Relative Cost Ratio/Index Method
This is another interesting and novel method of
calculating capital cost developed by author during his experience over the
years. This is based on the concept that relative cost of any plant and equipment;
industrial products remain constant and fixed over the period of time for any
place or country. For example, relative cost of a bicycle, scooty and car will
be same irrespective of time and place. Similarly, relative cost ratio of a three-phase
motor and matching gear box and coupling is a constant not affected by time or
place. Similarly, relative cost ratio of one Million Tonnes (MT) steel plant
& four MT steel plant is constant (Not necessarily linear). Similarly,
ratio between 1000 MW Thermal Power Plant with 1 MT steel plant, Cement Plant
is constant for a place at any time. By knowing the cost of one the cost of
other can be easily calculated. Engineer shall work out these ratios and use
them for the calculation of capital cost. These can be cross checked with other
methods.
Author has found this method so effective that by
knowing the average cost of one cup of tea at particular place, the cost of a
plant of a particular capacity can be approximately estimated quickly for
estimation purposes.
Operating
Cost
1. Fixed
Cost
2. Variable
Cost
Fixed Costs
1. Fixed
costs are those business costs that are not directly related to the level of
production or output. In other words, even if the business has a zero output or
high output, the level of fixed costs will remain broadly the same. In the long
term fixed costs can alter - perhaps as a result of investment in production
capacity (e.g. adding a new factory unit) or through the growth in overheads
required to support a larger, more complex business.
2.
Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs
Variable
Costs
1.
Variable costs are those costs which vary directly with
the level of output. They represent payment output-related inputs such as raw
materials, direct labour, fuel and revenue-related costs such as commission.
2.
A distinction is often made between "Direct"
variable costs and "Indirect" variable costs.
3.
Direct variable costs are those which can be
directly attributable to the production of a particular product or service and
allocated to a particular cost center. Raw materials and the wages those
working on the production line are good examples.
4.
Indirect variable costs cannot be directly
attributable to production but they do vary with output. These include
maintenance and certain labour costs.
Profit
& Loss Calculations
Every
engineer/entrepreneur must learn to calculate profit and loss for the industry
being set up and this shall be part of curriculum. Following cost to be calculated for arriving
at the profit/loss.
Variable Cost
Calculate variable cost as follows:
i.
Raw
materials cost /yr of finished product
ii.
Consumables
@ 2-8 % OF Raw Mats Cost
iii.
Utilities
– Power Cost
iv.
Utilities
– Water + Land use
v.
Factory
Salary & Wages
vi.
Repairs
& Maintenance 5 %
vii.
Factory
insurance 1-1.5%
viii.
Other
Factory overheads
Total Variable Cost/t (Sum of i to viii
above)
Fixed Cost
Calculate fixed cost as follows:
i.
Admn.
Salary & R&D
ii.
Term
Loan interest
iii.
Bank
borrowing interest
iv.
Depreciation
Total
fixed cost/t (Sum of i to iv above)
Fixed Cost +Variable Cost = Total
operating cost
Calculate Profit as follows
Realization from Sales (Turn Over) =
Gross Turnover
Gross Profit (Gross
Turnover-Variable Cost)
Net Profit/yr (Gross Profit - Fixed Cost)
Net Profit/Year
Income Tax
Profit after tax
Retained earnings per yr.
Cash Generation Over 10 yrs.
This can be calculated on yearly
basis or per t basis.
Financial Indices Calculations
Knowledge of financial indices is important for
taking investment decision. Below are given some important indices which every
engineer/entrepreneur shall be able to work out and take appropriate investment
decision.
Debt-Service Coverage Ratio
The
debt service coverage ratio (DSCR), also known as "debt coverage
ratio," (DCR) is the ratio of cash available for debt servicing to
interest, principal and lease payments. It is a popular benchmark used in the measurement of a
company’s ability to produce enough cash to cover its debt (including lease)
payments. The higher this ratio is, the easier it is to obtain a loan.
Internal Rate of Return
The internal rate of return on an
investment or project is the "annualized effective compounded return
rate" or "rate of return" that makes the net
present value of all cash flows (both positive and negative) from a
particular investment equal to zero.
In more specific terms, the IRR
of an investment is the discount rate at which the net
present value of costs (negative cash flows) of the investment equals the net
present value of the benefits (positive cash flows) of the investment.
An investment is considered acceptable if its internal rate of return is
greater than an established minimum acceptable rate of return
or cost of capital
Break-Even Capacity (Average)
Break-even analysis
is a technique widely used for financial analysis of a project. It is based on
calculating operating cost (production costs) between those which are
"variable" (costs that change when the production output changes) and
those that are "fixed" (costs not directly related to the volume of
production).
Total variable and
fixed costs are compared with sales revenue in order to determine the level of
sales volume, sales value or production at which the business makes neither a
profit nor a loss (the "break-even point").
Pay Back Period
The
length of time required to recover the cost of an investment. The payback
period of a given investment or project is an important determinant of whether
to undertake the position or project, as longer payback periods are typically
not desirable for investment positions.
Calculated as: Payback Period = Cost of
Project / Annual Cash Inflows
All
other things being equal, the better investment is the one with the shorter
payback period. For example, if a project costs 100,000 and is expected to
return `20,000 annually, the
payback period will be `100,000/`20,000, or five years.
There are two main problems with the payback period method:
Ø It
ignores any benefits that occur after the payback period and, therefore, does
not measure profitability.
Ø
It ignores the time value of money.
