Claudiu Albulescu - UPT · • Investment ratios (IRR, NPV, ROI) IV. CASH FLOW ANALYIS V. FINANCIAL MANAGEMENT: TASKS L3 FINANCIAL MANAGEMENT IN CONSTRUCTION COMPANIES ... - The break-even

2C11

Business economics and entrepreneurship

Claudiu Albulescu

Lecture 3: Financial management in construction companies (03/05/2017)

European Erasmus Mundus Master Course

Sustainable Constructions

under Natural Hazards and Catastrophic Events520121-1-2011-1-CZ-ERA MUNDUS-EMMC

L10 – B.2 – Mechanical properties of cast iron, mild iron and steel at historical structures


Sustainable Constructions under Natural

Hazards and Catastrophic Events

Lectures

L1 Trends and challenges for the construction industry

L2 Business strategies and business development in construction companies

L3 Financial management in construction companies

L4 Project management – generalities

L5 Project management – support activities

L6 Project management systems applied in constructions

L7 Entrepreneurship issues

L8 Risk management in construction company

L9 Standard contracts in civil engineering

L10 Summary and discussion of the exam questions

Applications

A1 Examples of financial and cash flow analyses

A2 General presentation of the case study (WTP – Hunedoara)

A3 Financial and cash flow analysis (case study: WTP – Hunedoara)

A4 Project’s presentation

A5 Project’s presentation

LIST OF LECTURES

Lecture 3: Financial management in construction companies





OBJECTIVES

- Student is familiar with the basic economic concept used in the construction

industry

- Student understands the role and the structure of the main financial

statements

- Student can use common financial ratios and interpret them

- Student can make a cash flow analysis based on projected expenditures and

revenues

- Student is familiar with the tasks performed by a financial manager

L3 FINANCIAL MANAGEMENT IN

CONSTRUCTION COMPANIES






TOPICS

I. BASIC ECONOMIC CONCEPTS

• Expenditures

• Costs

• Prices & Revenues

• Profit

• Break-even point

II. FINANCIAL STATEMENTS

• Income statement

• Balance sheet

III. FINANCIAL RATIOS

• Activity ratios (Sales dynamics, Inventories dynamics, Total asset turnover ratio)

• Debt ratios (Total Liabilities/Total Assets)

• Profitability ratios (ROE, ROA)

• Liquidity ratios (Quick ratio, Current ratio)

• Investment ratios (IRR, NPV, ROI)

IV. CASH FLOW ANALYIS

V. FINANCIAL MANAGEMENT: TASKS








TOPICS

• Expenditures

• Costs


• Profit








Expenditures

- Represent the amounts of money that support the activity of a company. Are

the monetary expression of the production factors consumption (i.e. capital, work

force, natural factors).

- Examples:

• Operating expenses: Staff costs (wages, social contributions, taxes, etc.),

Capital costs (equipment, plants, technologies, materials etc.), Land,

Administration, Rent.

• Financial expenses (interests, provisions, etc.)

• Unexpected expenses (penalties, loses due to natural causes).

- Their inclusion in one or another category depends on the accounting system

(European continental, Anglo-Saxon system, etc.).

- A complete list with expenditures is found in the Income statement (detailed

version).







TOPICS

• Expenditures

• Costs


• Profit








Costs

- Accountants use the term of expenditures, economists employ the term costs

- The production cost include only those expenses items generated by the production (Q)

process

- Categories of costs:

• Fixed (indirect) and variables (direct) costs

A. Fixed costs are independent of output. These remain constant throughout the relevant

range, on short-term (depreciation, rent, managers wages, administration, interests)

B. Variable costs vary with output. Generally variable costs increase at a constant rate

relative to labor and capital. Variable costs may include employees wages, utilities,

materials used in production, etc.

• Total and unit costs (each of them are fixed and variables)

A. Total costs, including direct and indirect components are the costs related to the entire

production volume (i.e. for 10 steel beams)

B. Unit costs (direct and indirect component) are the costs per unit (i.e. for 1 steel beam)







Costs

Total costs (C) and output volume (Q)

C = FC + VC (Total costs = Fixed costs + Variable costs)

UC = UFC + UVC (Unit cost = Unit fixed cost + Unit variable cost)



Q

C

0

FC

VC

C

𝑈𝐶 =𝐶

𝑄

Costs Total Unit

Fixed FC UFC

Variable VC UVC





TOPICS

• Expenditures

• Costs


• Profit








Prices & Revenues

• The price (P) is the quantity of money paid for a unit of goods and

services

• The prices of factors of production (inputs) = costs of production

• The prices establishment is influenced by the type of the market (perfect

competition, oligopoly, monopoly)

• An increase in general level of prices on the market = inflation

• The revenues of a company can come from its sales (turnover), from interests

(bank accounts) or other sources. The turnover (T) is the more important

component of the revenues.

