Unit-2 Project formulation
1) SIGNIFICANCE OF PROJECT FORMULATION
1.
Selection of Appropriate Technology-
The first
problem faced by entrepreneur is in the matter of selection of appropriate
technology for his enterprise. Modern technology developed in the highly
advanced countries may not be suitable for adoption in the developing
countries, as the conditions prevailing differ from country to country.
2.
Absence of External Economies-
The
second problem relates the absence or non-availability of external economies. A
project has to depend on other industries for the supply of raw materials,
power, tools, spare parts etc. or an ancillary enterprises which can provide
technical , financial & managerial services or on a complex network of
transport & communication facilities or on an intricate system of business
practices.
3.
Dearth of Technically Qualified
Personnel-
The third problem is the non-availability of technically qualified &
appropriate personnel. Modern technology calls for a certain minimum supply of
various skills that are generally lacking in developing countries.
4.
Resource Mobilization-
The fourth problem is resource mobilization. In the context of present day
development of the magnitude & the size of the project, it would be very
difficult for an entrepreneur to provide the entire development capital that a
project may need.
5.
Knowledge about Government
Regulations-
The government from time to time formulates its own policies regarding
industry, import, export, taxation, price control etc. The entrepreneur must
have a thorough knowledge about government regulations, policies &
licensing procedures etc.
These problems make the entrepreneur to undergo a lot of harassment &
disappointment. But a project formulation, at the right time minimizes the
severity & the magnitude of the above problems.
2)
PROJECT FORMULATION
(i) Technical:
a. Whether the technology involved in
the project is appropriate to meet the objectives, to ensure that
b. It is not an obsolete technology;
c. The technical collaborator is capable
to impart such technology often assured by a term of buy-back of part of the
production;
d. The other terms for the know-how are
reasonable and acceptable as per norms.
(ii) Economical:
a. The investment for the project is
justified considering the overall economical situation and, in particular,
relevant to the industry for which the project is being planned.
b. The project cost is justified as
against the economic benefit to be derived from it.
(iii) Financial:
a. The necessary resources will be
available in time during the implementation of the project and its subsequent
operation. Experience indicates that many projects, after being partially
carried out, are stopped (particularly in the public sector) due to lack of
funds leading to delay in its implementation and cost escalation.
b. The estimated revenue to be generated
from the project after being implemented is sufficient to justify the project
capital cost.
(iv) Social:
a. The objective of the project is to
serve common people through rural development, education, health-care etc. It
should be ensured that sufficient funds are available to maintain such project
e.g. a hospital built-up and equipped with necessary machineries/apparatus
could not be run in the absence of funds to pay the doctors, nurses/maintenance
staff etc.
3) Feasibility
Studies
Feasibility studies
allow companies to determine and organize all the details to make a business
work. A feasibility study helps identify logistical problems, and nearly all
business-related problems and their solutions. Feasibility studies can
also lead to the development of marketing strategies that convince investors or
a bank that investing in the business is a wise choice.
A. Description: A layout of the
business, the products and services it will offer, and how it will deliver
them.
B. Market feasibility: Description
of the industry, the current and future market potential, competition,
sales estimations and prospective buyers.
C. Technical feasibility: The details on how a
company will deliver goods or services, including transportation,
business location, technology needed, materials and labor.
D. Financial feasibility: A projection of
the amount of funding or startup capital needed, what sources of capital a
business can and will use, and what is the return on investment.
E. Organizational
feasibility:
A definition of the corporate and legal structure of the business. This
may include information about the founders, their professional background and
the skills they possess necessary to get the company off the ground and keep it
operational.
4) FINANCIAL
ANALYSIS
Financial analysis is the examination of financial
information to reach business decisions. This analysis typically
results in the reallocation of resources to or from a business or a specific
internal operation. This type of analysis applies particularly well to the
following situations:
· Investment decisions
by external investor.
· Investment decisions
by internal investor.
The key source of information for financial
analysis is the financial statements of a business. The financial analyst uses
these documents to derive ratios, create trend lines, and conduct comparisons
against similar information for comparable firms.
The outcome of financial analysis may be
any of these decisions:
· Whether to invest in a business, and at what price per
share.
· Whether to lend money to a business, and if so, what
terms to offer.
· Whether to invest internally in an asset or working capital,
and how to finance the acquisition.
Financial analysis is one of the key tools
needed by the managers of a business to examine how their organization is
performing. For this reason, they are constantly querying the financial analyst
about the profitability, cash flows, and other financial aspects of their
business.
FUNDAMENTAL ANALYSIS
5) TECHNICAL ANALYSIS
Technical analysis is a trading
discipline employed to evaluate investments and identify trading
opportunities by analyzing statistical trends gathered from trading
activity, such as price movement and volume. Unlike fundamental analysts,
who attempt to evaluate a security's intrinsic value, technical analysts focus on patterns of price
movements, trading signals and various other analytical charting tools to
evaluate a security's strength or weakness.
