 lakhs Debt: Rs.274.40 lakhs __________________________________________________________________ Glossary: Budget: A plan expressed usually in financial terms Capital Structure: The composition of a firms long-term financing consisting of equity, preference capital and long-term debt. Risk: It refers to variability; it is measured by standard deviation. Term Loan: A loan which is generally in more than one year and less than ten years Top Down: A budgeting method that begins with top managers estimates of the resources needed for a project.

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