𝑇 = 𝑃 × 𝑄

Ex.: If a firm produce a quantity (Q) equal to 20 pumps in a specific period and

sells these pumps with a price (P) of 200 Euros each, the turnover T equal 4,000

Euros.







TOPICS

• Expenditures

• Costs


• Profit








Profit

• The profit is the differences between revenues and expenditures. Simplifying,

the profit (Pr) is the difference between turnover (T) and costs (C).

𝑃𝑟 = 𝑇 − 𝐶

!! When the profit is calculated per unit (i.e. the profit generated by a single traded

pump), we refer to profit margins (Pm), as the difference between the price (P)

and the cost per unit (UC).

𝑃𝑚 = 𝑃 − 𝑈𝐶 ; 𝑚(%) =𝑃 − 𝑈𝐶

𝑃× 100

• In accounting (the Anglo-Saxon system), we find different forms of profit:- Gross profit equals sales revenue minus cost of goods (expenses related to directly to

production)

- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

- Earnings Before Interest and Taxes (EBIT)

- Earnings Before Taxes (EBT)

- Net Income, obtained after paying the taxes.

• Factors influencing the profit: volume of production, efficiency, market prices,

strategy, etc.







TOPICS

• Expenditures

• Costs


• Profit








Break-even point

??? What volume of production or of the turnover is necessary in order to obtain

profit?

!!! The profit is not generated automatically after the start of a business (the fixed costs are high

while the output volume is reduced)

- The break-even point corresponds to the output level (Qbep) where the firm starts

to obtein profit (in this point, the profit is zero).


Lecture 3: Financial management in construction companiesQ

C

0

FC

VC

C

T

bep

Qbep

Loss

Profit





TOPICS


• Expenditures

• Costs


• Profit




• Balance sheet
















TOPICS



• Balance sheet







Income statement

DEF: An income statement (profit

and loss account) shows the

company’s revenues and expenses

during a particular period.







Income statement

Resume



Revenues

Expenses

PROFIT

Revenues

Expenses

LOSS





TOPICS



• Balance sheet







Balance sheet

DEF: A balance sheet

summarizes an organization or

individual's assets, equity and

liabilities at a specific point in

time.

Equity = Owners’ contribution

Liabilities = Bank loans + Other

debts (i.e. state, employees, etc.)







Balance sheet

Resume



Balance sheet

Assets Liabilities and Owners' Equity

Show which is the wealth of the company (the patrimony, the value).

Represents a snapshot of a company's technical condition.

Show where the money came from (owners or loans).

Represents a snapshot of a company's financial condition.

Perfect equality





TOPICS


• Expenditures

• Costs


• Profit




• Balance sheet
















FINANCIAL RATIOS

• Activity ratios (Sales dynamics, Inventories dynamics, Total asset turnover

ratio)











FINANCIAL RATIOS

• Activity ratios

Sales dynamics ∆𝑆𝑎𝑙𝑒𝑠[%] =𝑆𝑎𝑙𝑒𝑠𝑡1−𝑆𝑎𝑙𝑒𝑠𝑡0

𝑆𝑎𝑙𝑒𝑠𝑡0[%]

Inventories dynamics ∆𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠[%] =𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠𝑡1−𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠𝑡0

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠𝑡0[%]

Total asset turnover ratio - measures the ability of a company to use its assets to

efficiently generate sales (the lower the ratio is, the more sluggish the firm's

sales)

Total asset turnover ratio [%]=Net sales𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑠𝑡

[%]







FINANCIAL RATIOS

• Debt ratios – the higher the ratio is, the grater the failure risk is

𝐷𝑒𝑏𝑡 𝑟𝑎𝑡𝑖𝑜 % =𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠[%]

• Profitability ratios (ROE – return on equity, ROA – return on assets)

measures a firm's efficiency at generating profits (Net income = Profit)

𝑅𝑂𝐸[%] =𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒

𝐸𝑞𝑢𝑖𝑡𝑦[%]

𝑅𝑂𝐴 % =𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠[%]


𝑄𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 =𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠Evaluate the firm's ability to pay its short-term debt obligations

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 =𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠Measures the ability to meet current obligations in a timely manner. A healthy

current ratio is greater than 2.







