Financial Management in

Construction

CoTM

Melaku Adane
March, 2018
 CHAPTER 1: Introduction
An Overview of Financial Management

 Capital Requirement of a Firm

 Fields of Finance
 Forms of business organization
 Goals of Financial Management
 Functions of Financial Management
 Organization of Finance Functions
 What is Financial Management all
about?
 FM is the planning for, acquiring and
Utilizing of funds in order to maximize the
efficiency and value of the firm
 It involves
 Forecasting & Planning
 Major investment and financing decisions
 Coordination and Control
 Risk Management
 Cont’d

 No matter what the nature the proposed business

is and how it is organized, one has to address the
following questions.
 What capital investment should be made? That
is what kind of material and equipment should
be purchased, or building to be rented, etc.
 How and where the money to pay for the
proposed capital investment will be raised?
 How the day-to-day financial activities are
handled like collecting the receivables and
paying the suppliers?
 Cont’d

It has now broaden to deal with issues like:

 Which new proposals for employing capital should be
accepted by the firm?
 What steps can be taken to increase the value of the
firm’s common stock?
 How much working capital will be needed to support
and expand the company’s operation?
 Where should the firm go to raise the short and long-
term capital demand and how much will it cost?
 Should a firm declare a cash dividend on its common
stock and if so, how much a dividend should be
declared?
 Cont’d

 The term finance can be defined as the

management of the flows of money or its
equivalent through an organization, whether
it is a for or not-for profit firms, corporation or
non-corporate business, or government
agency.
Finance concerns itself with the actual flow of
money as well as any claims against money.

 The flow of fund is a continuous process

 Cash Flow in a Firm
Stockholders’ Other Corporations, Creditors
(Equity) Businesses and Agencies (Debt)

Outside Investment Loan Payment Loan

Dividends

Investment
CASH
Collections

Purchase Sale Payment Accounts

Payment for of Assets of Assets of Expenses Receivables
Material

Personal Expenses
Fixed Wages, Benefits Net Net
Raw Assets Credit Cash
& Operating Exp.
Materials Sales Sales
Sales
Depreciation Labor Expense
Expense

Work in Product
Process Inventories
 Cash flow of contractors towards project
participants

Financial
Equipment
Institutions
and Form & Sub
False Works Contractor
Rent

Construction Contractor
Plant Supplier’s
Products Credit
Sales

Head office
Project owner finance
- Payments (Own reserve)
 Major financial demand required for
Construction works include:

 Financial demand for Tendering

 Financial demand for Contracting
 Financial demand for Inputs
(Resources)
 Financial demand for Supervision
 Financial demand for Payment
Processing
 The Financing Problem

 The project finance problem is to obtain funds

to bridge the time between making
expenditures and obtaining revenues
 Investment in a construction project
represents a cost in the short term that returns
benefits only over the long term use of the
facility.
 Costs occur earlier than the benefits, and
owners of facilities must obtain the capital
resources to finance the costs of construction.
 REAL WORLD

Finance on the back of a postage stamp

The leading textbooks in finance are nearly 1,000

pages long. Many students learn by making notes
on each topic. They then summarize their notes.
Here is one student’s summary of his Finance
course . . .
 Time is money . . .
 Don’t put all your eggs in one basket . . .
 You can’t fool all the people all of the time.
 Sources of Finance to Contractors

 Internal
Cash flow from operations
Sale of assets
 External
owners (equity)
creditors (debt)
 Debt vs. Equity Financial Securities

 Debt Security
 It arises when a firm borrows money
from creditors. The firm incurs liability
to repay the amount of money
borrowed in some future maturity date
 Equity Securities
 It represents ownership claim in the
firm. People who purchase equity
securities are entitled to rights and
conditions that are different from those
of firm’s creditors
 Debt vs. Equity Financial Securities
 Debt security
 There's relatively less loss of ownership
through warrants.
 It's a less-expensive financing option: it costs
more than senior bank debt but less than
equity.
 The loan must be repaid and includes interest
charges, but the interest is tax deductible.
 The company needs to provide security on
the loan, perhaps even personal guarantees.
 It's unlikely there'll be management advisors,
but financial disciplines and controls may be
imposed by the lender.
 Debt vs. Equity Financial Securities
 Equity security
 There's a distinct loss of ownership.
 It's the most expensive financing option with
the cost of capital.
 The capital stays in the business for the
long term; dividends are taxable.
 The valuation of the company is a huge
issue in landing the capital.
 Investors will want a say in how the
business is run and may elect to take seat(s)
on the board of directors.
 2. Fields of Finance
Fields of finance Fund owned by Fund collected through Use of fund
Public Finance Federal, State and Local Revenue from taxes and To accomplish Social and
Government levies, Loan , Grant Economic objectives.
etc Perform non-profit oriented
corporations.
Finance Securities Individuals, Institutional Purchase and sale of Means of raising finance for
investors stocks and bonds. institutional investors.
Means of achieving profit
for individuals.
International Finance Individuals, businesses Through International Means of collecting foreign
and governments transactions currency.
involved in
international
transactions

Institutional Finance Banks, Insurance Individual savers Finance function of the

companies, and economy through capital
pension funds and formation.
credit unions.
Alternative Forms of Business
Organization
 Sole proprietorship
 Partnership
 General Partnership
 Limited Partnership

 Corporation
 Joint Venture
 Sole Proprietorship

 Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
 Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital
 Partnership

 A general partnership has roughly

the same advantages and
disadvantages as a sole
proprietorship.
 Corporation

 Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
 Disadvantages:
Double taxation
Cost of set-up and report filing
Double Taxation of Corporate Profits/Income
Assume Corporate and Individual Tax = 50%
Earnings Before Taxes $100 EBT
($50) Corporate Tax
Net Income After Tax $50 NIAT (Profits)
Assume 100% Div. Payout $50 Dividend income
($25) Personal Income
$25 After-tax Income
 Joint Venture

A joint venture is a partnership agreement in

which two or more individual- or group-run
businesses join together to carry out a single
business project sharing the initial investment &
risks.

In the Ethiopian Code:

“A joint venture is an agreement between
partners on terms mutually agreed and is
a subject to the general principles of law
relating to the partnerships.”
 Goals of Financial Management
 Profit Maximization:
 It is vague
 It leaves consideration of timing and
duration undefined
 It overlooks future aspects
 Wealth Maximization:
 Avoid high level of risk
 Pay consistent dividend
 Seek growth in Sales
 Maintain market Price of Stocks
 Functions of Financial Management

 Liquidity functions
 Forecasting Cash flow
 Raising Funds
 Managing the flow internal funds
 Profitability functions
 Cost Control
 Pricing
 Forecasting profits
 Profit-risk analysis
 Managing assets
 Organization of Finance Function

 Most firms designate three major

financial positions
Chief Financial Officer (CFO)
Treasurer
• Managing cash flows
• Forecasting financial need
• Relations with FI
Controller
• Financial accounting, internal auditing,
taxation, payroll functions
 CFO

Treasurer Controller

Cash Credit Financial Management

Manager Manager Accounting Accounting
Manager Manager

Capital Fund Tax Data

Budgeting Raising Manager Processing
Manager Manager Manager

Portfolio Internal
Manager Auditor
 End of
Chapter 1