Financing for Road Construction Business Growth
Learn to recognize the capital needs of a growing construction business, identify alternative means of capitalizing the business, understand the gearing effect on risk and profitability, demonstrate the effect of borrowing on profitability, and evaluate borrowing decisions to finance projects. Explore working capital needs, plant and equipment requirements, and different sources of capital. Discover how gearing influences financial risk and profitability in a construction business setting.
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Presentation Transcript
Module 1: Session 9 Financing Road Construction Business Module 1: Session 9 1 3/20/2025
Purpose of Session Recognize the capital needs of a growing construction business Identify alternative means of capitalizing the business Understand gearing effect on risk and profitability Demonstrate the effect of borrowing on profitability Evaluate a borrowing decision to finance a project. Module 1: Session 9 2 3/20/2025
Working Capital Need Ascertain the targeted capacity say in terms of kms per month or year. Ascertain the common operating costs and the period they are paid for before billing and payment by the client. These may include: Rent Management expenses Labour Vehicle running Insurance Bidding costs Materials to be delivered on site Machine hire and fuel Module 1: Session 9 3 3/20/2025
Working Capital Need If there is an advance payment, it offsets the working capital needed. The longer the period before certification and payment the heavier the working capital needed. Module 1: Session 9 4 3/20/2025
Plant and Equipment Identify the targeted capacity per month or year. Identify the required capital items and their cost. In order to minimize the capital needed ownership of some assets should be avoided. Items of heavy equipment constantly used can be funded by leasing e.g. trucks. Other items that are not frequently used should only be hired. Sterile assets such as land and buildings should be avoided unless alternatives are not available. Module 1: Session 9 5 3/20/2025
Sources of capital Share capital: permanent and non refundable allows pooling of resources by different parties Retained profits: could be converted into bonus share capital Is the most common source of capital for growth Long term borrowing on the stock exchange Medium term borrowing by bank loans Short term borrowing by bank loans, leases or overdraft Short term borrowing through trade credit Module 1: Session 9 6 3/20/2025
Gearing Means the combination of equity and debt Gearing increases financial risk (exposure to and prior charge to profit) Gearing reduces the cost of capital, therefore increases profitability to shareholders. The capital structure between debt and equity depends on how risk averse the owners are. Gearing has adverse cash flow implications. Module 1: Session 9 7 3/20/2025
Effect of debt on return on investment No gearing Gearing 2:1 Capital is shs150m, equity shs. 100m, loan shs 50m at 20% interest. Profit before interest 45m Interest is shs 10m Profit after interest 35m Profit after tax is 35*0.7=24.5m ROI =24.5/100 = 24.5% Capital is Shs 150m all equity Profit before interest 45m Interest is zero. Profit after tax is 45x0.7=31.5m ROI is 31.5/150= 21% Module 1: Session 9 8 3/20/2025
Effect of gearing Gearing 2:1 Gearing 1:2 Capital is shs150m, equity shs. 100m, loan shs 50m at 20% interest. Profit before interest 45m Interest is shs 10m Profit after interest 35m Profit after tax is 35*0.7=24.5m ROI =24.5/100 = 24.5% Capital is shs150m, equity shs50m, loan shs 100m at 20% interest. Profit before interest 45m Interest is shs 20m Profit after interest 25m Profit after tax is 25*0.7=17.5m ROI =17.5/50 = 35.0% Module 1: Session 9 9 3/20/2025
Impact of gearing on Return on shs 150m Investment Total capital Equity Gearing Gearing Ratio Actual profit after tax ROI 150m 150m Zero 1:0 150m 100m Low 2:1 150m 50m high 1:2 31.5m 24.5m 17.5m 21% 24.5% 35% Module 1: Session 9 10 3/20/2025
Impact of gearing on profit risk (drop by 44.4% from sh.45m to shs. 25m) Gearing Zero Low high Gearing Ratio 1:0 2:1 1:2 Profit before interest 25m 25m 25m Interest 0 10m 20m Profit after interest 25m 15m 5m Profit after taxation 17.5 10.5m 3.5m ROI 11.6% 10.5% 7% ROI before 21% 24.5% 35% drop in profitability 44.4% 57% 80% Module 1: Session 9 11 3/20/2025
Impact of gearing on interest risk (increase by 50% from 20% to 30%) Gearing Gearing Ratio Profit before interest Interest Profit after interest Profit after taxation ROI ROI before drop in profitability Zero 1:0 45m 0 45m 31.5 21% 21% 0% Low 2:1 45m 15m 30m 21m 21% 24.5% 14.3% high 1:2 45m 30m 15m 10.5m 21% 35% 40% Module 1: Session 9 12 3/20/2025
Decision to borrow for a project Consider the cost of borrowing Consider the period of repayment Consider the ratio of borrowed funds to own funds Consider the interest risk Consider the profit risk Consider the cash flow risk (size and frequency of repayment as well as alternative sources of cash) Module 1: Session 9 13 3/20/2025
Group assignments 1) Identify the basic requirements for Munaku to setup a simple gravel road construction unit 2) Identify the type of capital needs and possible sources of it for a medium road construction business doing say 24kms. 3) Work out the average cost of capital for Munaku . State what capital structure you would chose for his new venture and explain why.. 4) Study the projects available to Munaku and advise whether you would borrow to undertake them and state why. 5) Explain why road contractors may find it difficult to obtain adequate funding. Module 1: Session 9 14 3/20/2025
END Q&A Module 1: Session 9 15 3/20/2025
