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ECONOMICS AND
FINANCIAL
MANAGEMENT IN
CONSTRUCTION
CONTRACTING
S. Vindya Herath
NG/HNDQS/09/49
CONSTRUCTION ECONOMICS ANDFINANCIAL MANAGEMENT INCONSTRUCTION CONTRACTING
Lecturer Mr.S.Kalananthan
Initial Assessor
2nd Assessor
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ACKNOWLEDGEMENT
I would like to express my special gratitude and deepest appreciation to The International
College of Business and Technology and most of all, our lecturer, Mr. Kalananthan, for a
successful report on CEFMIC and Its Application and giving all the required encouragements and
unerring guidance.
Finally, I would like to thank everyone who helped me in various ways to convert this is
into a successful one.
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TABLE OF CONTENT
ACKNOWLEDGEMENT ............................................................................................................ 2
TABLE OF CONTENT................................................................................................................ 3
TABLE OF FIGURES .................................................................................................................. 4
INTRODUCTION......................................................................................................................... 5
TASK 01 ..................................................................................................................................... 6
1.1 Identify the determinants of construction demand & supply. ......................................................... 6
1.2 Explain how the change in each determinant and effects the supply & demand. ........................... 6
TASK 02 ................................................................................................................................... 12
2.1 Market Changes to fluctuations in supply and demand and the market equilibrium. ................... 12
2.2 The Project Management Life Cycle. ........................................................................................... 14
TASK 03 ................................................................................................................................... 16
3.1 Various methods financial appraisal of various types of construction contracts. ......................... 16
TASK 04 ................................................................................................................................... 19
4.1 Fundamentals of finance management and the important in the construction. ............................. 19
4.2 Evaluate the significance of effective finance management in construction. ............................... 22
TASK 05 ................................................................................................................................... 23
5.2 Identify the 2 major kinds of policies which a government uses to control its economy. ............ 23
5.3 Effect of Fiscal Policy changes on construction economics and effective finance management. 25
CONCLUSION ........................................................................................................................... 26
REFERENCES ............................................................................................................................ 27
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TABLE OF FIGURES
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INTRODUCTION
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TASK 01
A market facilitates the interaction of a buyer and a seller as they complete a transaction
furthermore Buyers, as a group, determine the demand and Sellers, as a group, determine the
supply. Markets exists in many forms. They determine the price and quantity of a good or service
transacted. The supply and the demand of a particular item differ from an item to item according
to the 02 main factors. According to their behavior the curves will shift and fluctuate
accordingly. Those are;
— Price
— Quantity
The inverse relationship between the price and the quantity demanded of a good or service
during some period of time. These main factors contribute for the change in supply and demand
where the slight variations results in fluctuations in the supply and demand.
Furthermore the supply and demand depends on some unique aspects such as Income, Taste, and
Prices of related goods, Aggregate demand, Expectations and number of buyers. For the demand
and Factors of production, Expectation of supply, more efficiency labor, No of suppliers. And
also quantity demand caused by changes in price only. It represented as movement along a
demand curve and the other factors determining demand are held constant.
1.2 Explain how the change in each determinant and effects the supply & demand.
Demand
The various amounts of a product that consumers are willing and able to purchase at various
prices during some specific period and demonstrated by demand schedule and demand curve.
The inverse relationship between the price and the quantity demanded of a good or service
during some period of time.
Basically DEMAND occurs;
— Income.
— Substitution.
— Quality.
— Advertising.
— Complements.
— Weather.
— Expectations.
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Demand curve shows the inverse relationship between price and quantity demanded for a good
or service. And derived from a demand schedule showing the quantity demanded at various
prices.
Some factors which affects the Demand are discussed below in detail.
— Income
When the income of the public increases the demand for plywood increases as the
potential of the buyers to buy increases.
— Aggregate demand
In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total
demand for final goods and services in an economy at a given time. So the aggregate
demand for plywood increases the demand too will increase.
