Project Management

Concepts of project management

A project can be defined as a one shot, time limited, goal-oriented, major undertaking,
requiring the commitment of varied skills and resources.
A project can be defined as “a combination of human and non-human resources pooled
together in a temporary organisation to achieve a specific purpose.”

Basic characteristics of a project

1. Temporary activity
2. big work
3. One time and unique work
4. It involves various dimensions (cost, time, performance etc.)
5. It involves risks and uncertainties
6. It is a process of working towards attaining the set of objectives.

Characteristic features of a project

1. Objectives : A project has a fixed asset of objectives. Once the objectives
have been achieved, the project ceases to exist.
2. Life span : A project cannot continue endlessly, it has to come to an end.
3. Single entity : A project is one entity and is normally entrusted to one
responsibility centre while the participants in the project are
many.
4. Teamwork : A projects call for teamwork-that team again is constituted of
members belonging to different disciplines, organisations
and even countries.
5. Life cycle : A project has a life cycle reflected by growth, maturity and
decay.
6. Uniqueness : No two projects are exactly similar even if the plants are
exactly identical or are merely duplicated. The location, the

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 infrastructure, the agencies and people make each project
unique.
7. Change : A project sees many changes throughout its life, while some
of these changes may not have any major impact, there can
be some changes which will change the entire character or
course of the project.
8. Successive : What is going to happen during the life cycle of a project is
principle not fully known at any stage. The details get finalized
successively with the passage of time.
9. Made to : A project is always made to the order of its customer. The
order customer stipulates various requirements and puts
constraints within which the project must be executed.
10. Unity in : A project is a complex set of thousands of varieties. The
diversity varieties are in terms of technology, equipment and materials,
machinery and people, work culture and ethics. But they
remain inter-related and unless this is so they either do not
belong to the project or will never allow the project to be
completed.
11. High level of : A high percent of the work in a project is done through
sub- contractors. In complex projects, normally around 80% of the
contracting work is done through sub-contractors.
12. Risk and : Every project has risk and uncertainty associated with it. The
uncertainties degree of risk and uncertainty will depend on how a project
has passed through its various life-cycle phases.

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Project management: Project management is the planning, organizing, directing and
controlling of company resources for a relatively short-term objective that has been
established to complete specific goals and objectives.

Categories of projects:

Based on speed needed for execution of a project, projects are categorized as:
Normal projects, crash projects and disaster projects.

Normal projects:
In this category of projects, adequate time is allowed for implementation of the project.
All the phases of a project are allowed to take the time they should normally take. This
type of project will require minimum capital cost and no sacrifice in terms of quality.

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Crash projects:
In this category of projects additional capital costs are incurred to gain the time.
Maximum overlapping of phases is encouraged and compromises in terms of quality or
also ruled out. Savings in time are normally achieved in procurement and construction
where time is bought from the vendors and contractors by paying extra money to them.

Disaster projects:
Anything needed to gain time is allowed in these projects. Vendors who can supply
"Yesterday" are selected- irrespective of the cost. Round-the-clock work is done at the
construction site. Normally, capital cost will go up very high, but project time will get
drastically reduced.

Project Life Cycle Phases

Projects live between two cut-off points; this time span is known as "Project life cycle ".
A project passes through the various phases in the life of a project. By and large, all
projects have to be pass through the following 5 phases.
1. Conception phase
2. Definition phase
3. Planning and organizing phase
4. Implementation phase
5. Project clean-up phase

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Conception phase:
This is the phase during which the project idea germinates. The idea may first come to
the mind to overcome certain problems. The problems are may be non-utilization of
the available fund, plant capacity, expertise or simply unfulfilled aspiration. Whatever
may be case, the ideas need to be put in black and white, and given some shape before
they can be considered and compared with competitive ideas. If this phase is avoided
or truncated, the project will have innate defects and may become a liability for investor.
A well- conceived project will go a long way for successful implementation and
operation of a project.

Definition phase:
The definition phase of the project will develop the idea germinated during the
conception phase and produce document describing the project is sufficient details
covering all aspects necessary for customer and financial institutions to make up their
minds on the project idea. If this phase is not done properly, it will increase the risk
content of the project. To avoid risk it is required to examine the some area thoroughly.

Planning and organizing phase:

This phase is involved with preparation for the project to take off smoothly. It does not
limit itself to paper work and thinking. Many activities are undertaken during this
phase. This phase is overlap so much with the definition and implementation phases
that no formal recognition is given to this by most organization. Some organization
prepares documents such as' project exhibition plan' to mark this phase.

Organizations deal with the following during this phase:

1. Project infrastructure and enabling services
2. System design and basic engineering packages
3. Organization and manpower
4. Schedule send budgets
5. Licensing and governmental clearances
6. Finance
7. Systems and procedure

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 8. Identification of project manager
9. Design basis, general conditions for purchase and contracts
10. Site preparation and investigations.
11. Construction resource and materials
12. Work packaging

Implementation phase:
This is a period of hectic activity for the project. Bulk of work in a project is done during
this phase. As far as the volume of work concerned, 80-85% of work is done in this phase
only. Therefore, people want to start this phase as early as they can. All techniques of
project management are applied to this area essentially. This phase itself being more or
less the whole project, every attempt is made to fast track. This phase has a high need
for coordination and control.

Project clean-up phase:

This is a transition phase in which the hardware built with the active environment of
various agencies is handed over for the production to a different agency who was not so
involved earlier. Drawing, documents, files manuals are handed over to the customer.
The customer has to be satisfied with guarantee - test run. Project accounts are closed,
outstanding payments made, and dues collected during this phase. The most important
issue during this phase is planning of the staff and workers involved in execution of the
project. The place of project personal will be taken by the customer's engineers who
may be either for production or maintenance.

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 Tools and techniques for project management
There are several techniques which would contribute significantly towards effective
project management. These can be broadly grouped under the following heads.
1. Project selection techniques -
a) Cost benefit analysis
b) Risk and sensitivity analysis
2. Project execution planning techniques
a) Work breakdown structure (WBS)
b) Project execution plan (PEP)
c) Project responsibility matrix
d) Project management manuals
3. Project scheduling and coordinating techniques
a) Bar charts
b) Life cycle curves
c) Line of balance
d) Networking techniques (PERT/CPM)
4. Project monitoring and progressing techniques
a) Progress measuring techniques (PROMPT)
b) Performance monitoring technique (PERMIT)
c) Updating, reviewing and reporting techniques
5. Project cost and productivity control techniques
a) Productivity budgeting techniques
b) Value Engineering (VE)
c) COST/WBS
6. Project communication and clean up techniques
a) Control room
b) Computerized information system

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Rules and responsibilities of project manager

1. Defining and maintaining the integrity of the project

2. Development of project execution plan
3. Organization for execution of the plan
4. Setting of targets and development of systems and procedure for accomplishment of
project objectives and targets
5. Negotiation for commitments
6. Direction, coordination and control of project activities
7. Contract management
8. Non-Human Resource Management and fiscal matters
9. Projectising and problem solving
10. Men management
11. Satisfaction of customer, government and the public
12. Achievements of project objectives, cash surplus and higher productivity.

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 Project Planning and Estimating
Feasibility report: Feasibility report is prepared to present an in-depth techno -
commercial analysis carried out on the project idea for consideration of the financial
institutes and other authorities empowered to take the investment decision. According
to the guidelines published by the planning commission a feasibility report should
include:
1. Raw material survey
2. Demand study
3. Technical Study
Product pattern
Process selection
Plant size
Raw material requirements
4. Location study
5. Project capital cost estimates and source of finance
6. Profitability and cash flow analysis
7. Cost benefit analysis

Raw material survey

Real survey may be belonging to any of the following categories:
1. Available in natural form as deposit, either on the surface or underground, in one
part or different parts of country.
The size and life of the plant depends on available quantity of raw materials and
quantity of raw material already committed for different plant in operation.

2. Available as finished product or by-product or available near future.

3. Not available in the country but to be imported. It may be natural form or

finished product or by-product.

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Demand study
A demand study normally would establish the following:
1. Demand : Covering uses of the proposed product, the prospective
consumers, present consumption, expected consumption and
possibility of export.
2. Supply : Covering assessment of existing capacity, present level of
production, capacity utilization, expected consumption,
extent of import.
3. Distribution : Covering channels of distribution, mode of transport, mode of
packaging, cost of distribution, government policies.
4. Prices : Covering both domestic and internal price trends, control on
price as impossible by the government, prevailing duty Centre
taxes.

Required Information for demand study is available from published literature. However,
an independent survey may be needed.

