Project Analysis

Financial Analysis Economical Analysis

Master of urban planning Semester-II Project formulation & appraisal Harita Salvi 12UP02

The planning process

The planning process may include the following steps:

1) Problem diagnosis

2) Goal articulation
3) Prediction and projection 4) Alternative development 5) Feasibility analysis

6) Evaluation and selection of recommended alternative

7) Implementation 8) Performance evaluation

Project Analysis
Technical Analysis

Financial Analysis

Social and Stakeholder Analysis

Project Feasibility
Economic Analysis Institutional Analysis Environmental Analysis

Economic Analysis
Economic analysis referred to as social cost benefit analysis, is concerned with judging a project from the larger social point of view. In such an evaluation the focus is on the social costs and benefits of a project which may often be different from its monetary costs and benefits. The questions sought to be answered in social cost benefit analysis are:

What are the direct economic benefits & costs of the project measured in terms of shadow (efficiency) prices and not in terms of market prices? What would be the impact of the project on the distribution of income in the society? What would be the impact of the project on the level of savings & investment in the society? What would be the contribution of the project towards the fulfillment of certain merit wants like self-sufficient, employment and social order?

Economic analysis

The objective of economic analysis is to determine if a project represents the best use of resources over the analysis period (that is, the project is economically justified): The economic analysis should answer questions such as, Should the project be built at all? Should it be built now?, Should it be built to a different configuration or size?

Will the project have a net positive social value for Californians irrespective of to whom the costs and benefits accrue?
Three common methods of economic analysis are cost effectiveness, benefit-cost, and

socioeconomic impact analyses.

Financial Analysis

Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense of being able to meet the burden of servicing debt and whether the proposed project will satisfy the return expectations of those who provide the capital. Purpose of the financial analysis :
Assessment of project viability and implement ability for the municipal utility and the local community economy
A tool for analysing, structuring and selecting different project options Assessment of project returns on overall investment and capital A tool for identifying appropriate types of project financing

Analysis of project broader socio-economic impact to the community

Financial analysis

The objective of financial analysis is to determine financial feasibility (that is, whether someone is willing to pay for a project and has the capability to raise the necessary funds). The test of financial feasibility is passed if Beneficiaries are able to pay reimbursable costs for project outputs over the projects repayment period, Sufficient capital is authorized and available to finance construction to completion, Estimated revenues are sufficient to cover allocated costs over the repayment period. Thus, a financial analysis answers questions, such as, Who benefits from a project?

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2.

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Who will repay the project costs?

Are they able to meet repayment obligations? Will the beneficiaries be financially better off compared to what they will be obligated to pay?

Stages of Financial & Economic Analysis

This requires an analysis of all economic costs for structural and non-structural alternatives. These costs include capital, operations, maintenance, and mitigation. Non-monetary costs and benefits must also be taken into account. In addition, identifying how the costs and benefits are allocated among stakeholders is an important component of any plan.

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2. 3. 4. 5. 6. 7.

Links with the key elements of the project analysis framework

Analysing the interests of the main STAKEHOLDERS How to define the WITH - AND WITHOUT - PROJECT Situations QUANTIFYING BENEFITS - and comparing them to costs FINANCIAL VS ECONOMIC: narrow or wider perspectives Analysing ASSUMPTIONS and Risks Summarising conclusions, and CRITERIA FOR DECISION

Economic Analysis vs. Financial Analysis A common misconception is that economic and financial analyses are the same.
Although both are required to determine overall project feasibility and sometimes use the same data, they are conceptually different types of analyses.

Economic Analysis

Economic analyses can be evaluated from many different perspectives individuals, communities, etc.

Evaluation period is the economic life of the project (for example, 50 years).
Project benefits and capital and annual operation costs are estimated. Benefits and costs are adjusted to show expected differences in their relative economic value over time. Economic discount rate is applied to account for time value of project costs and economic benefits produced by the project. Forgone investment cost during construction are included. Project inputs are valued at their economic opportunity cost. Financing costs are not included.

