Project Management: Lecture 7 – Sources of Finance

1. At the National Level

Government finances are derived from:

• Direct and indirect taxation

• Levies
• National Savings and Bonds,
• Public assets – Nationalised Industries (especially if making money) and
Public/Private borrowing companies, again if making money
• Borrowings from other governments
• IMF
• Etc….

Revenues distributed by Chancellor of Exchequer annually to various Ministries, under a

cabinet-agreed spending plan – (Defence, Health and Social Services, Education.
Environment etc…). Each Ministry will have its own programme of expenditure and its own
priorities
 Project Management: Lecture 7 – Sources of Finance

2. At the Company Level

Capital structure may be based on shares issued for sale to the public or private individuals,
or in a Partnership, by amounts lodged to firm’s name by each of the Partners. (Cash in)

Other routes:

• Lending Banks
• Merchant Banks
• Government Industrial Support Schemes etc.
• Retained Margin monies from previous year(s): may provide capital for expansion

Compared with other industries/businesses CAPITAL INVESTMENT required to support a

construction company is small in relation to turnover (the total sales value of work
executed in one year)

Remember our example: Company needed to “find” £150 000-200 000 to finance monthly
work

Why companies go bust – Taking on more work with small bank balances
 Project Management: Lecture 7 – Sources of Finance

Necessary requirement: Skilled financial management and continuous attention. Earned

Value Analysis?

Note: large share of finance required is provided by others associated with the works:
Suppliers, Sub-Contractors, the Bank(s).

Investment used in two parts:

• Tangible resources necessary to operate the business – Fixed assets such as plant
and equipment, offices
• Finance required to support the work being carried out until payment for such
work is reimbursed to the company – Working Capital (eg that 150/200 000 per
month)
 Project Management: Lecture 7 – Sources of Finance

Business Finance Cycle (similar to most other types of companies)

Capital Equipment Funds Invested

Goods and Services

Suppliers
Payments
Sources
Company Retained of
Capital
Sale of Goods and Services Profits
Customers
Payments

Tax Payments
Dividends to shareholders
 Project Management: Lecture 7 – Sources of Finance

Working Capital Cycle (similar to most other types of companies)

Working
Capital

Debtors
Cash
(Client)

Materials
Sales
Wages
Including
Expenses
Profit
Costs

Stock
 Project Management: Lecture 7 – Sources of Finance

Rates of Interest

Construction industry is sensitive and vulnerable to changes in rates of interest

Example: Rise in housing mortgage interest rates, leads to fall in demand for
housing. Currently 4 - 6% (and rising?)
Mortgage rates have been as high as 15-18%

Current BoE Base lending rate is 5%+ (and rising?)

Construction really needs to forecast
for the following years.

Higher interest rates mean higher borrowing costs, therefore need a higher rate of return
from investment to make it viable. (An increase in margin required)

High rates of interest squeeze construction companies between falling demand and higher
costs (from suppliers etc)

Interest rates dependant on diverse and international factors so only approximate

guidelines are issued to those carrying out financial feasibility or cost-benefit studies
Project Management: Lecture 7 – Sources of Finance

BoE Base Rate (2014- Feb 2024) %

6

0
 Project Management: Lecture 7 – Sources of Finance

Rates of Interest

Interest rates are closely related to the Minimum Lending Rate (MLR), the base rate.

Apart from the stocks and shares market, savings investment lies between the Big Banks,
Building Societies, Insurance companies and various National Saving Schemes.

If interest rates go up in USA, for example there is an outward rush of UK sterling to the
USA, leading to jump in our rates and vice versa

If inflation is low and continues to fall, interest rates follow suit. Can even go negative,
meaning that if you have money in the bank, you have to pay the bank for the privilege of
them having it. If there are major wage increases or increases in essential imports,
inflation rises and interest rates follow.

Therefore interest rates are difficult to predict. But still necessary to predict to get best
value in investment even if proved wrong later
 Project Management: Lecture 7 – Sources of Finance

Financial Risk

The real rate of return on an investment must reflect the risk of loss. For example certain
construction projects can be very “risky” (marine works, tunnelling etc). Contractors who
take on that risk look for higher margins moreso than elsewhere but they need a higher
capital base in case things do go wrong and they can maintain cashflow. They compete in a
small pool of contractors – more opportunities

Public works projects arise from social need (transport, water, sewerage etc) and not
usually regarded as high risk investment however the investment in contractors carrying
out the work is “risky”: they may be doing this low risk work while simultaneously doing
high risk work elsewhere which may fail – domino effect

Funding public works (clients) can be regarded as relatively risk free and local authorities
raise money by issue of Bonds as well as receiving rates and Central Government grant
allocations
 Project Management: Lecture 7 – Sources of Finance