Some of the documents that are usually referred for demand study or as follows:
1. Plan documents : Issued by the planning commission, provides
information on plan proposals and growth targets
that are both physical and fiscal.
2. Guidelines to : Published by the department of industrial
industries development, ministry of industry. It provide
information about licensed and installed capacity,
present production, import and export, indigenous
capacity, design and fabrication, future scope etc.
3. Economic survey : Published by the Ministry of Finance, it provides
data on industrial production, prices exports etc.
4. Annual survey of : Published by central statistical organization, it
industries provides data on production, number of units
installed, capacity etc. for several industries.

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 5. Import and export : Published by Ministry of Commerce, it provides
statistics data on import and export of a very large number
of items.
6. Monthly Bulletin of : Provides information on production and cost
RBI indices for various industrial items.
7. Survey reports of : Publications of the Industrial Development Bank of
various institutions India, National council of applied economic
research, Times of India economic division etc.
Documents provide information relating to
production, consumption, import, export and
prices.
Technical Study
Product pattern: Demand survey, raw material survey and economy of scale should be
sufficient to select the plant capacity. The selected process determines the various co-
products and by-products that are possible. The total spectrum of products, co-products
and by-products- represents what is known as the product pattern.

Process selection: The product pattern so selected and raw material availability will
govern the selection of the processing scheme. But detailed evaluation including the
economics of operation of alternative processing schemes is necessary for selecting an
optimum process.

Location study
To meet the targets relating to time and cost, it is necessary that the site as been properly
selected and position taken before the zero date. Normally, the financial institutions
will deputy team experts to inspect the site before the loan sanction.
Project sites are selected on several considerations, the basic considerations are:
1. Availability of land, soil characteristics and cost of the land.
2. Approach to site.
3. Source of raw materials and transportation requirement.
4. Transportation and marketing of finished product.
5. Source and availability of water.

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6. Availability of power and source
7. Availability of skilled manpower.
8. Social amenities in the area.
9. Availability of tax incentives, if any.
10. Facilities for drainage and effluent disposal.
11. Availability of engineering and maintenance facilities.
12. Acceptance of the project by the local bodies.

Types of project costs

Capital costs:
All the costs incurred in the project before it becomes ready to start
commercial production will be treated as capital costs. Therefore, capital cost
include not only expenditure on assets such as land, plant and machinery,
township etc. But also software costs such as design engineering, licenser's fees,
management and supervision, and even pre-operative expenses.

Working capital:
The fund required for maintaining various inventories in the form of raw
materials, operating supplies, intermediate products, finished products and
meeting miscellaneous cash requirements for maintenance of level of production
is treated as working capital.

Operating costs:
These are the costs which will be incurred on a recurring basis for
production, maintenance and marketing. Operating costs will also include
interest on loans taken for the financing the project.

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 Types of cost estimates
There are roughly five types of caste estimates that are made during the life-cycle
of a project. These are:
1. Order of magnitude estimates
2. Study estimates
3. Preliminary estimate
4. Definitive estimates
5. Detailed estimate

Order of magnitude estimate: This estimate is made when a project has been
identified and the entrepreneur wants to get a rough idea of the investment so as to
decide whether to pursue the project or not. At this stage, the entrepreneur knows the
description of the product and the capacity of the plant for production. Even with this
information it is possible to prepare an estimate with an accuracy of about +/- 60%.

Various ratio methods are used to find such estimates.

i) Investment per annual tonne capacity:
If installed cost of plant P1 of annual capacities C1 tonne is rupees R1. Then
installed cost R2 of plant P2 having annual capacity C2 can be estimated
as
R1 C 2
R2 
C1
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 ii) Turnover ratio and capacity ratio:
The ratio between annual sales and investment expressed in rupees is
known as turnover ratio.
The ratio between plant investment (Rs) and annual sales (Rs) is known
as capital ratio.
R2  C V1  P1
R2 is estimated cost
C is plant size
V1 is projected annual sales value
P1 is prices
iii) Sixth- tenth factor:
In this method, plant investment is assumed to vary has 0.6 power of the
plant size.
0.6
C 
R2  R1   2 
 C1 
iv) Inflation index:
This Index can be used to workout estimate if the capacity for the new
unit remains the same as that of one for which installed cost data are
available.
Cost Index (New)
Installed Cost (Now)  Installed Cost(Past) 
Cost Index (Past)
v) Location index:
Knowing a plant cost in USA or any other country, the cost of a similar
plant in India can be estimated using location index. The index can be
developed, if data related to productivity of country involved are available.

2. Study estimate: This estimate is for studying the economic viability of the project
and also for arranging funds for the project. Overall plant cost is estimated by
multiplying that total equipment cost by a factor known as long-factor. Long-factor take
care of civil, electrical, piping, instrumentation, insulation and installation cost.

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Accuracy of this estimate at this stage is about +/- 30%. The project approved with this
estimate.

3. Preliminary estimate: The estimate is prepared when the technology package is

frozen and a firm implementation schedule is available. Estimate can be made with
acceptable accuracy. The accuracy even at this stage is about +/- 20%.

4. Definitive cost estimate: This estimate is prepared after zero date when the detailed
engineering of a project is in an advanced stage. At this stage, additional information
which will add for the accuracy to the estimate or lately to be available. This estimate
may have an accuracy of +/- 10%.

5. Detailed estimate: This estimate may be made on completion of Engineering,

ordering of equipment and machinery, and award of major field constraints. But this
stage head office work for the project is mostly complete. The estimate at this stage may
have an accuracy of +/- 5%.

Evaluation of Project Profitability

The economic viability of a project can be assessed by the following methods:
1) Pay Back period (PBP)
2) Return on Investment (ROI)
3) Net Present Value (NPV)
4) Internal Rate of Returns (IRR)
5) Benefit Cost Ratio (BCR)

1) Pay Back Period (PBP):

Pay back period is the time required to recover the original investment through
incomes from the project. Assuming that the annual income from the project
before depreciation but after taxes is uniform, then the payback period is:

Original Investment ( Rs)

PBP  Number of years 
Annual Income( Rs)

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2) Return On Investment (ROI):
The ratio relates earnings to investment. There are several variants in this ratio
but the one most commonly used computes on investment as:
Average annual earnings after Tax
ROI 
Average book investment after depreciati on

3) Net Present Value (NPV):

The value of money changes with the time. The Present Value (PV) of a rupee of
next year is going to be less by 1 year's interest. All future amounts will be
required to be discounted by the applicable interest rate to determine their
present value.
The present value of a future cash flow can be computer as:
1
PV  S  S = Cash flow at ‘t ' years = Future value
1  r t
1
=Discount factor
1  r t
n
St
NPV   I St = net cash flow
t 1 1  r 
t

n = operating life of project

I = original capital investment
4) Internal Rate of Return (IRR):
This is a discounting method. In this case, instead of assuming a fixed discount
rate, the discount rate is varied till the Net Present Value (NPV) becomes zero.
The discount rate at which the net present value becomes zero is known as
internal rate of Returns.
5) Benefit Cost Ratio (BCR):
This method is modified form of NPV method. The benefit cost ratio is computed
as the ratio of aggregate present values of all future cash flows to initial capital
investment.
n
St
 1  r 
t 1
t
BCR 
I

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 Organizing Human Resources and Contracting

Project manager’s authority

1. Project scope 8. Project schedules and budgets

2. Project goals 9. Fund and other resources
3. Project execution mode 10. Project personnel
4. Project organization 11. Public/ share holders
5. Project purchase 12. Project environment
6. Contracts, contractors and consultant 13. Management systems and procedures
7. Project technical performance 14. Project performance review

Skills required for project manager

1. Team building skills. 6. Organizational skill

2. Leadership skill 7. Entrepreneurship skill
3. Conflict resolution skill 8. Administration skill
4. Technical expertise 9. Management support skill
5. Planning skill 10. Resource allocation skill

Delegation
In some situation manager has to be at more than one place and doing more than one thing
simultaneously. A manager at his individual level can achieve this by entrusting same task
to one to take care or management of his subordinates. This is called delegation. In project
management, project management, delegation has to be take place not only at the
individual level but also at the institutional level.

Reasons for delegation—

1. To help internally/externally
2. To reduce the bourdon of the manager
3. Time constraint
4. If it is routine work
5. When the other person can do the work with a better quality.
ISSUES RELATING TO THE DELEGATION

What to delegate?
Delegation does not take place when a project manager is merely asked to go head with a
project without authority.
The project manager, in that case, is being merely asked to do a task and not manage a
task. He cannot be expected to assume responsibility nor held accountable for results.

