Construction Management Chair

FINANCIAL MANAGEMENT IN
CONSTRUCTION

Chapter 2
Financing Decisions
MINWEYELT EJIGU
2020/2021
 Contents
Financing Decisions

1. Short Term Financing

2. Medium Term Financing
3. Long Term Financing

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Financing Decisions
 The availability of resource is dependent on the
current cash position of the company and the ability
to acquire additional sources of funding for the
project support.
 Thus part of the investment and financing
decisions, management should
1. Review the firm’s profitability & cash
position
2. Forecast future cash needs
3. Determine possible methods of attaining
additional funds through short term/or long
term financing. 3
1. Short Term Financing
1.1 General
 Short-term financing usually includes loans that
mature within a year or less.
 Such loans are frequently used to raise
temporary funds to cover seasonal or cyclic
business peak or special funding needs involving
a short time frame.
 Short term loans are generally self-liquidating
in that the assets acquired with the borrowed
money should be easily convertible to cash with
high degree of certainty.

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1. Short Term Financing

1.2 Goals of Short Term Financing

 Finance inventories during a production/construction
period. Short-term financing allows the firm to
match its funds against its needs over an annual,
seasonal or other cyclical period.
 To achieve low-cost financing. The interest-free
sources provide low-cost financing for the firm by
reducing its borrowing need from interest-bearing
sources.

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1. Short Term Financing
1.3 Sources of Short Term Financing
1.3.1 Unsecured Interest-free Sources
 Accounts Payable;/Trade Credit from
Suppliers
 Accruals ( sub contracts, salaries,
wages, taxes)
 Advance payments(10-30%)
 Advance for purchase of
materials/material on site.

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1.3.2 Unsecured Interest-Bearing Sources

 Self-Liquidating Bank Loans

 Single payment note(30-90 days) lending a business
customer with as lump sum repayable with interest in a
single payment and at a specified maturity, usually 30 to
90 days.
 Unsecured overdraft facility/line of credit (usually
one year , agreement b/n bank and the firm)
 An agreement between Bank and Firm where by the
bank agrees to make available upon demand up to a
stipulated amount of unsecured short-term funds.
 Revolving credit agreement (Extended Lines of Credit
to avoid the need to reexamine the credit worthiness of a
customer each time a small loan is required.)
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1.3.2 Unsecured Interest-Bearing Sources

 Non Bank Short-Term Sources

 Commercial Paper/Bond Commercial paper
Short-term unsecured promissory notes issued by
a corporation.
 The maturity of commercial paper is typically
less than 270 days; the most common maturity
range is 30 to 50 days or less.
 Private Loans

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 1.3.3 Secured Short Term Loans

 A secured loan occurs when the borrower

pledges a specific asset, collateral, to back
a loan.
 Collateral may be in the form of:
 Warehouse receipt loan;
 Receivables:
o Pledging of accounts receivable; and
 Physical assets.

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2. Intermediate Term Financing
 Intermediate-term financing usually includes loans with
maturity between 1 to 5 years.
 Intermediate-term finance categories:
 Revolving Credit Agreement;
 Term Loan; and
 Lease.
 Intermediate-term financing institutions:
 Commercial Bank Loans;
 Insurance Companies;
 Pension Funds; and
 Equipment Manufacturers.

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 3. Long Term Financing
3.1 General
 Long-term financing usually refers to the borrowing of
money for a long period of time in order to invest in fixed
assets relatively permanent in nature with long life.
 The Two Common sources:
 Debt: Sources can be classified into two:
o Term loans; and
o Bonds.
 Equity:
o Ownership money acquired through the sale of
stocks.
o Ownership rights in the company and includes:
 Preferred Stock,
 Common Stock,
 Contributed capital in excess,
 Retained earnings. 11
Equity Vs. Debt
 Debt investors are entitles to a contractual set of cash
flows ( interest and principal) whereas equity investors
have a claim of residual flows of the firm after it has
satisfied all other claims and liabilities.
 Interest paid to debt investors represents a tax-deductible
expense whereas dividend paid to equity investors has to
come out of profit after tax.
 Debt has a fixed maturity whereas equity ordinarily has
infinite life.
 Equity investors enjoy the privilege to control the affairs
of the firm whereas debt investors play a passive role.
However, they often impose certain restrictions on the
way the firm is run to protect their interests.
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Equity Capital
1. Common Stock
 The most basic form of ownership that a corporation
issues.
 Dividends are paid based on how well company
does or does not do (normally issued at or above par)
 The value of a common stock is directly influenced
by the successes and failures of the issuing company.
 It may or may not pay a dividend, which is the
portion of the company's profits paid out to its
shareholders.
 They have a residual (leftover) claim to all corporate
income that is not paid out to others.
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I. common Stock
 Common shareholders have the right to vote on
all major issues, including election of the board
of directors.
 Rights and Position of Equity Shareholders:
 Right to income: The equal investors have a residual
claim to the income of the firm. The income left after
satisfying the claims of all other investors belong to the
equity shareholders. This income is simply equal to
profit after tax minus preferred dividend.
 Right to Control: Equity shareholders as owners of the
firm elect the board of directors and have the right to
vote on every resolution placed before the company.
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I. common Stock

 Pre-emptive Right: It enables existing equity

shareholders to maintain their proportional
ownership by purchasing the additional equity
shares issued by the firm.
 Right in Liquidation: In the event of liquidation,
claims of all others – bondholders, secured and
unsecured lenders, preferred stock – are prior to
the claim of equity shareholders.

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ii. Preferred Stock
 Has a fixed dividend that must be paid before
dividends on common stock
Itis an expensive source of financing
No right to vote
Claim come before common stock
Preferred Stocks have lower risk.
Receive dividends before common (fixed
amount)
 upon company liquidation, receive assets
before common.
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Equity Capital

iii. Retained Earnings

 Represents the only internal source of financing for
expansion and growth.

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 Long-Term Debt
i. Term Loans
 Represents a source of finance which is generally
payable in 5 to 10 years.
 Used for acquisition of fixed assets and working capital
margin
ii. Bonds
 Issue a bond with the promise of paying the
investor (Bond holding firm) a designated
interest on his money at certain scheduled
intervals of time.

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Quiz +Assignment (10%)
 Financial institution and other finance, contribute a good
source of finance for a construction industry by providing
different loan arrangements: Discus in detail the
following loan arrangements and in which conditions they
should be adopted? (5%) {Assignment}
1) Construction loans
2) Equipment financing
3) Overdraft facilities
4) Bridge financing
 Discus in detail the following financial
institutions/government Agencies Financial Relationship
with construction companies.(5%) {Quiz}
1) Banks
2) Insurance companies
3) Pension fund
4) Insurance Broker companies
5) Revenue and Custom Authority 19
THANK YOU!

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