Introduction
Projects are often designed to accomplish specific objectives. However, the achievement of these objects is not without various obstacles. These obstacles interfere with the project at different stages hence making the success of the project uncertain. A risk can be defined as a possible harmful outcome, which often comes along with financial losses for businesses. A project has various stages including project preparation, project implementation and project post-implementation stages. These stages are subject to particular risks hence creating the need for measures to cushion against the risks.
Various risks are associated with project implementation including political risks, financial risks and project performance or appraisal risks (Mullaly 2006). Political risks relate to the challenges that arise from the government or political organisations that make the implementation of projects difficult. On the other hand, performance or appraisal risks are associated with the managerial skills and experience of staff members. This paper looks at financial risks associated with the implementation of projects. It also looks at the impact of these risks on the project.
Financial Risks Associated With Project Implementation
Financial resources are fundamental to the acquisition of all inputs necessary to kick-start and run a project to completion. Rigorous and efficient resource allocations are vital to bringing the project to financial closure (Mullaly 2006). Efficient resource allocation requires a competent management process that uses the available finances carefully. Activities such as soliciting for credit from lending institutions or seeking donations have to take place to obtain financial resources. Grants from various institutions and organisations can also be used to fund projects. Various financial risks can affect a project during its implementation stage. Therefore, these hazards should be considered before implementing the project.
Types of Financial Risks Associated With Project Implementation
According to Themistocleous and Wearne, various financial risks contribute to the cost of projects (2000). These costs often cause donors and other project funders to be cautious about undertaking projects that appear risky. The following are the financial risks that affect projects during the implementation stage.
Risks Associated with Interest Rates
Any credit advanced to finance an activity comes along with cost in the form of interest. Projects often pay interest rates directly to the lenders (Raz, Shenhar, & Dvir 2002). Therefore, the payment of the interest to the lending institutions has to be as agreed between the lender and the project stakeholders. The interest rates are predetermined and are divided into regular repayments that the project should adhere to. In the case of defaulting, there are certain costs associated with failure to honour the repayments (Urli & Urli 2002). When a fixed-rate debt finances a project, it leads to an interest risk. Projects require long-term financing ranging from 10 to 30 years with fixed rates of interests (Wallace 2000). Projects that generate revenue can pay interests accruing from credit advance according to the signed agreements.
Transfer Risk
Foreign exchange control is a significant risk on currency movement between different countries (Karlsen 2002). Transfer risks result from the challenges of moving currencies between nations especially where international groups fund projects (Zehner 2003). Investors and lenders are under prohibition to repatriate their revenues from their projects in a different country (Morris, Patel & Wearne 2000). Therefore, investors are subject to strict foreign currency transfer regulations, which require them to change their currencies through national banks (Urli & Urli 2002).
Inconvertibility Risk
There are certain countries that block or control the conversion of local currency (Kolltveit, Karlsen, & Gronhaug 2007). The control of local currency, if poorly done, can interfere with the implementation of the project (Longman & Mullins 2004). Problems in converting foreign currencies into local currencies and vice versa pose challenges to the execution of projects with international donors.
Foreign Exchange Devaluation
Devaluation of foreign currency lowers the value per unit of currency during the exchange in the local country where the project is under implementation. Uncertainty about future exchange rates and the expected standard deviation of these rates creates a major challenge in project financing (Parker & Mobey 2004). The improbability poses a problem when evaluating the actual value of the project at future dates. The exposure to unknown future exchange rates causes anxiety to the project financiers and implementers (Zwikael & Globerson 2004).
This economic exposure brings about various risks that include contractual exposure, operational exposure and accounting exposure (Zobel & Wearne 2000). Contractual exposure or transactional exposure is tied to past cash flow obligations, which affect current cash flow obligations (Yeo 1993). The valuing of the project assets and liabilities using foreign currencies may face problems in the future if devaluation of the currency takes place. Operating exposure arises from the effects of strategic decisions affecting future operations of the project as the exchange rates change (Zwikael, Cohen, & Sadeh 2006). Accounting or translation exposure is financial risk caused by changes in the exchange rates because the consequences of these changes affect the income statement and the statement of financial position. Accounting is historical in nature since the data used in accounting are obtained from past transactions. Therefore, this information cannot be ignored in future transactions. The future changes are hard to account for using accounting information thereby posing a risk to project implementation.
Impact of Financial Risks on the Implementation of a Project
Risks have destructive and constructive effects on the implementation of projects. However, the adverse financial risks that exist are more than the positive effects that the risk can bring. Therefore, the ability to forecast and ascertain the severity of the financial risks can help to ameliorate the effects of the risks. The impact of the risks discussed above to the implementation of projects is as follows.
Impact Associated With Alterations in Exchange Rates
Devaluation of foreign currency lowers the value per unit of currency intended for exchange in the local country, which translates to increased prices of local products against the currency. The effect of this aspect on the implementation of the project is that the project financing has to increase to sustain it. The deviation of the expected expenditure from the mean due to alterations in exchange rates may cause projects to face resource constraints, which is detrimental to project implementation as it lowers the quality of the output. Uncertainty about future exchange rates poses a challenge when evaluating the expected future value of the project due to instability of exchange rates. The project’s future value becomes an approximation and not the actual value. Therefore, this poses a problem in attaching value to complete projects. However, the fluctuation can be beneficial if the foreign currency gains value over the local currency and the funded project gets more value for the converted currency. Consequently, the fluctuation allows the project to proceed without the anxiety of financial shortage.
Contractual exposure or transactional exposures are results of past debts that need to be paid by the project. During the implementation of a project, past costs become burdens that may affect the plans of the project (Zwikael & Gonen 2007). The asset value of the project changes if foreign exchange revaluation takes place. A project may suffer from loss of value if the revaluation lowers the importance of its currency. Liabilities due to foreign currencies increase and the project may have to meet higher costs. Conversely, a project may benefit if the revaluation improves the strength of the currency hence increasing the value of the assets owned.
Impact of Inconvertibility Risk
Inconvertibility risks may cause the implementation of a project to be behind the schedule. The conversion of currencies to the required currency at the project site is crucial to provide finances for timely delivery of results. These finances are required to pay for all the factors of production that are needed for the project to progress. Failure to pay for these factors stalls the entire project thereby affecting the project negatively.
Impact of Interest Rate Risks
Interest is the fee charged on loans. Projects are financed using fixed interest due to the cost incurred in their implementation. If the rates are flexible, they affect the implementation of the project negatively. If the repayment of the interest is charged before completion, it may interfere with the flow of cash during project implementation.
Impact of Transfer Risks
Project implementation may face challenges if the countries involved have hold-ups in transferring funds. A project may stall at its implementation stage in instances where funds are not transferable if other means of financing are unavailable.
Conclusion
Project implementation stage is the most crucial part of a project that needs financing. The financing has to be timely and adequate to ensure that the project remains on the planned course. The financial risks associated with project implementation are pertinent to the commencement of the project. Therefore, they should be solved first before the implementation of the project.
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