When to delegate?
1. Over bourdon
2. when one does not have know-how
3. When the job is so specialized
4. When someone can do it better qualities, economically and on time.
5. When the work is not secret, or when delegation will not cause problems even it is a
secret.

How to delegate?
To get the most from delegation, the delegatee must be given a complete picture of what
he has to do it, and how much authority he has to get it done. It is also necessary that the
entire thing is put on record as otherwise the delegate would not know what the
delegator has in mind and also the basis for accountability will not be established.
 Project Organization
An organization chart is the simplest and quickest way to demonstrate the project
manager’s authority.

Details such as where a project manager is positioned, to whom he reports, those with he
communicates and all those who report to him, will tell much about a project manager’s
authority though not in clear terms.

1. Project Manager as a staff assistant to the chief executive

Chief executive

Project manager

Personnel Technical Finance Commercial

Contract
Engineering Construction Purchase
Administration

1. Figure shows arrangement in which the Project manager virtually has no

authority.
2. He serves, at best, as a staff assistant to the chief executive.
3. The project manager does not make any decision for the project.
4. This type of organization is work for very small organization.

2. Consultant as project manager

Project Manager acts as consultant to the Chief executive in project implementation.
Project manager would be an outsider without any authority.
Project manager influence the decision of chief executive and those functional executives.
His task would be to collect information, collate and communicate to the chief executive
and may add his own recommendations.
3. Project management as a specialized staff function

1. Project management is one of the functional department to advice the other functional
department.
2. Project manager, will be a specialist in project management tools and techniques.
3. A project manager carryout service activities like collection and transmission of data,
follow-up, maintain records, measure progress, analyze progress and prepare progress
report.
4. Project manager provides schedules, budgets and information to the various functional
departments who will executes the projects.
5. Project manager may acts as a single focal point regarding communication between
various participating functions and between his company and other interacting company
4. Matrix Organization
In Matrix organization, the sharing of authority between a project manager and functional
manager is formulated.

A matrix is a concept borrowed from the algebra where an individual will abide by the
decisions made by two superiors- one belonging to the project and other to the specialized
function. One will be his direct line boss and other his project boss. Both are responsible
for the successful completion of project.
Mutually supportive relation should exist between the partners in a matrix set up for the
successful execution of a project. No one needs to be flaunt (show off) positional authority
to get work done.

Ideally one would like to see both the parties as understanding, mutually supportive and
not trying to overtake each other. If the matrix ever operated at that levels, the
arrangement can be called a “balanced matrix”.

If the project influence is more in decision –making for the project, then the arrangement
is considered as “strong matrix”

If the functional departments are seen to influencing the decision-making more. The
arrangement is considered a “weak matrix”.

5. Task Force Organization

A task force is created by drawing personnel from various functional departments and
putting them under the project manager.

The project manager makes all decisions but within the policies and procedures laid
down for him.

Staff so assigned will receive all directions from the project manager, they will required to
follow the home organization policies and procedures.

If there is any violation of the policies and procedures, the task force will notify both the
functional head and the project manager.

In this organization, there is no intervention from the various functional department, no

dual decision making and no reporting relationship for the work force.
6. Totally projectized organization
A totally projectized organization is an arrangement in which the project manager has
total authority even regarding functional policies and procedures. There is no constraint
whatsoever with respect to any function. The functional specialists will be carrying out
what the project demands and the project manager instructs.

Many people compare this arrangement to a mini company, a totally autonomous

organization, in which the project manager is the chief executive. Functional manager
would act on behalf of the project manager and would have authority delegated to them
by the project manager for taking decisions in their area of competence.
Such an arrangement is obviously possible when the project is to be large and complex or
geographically isolated that there is no way of managing it without granting autonomy to
the team handling the project.
Contracts
All projects cannot be executed with in-house resources and the project manager has to
requisition extra-organizational resources for the execution of the project. When a project
manager has to get things done with resources over which he has no direct authority, it
becomes necessary to acquire the required authority in some considerations. Such an
arrangement can be termed as a ‘contract’ and the authority so acquired as ‘contractual
authority”.

Business Contracts
A contract as such as an agreement between 2 or more parties in writing, to do or not to
do certain things. Business contracts are those agreements which are enforceable at law.

A consideration is made in return for a specific promise contained in the offer of the
promisor. In order to enter into a contract, there must first be an offer or proposal
signifying the willingness of one party to do or abstain from doing something at the
desire of the other party. The desire of the other party is expressed in the enquiry often
known as Notice Inviting Tender (NIT) and the offer to carry out the services at certain
terms is known as tender.

Sequence of events resulting in a business contract are shown below:

Enquiry  Offer  Acceptance  Agreement Contract

Enquiry -Issue of NIT to selected parties or to the newspapers by the project authority
and sale of tender document.
Offer- submission of the tender documents by the bidder.
Acceptance- Communication from the recipient of the offer to the bidder indicating
intent to enter into an agreement and acceptance of the same by the bidder.
Agreement-offer and considerations as accepted given a legal form and content duly signed by
competent authorities of both parties.
Contract-Consists of an agreement on stamped paper, a detailed letter of intent with agreed
variations and original tender documents.
3R’s Contracting
3R’s in the case of contracting are:
Responsibility, reimbursement and risk.

Responsibility:
The issues of the responsibility are:
1. What to parcel out to the contractors and what to retain.
2. How to define the work parcels so that the contractors know their scope precisely and there is
no overlapping, undefined, unallocated or ambiguous work area.
3. What are the relevant performance parameters for fulfilment of which contractors must assume
responsibility?

Sometimes, the owner may not like to define everything clearly in order to keep some flexibility
with him to play with the scope of work. The contractor may also not be interested in a clear
definition so that he can latter make extra claims and earn disproportionately high
reimbursement for any additional work. But in the interest of both parties, ambiguities to be
minimum. If the ambiguities are more, this lead to evasion of responsibility, extra claims, ill-
feeling, strained relationship, decay in work progress and additional cost in the completion of the
project.

Reimbursement
The second “R” of contract refers to the type of reimbursement. This “R” is more important for the
contractor than the owner, while the owner may refer to the responsibility to describe the
contract arrangement. The contractor may choose to refer to it by the types of reimbursement
such as lump sum contract, item rate contract etc.
Types of Reimbursement
1. Lump sum contract
2. Cost-plus contract
3. Convertible contract
4. Item-rate contract
5. Hybrid contract

1) Lump sum contract

In order to make a lump sum offer a contractor would like to have all the details. If the details are
not know he would like to build contingencies in his price to take care of the unknown. Lump
sum contract more expensive than a Cost-plus contract.
Lump sum - Fixed price
Negotiated- Fixed price is negotiated with the contractor.
2) Cost-plus contract
In cost-plus contract, the owner agrees to cover the actual expanses of the project. These costs
include labour, materials and other costs incurred to complete the work. The “plus” part refers to
a fixed fee agreed upon in advance that covers the contractors overhead and profit. The cost-plus
contract are “open book”, meaning the owner has the right to see exactly what the expense are.
Cost plus contract are an alternative to lump sum contract that allow greater flexibility and more
transparency for the owner. For contractor risk is reduced, because a cost-plus contract
guarantees a profit.

3) Convertible contract
In this type of contracts, initially works like a cost-plus contracts, after the scope of works defined
and later converted to lump sum.

4) Item rate contract

Item rate contract is also known as unit price contract or schedule contract. A contractor
undertakes the execution of work on an item rate basis. He is required to quote rate for individual
item of work on the basis of schedule of quantities furnished by the department. The amount to
be received by the contractor, depends upon the quantities of work actually performed. The
payment to the contractor is made on the basis of the detained measurements of different items
of work actually executed by him.

4) Hybrid contract
The contract in such cases may be divided into two parts,
The parts where design parameter and quantities are frozen and are put on lumpsum.
For the balance parts where quantities may change during detailed design, item rates are invited
from the contractor.
a) Lumpsum + item rate
b) Lumpsum + Lumpsum + cost Plus
c) Lumpsum + fixed rate.

Risk
Both the owner and the contractors are much concerned about Risk. In fact, a contract is
considered to be an instrument for transfer of risk from the owner to the contractor. The
contractor need protection from risk in one or other form. But the contractor risks only his fee.
Small risks can be may be covered by insurance and little more protection may be provided by in
the contract document.
Owner Risk
Contractor Risk

Owner Risks
1. will the contractor be able to carry out the work as per specification?
2. Can the work be completed within the quoted cost?
3. Will the plant perform at the required level?
4. Will the contractor stay on the job till its completion?
5. Will the contractor adhere to the time schedule?
6. Will the contractor cooperate with the owner and third parties?
7. Will the party submitting the tender back out when the contract is awarded to him?
8. Will the contractor rectify defects discovered after he leaves the scene?
9. Will the contractor leave behind liability for the owner to deal with in regard to his staff or
third parties?
10 If the reltionship does not click, what can happen?

