Issues in Costing of contracts with public fund

Kumar BijoyChartered Financial Analyst

09810452266kumarcfa@yahoo.com

FINANCIAL MANAGEMENT CYCLE

Corrective Action

Audit

Reporting, including

claims

Accounting/ Internal Controls

Flow of Funds

Budgeting

FM

Issues…

• Estimation…in inflationary market • Cost control… during time over-run• Costing approach…infrastructure projects• Costing objective…customer’s need• Cost savings…source of financing• Costing manual…reliability• Cost driver…handy tool• Value engineering…scope• Facility assessment…alternatives• Costing types…Quality costing, life cycle costing

Cost … Issues

• Cost is the monetary value of the resources consumed• Every event of a project is a cost• Frequent cost and time overrun is a great concern for the

project managers• Time overrun itself translates into cost overrun • Cost saving is an essential requirement for competitive

success of any project• Cost saving is different from cost cutting• Cost cutting is a negative approach where cost saving is

smart approach• A combination of Cost cutting and savings could be

better tool to make the project very cost effective “Cost is Prime Concern for Customer”

Cost and Finance issue…why?

• Increased competition• Customer focus • Target costing• Life cycle costing• Private participation (PPP/BOT etc)• Commitment charges• Higher inflation level• Greater environmental concern

“IF you will not do it your competitor will do”

Examples of Cost Drivers…

• Number of purchase orders for purchase department• Number of despatch orders for the despatch department• Number of Inspections• Number of Customers orders processed.• Number of employees.• Number of machine hours used.• Number of material handling hours.• Number of labour transactions.

Cost management…steps

• Identify the different types of cost and their relationship with time– Two types of relationship

• Directly proportional • Inversely proportional

• Directly proportional will be taken care by time reduction whereas inversely proportional will be trade-off between time and cost

• All indirect costs like HQ’s costs, financial charges etc are directly proportional to the time

• The delay in the project tends to increase the indirect costs making project financially unattractive

“Save time-Save Cost”

• Direct costs like labor wages or material price etc may also increase because of inflation with time overrun

• Some costs like legal fee, project consultancy charges etc are time independent. They depend on the project itself.

• so, delay means cost overrun, financially unattractive and heavy social cost etc

“Delay means cost overrun”

Cost savings…How?• Never delay the project because every delay is a cost• Have a holistic approach of cost reduction through:

– Cost Budgeting & Monitoring– Alternative sources of financing– Enhancing the skill of the labor– Adopting advanced technology– Proper disclosure– Effective Reporting system– Reducing wastage– Streamlining the operation– Respect for people– Quality at source

“Quality is free, it is the defect which has cost”

Cost Budgeting….

• Budgeting is an essential tool in cost management; we make use of several kinds depending on the client and their needs

• At the time of budgeting extra care is required to integrate the cost saving strategy in the basic planning

• Orientation of the project can be directed towards Target costing or Life cycle costing at the time of planning itself.

BUDGET CALENDER Rs. In Lakhs

Year 1 Year 2

Year 3 Year 4 Year 5

Activity 1

Activity 2

Activity 3

Total

Target Costing…

LIFE CYCLECOSTS

CROSSFUNCTIONAL

CUSTOMER

FOCUSED

PRICELED

$$

DESIGN

DRIVENVALUE CHAIN

Target Costing…

• Global competitiveness requires balancing quality, cost, and time

Qua

lity

Cost

Time

Target Costing…

• Target costing focuses on all three dimensions of the strategic triangle

• Target costing focuses on all three dimensions of the strategic triangle– Price-led– Customer-focused– Design-centered– Cross-functional– Life cycle oriented– Value Chain-based

TARGET COSTING...Managing committed costs

PRODUCTCONCEPT

DESIGN ANDDEVELOPMENT

PRODUCTION

P R O D U C T D E V E L O P M E N T C Y C L E

0

20

40

60

80

100

Cost

s

Committed Costs

Incurred Costs

DISTRIBUTIONSERVICE

DISPOSITION

LCC costing

Economic assessment of alternatives that considers all of the significant costs of ownership over the useful life expressed in equivalent dollars.

– initial costs– financing costs– operational costs

LCC Steps

• Steps:– Establish Design Alternatives– Determine Activity Timing– Estimate Agency and User Costs– Compute Life-Cycle Costs– Analyze the Results

Alternative source of financing…

• Traditional Sources– Own Fund (Equity Fund)– Borrowed Fund

• (Debenture/Bond or Term Loan)

– Hybrid Fund (Preference Shares, Convertibles, perpetual debts)

• Alternate Sources

“Interest rate, tenure and convenience of funding-critical for source determination”

Alternate Sources

• Foreign Issues• FDI & FII• ECB• Private Equity• Hedge Fund• Securitization• PPP• Venture Capital / Incubation Fund• Franchising

Integration

Project SystemProject SystemMaterial & Contract management- PO and Contracts- Goods receipt & Work completion- Inventory, Material Valuation and transfer-Rejections and returns-Spares Mgmt

Material & Contract management- PO and Contracts- Goods receipt & Work completion- Inventory, Material Valuation and transfer-Rejections and returns-Spares Mgmt

Financial Assets -Receipt of Asset-Capitalization-Depreciation/Gross block-Transfer-Retirement

Financial Assets -Receipt of Asset-Capitalization-Depreciation/Gross block-Transfer-Retirement

Quality-Material testing

Quality-Material testing

DMS-Document monitoring

DMS-Document monitoring

Billing-Bill Generation

-Bill Tracking

Billing-Bill Generation

-Bill Tracking

Finance (FI)- Revenue Accounting-Budgeting-Cost Planning (non-project)-Expense booking

Profitability- Advances-Trial Balance- Payable- Receivable-Taxation-Banking

Finance (FI)- Revenue Accounting-Budgeting-Cost Planning (non-project)-Expense booking

Profitability- Advances-Trial Balance- Payable- Receivable-Taxation-Banking

Human resource-Assignment to project

Human resource-Assignment to project

Assets (P&M)-Procurement-Assignment-Utilization-Breakdown-Maintenance

Assets (P&M)-Procurement-Assignment-Utilization-Breakdown-Maintenance

Financial Management – Key Points

Adherence to Legal Covenants for Financial Management as per Financing Agreement

Accurate and Timely Preparation of Plans and Budgets Timely and Sufficient Flow of Funds to implementing

agencies at all levels Regular Maintenance of Project Records and Accounts Regular and Accurate Financial Reporting at all levels of

the Project Regular Monitoring of Project Budgets at all levels Strong Internal Control System in the project Adequate delegation Adequate staffing for finance function Adherence to FM aspects of Disclosure Management

Framework

Thank you

– Any question-