Session guide: Project design and implementation
Reading note: Financial management 3: Project design and implementation
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DATE |
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FORMAT |
Plenary participatory lecture |
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TRAINER |
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OBJECTIVES | |
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At the end of this session, participants should be able to appreciate: | |
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1. The care to be exercised by top management in the design of projects and programmes of the institute, particularly when such decisions may lead to acquisition of, fixed assets and hence involve capital expenditure. |
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2. Strategies for mobilizing resources for the development and growth of the organization. |
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3. Benefits of computerizing the finance function. |
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INSTRUCTIONAL MATERIALS | |
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Exhibit 1 |
Recurrent-cost coefficient |
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Exhibit 2 |
Break-even analysis |
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Exhibit 3 |
Portfolio of financing sources |
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REQUIRED READING | |
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Case study: National Institute of Food Research, (see Module 7 - Session 1) |
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Reading note: Financial management 3: Project design and implementation. |
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BACKGROUND READING | |
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None. |
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SPECIAL EQUIPMENT AND AIDS | |
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Overhead projector and chalkboard |
The next issue to be discussed is project design and implementation. Project budgeting and monitoring is an important component of this. Recurrent costs have to be provided over the life of the project. Show EXHIBIT 1 and discuss the recurrent-cost coefficient. Guidelines could be stipulated for recurrent costs. Capital costs have to be estimated carefully. Dovetailing different sources of finance for a project is a must.
Now introduce the concept of break-even analysis of projects. Show EXHIBIT 2. Break-even analysis is an approach which helps to identify the level of activity at which funds allocated to a project are just sufficient to recover the operational costs. In an agricultural research institute this may not be directly relevant.
Show EXHIBIT 3 to initiate discussion on financing of projects. For a research organization, the portfolio of financial resources usually consists of government grants and aid flows.
Research organizations - like all other organizations - face recurrent-cost problems, which have adverse implications for scientific work. Thus revenue mobilization is a continuous process which research managers have to pursue.
This session should be concluded by stressing the need for computerization of the finance function. Note that computerization will be discussed in detail in another session. Computerization should enable fast processing of data and can be used to identify interdependencies in financial and accounting variables. Mention the use of electronic spreadsheets and database management systems.
EXHIBIT 1
RECURRENT-COST COEFFICIENT
EXHIBIT 2
BREAK-EVEN ANALYSIS
Grants sanctioned for the project
· Fixed grants, e.g., grants received from the government
· Variable receipts, e.g., fees charged for services rendered
Costs associated with the project
· Fixed costs
· Variable costs
EXHIBIT 3
PORTFOLIO OF FINANCING SOURCES
INTERNAL SOURCES OF FUNDS
Government grants
· Plan expenditure
· Non-plan expenditure
Aid flows
· From domestic agencies
· From international agencies
Borrowing from national and international agencies
· Nominal-interest or interest-free loans ('soft loans')
· Market-interest loans ('commercial' or 'hard' loans)
Project design and activity implementation
Break-even analysis of projects
Financing of projects
Recurrent-cost problems
Computerization of financial functions
Electronic spreadsheets
Database management systems
Summary
Literature sources used in preparing the reading notes
The design of projects, programmes and activities is critical to the future of an organization. Management has to evaluate the financial dimensions of new projects and activities very carefully. Selection of better, financially viable projects ensures optimal allocation of scarce long-term resources.
Each project generally requires resources in terms of land and buildings, equipment, staff and, in some situations, foreign exchange. Most of the decisions related to initiating new projects are irreversible in nature. Resources employed in one project cannot be put to an alternative use. In selecting new projects, management must ensure that the new venture fits within the overall objectives of the organization. There should be a perfect match between what the organization is currently doing and what it intends to do in future. This will also be decided in the context of the administrative capability of the organization.
Project budgeting and monitoring
Most new projects and programmes involve investment of funds, for which estimates must be made very carefully. A major part of these investments would involve equipment and other fixed assets.
Each project involves recurrent costs for maintaining and operating the project. The recurrent-cost implications must be assessed carefully in advance of selecting a project. While designing new projects and programmes, management should take into account not only current but also future commitments. A balance must be achieved between these two commitments. During the design phase, the financial dimensions of the project must be considered and discussed in detail. A project can lead the organization to disaster if it is based on unsound financial suppositions.
The previous sessions in this module described aspects of budget preparation. In the same way, the organization must prepare budgets for each proposed activity. These budgets should have a long timeframe and project details should include information about:
· capital or development costs;
· recurrent costs; and
· sources of funds.
The capital cost of a project must be estimated very carefully. The experience of most organizations is that actual capital costs turn out to be much higher than projected. Projections of operating and maintenance costs should include factors such as inflation, likely growth and expansion of the activity, etc. Finally, the budget must provide information about different sources of funds for financing the project.