Contractor Risk
1. Will the owner terminates his work before completion of the same?
2. Will the owner make payments promptly?
3. Will there be work hold-up and and imposed idleness for him?
4. Will the owner carry certain obligations regarding his work?
5. Will the owner change the scope of work upsetting his plan and estimates?
6. Will the work quantities and specifications change significantly affecting his rate?
7. Will he get reimbursed for extended work duration?
8. Will there be price escalation and will he get compensated for the same?
9. Will he be penalized for failures beyond his control?
10. Will there be smooth cash flow?
11. Will the owner provide workforce and other inputs in time for uninterrupted progress?
12. Will the plant or equipment be taken over when ready?
13. Will the owner honor extra claims?
14. Will there be difference in interpretation of his scope and responsibilities with the owner?
15. Can he make a profit?

Tendering and selection of contractor

A tender may be defined as an Offer to carry out certain work or supply certain materials or
services in accordance with clearly detailed description and conditions.
The Tendering procedure deals with:
1. Prequalification of contractor
2. Preparation of tender documents
3. Mode of floatation enquiry
4. Receipt of tender
5. Guidelines for evaluation of tenders
6. Selection of contractor

Pre-qualification of contractors
1. Contractor has had similar experience earlier and his performance.
2. His past turnover and present financial commitments.
3. He has the necessary infrastructure, adequate technical manpower, equipment and his present
commitments.
4. His credibility in terms his associates and associations with other agencies.
Preparation of tender documents
A good tender documents will include the following

1. Letter of invitation to tender

2. Instruction to tender
[Link] conditions of contract
4. Technical specification
5. Special conditions of contract
6. Scope drawing
7. Bill of quantities
8. General information about site
9. Form of tender

Receipt of tenders
The tenders may make a request to visit the site for further information. For supplementary
queries, pre-bid conference may arranged for better information. The bids may be opened infront
of the tenders present. The names of the tender would announced and recorded.

Evaluation of tenders

The tenders are evaluated from technical, commercial, contractual and managerial angles.
Normally, separate meetings are held with each contractor to obtain clarification and also to
bring all the offers in line with the tender requirements.
The lowest bidder who is technically and managerially acceptable is awarded the contract.

Agreement
An agreement is now to be signed on a stamped paper. The form of agreement is probably the
most standardized document.

The accompanying documents normally are:

1. Original tender papers comprising the conditions of contract, specifications, dates and other
relevant information.
2. Schedules of rates and prices.
3. List of deviations from original tender stipulation
4. Other relevant attachment

Form of guarantee
Finally, a guarantee from sureties in the standard form may be asked from the contractor as an
insurance against uncertainties in dealings with the contractor.
Unit-3 Tools and techniques in Project
management
GANTT Chart (Bar Chart)

GANTT chart is pictorial representation showing the various job/activity to be done and the time.
In dealing with complex projects, a pictorial representation showing the jobs to be done with time
is generally helpful. One such pictorial chart is known as the bar chart. It consists of two co-ordinate
axes, one representing time elapsed and the other, jobs and activities performed. The jobs are
represented in the form of bars. The length of the bar indicates the duration of the job takes for
completion. The chart clearly showing: 1. Activities involved in the project 2. Start and end time of
the activities.

Advantages of Gantt chart

1. Simple to understand
2. Easy to change
3. Simple and least complex means portraying progress.
4. Easy to identify specific elements that be either behind or ahead of schedule.
Limitations
1. It Cannot indicate interdependencies of activities. Some activities are depend on the other
activities and some are independent.
2. It cannot show the progress of work
3. It cannot reflect the uncertainty and tolerances in the duration time estimated for various
activity.
Network Techniques
Structurally, Network is graphical model depicting the inter-relationship between the various
elements of the project work system. It propagates holistic approach, that is individually nothing
can be achieved and only when all of us work together. Arithmetically, a network computes the
time, cost and resource requirement for the project. It highlights the importance of each activities.

Terms used in network

WBS: Break down the project into activities such that each activity is clearly identifiable and
manageable.
Activity: This is physically identifiable part of the project that consumes time and resources. It is
represented by an arrow.
Events(Node): These are the beginning and end of an activity.
Path: This is a continuous chain of activities from the beginning to the end of the project. Activity-
On-Arrow(AOA) diagram: A network with activities represented on arrows and events on nodes.
Activity-On-Node(AON) diagram: A network with activities represented on nodes. Arrows indicate
only the interdependencies between them.

Network construction
1. Activities progress from left to right.
2. Each activity is represented by only one straight and solid arrow.
3. If two activities having same start and end nodes, show one of them separately with
dummy activity with dashed line.
4. An activity which shows the logical relationship between its immediate predecessor and
successor activities.
5. Arrows should not cross each other as far as possible.
6. Avoid curved arrows, dangling arrows and looping of network.
 Common errors committed in network
construction

Type of network analysis

1. CPM (Critical path method) network
2. PERT (Project evaluation review technique)
CPM does not incorporate uncertainties in job time, suitable for project activities having single
time estimates. Determine the critical path, minimum project duration, floats available with each
activity.

PERT is suitable for non- repetitive projects, where job times are not estimable with certainty. So
it is probabilistic nature

Difference between PERT and CPM

Critical path

Paths
1-2-3-8 = 10 day
1-2-6-7-8 = 14 days (Critical path)
1-4-6-7-8 = 12 days
1-4-5-6-7-8 = 13 days
1-4-5-7-8 = 10 days

Critical path: This is the longest path time –wise connecting the start and end events. The events
laying along this path are critical in the sense that their occurrence cannot be delayed if the
scheduled completion time is to be met. Critical time is the minimum time required to complete
the project.

Earliest start and Late finish time

Early Start (ES) of an activity in a project is the earliest possible time that the activity can start.
Forward pass: To determine the ES times of events, the computations stars at Node 1 and
advances recursively to the last Node “n”.
Late Finish (LF) represents the latest date an activity can finish, without delaying the finish of
the project.
Backward pass: To determine the Latest Finish times of events. The computations start at the
last Node “n” and end at Node 1.

Float/Slack
Float is the length of the free time available within the estimated times of the non-critical path.
The float time is zero along the critical path activities

Total Float (FT): It is the amount of time by which an activity can be delayed without affecting
project duration time.
TF=(LFj - ESi)-t

Free Float (FF): Free float is the how much an activity’s completion time may be delayed without
causing any delay in its immediate successor activity.
FF=(ESj - ESi)-t
Independent Float(IF): It is the amount of time an activity can be delayed for start without
affecting the completion of preceding activity.
IF=(ESj - LFi)-t

Time estimates
After the network has decided, need to find time required for execution of each activity.

Because of uncertainty involvement, difficulty to find exact time of activities.

Three kinds of time estimates

1. Optimistic time estimate (to)
2. Pessimistic time estimate (tp)
3. Most likely time estimates(tm)

1. Optimistic time estimate (to): This is the estimate of the shortest possible time in which an
activity can be completed under ideal conditions.

2. Pessimistic time estimate (tp): This is the maximum possible time it could take to accomplish
the job. If everything went wrong and abnormal situations prevailed, this would be the time
estimate for the activity.

3. Most likely time estimates(tm): This is the time estimate which lies between the optimistic and
pessimistic time estimates. It assumes that things go in the normal way, with a few setbacks, usual
lapses in deliveries, no dramatic breakthroughs and so on.

Beta Distribution
Fairly satisfactory results for the most activities.

t O  4t m  t P
tE 
Earliest Expected Time 4
t P  tO

Standard deviation 6

Crashing of Project
In many situations it becomes necessary to cut down the project duration. How can it be done?
Activities that are critical need be to be crashed in order to reduce project durations as it is these
activities that determine the project duration. But this has got its own cost implications.
Reduction in project duration calls for more resources to be pumped in and hence, the direct
costs increase. Whereas indirect costs such as equipment, rent, supervision charges, etc. reduce.
Thus, it becomes necessary to identify a project duration up to which the project can be crashed
so that overall project costs are minimum.
Cc  Nc
Costslope 
Nt  Ct

Nt = Normal time
Nc = Normal cost
Ct = Crash time
Cc = Crash cost

Resource allocation
Every organization in any industry/company has its own resources, which consists of
equipment, materials, people, time and knowledge. Most organizations have limited
resources. The limited resources are utilized by the project management team based on
the priority. This is a tough task to deal with, but with the help of an effective allocation
plan, it becomes easier to effectively manage the shortage resources. By doing this
planned resources allocation, cost of the company is saved and resources utilized
effectively.

