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Financial Management and Analysis of Projects : 3. Preparing and Appraising Investment Project
3.5. Preparing Financial Benefit-Cost Analyses
3.5.1. Introduction
3.5.1.1.
ADB requires that financial and economic
analyses be undertaken for projects. Both types of analysis have
the same objective-to assess whether the proposed investment is viable.
The concept of financial viability is not the same as economic viability.
The financial analysis of a project examines the adequacy of returns
to the project-operating entity and to the project participants,
whereas economic analysis measures the effect of the project on
the national economy, as a whole.
3.5.1.2. For a project to be economically
viable, it must be financially sustainable, as well as economically
efficient. If a project is not financially sustainable, economic
benefits will not be realized. Financial analysis and economic analysis
are therefore complementary.
3.5.1.3. While both types of analysis
are conducted in monetary terms, the major difference lies in the
definition of costs and benefits. In financial analysis, all expenditures
incurred under the project and revenues resulting from it are taken
into account. This form of analysis is necessary to (i) assess the
degree at which a project will generate revenues sufficient to meet
its financial obligations, (ii) assess the incentives for producers,
and (iii) ensure that demand or output forecasts on which the economic
analysis is based are consistent with financial charges or available
budget resources. Economic analysis attempts to assess the overall
impact of a project on improving the economic welfare of the citizens
of the country concerned. It assesses a project in the context of
the national economy, rather than for the project participants or
the project entity that implements the project.
3.5.1.4. This part of the Guidelines
describes ADB's approach to preparing financial benefit-cost analysis,
which involves six steps:
- Preparing
project cost estimates (see section
3.4.3)
- Forecasting
incremental project net cash flows (see
section 3.4.7)
- Determining
the appropriate discount rate (i.e., Weighted Average Cost of
Capital (WACC) serving as a proxy for the financial opportunity
cost of capital (see section 3.5.2))
- Calculating
the financial net present value (see
section 3.5.3)
- Calculating
the FIRR (see section 3.5.3)
- Undertaking
risk and sensitivity analysis. The sensitivity analysis examines
the likely effect of changes in forecasting assumptions on the
project's financial viability (see
section 3.5.4)
3.5.1.5.
The project RRP should describe how
the project's FIRR compares with WACC. The RRP appendixes should
include supporting analyses including sensitivity analyses. The
Knowledge Management section of the web-based Guidelines contains
Chapter 5 of ADB's Handbook for the Economic Analysis of Water
Supply Projects. The chapter is structured around a worked example
of financial cost-benefit analysis for a water supply project and
should be read in conjunction with ADB's Guidelines for the Economic
Analysis of Projects.
3.5.1.6.
ADB requires that poverty aspects
of projects be considered. To this end, consideration must be given-when
preparing project cost estimates, financial benefit-cost analyses and forecasts-to the preparation of the poverty impact assessment
(See Handbook for Integrating Poverty Impact Assessment in the
Economic Analysis of Projects).
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3.5.1. Introduction |
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