Almost every project has a capital expenditure component. Once the capital expenditure phase is over, the project requires recurrent expenses to maintain and run the project. The organization should prepare separate budgets for capital and recurring costs because:
· there are always technical differences in financial administration of capital expenditure and recurrent-cost expenditure;· the bulk of capital expenditure is very often financed by external sources, whereas a more of the recurrent costs would be financed through internal accruals, and hence the controls for the two would be different; and
· factors causing recurrent costs to grow are not related to capital expenditure.
The capital budget of a project should always be set relative to the recurrent expenditure budget and the rate at which it should grow. Management should always aim to check that there is no overspending. The relationship between recurrent and capital expenditure can be quantified as follows:
This coefficient relates the annual recurrent costs of the project to the total capital expenditure. A higher coefficient indicates that the organization would be required to raise a larger amount of money to meet the recurrent costs. This coefficient can be very useful in situations where the organization is in an early phase of development and with a comparatively high dependence on external finance or loans.
To examine whether a project is going in the right direction, management can:
· lay down guidelines for recurrent costs, not just for the year for which the estimates are under preparation, but for a longer period. While projecting the upper limit for recurrent costs, the organization should consider real growth rates and expected inflation;· set non-monetary ceilings for recurrent costs such as human resources employment, thus providing an effective way to monitor whether a project is proceeding as expected;
· estimate accurately the time needed to bring the project to its operational stage; and
· examine administrative capabilities for project implementation.
The organization should critically evaluate all new projects. Critical evaluation is necessary to emphasize internal controls and justify the costs. One of the important dimensions of this evaluation is to find the operating level which justifies the costs implicit in the activity. There will always be a scale of activity below which the costs do not justify starting the proposed activity. The knowledge of this level of activity is necessary for decision making. Break-even analysis is an approach which helps management to identify the critical level of activity, namely the break-even level, which is that level of activity at which funds allocated to the project are just sufficient to cover costs of operation. If the activity is operated below this level, the project will incur losses. In order to find this break-even level, management requires information on:
· funding sources sanctioned for the project, which usually are- fixed grants, such as grants received from government, and
- variable receipts, such as participation fees charged; and· costs associated with the project, which again will be
- fixed costs, and
- variable costs.
The break-even level of activity would be identified by equating the two revenue and two cost components. This is an important tool in project analysis. One can also find break-even levels under different revenue levels.
Financing is an important component of project design. When designing a project, the organization must make a realistic assessment of both the fiscal requirements and the probable availability of funding.
Sources of funds include:
· internal sources, such as- government grants,· aid flows, including
- plan expenditure, and
- non-plan expenditure;- domestic agencies, and· borrowing from national and international agencies, including
- international agencies; and- interest-free loan sources,
- interest-bearing loans, but at less than commercial rates (i.e., soft loans), and
- commercial loans at market interest rates.
When assessing resource availability, the organization should consider all relevant factors. For example, availability of funds from internal sources depends upon the internal capability of the organization. In general, internal funds would in part cover recurrent cost. For large funding requirements, the organization cannot depend on internal generation. Support from government would depend on priorities and allocations.
It is important that deficits are closely monitored, and it also very important to be aware of inflation, as it can play havoc with budget management and can easily render a project non-viable by rapidly shifting the break-even premises.
Management has to ensure that activities or programmes operate in the ways and at levels that were initially planned. In general, programmes or activities are more likely to face problems as the project progresses. A common major problem area is recurrent-cost expenditure, as grants are often insufficient cover all aspects. Some effects of insufficient funds include:
· inability to produce output because of lack of staff or equipment;
· shortages of consumable supplies;
· no qualified staff to operate equipment or machinery;
· poor maintenance of buildings, equipment, facilities, etc.;
· transport constraints; and
· a large number of positions unfilled due to recruitment freezes.
One can immediately visualize the consequences: reduced efficiency, reduced service quality and quantity, reduced utilization of facilities, reduced equipment life due to poor maintenance, and low staff morale.
Factors contributing to recurrent-cost problems include:
· dramatic changes in the environment;
· overall budgetary constraints;
· poor budgetary planning; and
· imbalances in resource allocation.
Revenue mobilization efforts can redeem the organization from recurrent-cost problems arising from changes in external factors. If the problem arises because of poor budgetary planning and mis-allocation of resources, management has to identify ways and means to redeploy all resources to optimize efficient and effective utilization.
Financial management involves recording and analysis of large number and wide variety of transactions. Timely use of information generated by various reports and statements is critical to the success of the finance function. Manual systems of recording transactions and producing reports are very time consuming, with numerous shortcomings. As the number of transaction increases, the recording and processing system may be affected because of errors arising from overloading. The major disadvantage of a manual system is that, because of interdependencies in financial and accounting variables, a small revision or a minor change may involve lot of work. Conducting sensitivity analysis of various programmes or activities may prove to be a Herculean task.
In recent years, information processing technology has developed enormously in capacity and sophistication. Computerization of financial functions and accounting is no longer restricted to big organizations: even small organizations can profit from use of a small personal computer. The widespread use of computers for financial functions is the outcome of the low prices of commonly available, standard software packages. Software packages which have really made the use of computers easy for financial purposes are electronic spreadsheets and database management systems.