To achieve this, resource optimization techniques are used by project management.

1. Resource smoothing
2. Resource leveling

Resource smoothing:
Resource smoothing is the resource allocation method without extending the schedule of
the project. i.e., time is the main constraint. The project completion date and critical path
will stay the same. So flexibility is reduced, the schedule will be optimized and cost
effective.

Resource leveling
If there is limited resources in the company/ project management (resource constraint) ,
in such cases, to complete the task, the schedules are extended. This method resource
allocation is known as resource leveling. It is technique of using limited resources at a
constant level and resources optimized by extending the schedule, i.e., the project duration
will be extended.
Resource leveling is used when:
1. A critical resources may not be available for certain duration.
2. To share a resource with another project.
3. The demand for a resource exceeds the supply.

Unit-4 Project management performance

When shall we consider a project a total success? Ideally, a project will be considered totally
successful if it gets completed on time, within, budget and performs exactly to the designer’s
specifications. Many projects would not meet these requirements. In real life, a project cannot be
considered either a total success or a total failure it would fit somewhere in-between.
Performance indicators of PM

1. Time overrun
2. Cost overrun
3. Project sickness
4. Productivity as performance indicator
5. Value as performance indicator

1. Time over run

Time overrun is the non-completion of the project within the original or stipulates or agreed
contract period.
Time overrun is one of the most significant issues being faced by the projects today. There are
various factors responsible for the time overrun which require serious attention to understand
and address in order to achieve successful completion of projects on time. This is because time
overrun has great impact on cost which can never be recovered.

2. Cost over run

Time can be misquoted, cost cannot. Anything done to a project would be reflected in the cost. If
a project is not managed well, its cost will go up., if a project is managed well, its cost should
come down. Therefore, cost can be used as an indicator for project management performance.
Cost estimates are to be revised at various stages to improve their accuracy.

3. Project sickness

The project management is responsible to best use of resources in the project in the project. The
resources used for project reflect in the plant. The ratio of this out put to the cost incurred for
putting up the plant could be an indicator of project management performance. This indicate the
health of plant. If a project is implemented at a lower installed cost, the plant performance will be
so much better, if not, the plant faces the risk of falling sick. Installed cost per tonne is a
performance indicator and commercial production cost per tonne is also an indicator. If both
production cost and installed cost are not managed well the project fall sick.

4. Productivity as performance indicator

Productivity at the project implementation stage will affect the productivity of an operating
plant. Operating cost per tonne reflects the productivity of an operating plant. A productivity
indicator reflects how resources have been utilized either for production of goods and services or
for creation of facilities for the same.

5. Value as performance indicator

Value, which can be expressed as performance, improves only when performance is achieved as
at no extra cost or when cost can be reduced for the desired level of performance.
If the installed cost per tonne of capacity is higher than normal, then the plant will invariably fall
sick.
In fact, value engineering encourages increase in quality if it can be attained at no extra cost.

DO-IT-YOURSELF TRAP
Many owner would feel tempted to do everything themselves to bring down the project cost. In
such cases, the owner engages the team of production to manage his project. He may try to get all
the design work done in-house, fabrication as much as possible at his shop, engage labor
contractors for construction and supervise the Design, procurement and construction work all by
himself.
Unfortunately, these projects which have maximum time and cost overrun. They are also the
ones where quality is ignored. The main drawback with this arrangement is that it imposes a
tremendous load of coordination on a working group which has no experience nor is equipped
with the tools and techniques of project coordination. Working team do not have the experience
of working in an uncertain and dynamic work. This results in time and cost overrun for the
project.

The operating people will invariably expand the scope of the project for the shake of flexibility to
avoid any possible difficulty during operation. There are endless changes even after the basic
package is finalized.
Contractor is enough to take the fun of “Do-it-yourself” type of management and unless some one
intervenes, contractors are only interested in picking up payments. A project does not get
completed easily and costs very heavily.

Project Management Environment

The project management environment in India, as shown in figure, is very different from other
country. There are many problems experienced in the execution of both small and big projects.

The important problem is lack of mutual trust and respect amongst the participating agencies:
owner, financial institutions, consultants, vendors and contractors.
The owner believes that the agencies would take him for a ride. Lack of professional ethics to the
consultants. Most of procurement may often be selected purely on personal rather than techno-
economic considerations.
The financial institution may not trust the owner since owner may disown a project and the
financial institutions have more stake in the project than the owner himself.
Sometimes, owner may intentionally under estimate the project cost with the intension of
reducing his contribution. So there will be cost overrun and time overrun for financial
arrangement.
The project management environment in India, can broadly be grouped into four classes of
environment problems:
Social
Economic
Technical
Managerial.
The figure details the problems which normally experienced during project execution in India.

Risk analysis
Investment risk is the probability or likelihood of occurrence of losses relative to the expected
return on any particular investment.

Risk is inherent in almost every business decision .Different techniques have been suggested to
handle risk in capital budgeting fall into two broad categories.

1) Technique that considers the stand-alone risk of a project.

2) Technique that consider the risk of a project in the context of the firm or in
the context of the market.

Sources, Measures and Perspective on risks

Sources of risk:
1) Project - specific risk: This type of risk is specific to the project like the quality of
management .
 2) Competitive risk: This type of risk may be affected by the unanticipated actions of the
compotators.
3) Industry - specific risk: Unexpected technology development and regulatory changes that
are specific to the industry will causes risk.
4) Market risk : Unanticipated changes in macro economic factors like the GDP growth rate ,
interest -rate and inflection have an impact on all the projects.
5) International risk: In the case of foreign project, earnings and cash flows maybe different
than expected due to the exchange rate risk or political risk.

Measures of risk
A variety of measures have been used to capture different facets of risk. These are: range, std.
deviation, co-efficient variation and semi-variation.
Range: it is simplest measure of risk, the range of a distribution is the difference between the
highest value and the lowest value.
Std. deviation: the std. deviation of a distribution is :
pi= Probability associated with i the value

Xi = ith value x = expected value

Co-efficient of variation (CV): CV adjusts std. deviation for scale
CV = Std. deviation/expected vale
Semi variance: The semi-variance is compared the way the variance is computed, except that
only outcomes below the expected value are taken in to consideration
SV  pi di2

Sensitivity analysis
Sensitivity analysis is technique for investigating the impact of changes in project variables on
NPV or IRR.
Only one adverse changes are considered in sensitivity analysis.

Purpose of sensitivity analysis

1. to identify the key variables which influences the project cost and benefit.
2. to investigate the consequences of adverse changes by the variables on project by considering
each key variables at a time.
3. to identify the actions that could mitigate possible adverse effects on the project.

Scenario analysis
The variables are interrelated. So need of considering plausible (appearing) variables to study the
effect of variables on project. Each scenario representing a consistent combination of variables.

Steps involved in scenario analysis

1. Select the factors around which scenarios will be built.
2. Estimate the values of each of the variables in investment analysis for each scenario.
3. Calculate NPV/IRR under each scenario.

Best Scenario: High demand, high selling price, low variable cost and so on.
Normal Scenario: Average demand, average selling price, average variable cost and so on.
Worst scenario: Low demand, low selling price, high variable cost and so on.

Break-even analysis
Accounting break-even point, on the one hand, is the easiest and most common method of
analyzing profits. It is easily calculated by taking the total expenses on a particular production
and computing how many units of the product need to be sold in order to cover the expenses.

Financial break-even point, on the other hand, It doesn’t address a specific product or units
number, but instead, a company’s earnings, specifically about how much it needs to earn in order
that its earnings per share are equal to zero. Earnings mean the gross amount of money earned by
the company before taxes and expenses are taken out.

The term contribution margin is often heard in relation to the break-even point. It refers to the
actual profit a business can earn from every single unit sold. It is understood to be the product’s
price, less the variable costs. Often, experts say the contribution margin shows the real profit and
not the revenue.
The formula for breakeven analysis is as follows:

Break even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)

Where:
Fixed costs are costs that do not change with varying output (e.g., salary, rent, building
machinery).
Sales price per unit is the selling price (unit selling price) per unit.
Variable cost per unit is the variable costs incurred to create a unit.

Hillier model of risk analysis

According to the Hillier model, the risk associated with the project can be assessed through the
standard deviation of expected cash flows. In other words, determining the viability of the project
through calculating the deviations in the cash flows from the mean of expected cash flows.
Two cases of such analysis are
1. Uncorrelated cash flows
2. Correlated cash flows
Uncorrelated cash flows:
In this type of investment in a project, there is no relationship between cash flows from one
period to another

Perfectly correlated cash flows

If cash flows are perfectly correlated, the behavior of cash flows in all periods is alike. Cash flows
of all years are linearly related to one another.