Technical analysis
can be used on any security with historical trading data. This includes as
follows:
Stocks
- 1 futures
- 2. commodities
- 3. fixed-income
- 4. currencies
- 5. other securities
In general, technical analysts
look at the following broad types of indicators:
- price trends
- chart patterns
- volume and momentum indicators
- oscillators
- moving
averages
- support and resistance levels
6) COST OF PROJECT
The project cost is a
cost required to procure all the needed products, services and resources to
deliver the project successfully.
Example: In an example of a construction project, the cost
estimation starts from land acquisition cost, construction cost, materials
cost, administration cost, labor cost and other direct and indirect costs.
Now you have an understanding of what is project cost. Next,
let’s look at why it is important.
Types of Project Costs.
There are 5 types of project costs incurred in any project. They
are
·
Fixed Cost
·
Variable Cost
·
Direct Cost
·
Indirect Cost
·
Sunk Cost
a) Fixed Cost:
Any Cost which is fixed throughout the
project life cycle and would not change by quantity, time or any other project
factors called for a fixed cost.
Fixed cost Example: In a software project, rent for the company space, systems cost, software license cost, salaries are considered as a fixed cost.
“In short term, the costs are fixed, however, the costs are variable in the long term”
Fixed cost Example: In a software project, rent for the company space, systems cost, software license cost, salaries are considered as a fixed cost.
“In short term, the costs are fixed, however, the costs are variable in the long term”
b) Variable Cost:
On the contrary to
fixed cost, the Variable cost is a cost which varies or changes in proportion to
product or service that the project produces.
Variable Cost Example 1: Let’s understand it with a simple example. Imagine you are running a pizza shop. Once you make, boxed and delivered the pizza to the customer, you have encountered several variable costs. Which are (prices mentioned below are just for the sake of illustration),
Variable Cost Example 1: Let’s understand it with a simple example. Imagine you are running a pizza shop. Once you make, boxed and delivered the pizza to the customer, you have encountered several variable costs. Which are (prices mentioned below are just for the sake of illustration),
- Pizza
base: 50cents
- Pizza
sauce: 10cents
- Pizza
seasoning: 10cents
- Pizza
topping (any): $1
- Box
to deliver:50cents
c) Direct Costs:
Costs which are directly visible and accountable to produce the
project output are called direct costs.
Direct Cost Example: Materials which are used to produce a product can be considered as the direct cost. Logistics, Human Resources, project development cost used specifically to the project can also be considered as a direct cost.
Direct Cost Example: Materials which are used to produce a product can be considered as the direct cost. Logistics, Human Resources, project development cost used specifically to the project can also be considered as a direct cost.
d) Indirect Costs:
Costs which do not directly contribute or specific to the output
of the project are called indirect costs. It may be either variable or fixed.
Indirect Cost Example: Overhead Cost, Electricity consumption,
rent, salary, administrative, security cost. These costs are not directly
related to the production. A project manager is considered as an overhead cost
or indirect cost as he is not directly involved in the production whereas
developer of a project will be considered as a direct cost.
e) Sunk Costs:
Sunk Costs are costs which are already spent, but failed to
incur any business value and cannot be recovered and permanently lost.
f) Total Project Cost:
Calculating Total Project Cost (TPC) is a vital step for any project.
TPC should include all the costs (fixed and variable) of the project. The
calculation should include total estimated cost (TEC) and other project costs
(OPC). I.e., it includes but not limited to activities Costs such as
pre-planning, feasibility, operating cost, commissioning, risk analysis,
contingency, design, development, maintenance etc.
7) financing and estimates of sales of project:
A.
Cost of Production
Cost of production
refers to all costs involved in acquiring goods and services required as input
for producing a product. The four major components of cost of production are –
a)
Material cost – It includes cost of raw material, chemicals, components, and
other inputs required for production.
b)
Labour Cost --It includes cost
of all manpower employed . It is a function of number of employees and rate of
remuneration
c)
Cost of Utilities --It
includes Cost of Power, Water and Fuel. The requirements for fuel, water and
power are determined on the basis of norms specified by collaborators,
consultants etc
Factory
Overhead Cost – It includes expenses on repairs and maintenance, rent, taxes,
insurance on factory assets. It is low in initial years high in later years
B.
Estimates of sales and production
In order to determine profitability of a project the first task
to be carried out is the forecast of sales revenue. While estimating sales
revenue the following things must be kept in mind –
(i)
It is not advisable to assume a high capacity utilization
of machinery level in the first year of operation even if the technology is
simple and company does not face any technical problems.
(ii)
It is not necessary to make adjustments for stock of
finished goods. It may be assumed that production will be equal to sale.
(iii)
The Selling Price used may be the present selling price. It
is assumed that change in selling price will be matched by change in cost of
production.
In order
to make estimates of Sales and Production the following details must be
furnished for each product and until the maximum capacity utilization of the
plant –
1. Installed Capacity
2. Number of working days
3. Number of shifts
4. Estimated production per day
5. Estimated annual production
6. Estimated output as a percentage
of plant capacity