— Govt. Policies
When the government policies are favorable for Plywood the demand increases as the
customers can get the services and the goods with ease.
— Expectations
When the customers’ expectations are met the demand for Plywood or a service increase
eventually.
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— Information
When the information regarding Plywood or the services are elaborated profoundly the
demand will increase as the buyer will have good understanding about the plywood types
and the use of each type for his or her work..
Supply
The various amounts of a product that producers are willing and able to supply at various prices
during some specific period. This method demonstrated by the supply schedule and supply
curve. Supply is the quantity of a good or resource that sellers (or suppliers) are willing and able
to offer to the market for sale under a given set of conditions over a specific period of time.
Mainly;
— Direct relationship between the price and quantity supplied.
— Increased price causes increased quantity supplied.
— Decreased price causes decreased quantity supplied.
— Related to cost-plus pricing model.
Determinants of Supply factors affecting supply of a good include price, prices of inputs,
technology, prices of related goods, taxes, expectations, number of firms, etc. Other things
remaining constant, as the price of a good rises, the corresponding quantity supplied increases,
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and as the price falls the quantity supplied decreases; the relationship between price and the
quantity supplied is positive.
— Changing technology
When the used technology for Plywood production changes with the time the supply of
the goods also changes accordingly.
— Expectation of supply
When the expected supply of plywood increases the supply for that good will also
increases targeting a higher expectation.
— No of suppliers
When the number of suppliers for an item increases the supply will also increase to keep
up the previous market of the product.
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— Govt. Regulations
When the regulations regarding plywood production becomes favorable the supply too
will eventually increase.
A demand increase will cause a shift to the right in the demand curve, causing both price and
quantity to increase. A demand decrease will cause a shift to the left in the demand curve,
causing both price and quantity to decrease.
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A supply increase will cause a shift to the right in the supply curve, causing price to decrease and
quantity to increase. A supply decrease will cause a shift to the left in the supply curve, causing
price to increase and quantity to decrease.
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TASK 02
2.1 Market Changes to fluctuations in supply and demand and the market equilibrium.
Market equilibrium is a condition under which the quantity supplied is equal to the quantity
demanded; when a market is in equilibrium, there is no tendency for change. Occurs when the
buying decisions of households and the selling decisions of producers are equated.
A situation in which the supply of an item is exactly equal to its demand. Since there is neither
surplus nor shortage in the market, price tends to remain stable in this situation. Determines the
equilibrium price and equilibrium quantity bought and sold in the market. The equilibrium price
is the price at which the quantity demanded is equal to the quantity supplied.
Shortages occur when price is below the equilibrium price; shortages cause the price to
rise.
Surpluses occur when price is above the equilibrium price; surpluses cause the price to
fall.
Surplus
• Quantity demanded is less than quantity supplied Q d < Qs
Equilibrium
• Quantity demanded is equal to quantity supplied Qd = Qs
Shortage
• Quantity demanded is greater than quantity supplied Q d > Qs
The operation of the market depends on the interaction between buyers and sellers. An
equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.
At equilibrium, there is no tendency for the market price to change.
— Only in equilibrium is quantity supplied equal to quantity demanded.
— At any price level other than P0, the wishes of buyers and sellers do not coincide.
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If a market is not at equilibrium, market forces tend to move it to equilibrium. Let's break this
concept down.
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No matter what project it is that you’re preparing for, the project management life cycle can
assist you and your team in narrowing the project's focus, keeping its objectives in order and
finishing the project on time, on budget and with a minimum of headaches. The Project
Management Life Cycle is the Initiation, Planning, Execution and Closure.
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TASK 03
3.1 Various methods financial appraisal of various types of construction contracts.
Financial appraisal views investment decisions from the perspective of the organization. It
assesses the viability of a project based on the direct effects on the cash flow of the organization.
It considers whether the projected revenues will be sufficient to cover expenditures and whether
the financial return is sufficient to make the investment commercially viable.