Simulation analysis
The information can be generated by simulation analysis. Simulation analysis is a computer based
exercise that generates large number of simulations and computes NPV of each of them to find
out the distribution of NPV, its expected value and std. deviation as a measure of risk. Simulation
analysis computes the probability distribution of NPV.

Commonly used distributions are

Uniform distribution, Trapezoidal distribution, step rectangular distribution, Normal distribution
Steps involved in simulation analysis
1. Identification of exogenous variables that influence cash inflows and out flows of a project
and its NPV.
Eg. Demand, selling price, variable costs, market size, market growth, variable and fixed cost etc.

2. Understanding the relationship among the variables and NPV.

Ex.
● Revenue depends on sales volume and price.
• Sales volume depends on market size and market share etc.

3. Specify the probability distribution of each of the exogenous variables.

3. Develop a computer programme that randomly selects one value from probability
distribution of each variable and uses this value to calculate the project NPV.

Decision tree analysis

A decision tree is a graphical representation of relationship between a present decision and future
events, future decisions and their consequences. The sequence of events is shown in a format
resembling branches of tree. The decision tree branches depict the cost and return associated
with each branch and the probabilities are estimates for each possible outcome. The alternative
with the highest amount of expected monetary is selected.
Steps is decision tree analysi
1. Identification of problem and alternatives:
To understand the problem and to develop alternatives, information from different
sources has been to be tapped. Imaginative efforts must be made to identify the nature of
alternatives that may arise as the decision situation.
Recognizing that risk and uncertainty are inherent characteristics of investment
projects.

2. Delineating the decision tree:

Constructing decision tree indicating decision points representing the various
managerial courses of action available at a given point and following by the chance events that
follow each action that impacts the future courses of action and is again followed by
decision points.

3. Specifying probabilities and monetary values for outcomes:

Assignment of probabilities of chance events and determination of monitory values of
cash inflows of each decision point.
These probabilities and cash flows are analyzed from the end to arrive at a judicious
decision.

4. Evaluating alternatives:
The alternative decision with highest amount of expected monetary value is
selected.

Managing Risk
Managers want to explore ways and means of reducing risk. Some of the ways of doing this are
given below:

1. Fixed and variable cost: By increasing the variable cost and reducing the fixed cost, risk may
be reduced. By buying the most of its components from a manufacturing and assembly company,
fixed cost is reduced and increases is variable cost. The net effects is that its breakeven level
declined.

2. Pricing Strategy: A lower price increases potential demand, but also raises the breakeven
point.

3. Sequential investment: Firm is started with low investment, after knowing the mark
response. Later expand as the market grows. This reduces risk exposure.

4. Improving information: It is good to gather more information about the market and
technology before taking the plunge. Additional study often improves the quality of forecasts but
involves direct costs.

5. Financial leverage: Reducing the dependence on debt (loan) lowers the risk. The debt entails
a definite contractual commitment whereas equity carries no fixed burden.

6. Insurance: Insurance covers a variety of risks like physical damage, theft, loss of key person,
and so on. For insurance, we need to pay the insurance premium.

7. Long-term arrangements: One way to mitigate risk is to enter into long-term arrangements
with suppliers, employees, lenders, and customers.
A long–term contract with suppliers ensures availability of inputs at predictable price.
A long-term wage contract with employees removes uncertainty about employee cost.

8. Strategic alliance: A strategy alliance is legal agreement between two or more companies to
share or access to their technology, trademarks and other assets.

9. Derivatives: Derivate instruments like options and futures can be used for managing risk.
An option gives its owner the right to buy or sell an underlying assets on or before a given
date at a predetermined price.
A future contract is an agreement between two parties to exchange an assets for cash at a
predetermined future date for a price that is specified today.

Project Selection under Risk

several methods are there to accept or reject a project proposal after gathering the information
about expected return and variability on return.

1. Judgmental Evaluation:
The decision, to accept or reject a project, is based on collective view of some group like,
 Board of Directors, the executive committee etc. without using any formal method of decision
analysis.

2. Payback period requirement: If the risk is function of time, a shorter payback period is required
even if the NPV is positive. Lower the payback period is better to come out from risk.

3. Risk profile method: In this method, transform the probability distribution of the NPV into
probability distribution of profitability index.
The higher the expected value of profitability index, greater the dispersion that is
acceptable to the management.

4. Risk Adjusted Discount rate method: The risk adjusted method calls for adjusting rate
to reflect project risk. If the risk of the project is greater than the risk of the existing
investments of the firm, the discount rate used is higher than the average cost of capital of
the firm.
rk  i  n  d k

rk = risk adjusted discount rate for project k.

i = risk free rate of interest
n = adjustment for firm normal risk
dk = adjustment for the differential risk of project k
Once the project’s risk adjusted discount rate is specified, the project is accepted if its NPV
is positive.
5. Certainty equivalent method:
Certainty equivalent co-efficients transform expected values of uncertain flows into their
certainty equivalent.
 Unit-5 Financing of Projects
Project financing is a long-term, limited recourse financing solution that is available to a
borrower against the rights, assets and interests related to the concerned project.
Sources of finance
Capital structure
Menu of financing
Equity capital
Preference capital
Internal accruals
Term loans
Debentures
Working capital advance
Miscellaneous sources
Raising venture capital
Raising venture capital in international market

Capital Structure
Two broad sources of finance available to a firm are
1. Shareholder’s funds
2. Loan funds
1. Shareholder’s funds are:
a) Equity capital and Retained earnings
b) Preference capital
2. Loan Funds are:
a) Debenture capital
b) Term loan
c) Deferred credit
d) Fixed deposits
e) Working capital Advance

Difference between share holder’s funds(equity) and loan funds (debt)

Equity holder Debt holder
1. Share holder have a residual claim on 1. have a fixed claim in the form of the
income and the wealth of the firm interest and principal payment
2. Not a tax deductible payment 2. Interest paid to creditors is a tax
deductible payment
3. Has an indefinite life 3. has a fixed maturity
4. Control the affairs of firm 4. play a passive role

Important considerations in planning the

capital structure are:
 1. Earning per share
2. Risk
3. Control
4. Flexibility
5. Nature of assets

1. Earning per share (EPS):

Earnings per share, which is simply equity earnings divided by the number of outstanding
equity shares.
EPS= (Profit before interest and taxes-interest)(1-tax rate)-preference dividends
Number of equity shares
To expand firm, the management has to raise additional capital either by issuing equity
shares or through debentures with some percent interest. Breakeven analysis is also
carried out for the financing plans

2. Risk: The two principal sources of risk in a firm are

Business risk
Financial risk
Business risk refers to the variability of profit before interest and taxes.
It is influenced by the following factors:
• Demand variability
• Price variability
• Variability in input prices
• Proportion of fixed costs
Financial risk represents the risk emanating from financial leverage. If debt is in high
proportion, it increases the fixed financial commitments. Equity shareholders face the
risk in additional to the business risk.

3. Control: To enhance the additional capital for a firm, it may go for debt finance or a
rights issue of equity capital, or combination of these. The control on firm depends on
type of capital.

4. Flexibility: Flexibility refers to the ability of a firm to raise capital

from any source. It may be equity or debt capital. However debt equity ratio is normally
not permitted to exceed a certain level. A firm does not fully exhaust its debt capacity. It
implies that the firm maintains reserve borrowing power to enable it to raise debt capital
to found unforeseen fund.
5. Nature of assets: If the assets of a firm is tangible (physical), their assets are debt.
If the assets are primarily intangible (brands and technical know how), debt
finance is used less.
Different ways of raising Equity and debt
Public and private sources of capital:
Public and private sources of capital is available to a firm to raise equity and debt.
Public source is in the form of securities offered to the pubic through an offer document
filed with the Securities Exchange Board of India(SEBI).

Private capital is in the form of loans given by banks and financial institutes or in the
form of securities like equity shares, preference shares and debentures from investors like
financial institutions, insurance companies, mutual funds and wealthy individuals.

The typical pattern of financing:

When a company is formed, it first issues equity shares to the promoters (Founders) and
also, raises loans from banks, financial institutions and other sources. As the need for
financing increases , the company may issue shares and debentures privately to
promoter’s relatives, friends, business partners, employees, financial institutions, banks,
mutual funds, venture capital funds and others.
As the company grows further, it may have the rise capital from the public.
Apart from the equity shares, a firm may issue preference shares and debentures to the
general investment to public through a public issue.