Financial Analysis

Evaluation is from the perspective of parties expected to pay their allocated costs. Evaluation period is the bond repayment period (for example, 20 years).

Project costs are expected monetary outlays to implement and operate the project.
Project income and capital and annual operation costs are estimated. Income and costs are adjusted to show expected differences in their relative market value over time.

Expected interest rate of bonds sold to finance the project is used as the time value of project costs.
Expected financial rate of return on alternative investments is used as the time value of income (or cost savings) produced by the project. Interest paid during construction is included.

Project inputs are valued at their purchase cost.

Bond sale and service costs are included.

Conclusion

It is possible for projects to be economically feasible but financially infeasible, or vice versa.

For example, a project can be shown to have economic benefits that exceed costs at the state wide level, but there may be no sponsors willing or able to finance it. On the other hand, it may not be possible to demonstrate positive net economic benefits for a project, but a sponsor may still be willing to finance and implement the project.

Linking with Project Cycle Management and Framework

The first step in FINANCIAL & ECONOMIC Analysis is to place it in context in relation to other analyses that may be necessary, and to the Framework. F & E Analysis is only one of the relevant forms of analysis: the Project Cycle Management methodology refers also to criteria such as institutional capacity, the strength of the policy framework, environmental soundness, social issues. It can be used to make project definition more precise It can quantify the problem to be solved, the necessary inputs , the expected results , and often also the degree to which the specific objective ('project purpose') is expected to be achieved. It may also be useful to determine by how much the project will contribute to the achievement of the overall objective.

Analysis of the Main Entities (Stakeholders)

The second step of Financial and Economic Analysis is to determine which are the entities or 'Stakeholders', and analyse their interests in the project.

When should the entities / stakeholders be identified?

Stakeholder analysis should be done during the identification of the project; if not, it should be done as part of the Economic and Financial analysis.

The focus is on economic functions Entities can be individuals, groups of individuals or institutions of many kinds. A project may involve a vast number of entities whose interests cannot all be analysed. The beneficiaries should come first, followed by the other major entities (e.g. ministry, government) significantly affected by the project.

Which entities?

The main entities should be analysed separately.

Beneficiaries who behave very differently economically may have to be divided in groups.The project may have to be redesigned in order to avoid a blockage if one of the target groups may lose from the project. In conclusion, it is not always simple to define stakeholders, but it is very important.

Social and Stakeholder Analysis

Local Government Consumers Operator/Utility Vulnerable groups Wider community

Financier

Ultimately all ventures are about people! Its more important to understand the people than the technology: Who gains? Who loses? Social and distribution analysis of project effects (different beneficiaries) Poverty Impact Analysis

The with project and the without project" situations

It involves a degree of arbitrary judgement, but helps to define what the additional benefit of the project is.

The without project situation is not the before project situation, because without financing, the situation would anyway change over time.
One should avoid presenting a picture of only one part of the project. The incremental situation is the with project minus the without project situation. In the end the project should generate more net benefits (benefits minus costs) than without the project the incremental situation should be positive. The three situations (with, without and incremental) should be summarised in three cash flows. The with project situation should be compared with relevant alternative options which should be adequately quantified. Justification should be given for the preferred option.

Economic Analysis Methods

Three common economic analysis methods are cost-effectiveness, benefit-cost, and socioeconomic impact analysis.

A cost-effectiveness analysis identifies the least costly method for achieving specific physical objectives.
A benefit-and-cost analysis determines whether the social benefits of a proposed project or plan outweigh its social costs over the analysis period. Such a comparison can be displayed as either the quotient of benefits divided by costs (the benefit-cost ratio), the difference between benefits and costs (net benefits), or both. A project is economically justified if the present value of its benefits exceeds the present value of its costs over the life of the project. Socioeconomic impact analysis is broader in scope because it identifies the direct and indirect (secondary) positive and negative effects of an action or project.

The use of one or more of these methods will depend upon the scope and objectives of the analysis as well as available data.

