Financial Ratios in Construction Analysis

Introduction

This assignment is performed taking in consideration the summary of the assignment two. This assignment’s objectives are as follows:

To acknowledge the contribution of the financial ratios on the field of economic condition of the construction industry

To assess the techniques of cost management which is being applied in the construction industry

To evaluate the importance of the government and construction sectors in the production of capital goods and in excellence.

This assignment possesses four parts which starts from the financial ratios. This part will explain financial ratio’s application in the evaluation of the performance of two construction company namely Kier Group and Carilion Plc. The second part of the assignment will perform a detail analysis on the methods of management of the costs which is being applied in the construction industry. The third part will then evaluate the contribution and importance of construction industry and government in the production of capital and merits products. The last part will provide the summary and some information regarding the learnt units.

1.0 Financial Ratios

There are number of factors which is evaluated by the firms at the time of decision-making. Some of the factors consists of the evaluation of the economic situation, estimation of the actions of the competitors and also reviewing of the opportunities of market. However, the major criteria for the making of decision is the appropriate situation of the business. It is the role and duty of the owners as well as managers of the company so as to take into consideration the health metric of the construction industry before performing any task or activities. There are number of financial ratios which are termed as useful so as to perform business with the help of statistics (Sloman, et al., 2016). The process of calculating the company’s economic health is termed as the financial ratio analysis. This process helps in equating the economical performance of the construction firms in variant periods of time. It further helps in comparing the performance in contract to the competitors of the industry. It is stated that Financial Ratios is the effective means so as to evaluate the development in liquidity, gearing, profitability, efficiency as well as return on investment in the entities of the business (Marsh, 2012). The major role and functionality of some ratios are explained in the Table 1.

1.1. Ratios’ Purpose and Characteristics

The Performance Comparison of Carillion PLC and Kier Group PLC.

The two construction companies namely Carillion PLC and Kier Group are situated in the UK wherein both of them got spread into two different sectors. On 15th January, 2018, the Carillion PLC got insolvency. The calculated ratio of Carillion Plc and Kier Group PLC is explained in Figure 1. The analysis of the Carillion PLC ratio had been performed so as to review the health of the company before the company was liquidation. Further, the ration was then associated with the Kier Group Plc and with other averages of industries. The analysis of the ratio of a company have demonstrated various issues. The excessive gearing level showcased the dependency degree on the funds which are borrowed and resulted into lower stability of finance. Even though, the companies gearing level was higher than the average industry, the gearing ratio of Carillion of trading have changed in the past 6 months which resulted into insolvency of the company. The main reason behind the insolvency was the rise in the borrowing and decline in the equity capital. The ratio of debt had also declined which showed higher rise in the liabilities to the assets and had not reached an average of 1.16. The analysis of liquidity also showed a decrease in current and acid test ratio which was lower as compared to the average industry. This have stated that lenders were mostly unwilling so as to provide the facility of credit as they were not able to gain faith upon the ability of the company to pay the liabilities. Moreover, there was decline in the profitability ratios of both the companies wherein the Carillion PLC had faced more severe decline in ROCE and ROE in the year 2017. This was because of the decrease in equity and negative operating profit of approximately £290 million. The decline in the operating profits were because of the unwanted expenses and higher interest which further led to higher borrowing from other company.

It had been suggested by conducted ration analysis that Carillion plc became bankruptcy because of the ineffective management of the activities of trading and the employed capital which have resulted into higher gearing and problems of liquidity. This is the reason that the company was not able to increase the funds for the financing of the activities.

2.0. Cost Management Practices

The most significant aspects of the project management can be considered as estimating and cost management, in case of cost management the accountant tends to calculate cost of structure or the building. When the estimates are prepared in a correct manner, then it has a major role to play in attaining major contracts or in creating profits. Two main methods are used in estimating costs of construction projects. They are bottom up and top down methods. Top down estimates comprises of attaining and enhancing the employer’s target project price (Ashworth, et al., 2013). It tends to be developed based upon two main assumptions such as

The company can ascertain the target price before the completion of the design There is proper cost information that is easily assessable for the purpose of estimation (RICS, 2012; Brook, 2017). Bottom up estimation tends to make use of the design solution, creates a bill of quantities and attains quotation for work packages. The management is needed to develop programme with prelims that is computed at tender stage (Brook, 2017).

However, it is not often when the cost tends to be accessible by inserting them into work package boxes. Hence, it becomes important for them to develop reliable estimates of each package and then of entire project before thorough cost estimation can be conducted. The projects demanding reliable level of accuracy, it becomes important to implement bottom up method (Lester, 2007). ZIn order to obtain reliable results, the estimation of project cost demands that there is structural method that is dependent upon the information and data available along with the status of project. Four main methods of estimating can be implemented that arises from very approximate to very accurate. They are comparative, subjective, analytical and parametric. It can be revealed that each method or the combination of two or more methods would offer different levels of accuracy and will suit to different stages of the project. The features of the method have been detailed in table two below.

It is essential to produce the most accurate estimate at every phase. The level of accuracy will vary with the stages of the project as it can be seen in Figure 3.

It is well known fact that the estimate tends to become exact with the progress of the project and when more information is made available to them. Such estimation is identified as rolling wave estimating. The reviewed cost is applicable for estimating steps once the final budget phase has been attained and once the price has been accepted by the company. The extra cost related adjustment tends to be made applicable in order to correct monthly cost estimates that possess an influence over profit and loss without any changes in price (Lester, 2007).