Equity capital
Equity capital represents ownership capital as equity share holders.
The equity share holders are the owners of the company who have significant control
over its management. They enjoy the rewards and bear the risk of ownership. The equity
capital is also called as the share capital or equity financing.

Some terms
Authorized capital: it is the maximum amount of capital that a company can raise
through the issue of shares to the shareholder.
Issued capital: The issued capital refers to the number of shares issued by the company to
the shareholders.
Subscribed capital: The part of issued capital which has been subscribed to by the
investors represents the subscribed capital.
Paid-up capital: The actual amount paid up by the investors is called paid-up capital.
Par value: of an equity share is the value stated in the memorandum and written on the
share scrip.
Par value generally Rs. 10.
Issue price: is the price at which the equity share is issued. An existing company may
some times set its issue price higher than the par value.

Book value : Paid-up equity capital + Reserves and surplus-intangibles

No. of outstanding equity shares

Market value: of an equity share is the price at which it is traded in the market

Rights of equity share holders

Rights to income:
The equity investors have a residual claim to the income of the firm. The equity
shareholders are entitled to dividend that is declared by the Board of Director

Right to control:
Equity share holders as owners of the firm elect the Board of Directors and have the right
to vote on every resolution placed before the company. Board of directors selects the
management which controls the operations of firm.

Pre-emptive right: The pre-emptive right enables exiting equity share holders to
maintain their proportional ownership by purchasing additional equity shares issued by
the firm. Equity share holder has the right to purchase additional share with first
preference.

Right in liquidation: As in the case of income, equity shareholders have a residual claim
over the assets of the firm in the event of liquidation. The claims of all other-debenture
holder and preferred share holder-are settled prior to the firm of equity share holders.

Methods of raising equity capital

When a company is formed, it first issues equity shares to the promoters (Founders)
And to the selected group of investors.
As the company grows, following are methods of raising equity shares:
1. Initial public offering (IPO) 2. Seasoned offering
3. Rights issues 4. Private placement
5. Preferential allotment

1. Initial public offering

The first public offering of equity shares of a company, which is followed by
a listing of its shares on the stock market, is called the initial public offering.
Benefits of IPO are
 1. Access larger pool of capital
2. Respectability
3. Lower cost of capital compared to private placement.
4. Liquidity
2. Seasoned offering
As company grow, they are likely to make further trips to the capital market with issues of
debt and equity.
The procedure for a public issue of seasoned offering is similar to that of an IPO.
3. Rights issue
When a company issues additional equity capital, it has to be offered in the first instance
to the existing shareholders on a pro rata basis. This is required under Section 81 of the
companies Act 1956.
4. Private placement
It is refers to sale of equity of an unlisted company or sale of debentures of a listed or
listed company to sophisticated investors such a financial institutions, mutual funds
banks etc.
5. Preferential allotment
An issue of equity by a listed company to selected investors at a price which may or may
not be related to the prevailing market price is referred to as preferential allotment in the
Indian capital market.
Advantages of equity capital to the company
1. There is no compulsion to pay dividends.
2. Equity capital has no maturity date.
3. Larger the equity base, the greater the ability of the firm to raise debt
finance on favorable terms.
4. Equity dividends are tax-exempt up-to a certain extent.

Disadvantages of equity capital to the company

1. Sale of equity shares to outsiders dilute the control of existing owner.
2. The cost of equity capital is high.
3. Equity dividends are paid out of profit after tax.
4. Cost of issuing shares is generally higher than the cost of issuing other types of
securities.

Preference capital
Preference capital is hybrid form of financing. It has characteristics of equity and
debentures.
Some characteristics of equity shares
 1. Profit is distributed.
2. Not an obligatory payment.
3. Not a tax-deductable payment.

Some characteristics of debentures

1. Divided rate is fixed.
2. Claim is prior to the equity share holder.
3. Do not enjoy the right of vote.

Advantages of preference capital to the company

1. There is no legal obligation to pay preference dividend.
2. There is no liability in the case of perpetual preference shares.
3. It is the part of net worth.
4. No voting rights, so no dilution of power.
5. No collateral is pledged for preference share.

Disadvantages
1. More expansive than debt capital.
2. Skipping dividends can adversely affect the image of the firm in the capital market.
3. Prior claim than the equity share holders.
4. If a firm skips preference dividends for three years, it has to grant voting rights to
the preference shareholders.

Term Loan
The firms obtain long term debt mainly by raising term loans or issuing debentures for
private firms and public firms.
Term loan is referred as term finance, loan is generally repayable is less than
10 years with equal installments.
Features of term loans
Currency
Security
Interest payment and principal repayment
Restrictive covenants

Currency: Financial institutions give rupee term loan and foreign currency term loan.
The rupee term loans are given directly for buildings, preliminary expenses, working
capital etc.
Financial institutions provide foreign currency term loan for meeting the foreign currency
expenditure towards import of plant, machinery etc.

Security: Usually assets, which are financed with the term loan, provide the prime
security. Other assets of the firm may serve as collateral security. All loans provided by
financial institution with interest, liquidated damages, commitment charges, expenses
etc. are secured by the way of
1. Equitable mortgage for immovable properties of the borrower.
2. Hypothecation of all movable properties of the borrower.

Interest payment and principal repayment: Typically, term loans provided by

financial institutions are repayable in equal instalments. This installments includes
interest and part of principal. Interest burden is decline over time.
The borrower has to pay principal with interest irrespective of the financial situation of
the firm.
Financial institutions impose a penalty for defaults and in this case borrower is liable to
pay compound interest and other additional charges.

Restrictive covenants: Financial institutions impose restrictive conditions on the

borrowers. This conditions depends on nature of project and financial situation of the
borrower.
1. Obtain clearances and licenses from various govt. agencies.
2. Repay existing loans with the concurrence of the financial institutions.
3. Refrain(stop) from undertaking any new project or expansion without
prior approval. Refrain from additional borrowings.

Term loan procedure

1. Submission of application: The application submitted for term loan covers
the following:
• Promoters background
 • Particulars industrial concern
• Particulars of the project
• Cost of the project
• Means of financing
• Marketing and selling arrangements
• Profitability and cash flow
• Economic considerations
• Govt. consent
2. Initial processing of loan applications: Officers of the financial institution reviews it
to ascertain whether it is complete for processing. If it is incomplete asked to give
required information. Then they prepares “Flash report”. Flash report is Summarization of
loan application.

3. Approval of the proposed project: Approval covers the marking, technical, financial,
managerial and economic aspects. Based on this a decision is taken to accept or reject.

4. Issue of the letter of sanction: If the project is accepted, a financial letter of sanction
is issued to the borrower. This communicates to the borrower in terms and conditions.

5. Acceptance of the terms and conditions by the borrowing unit: the acceptance of
the terms and conditions has to be conveyed to the financial institution with in a
stipulated period
6. Execution of loan agreement: After the acceptance from the terms and conditions by
the borrower, the agreement is executed as per the Indian stamp Act 1899, along with
other documents. Once the financial institution signs the agreement, it becomes
effective.
7. Creation of securities: The term loan and the deferred payment provided by the
financial institutions ate secured through mortgage of immovable properties and
hypothecation of movable properties.
8. Disbursement of loan: Periodically, the borrower is required to submit information
on physical progress of the project. Based on the information provided by the borrower,
the financial institution will determine the amount of term loan to be disbursed from
time to time.
9. Monitoring: Monitoring of the project is done at the implementation stage as well as
at operation stage through:
• Regular reports- which provide information about placement order etc.
• Periodic visits
• Discussion with promoters, banker etc.
• Progress reports
• Audited accounts of the company.

Project Appraisal
Financial institutions appraise a project from the marketing, technical, financial,
economic and managerial angles.
Market Appraisal: Examine the reasonable demand projections by utilizing the demand
findings of available surveys , industry association projections, planning commission
projections, and independent market survey.

Technical appraisal: This focuses on product mix, capacity, process of manufacture, raw
materials, location and site, building etc.

Financial appraisal: Seeks to assess: Reasonableness of the estimate of capital cost,

Reasonableness of the estimate of working results, Adequacy of rate of returns,
Appropriateness of the financing pattern

Economic appraisal: The economic appraisal looks at the project from the larger social
point if view. It referred to as social cost benefit analysis.

Managerial appraisal: In order to judge the managerial capabilities of the promoters,

the following questions are raised:
1. How resources are the promoters?
2. How sound is the promoters’ understanding of the project?
3. How committed are the promoters?

Debentures
Debentures are the instruments for raising debt finance from public. Debenture holders
are the creditors of a company. For large publicly traded firms, debentures are a viable
alternative to term loans.