Cost - Benefit Analysis

values benefits by direct calculation e.g. extra production of rice X value per tonne (- extra production costs, + other benefits.); or by proxies: i.e. indicators or representative factors which give a more or less reliable value e.g. in a road project, reduced vehicle operating costs (VOC) are relatively easy to estimate. includes 'Cost recovery' (contributions by users to pay for services) in calculating costs, cash flows, solvency and sustainability. It is important to compare such costs with household incomes or any similar statistics to verify affordability. For example, when final beneficiaries have to pay a fee for water, from which the maintenance of the pumps etc is paid, it is vital to check that this fee can really be afforded by the beneficiaries. allows calculating profitability criteria that show the proportion between costs and benefits, and can be used to choose between various possible projects or components.

Costs

Project costs generally can be classified as either capital or annual operating costs. All costs necessary to obtain project benefits over the period of analysis must be included in the cost analysis. all costs in the economic analysis should reflect the opportunity costs of using resources to construct and operate the project. In practical terms, however, the cost information used in the analysis is often limited to the actual purchase expenditures: Financial Costs Financial costs are the actual expenditures, out of pocket, costs that are required to construct and operate a project. Financial costs can be grouped into two main categories capital costs and operation, maintenance, and replacement costs. Capital. Capital costs are all expenditures necessary to complete the project so operations can commence. Capital costs (for example, construction, fixed or first costs) include expenditures for land, structures, materials, equipment, and labour, as well as allowances for contingencies. Financial costs (such as, interest during construction and long-term debt service interest) are not included, although they are important in a financial analysis. Operation, maintenance, and replacement. These include the projects annual administrative, maintenance, energy and replacement costs and they are often called variable costs because they vary with different levels of project output. Externalities. Often the activities of producers or consumers have effects upon others that impose costs (or sometimes benefits) for which no compensation is received. Unfortunately, many externalities are difficult to identify, quantify, and ultimately, assign monetary values.

Benefits

Benefits are the values of goods and services produced by the project and by activities stemming from or induced by the project. Benefits play a critical role in determining the economic justification of a project and in allocating costs among different project purposes and sponsors. Types of benefits
Primary vs. Secondary. Primary benefits are the increased values of goods and services attributable to a project; Secondary (indirect) benefits are the values that accrue to persons other than primary beneficiaries as a result of economic activity induced by or stemming from a project. Tangible vs. Intangible. Tangible benefits can be expressed in monetary terms. Intangible benefits cannot be expressed easily in monetary terms. Private vs. Public.

Private benefits are obtained from goods and services purchased by individual producers and consumers through markets.
Public benefits are obtained from providing goods and services that are consumed by society as a Short- or long term and Their geographic scope (local, regional, statewide, or national).

Profitability criteria
1.

The NPV is the Net Present Value of the project, using a defined discount rate (rate of loss of value of money over time or opportunity cost of capital6).

It is an absolute figure, an amount that can be compared to the return (NPV) of other investments of the same amount. If alternative projects require investments of different sizes, it is recommended to divide the NPV of each project by the discounted investment, so as to allow comparisons between these projects.
2.

The IRR - Internal Rate of Return - is the discount rate that makes the NPV equal to zero. In other words, the IRR should at least be above the opportunity cost of capital in the country where the project takes place. Both the IRR and the NPV should be calculated, as they do not provide the same information

Cost-Effectiveness Analysis

Analyses non-tangible benefits which cannot be valued in monetary terms by direct calculation or by proxies

Focuses on costs per unit of benefit, and compares them with comparable costs elsewhere - e.g. Comparing the cost of vaccinating one person, or of one bed-night in hospital, or of a child's schooling for one year, in the project area; with the costs elsewhere in the country, in neighbouring countries, or even, in certain cases, regionally or world-wide7.
Is usually specific to a sector, since comparisons are normally only possible within a sector (health, education) and not between sectors.