Sources of Short-Term Finance

• Clearing Bank Overdraft Facility

• Clearing Bank Loan Facility
• Finance House (e.g. Hire Purchase)
• Private Source
• Provision for taxation
• VAT
• Market Instruments and Bonds
• Creditors
• Internal Transfer
• Factoring
Harris and McCaffer
Modern Construction Management
 Project Management: Lecture 7 – Sources of Finance
Sources of Short-Term Finance
Clearing Bank Overdraft Facility: A short-term overdraft agreed with the bank, on certain
charges, perhaps until a payment clears through the banking system.
These funds can, in certain circumstances and with strict ‘internal’ conditions (security)
applied, be used in the short-term to plug cash-flow requirements within the company

Clearing Bank Loan Facility: A short-term loan agreed with the bank, on certain charges

Finance House (Hire Purchase): Plant and equipment perhaps, for which ownership is
obtained over a specific period when purchased by way of an agreed loan (Ts and Cs) from
the Hire Purchase company. Better for cash flow if not bought outright. The loan is secured
against the value of the piece of equipment. Defaulting on HP terms means the plant or
equipment falls to the ownership of the HP company.

Private Source: Self explanatory agreement with Ts and Cs. If the lender, ask appropriate
questions. Needs good security for the lender. Stay away? Why does company require
short-term financing?

Provision for taxation: An understanding that certain monies are held for Tax liability
payments - and that these funds can, in certain circumstances and with strict ‘internal’
conditions (security) applied, be used in the short-term to plug cash-flow requirements
within the company
 Project Management: Lecture 7 – Sources of Finance

Sources of Short-Term Finance

VAT: An understanding that certain monies are held for VAT liability payments - and
that these funds can, in certain circumstances and with strict ‘internal’ conditions
(security) applied, be used in the short-term to plug cash-flow requirements within
the company. Security may be set at the level of VAT refunds the company expects
to receive within the VAT reporting period.

Market Instruments and Bonds: Short-term financing securities that aim to increase
the financial liquidity of a business. They mature in less that one year and offer a
fixed income. A Bond is an instrument of indebtedness (an I.O.U.) of the bond issuer
to the holders. They offer regular interest payments and have a fixed end-date

Creditors: Agreeing Ts and Cs with suppliers, sub-contractors, or service providers for

payment within a certain period AFTER application for payment has been made (a
credit period)

Internal Transfer: The transfer of funds between companies with a group of

companies
 Project Management: Lecture 7 – Sources of Finance

Sources of Short-Term Finance

Factoring: A business sells the debt it is owed by its debtors to a Factoring company
at a discount. Amount of discount will reflect the size of the debt

The factoring company makes its money by maximising the recovery of the debt
against its discounted value. It takes the risk of any non-recovery

The business selling the debt perceives it is better for its cash-flow to have the
discounted value of debt now, rather than waiting a longer time to recover the debt
directly from the debtor. It effectively negates any risk of non-recovery.
 Project Management: Lecture 7 – Sources of Finance

Sources of Long-Term Finance

• Retained Profits
• Shares
o Ordinary
o Rights
o Preference
• Investment bank Loan
• Market Instruments and Bonds
• Government Regional Development Funds
• Clearing Bank
• Debentures
o Mortgage
o Floating Charge
• Venture Capital Lenders
 Project Management: Lecture 7 – Sources of Finance
Sources of Long-Term Finance
Retained Profits (Retained Margin): As discussed previously – part of the overall margin, from
the previous year, can be retained to increase cash available for investment in projects. Perhaps
increasing opportunity to increase turn-over. Perhaps to maintain cash level for investment in
projects. Perhaps to reinvigorate lost capital in other projects.

Shares: Ordinary shares (voting and non-voting); holders are entitled to a dividend (if available)
after payment of dividend to Preference Share holders. Ordinary shareholders can receive
distribution on winding-up of the company. Variable rate of dividend

Preference shares; have no voting rights, but are first in-line for dividend over ordinary shares
and for distribution on winding-up of the company. Fixed rate of dividend

Rights Issue Shares; these are offered to existing share-holders as a way to raise capital for
investment in the company. Doesn’t always raise the amount required to keep company afloat

The new shares are offered in proportion to a share-holders holding (usually at a discount on
current shareprice). By taking-up your rights, your holding in the company is not diluted.