Features of debentures.
a) When a debenture issue is sold to the investing public, a trustee is appointed
through a trustee deed.
b) Debenture issues in India are typically secured by mortgages/charges on the
immovable properties of the company.
c) Debentures are typically redeemable in nature.
d) Debenture maturity period of less than 1 year (short term debentures), 1year – 5
year (medium tem) and 5 year -12 year (long term).
e) Publicly issued debentures that have a maturity period of 18 months or more.
f) Debentures may carry a fixed rate of interest or floating rate of interest or zero rate
of interest.

Innovations in debentures
Deep discount bond: A deep discount bond is a form of bond, which is issued at
significant discount to its face value. It records a promise by its issuer of the bond to pay
the bond holder, on the stated maturity date, an amount which is greater than the
amount originally received.
Convertible debentures: A convertible debentures is a debenture that is convertible,
partially or wholly, into equity shares. SEBI guide lines are followed during the
Conversion. Convertible debentures are commonly used all over the world.
Floating rate bonds: Convertible bonds carry a fixed rate of interest. Floating rate bonds
earn an interest rate that is linked to a benchmark rate such as the Treasure bill interest
rate.
Secured Premium Notes (SPN): After getting approval from the Central Govt, SPN are
issued by listing company. These are non-convertible debentures issued by the companies
with the lock-in-period. SPN holder will get principal amount with interest on
installment basis after the lock-in-period.
Indexed bond: The payoff of a typical indexed bond consists of two parts. The first part
represents a fixed amount and second part represents a variability component whose
value is linked to some index.

Private placement of debentures

Private placement implies any offer or invitation to subscribe or issue debentures by a
company to a certain category of listed financial institution through private placement
offer-cum application letter. The principal buyers of privately placed debentures,
insurance company, army group insurance, Navy group insurance and so on.
Accessibility of private placement of debenture: Almost every company can access the
private placement market. The private placement market can accommodate issues of
smaller size whereas the public issues of market does not permit an issue below a certain
minimum size.
Flexibility: In a private placement, there are greater flexibility in working out the terms
of issue. For example, when a non-convertible debenture issue is privately placed, a
discount May be given to institutional investors to make the issue attractive.
Speed: A private placement issue of debenture requires lesser time than the public issue
cycle. An elaborate procedure followed in a public issue is largely bypassed in private
placement.
Lower issue costs: The issue of debentures in private placement is substantially less
compared to public issue. Because, public issue entails the expenses like brokerage,
printing, promotion and so 0n.

Working capital advance

Cash credits/overdraft: Under a cash credit or over draft arrangement, a pre-
determined limit of loan for borrowing is specified by the bank. Whenever required the
borrower can draw cash within the limit. He can also repay the amount, partially or fully,
as and when desires.
Interest is charged only on the running balance, not on the limit sanctioned. A minimum
charge may be payable irrespective of the level of borrowing for availing of this facility.

Loans: These are advances of fixed amounts to the borrower. The borrower is charged
with interest on the entire loan amount, irrespective of how much he draws.

Purchase/Discount of bills: A bill arises of a trade transaction. The bill may be payable
after a usance period. The seller offers the bill to the bank for discount/purchase. When
the bank purchase the, it releases the funds to the seller. The bank present the bill to the
purchaser on the due date and gets its payment.

Letter of credit: This document will be issued by the bank of the buyer to the bank of
seller guarantying to pay the agreed amount of money to the other as specified in the
letter of credit.

Miscellaneous sources
Apart from regular sources of finance, there are several other ways in which finance may
be obtained.
1) Deferred credit
2) Lease and hire-purchase finance
3) Unsecured loans and deposits
4) Special schemes of institutions
5) Subsidies and sales tax deferments and exemptions
6) Short-tem loans from financial institutions
7) Commercial paper

Deferred credit: Many time the supplier of machinery provide credit facility under
which payment for the purchase of machinery is made over a period of time.
Normally, the supplier of machinery when he offers deferred credit facility insists that a
bank guarantee should be furnished by the buyer.

Lease finance and Hire purchase: A lease represents a contractual arrangement

whereby the lessor (owner) grants the lessee the right to use an asset in return for
periodic lease rental payments. Leasing of industrial equipment is a relatively recent
phenomenon, particularly on the Indian scene.
Hire purchase is an arrangement made while buying expensive goods. The consumer
makes a down payment during the purchase and the outstanding balance will be paid in
installments with an interest charge.

Unsecured loan and Deposits: Unsecured loans are a type of funding, which is offered
without the applicant having to provide any collateral to the bank. These unsecured loans
are offered on the basis of an applicant’s financial documents, credit score, income etc.
Deposits from the public represent unsecured borrowing of one to three years duration.
Many existing companies prefer to raise public deposits instead of term loans from
financial institutions because restrictive covenants do not accompany public deposits.

Special Schemes of institutions:

a) Bill rediscounting scheme: Under this scheme, the seller realizes the sale proceeds
by discounting the bills accepted by the buyer with a commercial bank which in
turn rediscount them with the financial institutions.
b) Supplier line of credit: Under this arrangement, the bank directly pays to the
machinery manufacturer against usance bill duly accepted or guaranteed by the
bank of purchaser.

Subsidies and sales tax deferments and exemptions: Government and development
agencies may provide subsidies for certain kind of Projects. The central govt as well as the
state govt provided subsidies to industrial units located in backward area.

To attract industries, the state provide incentives in the form of sales tax deferments and
sale tax exceptions.

Short-term loans from financial institutions: Financial institutions provide unsecured

short-term loans for a period of one year (renewable) to companies with a good track record. To
be eligible for such a loan, a company must satisfy certain conditions relating to dividend track
record, debt-equity ratio, current ratio and interest coverage ratio.

Commercial paper: A commercial paper represents short-term unsecured promissory notes is

issued by firm while enjoy a fairly high credit rating. Maturity period of a commercial paper
ranges from 90 to 180 days.

Commercial paper is sold at a discount from its face value and redeemable at its face value.

Commercial paper is directly placed with investors who intend holding it till its maturity.

Venture capital
Startup companies with a potential to grow need a certain amount of investment.
Such investment is provided by venture capital funds. Venture capital represents
Financial investment in a risky proportion made in the hope of earning a high
rate of return.

Preparing a business Plan:

Some guideline to approach venture capitalist to finance your project:
1. Use simple and clean language during presentation and avoid technical terms.
2. Focus on four basic elements Viz. People, product, market and competition.
3. Give projections for about two to five years with emphasis on cash flows.
4. Identify risks and development of strategy to cope with the same.
5. Convince them that the management team is talented, experienced, committed
and determined.

Raising capital in International market

Indian firms can raise capital from
Euromarkets
Domestic markets of various countries
Export credit

1. Euromarkets: Euromarkets refers to a collection of international banks that help firms

in raising capital in a global market which is beyond the purview of any national
regulatory body. An Indian firm can access the Euromarkets to raise a
Eurocurrency loan
Issue of Eurobonds
Issue global depository receipts
Eurocurrency loan are often syndicated loan, where a group of lenders, particularly banks,
participate jointly in the process of lending under a single loan agreement. The syndicate
of lender is represented by the lead [Link] rate of interest on Eurocurrency loans is a
floating rate and usually linked to
LIBOR (London Interbank offer Rate) or
SIBOR(Singapore Inter Bank offer rate)

Eurobonds: Firms using Euromarkets can sell bonds:

1. Eurobond is issued outside the country in whose currency is denominated.
2. Managed by syndicate of investment bank.
3. It is bearer bond. Unregistered payable bond to any person.
4. The interest on it is usually paid annually or half-years.
 Global depository receipts: Indian companies have issued global depositary receipts
(GDR), which indirectly equity investment, in the Euromarkets. The underlying shares
called depositary shares. A company planning a GDR issue must obtain the approval
from the ministry of finance and FIPB (Foreign Investment Promotion Board)

2. Foreign Domestic Market

It is a way to raise money internationally is to sell securities directly in the domestic
capital market of foreign countries. This is referred to as direct issuance. Indian firms can
issue bonds and equities in the domestic capital market of a foreign country.

3. Export credit schemes

Export credit agencies have been established by the government of major Industrialized
countries for financing exports of capital goods and related technical services.

Two kinds of export credits are provided : Buyer’s credit and supplier’s credit.

Under buyer’s credit scheme, credit is provided directly to the Indian buyer for
purchase of capital goods and technical services from the overseas exporter.

Supplier’s credit scheme, in which credit provided to the overseas exporters

so that they can make available medium-term finance to Indian importers.