Page 62 - DMGT302_FUNDAMENTALS_OF_PROJECT_MANAGEMENT

Unit 4: Project Budgeting

2. Risk: The two main sources of risk for a firm (or project) are: business risk and financial Notes
risk. Business risk refers to the variability of earnings before interest and taxes and arises
mainly from fluctuations in demand and variability of prices and costs. Financial risk
represents the risk arising from financial leverage. It must be emphasized that while debt
capital is cheap it is also risky because of the fixed financial burden associated with it.

3. Control: From the point of view of the promoters of the project, the issue of control is
important. They would ordinarily prefer a scheme of financing which enables them to
maximise their control, current as well as potential, over the affairs of the firm, given their
commitment of funds to the project.

4. Flexibility: This refers to the ability of a firm (or project) to raise further capital from any
source it wishes to tap to meet the future financing needs. This provides maneuverability
to the firm. In most practical situations, flexibility means that the firm does not fully
exhaust its debt capacity. Put differently, it maintains reserve borrowing powers to enable
it to raise debt capital to meet largely unforeseen future needs.

Did u know? In some countries, the proposed means of finance for a project must either be
approved by a regulatory agency or conform to certain norms laid down by the government
or financial institutions in this regard.

4.3 Working Capital Requirement and its Financing

In estimating the working capital requirement and planning for its financing, the following
points have to be born in mind:

1. The working capital requirement consists of the following: (i) raw materials and
components (indigenous as well as imported), (ii) stocks of goods-in-process (also referred
to as work-in-process), (iii) stocks of finished goods, (iv) debtors, (v) operating expenses
and (vi) consumable stores.

2. The principal sources of working capital finance are: (i) working capital advances provided
by commercial banks, (ii) trade credit, (iii) accruals and provisions, and (iv) long-term
sources of financing.
3. There are limits to obtaining working capital advances from commercial banks. They are
in two forms: (i) the aggregate permissible bank finance is specified as per the norms of
lending, followed by the lending bank, (ii) against each current asset a certain amount of
margin money has to be provided by the firm.

4. The Tandon Committee has suggested three methods for determining the maximum
permissible amount of bank finance for working capital. The method that is generally
employed now is the second method. According to this method, the maximum permissible
bank finance is calculated as follows:

The implication of this norm is that at least 25 per cent of current assets must be supported
by long-term sources of finance.

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