Using an electronic spreadsheet, one can do detailed analysis of accounting and financial information. The word spreadsheet - also called a ledger sheet or worksheet - derives from the standard accountancy sheets of paper printed with several columns for recording financial transactions, keeping track of funds and commitments, and performing some computations. Just as on paper, the spreadsheet has rows and columns. Each row-column intersection forms a cell into which numbers can be entered and further processed by specifying the relationships between various individual and groups of cells. This type of electronic spreadsheet is useful for doing financial analysis, creating budgets, etc., which require a tabular form of presentation of information. Each piece of information can be accessed easily and further computations carried out. Verifications and revisions are simple. The spreadsheet will not produce accounting reports automatically as it does not understand accounting procedures and rules: it is merely a tool to perform calculations, but optimized for calculations typical of an accounting environment.
Lotus 1-2-3 and Excel are two well-known spreadsheet software packages for personal computers. Others include MultiPlan, SuperCalc, Paradox and Quattro.
Another important category of software is that used to manage databases. One very well known database management software package is dBase IV, the latest in a series of increasingly sophisticated packages. This programme uses data files in highly structured formats so that sorting, updating, indexing, accessing selected records, locating data, generating reports, adding or deleting information, etc., are easy and quick.
Major advantages of using such software include:
· the ability to identify and exploit a large number of interdependencies;· the timely availability of information, as the processing of transactions is very fast;
· reliability of information as, assuming the input data are correct and the interrelationships established are valid, the results are reproducible;
· lower costs in terms of human resources training; and
· the ability to perform sophisticated analyses and to do sensitivity analysis.
However, the effective use of computers for financial functions requires a more sophisticated and specialized form of database management system, namely a management information system (MIS). MIS is an integrated human-machine system that can provide information in support of planning and control functions. MIS provides support to largely structured planning and control tasks through routine reports.
Management of resources plays a critical role in the growth and development of an organization. The organization should strive for effective and efficient utilization of financial resources. The organization should also be concerned about the effectiveness of the control system in achieving its objectives and fulfilling its mission.
Preparation of financial statements, such as balance sheets and income and expenditure accounts, is important as they provide insights into the operating and financial performance of the organization. In preparing these statements, the organization should use an accrual system of accounting. Financial functions include analysis, planning and budgeting, control, and project and activity planning. Analysis involves preparing statements of the sources and uses of funds, developing diagnostic indicators, preparing cost of service statements, and deriving common-sized ratio statements, other coefficients and indices. Analysis of cost information can provide many insights into the performance of various programmes and activities. It also becomes the basis of planning and controlling. The classification of cost information into variable, fixed, capital and recurring costs helps the analysis a great deal. Planning of activities is important and is done by preparing budgets. For successful implementation of budgetary control, certain conditions have to be fulfilled. These are preparing statements of goals and objectives, creating budget centres, developing accounting controls, communication, coordination and budget administration. Control ensures that plans are achieved. Variance analysis and internal and external audits strengthen the control process.
The designs of projects, programmes and activities are critical to the future of an organization. Since most new projects and programmes involve significant investments, estimates must be arrived at very carefully. Each project involves recurrent costs for maintaining and operating the project, and so the recurrent-cost implications of a project must be assessed well before the project's approval. One of the important dimensions of new project evaluation should be to determine the operating level of activities which justify the costs incurred. This can be done by performing a break-even analysis. Financial management involves the recording and analysis of a wide variety of transactions. Timely use of information generated by various reports and statements is critical to the success of the finance function. Computerization of the finance function should ensure timely availability of reliable and accurate information.
Anthony, R.N., & Herzlinger, R.E. 1975. Management Control in Non-Profit Organizations. Homewood, IL: Irwin.
Anthony, R.N., & Reece, J.S. 1977. Management Accounting Principles. Bombay, India: D.B. Taraporevala.
Horngren, C.T. 1977. Cost Accounting: A Managerial Emphasis. 4th ed. Englewood Cliffs, NJ: Prentice-Hall.
Dearden, J. 1973. Cost Accounting and Financial Control Systems. Reading, MA: Addison-Wesley.
Gross, M.J., & Warshauer, W. 1979. Accounting Guide for Non-Profit Organizations. New York, NY: John Wiley.
Henke, E.O. 1971. Accounting for Non-Profit Organizations. Belmont, CA: Wadsworth.
Howell, J. (ed.) 1985. Recurrent Costs and Agricultural Development. London: Overseas Development Institute.
Pandey, I.M. 1992. Financial Management. New Delhi: Vikas Publishing House.
Turk, I. 1984. Accounting Analysis of the Efficiency of Public Enterprises. Lublijiana: International Centre for Public Enterprises in Developing Countries.
Vargo, R.J. 1977. Readings in Governmental and Non-Profit Accounting. Belmont, CA.: Wadsworth.
Welsh, C. 1976. Budgeting, Profit Planning and Control. New Delhi: Prentice-Hall of India.