1.4. Evaluation of Key Methods of Estimating

3. The Role of Construction Sector and Government Intervention in Production of Merit and Public Goods

3.1. Private Goods

Private goods and services can be considered as goods that can be used by one particular individual at a time. It can be revealed that the private goods comprise of the principles of exclusion (Mayers, 2017). There are two main characteristics of private goods such as rivalry and excludability. Rivalry comprises of the fact that for one particular unit of goods and services, the consumption of one person would be at the cost of another person. On the other hand, excludability takes place when a person has one goods and services and thus he has the right to prevent it from using by other person. Some examples of private goods are repair and maintenance of houses, development of building and so on (Cooke, 1996).

3.2. Public Goods

A public good can be considered to be the product that is easily consumable by one particular individual without minimizing its availability to others and from the ones, no one else is deprived. Some examples of public goods are national defense, public park, sewer system, law enforcement and so on. As opposed to the private goods, it is noted that the public goods and services tends to possess two main features such as non-excludability and non rivalry. In case of non-rival goods or services one’s consumption of goods or services might not deter a person from consuming it. As per the feature of non-excludability one cannot stop another person from consuming the product in question (Cooke, 1996). Figure 4 demonstrates different characteristics of public and private goods.

Two varieties of public goods prevail that are pure public goods and quasi public goods. Quasi public goods comprise of features of private and public goods such as partial rivalry, partial rejection, partial diminishability and partial excludability. The main example of quasi public goods is roads, bridges, tunnels and so on. The market associated with such goods is incomplete market. Furthermore, their lack of provision basically by the free markets is known to be inefficient and a market failure. In case of pure public goods, there is one major property known as non-excludability. It implies the fact that it becomes difficult to exclude anyone from the consumption of this goods and services. One major example of pure public goods and services are clean air, knowledge along with environmental goods. (Mayers, 2017).

3.3. Free Rider Problem

Both public and quasi-public goods are capable of offering instant benefits to large number of people. The free rider issue can be considered to be an economic term of market failure. It tends to take place when the people are attaining advantages from resources, goods and services that they are actually not paying for. In case of too many free riders, it can be noted that the resources, goods and different services would be underprovided. This is how free rider problem takes place. Such issue takes place with the public goods. The people are not motivated to pay for goods and services because of the fact that it is easy to consume goods and services without paying for it. Hence, no goods would be offered completely which can lead to social inefficiency.

3.4. Merit Goods

Merit goods and services are provided to the society for free for their benefit from the side of the government. The main reason behind government offering it for free has been that they would be under-provided in case they are left to the market forces. Merit goods offers positive externalities in case they are consumed. This type of spill over advantages possesses major impact over the social welfare. There are different examples of the merit goods and services such as fire protection, public parks, education, culture and housing (Mayers, 2017). In order to understand the main difference between public goods and merit goods, a table has been demonstrated in figure 5. Government intervention might assist by means of offering financial incentives or by means of behavioral nudge. By means of information campaigns, it becomes easier to change the choice of the people as well. Government intervention also assists to overcome the failure of market for supplying goods and services such as merit and public goods and services.

Government has a major role to play in the construction industry. The main reason behind this has been high demand for the public and merit goods. It is noted that the expenses of the UK public sector tend to be thirty-five percent of the business that is performed by construction companies. It becomes quite difficult to underestimate the inputs belonging to construction industry while creating both merit and public goods (Mayers, 2017). It is the construction industry that is accountable for the development and maintenance of the energy, houses, schools, communication and transport infrastructures. One best example associated with the contribution made by construction sector to merit goods has been linked with development of Barnhill school in Hillington (Figure 5).

In the example below, it is noted that near about £15m project was implemented with the assistance of the private finance initiatives. The task of funding was done by the private investors and once the project was completed the project was leased to the public. To show replacement cost and refresh programme, whole life costing tends to be implemented. Appendix 3 tends to demonstrate the details regarding the project.

Conclusion

The main findings of this report state the fact that the economic well being of the company can be assessed with the assistance of the financial ratios. With the help of ratio analysis, the companies are well capable of attaining significant information regarding management efficiency, capability to repay the debts, profitability of the company and also information regarding shareholders returns. It becomes important for the management to comprehend cost management practices so that adequate estimates can be identified. It proves to be quite important for any types of construction Company thereby assisting in winning tenders and making profit. It can be stated that the intervention of the state and the resources used by the construction industry has a major role to play in manufacturing the merit and public goods. This proves to be quite significant for the economic development of the nation.

References

Ashworth, A., Hogg, K. & Higgs, K., 2013. Willis's Practice and Procedures for the Quantity Surveoyr. 13th ed. Oxford: John Wiley & Sons.

Bragg, S., 2012. Business Ratios and Formulas. 3rd ed. New Jersey: John Wiley & Sons.

Brook, M., 2017. Estimating and Tendering for Construction Work. 5th ed. Oxon:

Cooke, A., 1996. Economics and Construction. 1st ed. London: Macmillan Press Ltd.

Fewings, P., 2005. Construction Project Management. 1st ed. Oxon: Taylor & Fracis Group.

Gruneberg, S. & Francis, N., 2019. The Economics of Construction. 1st ed. Newcastle upon Tyne: Agenda Publishing.

Harris, F. & McCaffer, R., 2013. Modern Construction Management. 7th ed.

Lester, A., 2007. Project Management Planning and Control. 5th ed. Oxford: Elsevier Ltd.

Marsh, C., 2012. Financial Management for Non-Financial Managers. 1st ed. London:

Mayers, D., 2017. Construction Economics a New Approach. 4th ed. Oxon: Routledge.