Through the financial appraisal and the financial statement analysis we can answer some major
questions which may arise in the industry;
Is the company in a state to fulfill their obligations in time by converting their assets?
Can the company earn adequate profit?
Is investment in the company safe?
Is the company properly capitalized?
Does the company earn enough to build reserves for future growth?
Appraisal helps to evaluate the past performance of a company. The Management Information
System is meant to ensure adequate profitability, to have an early warning of something going
wrong, to have basis for allocation of resources, to evaluate managers. Moreover there are some
types of financial appraisal. Those are;
Net Present Value.
Payback Method.
Internal Rate of Return.
Profitability Index.
Average Rate of Return.
R = Interest Rate
Payback Method.
A company or a construction contract chooses the expected number of years required to recover
an original investment. Projects will only be selected if initial outlay can be recovered within a
predetermined period and time required to recover original investment. This method is relatively
easy since the cash flow doesn't need to be discounted. Here the weakness is that it ignores the
cash inflows after the payback period, and does not consider the timing of cash flows.
𝑶𝒓𝒊𝒈𝒊𝒏𝒂𝒍 𝑪𝒐𝒔𝒕 𝒐𝒇 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
𝑷𝒂𝒚𝒃𝒂𝒄𝒌 𝑷𝒆𝒓𝒊𝒐𝒅 =
𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘𝒔
Merits:
— More on liquidity then profitability.
— Ignores cost of capital.
— Not cover the earning beyond payback period.
— Suitable for small projects.
— Best when project have shorter period and less cost.
— Helps to entrepreneur to invest in quick return funds.
— Easy to operate and simple to understand.
Profitability Index.
This method mainly talk about ratio of present value of inflow and outflow. And Profitability
ratio of project more than 01 is to be selected. This is the ratio of the present value of project
cash inflow to the present value of initial cost. Projects with a Profitability Index of greater than
1.0 are acceptable. The major disadvantage in this method is that it requires cost of capital to
calculate and it cannot be used when there are unequal cash flows. The advantage of this method
is that it considers all cash flows of the project.
𝑷𝒓𝒆𝒔𝒆𝒏𝒕 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘
𝑷𝒓𝒐𝒇𝒊𝒕𝒂𝒃𝒊𝒍𝒊𝒕𝒚 𝑰𝒏𝒅𝒆𝒙 =
𝑷𝒓𝒆𝒔𝒆𝒏𝒕 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑪𝒂𝒔𝒉 𝑶𝒖𝒕𝒇𝒍𝒐𝒘
Merits:
— Conceptually sound.
— Consider time value of money.
— Facilitates ranking of project.
Merits:
— Consider earning of full life.
— Helps to comparing with other projects.
— Simple to calculate and easy to understand.
— Consider net earnings after depreciation and taxes.
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TASK 04
4.1 Fundamentals of finance management and the important in the construction.
A construction company may be rich on paper & yet go bankrupt if it doesn’t have enough
liquidity to pay for its financial obligations. More companies fail for lack of liquidity than for
any other reason. It can be argued that cash is the most important resource that any contractor
can manage.
Breakeven Point
The breakeven point is the sales value at which a business neither makes profit nor loss. This will
assist organizations to setting both revenue and profitability targets & this is the relationship
between cost volume and profits at various levels of activity, with an emphasis placed on the
break-even point. If output of any product falls below that point there is loss; and if output
exceeds that point there is profit.
To find the breakeven point, you need to know your variable and fixed costs. Within a
reasonable sales range, fixed costs do not vary with sales or production volume. Variable costs
are directly proportional to the sales volume. Think of variable costs this way: sales cause
variable costs. If sales don't cause the cost, then the cost is fixed.
Thus, it is the minimum point of production where total costs are recovered. Therefore, at break-
even point.