Contracts Management
Engineer shall have basic knowledge of managing contracts. It includes understanding of following:
Legal aspects of contracts: definition of contracts, elements of a valid contract, offer and acceptance, capacity of the parties to the contract, types of mistakes encountered in contracts, misrepresentation, consideration, express and implied terms and statute of limitations.
Contract documents: drawings, specifications, bill of quantities.
General conditions of Contracts, Special Conditions of contracts.
Types of Contracts-Supply, Semi Turn key, Turn Key contracts
Contracts on BOO, BOOT etc.
Sample contracts
Contractor selection: -parties to a contract: duties of each party
Conditions of contract: clauses of conditions, quality of work during construction, contractor duties, site engineer contractual job, costs of construction, essence of time factor of construction, insurance and bonds and arbitration
Marketing
An engineer/entrepreneur
must be able to comprehend the challenges being faced in the present industry at
macro & micro level. As an example, Indian Steel Industry faced number of
challenges in the past and present- some of which are highlighted below:
Ø Scarce
natural resources (Iron Ore & Coal crisis)
Ø Over
capacity
Ø Price
Volatility
Ø Dumping
of inferior quality steel from China
Ø Demand
volatility
Ø Currency
Devaluation
Ø Increase
raw mats and energy costs
Ø Low
Productivity
Ø Higher
Production Cost
Ø Higher
Cost of capital
Ø Lack
of infrastructure (Rail, Road, Port Water, Power)
Ø Delay
in environmental clearances
Ø Technology
Obsolescence
Ø Structural
problems
Ø Delay
in carrying economic reforms
Ø Poor
Monsoon
An engineer must be able to recognize
the key drivers of the industry to estimate demand forecasting. For example,
following are considered the key drivers in fueling the growth of Steel Sector:
Ø Infrastructure
development (capacity building in Power Rail Road, Bridges, Ports, Airports)
Ø Speeding
up and modernization of railway, ports, airports, road transport
Ø Economic
Growth
Ø Massive
Water Supply & Sanitation Programs
Ø Make
in India Program.
Ø Atam
Nirbhar Bharat
Ø Housing
and urban development (Smart cities & Amrut Cities)
Ø High
degree of urbanizations
Ø High
demand in the auto sector
Ø Capacity
building in steel making
Ø Speedy
reforms (GST & Land Acquisition)
Ø Supportive
environment for investors
Ø Full
FDI in all non-sensitive sectors.
Ø Socio-economic
indicators coupled with announced directional plans of the Government
Ø World
economic situation
Ø Export
Potential
Similar challenges and key drivers
can be studied in details before venturing out for any new industry/project.
Demand Supply Analysis
There are some
basic principles of Demand supply forecasting. With the increase in population,
increase in urbanization and service industry, the basic needs of the masses
like Food, Clothing, Housing, Telecommunication
Information highway, Transport, Education, Health & Hospitality
Sectors, Insurance, Entertainments, Tourism & Event Management, Digital
Marketing & Payment, Pharmacy, House Hold appliances, the demand for products related to above ( For
example Food grains, Pulses, Vegetable Oils, Fruits & Vegetables, Houses,
House hold appliances like Smart TVs, Air Conditioners, Refrigerators, Ovens,
Lighting Equipment, Water Supply & Sanitation wares, Furnitures, Smart Mobile Phones, Tablets, Smart
Televisions , Two & Four wheelers, Petroleum Products, Chemicals & Fertilizers,
Hospitals, Schools, Banking , Entertainment
games, movies, ) are bound to increase and it shall be the duty of the
Central Government Agencies to estimate the short term, medium term and long
term demands in each sector. Based on the demand estimated by these agencies
and available capacity, the short fall shall be estimated for each sector.
These short falls shall be translated into skills demand and a holistic
planning model shall be prepared for every field right from Agriculture to
space industry. Accordingly, whole education system shall be planned to fill
the gap by skills development and engaging students in production activities
after finishing their education. (Refer my separate article on same1).
Technical Colleges shall become the hub for turning engineers into entrepreneur
and supply of skills manpower to the industry and service industries.
Conventional demand
forecasting methods like Time Series Analysis, Trend Projection, A Barometric
Forecasting, Casual Forecasting, Expert Demand forecasting are useful but
becoming less relevant due to growth of e commerce, on line marketing, B2B
Marketing, B to C marketing.
The other factors
to be considered are Pricing, Growth, Marketing / Distribution Channels, Trade
Practices and Export Potential.
Conclusion
As can be seen from above it is
imperative that all the aspects discussed above are necessary to be learned
during course of technical education for development of entrepreneurship
temperament in the minds of young engineers. Once any entrepreneur/engineer
applies above considerations and concepts for implementing any project, then it
can be safely said that the project has been taken care holistically from 360
degree and nothing more is left to chance. This all-round approach can turn all
young engineers to think in holistic sense or “Engineered Thinking”
This think like engineer approach can
help even non engineers and immensely benefit them for day to day purchasing of
house hold or industrial appliances, equipment, construction of house. By
applying above approach they will be able to select proper land, buy equipment
considering ease of operation, needing less maintenance, less spare parts and
inventory, keep interchangeability in mind (Say buy similar smart phones for
family), compliance to safety requirements (lower radiation levels from smart
phones), design (buying smartphone which works universally suiting to all the
bands say in India and US), better ergonomic design and so on. For example, one
of my colleagues who did not think like engineer bought Nokia Smart Phone from
India for use in USA. Sadly, it did not work in USA as the same was not
designed for US frequency bands.
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