Financial Aspects of the Project - PowerPoint by jpd18172

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									FINANCIAL ASPECTS OF PROJECT
ENGINEERING AND CONTRACTING



  THE BUSINESS PLAN


        Prof George Solt


                           Whitewater Limited
                           Consulting Engineers & Scientists
       How the business works
 Now that the necessary capital is in place, we
  can start to trade, for which we must first plan
  what we hope to achieve in the year.
 Business is like a jungle
 In the real jungle food (or flight) comes before
  fornication.
 Not going bust is more important than making
  a profit
 It is quite easy to go bust while trading
  profitably

                                        Whitewater Limited
                                        Consulting Engineers & Scientists
       How the business works
 TURNOVER is the year‟s output, measured
  by the total amount of sales invoiced
 DIRECT COSTS are the costs which are
  attributable to executing the contracts that the
  company is working on, such as materials,
  engineering, site cabins, craneage,
  subcontracts, project management
 OVERHEADS are costs which can‟t be
  attributed to any contract, such as the
  accounts department, the receptionist and
  the MD‟s Jag
                                        Whitewater Limited
                                        Consulting Engineers & Scientists
                   Overheads




Overheads or “Indirect Costs” are sometimes incorrectly
called “Fixed Costs” because over a limited range of
turnover they don‟t change very much.
                                            Whitewater Limited
                                            Consulting Engineers & Scientists
       How the business works
 CONTRIBUTION is what‟s left of the contract
  price of a particular contract after the direct
  costs of that contract have been paid, and
  which goes into the company‟s kitty to pay for
  the company‟s overheads and profit
 PROFIT is what‟s left at the end of the
  company‟s year, when the company has paid
  all its direct costs and overheads.




                                       Whitewater Limited
                                       Consulting Engineers & Scientists
         How the business works



TURNOVER - DIRECT COSTS - OVERHEADS = PROFIT


A single contract on its own doesn‟t make a profit. If the
sum of the contributions from all the year‟s contracts
doesn‟t cover the overheads, there is no profit




                                                Whitewater Limited
                                                Consulting Engineers & Scientists
           Planning for profit
 The elements of the Business Plan
 Turnover will be limited by working capital,
  the workforce and market share
 Overheads at the turnover can be estimated
  from historical information
 The anticipated percentage profit on turnover
 In contracting this is typically 2 – 5%
 These numbers fix the average contribution
  required on all contracts
                                      Whitewater Limited
                                      Consulting Engineers & Scientists
                Planning for profit

1   Turnover (T/O)   £m   10    that’s what you think you can do
2   Direct Costs     £m   7.5   That depends on the type of work
                                you are doing, and also on your
                                accountancy system
3   Overheads        £m   2.0   you hope that’s a good estimate
                                to go with the turnover of £10m
                                and would leave you:
4   Profit           £m   0.5   which is 5% on T/O - the most
                                that you thought the market will
                                stand.




                                                Whitewater Limited
                                                Consulting Engineers & Scientists
             Planning for profit
 This plan needs a total of £2.5m in addition to the
  direct costs of the contracts to cover overheads and
  profit
 Accountants call this £2.5m the “Gross Profit”
 That‟s 25% of the turnover, so each contract the
  company executes has to aim to make an average
  contribution which is 25% of its contract price
 The graph, which illustrates the point, is based on the
  assumption that all the contracts carry this same
  percentage contribution, so the contribution
  increases linearly with turnover.


                                             Whitewater Limited
                                             Consulting Engineers & Scientists
                             Planning for profit
                  3.5

                    3                                         PLANNED                 C
                                                              PROFIT
                                            OVERHEADS
Contribution £m




                  2.5                                                   B

                    2                                     A

                  1.5

                    1

                  0.5

                    0
                        0      2        4        6            8         10             12
                                            Turnover £m
                  At A the turnover is £8.0m and the contribution is £2.0m which
                  just covers the overheads but leaves nothing for profit. This
                  point is called the “breakeven point”.
                                                                        Whitewater Limited
                                                                        Consulting Engineers & Scientists
                             Planning for profit
                  3.5

                    3                                         PLANNED                 C
                                                              PROFIT
                                             OVERHEADS
Contribution £m




                  2.5                                                   B

                    2                                     A

                  1.5

                    1

                  0.5

                    0
                        0      2        4         6           8         10             12
                                            Turnover £m
                  B is the planned performance with a turnover of £10m and a
                  total contribution of £2.5m giving profit of £0.5m after the £2.0m
                  overheads have been paid.
                                                                        Whitewater Limited
                                                                        Consulting Engineers & Scientists
                            Planning for profit
                  3.5

                    3                                       PLANNED                 C
                                                            PROFIT
                                          OVERHEADS
Contribution £m




                  2.5                                                 B

                    2                                   A

                  1.5

                    1

                  0.5

                    0
                        0     2       4        6            8         10             12
                                          Turnover £m
                  Exceeding the planned turnover by a mere 20% to £12.0m
                  seems to increase the profit by 100% (Point C)!
                                                                      Whitewater Limited
                                                                      Consulting Engineers & Scientists
           Planning for profit
 But of course that isn‟t true - it would make
  two of our basic assumptions false
 First overheads do not remain constant with
  changing turnover – in practice, an increase
  in turnover would mean some increase in
  overheads
 Second the £10m turnover was the maximum
  which the company can achieve because of
  limited resources or working capital