Socio-economic Impact Analysis

Whereas benefit-cost analyses measure changes in resource costs and benefits to primary beneficiaries, socioeconomic impact analyses focus upon changes in regional population and economic activity as well as fiscal impacts upon local governments (changes in public services and revenues). Socioeconomic impact analyses are particularly relevant in evaluating the effects upon local communities. This requires for estimating population, employment, income, housing, land use/environmental, and fiscal impacts. input/output models can also be used to estimate secondary economic effects such as, income and employment.

Financial Analysis Methods

The aspects which have to be looked into while conducting financial Analysis are:
Investment outlay & cost of project
Means of financing Cost of capital Projected profitability Break-even point Cash flows of the project Investment worthwhileness judged in terms of various criteria of merit Projected financial position Level of risk

Fiscal impact analysis

Assess impacts of a project on government revenues and costs Identify added service requirements Estimate costs and revenues received from fees or taxes

Sensitivity Analysis
Projects do not always run to plan. Costs and benefits estimated at an early stage of a project may indicate a profitable project, but this profit could be eroded by an increase in costs or a decrease in the value of the benefits (the revenue). Sensitivity analysis provides a means of determining the financial impact of this type of fluctuation. By entering an anticipated percentage increase in costs or decrease in revenue the financial impact on the project can be identified by looking at the change to the NPV or IRR measures.
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Conclusions

Financial and Economic analyses have different perspectives or points of view : Financial analysis involves examining the activities and resource flows of the main entities (Stakeholders) or groups of entities separately. Economic analysis involves examining the impact on society (the economy) as a whole. Financial Analysis calculates the incentives for the main stakeholders, checks the solvency and longer-term sustainability of the project, and helps to design possible cost recovery mechanisms. It prepares the ground for an Economic Analysis, when the cash flows of the stakeholders are consolidated into a single cash flow. Economic Analysis also provides valuable information on the contribution of the project in the international context as well as domestic effects in the economy. One should always perform a Financial Analysis before proceeding to an Economic Analysis. It is useful to compare the results of the economic (notably shadow pricing) and financial analyses, as it may reveal that some benefits are transferred between certain stakeholders. Before conducting such Economic analyses, one should reflect on which issues are crucial for the success of the project. Before asking for an economic analysis, especially for the application of the effects method, one should first try to determine what data is available as well as how much time and funding such an analysis would require.

Overall Assessment of the Project

The final step of Financial and Economic analysis, is to decide whether or not, from a financial & economic standpoint to propose the project for financing. To do so, the criteria normally used in Evaluations can be helpful: efficiency, effectiveness, impact, sustainability and relevance. The questions to be answered, and the relevant techniques of Economic and Financial analysis, are shown in the following table: Criteria Efficiency Questions Relevant Economic Financial Analysis

Is the project using a minimum Cost Effectiveness of resources and are (financial and, if applicable, resources used efficiently? economical - i.e. using shadow prices) Are the returns of the project adequate (only for projects with tangible benefits)? Cost Benefit Analysis (financial and, if applicable, economical using shadow prices) Financial & if necessary Economic Analysis, comparing results (cash flow) with project purpose

Effectiveness

What is the extent to which the project reaches its purpose?

Criteria Sustainability

Questions Do the main stakeholders face solvency problems during the implementation of the project? Can the main stakeholders meet the recurrent costs after the end of the project? Is the project competitive (hence viable) internationally?

Relevant Economic Financial Analysis Financial Analysis of the main stakeholders' interests Financial Analysis of the main stakeholders' interests Economic Analysis: shadow pricing Economic Analysis: effects method

Impact

What are the effects of the project on the national economy (economic growth, government budget, foreign exchange, and income distribution)? Does the project address the real needs of the intended beneficiaries? How well does the project fit with national priorities and reforms undertaken by the government? How well does the project match policies and priorities of the EU?

Relevance

Financial Analysis of the intended beneficiaries Economic Analysis (effects method and shadow pricing) Economic Analysis (effects method and shadow pricing)