Sales Revenue – Total Cost
or, Sales – Variable Cost = Contribution = Fixed Cost
It can be concluded that at break-even point the contribution earned just covers the fixed cost
and, at levels below the point, contribution earned is not sufficient to match the fixed cost and, at
levels above the point, contribution earned more than recovers the fixed cost.
Construction industry is constantly keep evolving and changing and margins and overhead costs
are always changing. To keep organization’s break even amount relevant firm need to constantly
recalculate it to reflect the changes occurring in business.
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TASK 05
5.1 Classification of Taxes.
There are main two types of taxes:
5.2 Identify the 2 major kinds of policies which a government uses to control its economy.
Fiscal Policy
Fiscal policy is used to control the government’s revenue and expenditure & involves the
decisions that a government makes regarding collection of revenue, through taxation and about
spending that revenue. If the economy is growing fast, then the government may decrease the
spending.
Governments typically use fiscal policy to promote strong and sustainable growth and reduce
poverty. The role and objectives of fiscal policy gained prominence during the recent global
economic crisis, when governments stepped in to support financial systems, jump-start growth,
and mitigate the impact of the crisis on vulnerable groups.
Monetary Policy
Monetary policy refers to the attempts to manipulate either the rate of interest or the
money supply to bring about desired changes in the economy & this is how central banks
manage liquidity to create economic growth. Liquidity is how much there is in the money
supply. That includes credit, cash, checks, and money market mutual funds. The most important
of these is credit. That includes loans, bonds, and mortgages.
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Monetary policy involves altering base interest rates, which ultimately determine all other
interest rates in the economy, or altering the quantity of money in the economy. Many
economists argue that altering exchange rates is a form of monetary policy, given that interest
rates and exchange rates are closely related.
The core objective of the Central Bank of Sri Lanka is to maintain the economic and price
stability. Therefore, in order to achieve the objective, the Central Bank of Sri Lanka implements
the monetary policy which are the actions to influence costs and availability of money. Monetary
policy is used to control the inflation rates of the country.
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5.3 Effect of Fiscal Policy changes on construction economics and effective finance
management.
The fiscal policy is imposed by the government on the economy and related to the taxation
policy imposed by the government to control the overall spending within the economy.
The study finally recommended that there should be consistency in policy making by the
government in order to influence the level of aggregate demand in the economy in an effort to
achieve economic objectives of prices stability of building materials, full employment of labors
and economic growth. That taxes such as VAT, custom and exercise duties, road rolls, petrol
duties, wages tax, rent tax, interest tax, and profit tax should be reduced so that disposable
income of individual would be increased and stable in order to improve investment in
construction work.
When the government imposes taxes they receive a greater income which in turn will result in
the increase of government spending. Majority of the government spending will be on capital
infrastructure, in other words constructions. Therefore, the construction companies will be able
to obtain many contracts from the government. This will increase the demand for their products
and services. Also government sending includes providing subsidies to industries. When the
subsidies received by the construction industry increase it will directly benefit the business.
The government can influence the construction economy by reducing the taxes as well. Reducing
the taxes will lead to higher disposable income for the consumers. Once the consumers have a
higher income at their disposal then they will be prompted to invest in private capital expenditure
such houses. This will result in the increase in demand for constructions in the country. The
construction industry will be benefited by the changes in the fiscal policies by the government.
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CONCLUSION
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REFERENCES
Amadeo, K., 2016. Five Determinants of Demand with Examples and Formula. [Online]
Available at: https://www.thebalance.com/five-determinants-of-demand-with-examples-and-formula-
3305706
[Accessed 10 08 2016].
El-Ganainy, M. H. a. A., 2012. Fiscal Policy: Taking and Giving Away. [Online]
Available at: http://www.imf.org/external/pubs/ft/fandd/basics/fiscpol.htm
[Accessed 13 August 2016].
Unknown, 2016. Earned Value Management Terms and Formulas for Project Managers. [Online]
Available at: http://www.dummies.com/how-to/content/earned-value-management-terms-and-
formulas-for-pro.html
[Accessed 15 August 2016].
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