                                     Whitewater Limited
                                     Consulting Engineers & Scientists
                 Over-trading
 Increasing the turnover means overloading the
  workforce leading to mistakes and delays
 It also increases direct costs which requires more
  working capital
 If there isn‟t enough working capital available the
  company becomes insolvent
 This pattern is called “over-trading”
 Engineers who have a good idea and set up their
  own company to exploit it often fall into this trap.
 Their idea is so good that the company is profitable
  and grows but they don‟t increase the working capital
  to match the turnover and it fails


                                            Whitewater Limited
                                            Consulting Engineers & Scientists
               Over-trading
 A company failed because the Sales Director
  thought that overheads were “Fixed Costs”
 Once he had sold enough contracts to meet
  the turnover target he thought the overheads
  had been paid and went on selling more
  contracts but with a reduced contribution
  which undercut the competition„s prices
 For several years running he exceeded the
  turnover target by 10% or more, and after five
  years the company went bust
 Moral: if it‟s a good plan, then any serious
  departure from it can‟t be good.
                                      Whitewater Limited
                                      Consulting Engineers & Scientists
                Marginal selling
 If turnover fails to reach target the graph shows that
  profit falls sharply
 The overheads will probably fall a bit but not enough
  to maintain the profit
 Under these conditions it is right to sell contracts with
  a reduced contribution, which makes it easier to get
  contracts
 That in turn should go nearer to filling the company‟s
  capability to do work
 This is called “marginal Selling”
 If the company has under-used capacity, then any
  contribution which can be made from it is better than
  none
 Everything is different when there is spare capacity
                                               Whitewater Limited
                                               Consulting Engineers & Scientists
            How not to go bust
 Turnover is not the most important thing for the
  company
 There is only one way in which companies fail – by
  becoming insolvent due to lack of working capital
 Whether they are making a profit or not has little
  directly to do with that - many companies go bust
  with a full order book
 The Working Capital required as a percentage of the
  turnover varies between different types of industry
  and even between different companies in the same
  industry
 The figure for any individual company tends to
  remain fairly constant however much the turnover
  rises or falls
                                           Whitewater Limited
                                           Consulting Engineers & Scientists
               How not to go bust
 Here are some examples based on a £10m turnover company
  with £2m working capital
 Case 1
 In one year, the company makes a loss of 2% on turnover - i.e.
  £k 200. This reduces its working capital to £m 1.8 - i.e. by 10%.
  That will not make a massive difference to next year‟s trading
  when, with luck, business will be better, the loss recouped and
  the working capital restored. A modest and occasional loss
  doesn‟t bring a healthy company down.
 Case 2
 The Company has a major contract worth £3m, and there is a
  problem which delays a part payment of £1m. The company still
  has £1m of working capital with which to carry on and, if the
  delay is not too long, it ought to survive. The most obvious
  action is to go to the bank for extra finance, such as a
  temporary increase in its overdraft limit, especially if the cash
  crisis is expected to be short term.

                                                     Whitewater Limited
                                                     Consulting Engineers & Scientists
              How not to go bust
 Case 3
 The company is working on two contracts each worth £3m. Both
  these suffer some setback: a payment of £1m is delayed on
  each, which reduces the working capital to zero. Unless cash
  can somehow be raised quickly the company cannot pay its bills
  and is insolvent.
 This can happen as easily to a company which is making a
  profit as one running at a loss, but in practice there is a big
  difference. If a company commands the bank‟s confidence, the
  bank is more likely to help the company out of trouble.
 This shows that companies must not take on contracts so big
  that a serious setback on them can break the company. In the
  fatal case 3, the troublesome contracts are indeed only 30% of
  the turnover each, but with two of them in trouble that‟s enough
  to bring the company down.



                                                     Whitewater Limited
                                                     Consulting Engineers & Scientists
             How not to go bust
 It‟s not easy to turn down a contract that is too big for
  the company to handle
 Physical resources – manpower, machinery etc - can
  be hired
 A lack of working capital is less easy to solve unless
  the contractor has good relations with the bank
 There‟s always risk of trouble and delay by things like
  weather, strikes and accidents. With a small contract,
  that‟s a nuisance - with a very big contract, it can
  break the company
 That kind of disaster can happen as easily to a
  company which is making a profit as one running at a
  loss

                                               Whitewater Limited
                                               Consulting Engineers & Scientists
                    Summary
 A company needs a plan for the year in order to
  achieve its maximum potential.
 The plan has to set targets for turnover,
  overheads and profit.
 If the actual turnover significantly exceeds that
  planned, the company may get into trouble.
 If it looks unlikely that the target turnover will be
  reached, marginal selling (by cutting the
  contribution on contracts) can be a useful partial
  remedy.
 Companies fail if they run out of working capital.
 Small, temporary losses are not usually fatal.
 A company must not take on contracts which are
  so large that they could cause it to fail
                                            Whitewater Limited
                                            Consulting Engineers & Scientists

								
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