One of the most important aspects of starting any business is determining the project cost. The profitability performance of entire project is based on the accurate calculation of project cost and savings in the very project cost. Because, the project cost is the base to determine as to how much money the owner should invest and how much he should mobilize in the form of loan or co-promoter’s equity. This element is addressed as debt and equity ratio. Once we have clear understanding of debt & equity, we will be able to draw the cost of capital i.e. the interest rate for own equity and loan amount. High interest rate and longer amortization tenure will cause considerable cash outflow for the loan tenure. If the business is a slow revenue model, it would cause strain on the short-term capital. Besides, it could also contribute in the late break-even, negative DSCR, lesser IRR and even negative NPV.
How to fix project cost? What are the determining heads of expenses in the project cost? How to optimize project cost? What should be the right investment for the project?
Any given project at the outset will have following expenses before the project goes into commercial stage.
- Cost of infrastructure
- Deposits towards buildings or franchisee
- Legal & Professional fee
- Costs towards obtaining licenses & permits
- Setup and installation costs
- Pre-operative expenses
- Working capital
- Business launch and promotion
It is imperative that we save costs in each of the above items. For example:
- It is possible to save cost on the infrastructure by exploring phase-wise deployment of infrastructure, leasing of buildings in place of construction of own building, outsourcing services like packaging, maintenance, logistics, or even certain amount of product spares.
- If it is franchisee based business, it is possible to negotiate for deferred payment of franchisee deposits or fee or revenue based sharing totally avoiding the franchisee deposit.
- It is important to identify a right consultant who is economical and who could also advise on the total economics of the project.
- Licenses or permits which are not vital for initial project commencement could be deferred based on the dependent activity phase.
- Procurement of equipment, machinery, software, hardware or any such things should be carefully decided where the procurement cost absorbs the setup, installation and annual maintenance. With respect to Software, it is very important to practically assess the licensing requirement. Procurement as a whole is a professional job and it should be done by an experienced team member who could bring in savings in terms of taxes, delivery time, and value added benefits.
- The other major savings could be in pre-operative and launching expenses. This is always contextual and depending upon the type of business, the amount of PR or exposure required to the project, there could be considerable savings against this head.
- The contingency amount should be judiciously decided so that we don’t block the borrowings while we end up paying the interest costs for the unused amount.
Besides the above, the very major saving is effective management of project schedules and production schedules. Delayed project schedule would always result in the budget overheads. This is a common phenomenon in the government projects.
The right investment for a project is always contextual and the major consideration should be early recovery where-after one could always bring in more investments for expansion or capacity upgradation.