FINANCIAL RATIOS

• Investment ratios – used in business plans, feasibility studies,

etc.(investment opportunities)

!!! The feasibility study would be completed prior to the business plan. The feasibility study helps

determine whether an idea or business is a viable option and is usually made when we have a

construction objective (economic and technical parts).

IRR - internal rate of return (measure and compare the profitability of

investments). IRR is the discount rate (interest rate, i.e. 10 %) at which the

present value of all future cash flow is equal to the initial investment (NPV=0)







FINANCIAL RATIOS

• Investment ratios

NPV – Net present value of a time series of cash flows, both incoming and

outgoing, is defined as the sum of the present values of the individual cash flows

of the same entity (NPV is an indicator of how much value an investment or

project adds to the firm; value added in NPV >0)

ROI - Return on investment - is used to measure, per period, rates of return on

money invested in an economic entity in order to decide whether or not to

undertake an investment. It is also used as indicator to compare different project

investments within a project portfolio.







TOPICS


• Expenditures

• Costs


• Profit




• Balance sheet
















CASH FLOW

DEF: Is the movement of money into or out of a business or investment project.

Purpose: to determine problems with a business's liquidity (risk) and to determine a

project's rate of return or value.

Importance of cash management in construction

- Construction projects have inherent cash management problems

- One of the major problems is the range in the cost of projects, which can vary

- Large cash outflows take place during periods when cash inflows do not

- Cash management problems are often multiplied by other factors like: Sensitivity to

current economic trends; Lack of sufficient bank credit facilities; Low industry

profitability; Inadequate tax planning; Wrong pricing strategy.







CASH FLOW

Cash Flow Analysis:

- The goal in measuring project cash flow is to accelerate receipts so that there is a

positive cash flow from each contract (receive payments from the owner before the

cash payments to subcontractors, material suppliers, employees, and others)

- The cash flow analysis should be based on time periods (e.g., monthly, yearly) for

each contract or for each segment or activity of each contract in process (the

purpose is to identify the cash needs).

- To complete the cash-forecasting function, the projected cash flow from jobs in

process should be combined with non-job-related cash flows (general and

administrative expenses, interest, fixed assets expenditures, taxes, etc.).

- Cash flow analysis include all components which generate cash movements

(inwards and outwards).







CASH FLOW







CASH FLOW – construction (1)







CASH FLOW – construction (2)







CASH FLOW - general







CASH FLOW – tips

- Billing practices and the controlling of job expenditures are two important areas

that further enhance a contractor's cash flow

- Billing practices are related to: (1) comparison between number of days until

paying the suppliers and number of days until receiving payments from customers;

(2) retention by the owner, which is usually 10% of the progress billing of a portion

of the cash due on the contract (performance security)

- Factors that should be considered by the contractor when negotiating billing terms

in the contract with the owner include the following:

• Payment schedule

• Weekly billing procedures (when contracts are field-labor intensive)

• Payment for materials stored on-site prior to installation

• Contract closeout and punch-list procedures

• Rights to submit claims (approved and unapproved)

• Eliminating or minimizing retention provisions







TOPICS


• Expenditures

• Costs


• Profit




• Balance sheet
















TOPICS

Goals

Financial Manager Tasks

Key balance sheet accounts







Goals

- DEF: Financial management is the process of planning decisions in order to

maximize the owners' wealth.

- Financial managers have a major role in:

• cash management,

• in the acquisition of funds ,

• in all aspects of raising and allocating financial capital, taking into account the

trade-off between risk and return.

- Company goals usually include:

• stockholder wealth maximization

• profit maximization

• managerial reward maximization

• social responsibility

!!! The traditional goal frequently stressed by economists-profit maximization is

not sufficient for most construction companies today.







Goals








- Financial managers need accounting and financial information to carry out their

responsibilities.

- Tasks



Accounting Payroll

Reporting financial information Maintaining banking relationships

Interpreting financial data Investing funds

Budgeting Obtain financing

Controlling operations Investor relations

Preparing taxes Managing cash

Managing assets Disbursing dividends

Internal auditing Deciding on the financing mix

Reporting to authorities Managing pension funds












Financial Manager Tasks (!!! In large companies, the tasks are split)







Key balance sheet accounts (necessary to manage the cash)



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CONTACT

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Documents

Claudiu Albulescu - UPT · • Investment ratios (IRR, NPV, ROI) IV. CASH FLOW ANALYIS V. FINANCIAL MANAGEMENT: TASKS L3 FINANCIAL MANAGEMENT IN CONSTRUCTION COMPANIES ... - The break-even