Those who do not take-up their Rights Issue will however have their overall holding in the
company diluted. All Rights Issue shares that are not taken-up by share-holders will be offered
for sale on the Market, perhaps at a higher discount to get them sold.
 Project Management: Lecture 7 – Sources of Finance
Sources of Long-Term Finance

Investment Bank Loans: Investment Banks can arrange loans from other sources (they do not
lend money themselves). They make their money by offering their advice services to companies,
governments and investment funds; they are paid either by fee, or commission, as appropriate.

Market Instruments and Bonds: As before but over the longer term.

Government Regional Development funds: Regional development funds (or grants) are designed
to support Small and Medium sized businesses (SMEs) investing in new equipment and training
to expand their operations. (InvestNI)

Clearing Bank: A clearing bank loan is a stop-gap loan – it is offered if the time taken to clear a
payment between different banks might affect the cash-flow of the organisation ultimately
receiving the payment.
 Project Management: Lecture 7 – Sources of Finance
Sources of Long-Term Finance
Debentures: Debenture is a document that sets-out the terms and conditions of a loan. It gives
clarity and security to lenders when the borrower becomes insolvent.

Mortgage; a debt instrument, a loan is secured by the value of the specified property for which
the loan is taken-out. The borrower company is obliged to payback the loan through
predetermined payments. Default? – mortgage company takes the house

Floating Charge; gives a degree of protection when directors lend money from personal funds
into the company.

Venture Capital Lenders: A venture capital loan is a private loan from the Venture company to
the business seeking the loan. Banks are not involved. The loan is often referred to as a ‘senior
debt’ the Venture company will collect its debt before any other lender. Often the Venture
company will offer other assistance in the running of the business seeking the loan and may also
take a share-holding.
(Halo Business Angel Network – but not for real estate)
 Project Management: Lecture 7 – Sources of Finance
*Net Present Value (NPV)

“NPV is a discounted cash flow technique for analysing investment opportunities. It is

computed by first calculating the Present Value (PV) of the expected net cash flow of an
investment, discounted at the cost of capital, from which the initial cost outlay of a
project is subtracted. If NPV is positive the investment should be accepted” and vice
versa.”
Essentials of Construction Project Management – Uher and Loosemore

In other words, when looking at a project, what are the expected cash flows in (and out)
every year for a number of years and what was the original capital cost.

Example: during the feasibility stage a PM wants to purchase a significant piece of plant
to use over the next 10 years. Forward projections are necessary related to how much
use will be got out of the piece of plant in each of the next 10 years. Compare against
hire rates over those years to ensure that enough money is accrued to replace it. Don’t
forget maintenance and operational costs

An actuary (or more than one) is best placed to make these calculations – someone
trained in monetary risks. What’s the interest rate in 5 years, 10 years time?

*Not really what a PM should do, perhaps for very short time periods only
 Project Management: Lecture 7 – Sources of Finance
Net Present Value (NPV)

Question? Do you want £10 000 now or 10 years time? Most would select the money
now

Could invest it now or put into a savings account and attract compound interest. If at 10%
per year, In 10 years £10, 000 is now worth £25 930

Compound Interest = A(1+r)n

A = Initial Amount Deposited

r = annual rate of interest
n = number of years A is deposited

10,000x(1+0.1)10 = £25 930

Actuaries reverse this process

So, let’s say a project should be generating £25 930 (SUM) 10 years from now and will
have an NPV today of £10, 000

NPV = Future SUM/(1+r)n

 Project Management: Lecture 7 – Sources of Finance
Summary of Cash Flow and Margin

Monthly Value: S curve

Accrued Cumulative Costs
Difference is the Margin (3%)
 Project Management: Lecture 7 – Sources of Finance
Summary of Cash Flow and Margin

Approx: £260/270 000 to get work done over two months right before a payment is made
 Project Management: Lecture 7 – Sources of Finance
Summary of Cash Flow and Margin

Possibility of contractor purchasing materials on 28 day payment terms and/or

employing a sub-contractor. Now cost to get work done decreases considerably
 Project Management: Lecture 7 – Sources of Finance
Summary of Cash Flow and Margin

Contractor would have to invest through months 6 and 7 of approx. £271 000 to make their 3%
Margin

With sub-contactors and PTs on materials they only have to invest £186 000 for doing their
direct portion of work, through months 6 and 7, to make their 3% Margin on the Gross Costs of
£271 000. Other peoples money.

True Margin on their £186 000 investment to cover all remaining work through months
6 and 7 is not 3% but:

(271/186)*3% = 4.37%

If the £186 000 is invested 8 times a year it will earn 8 x 4.37% = 35% annually.
 Project Management: Lecture 7 – Sources of Finance
Summary of Cash Flow and Margin

For the largest contractors, more than one project so bank account sees
constant ins and outs. One goes wrong – negative cash flow then bank balance
starts to deplete