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p. 47 of 203 BACK | NEXT Foreword 1. Introduction to the Guidelines 2. User Instructions 3. Preparing and Appraising Investment Project 3.1. Investment Projects Overview 3.2. Possible Investment Projects 3.3. Appraisal Checklists 3.4. Forecasting 3.5. Preparing Financial Benefit-Cost Analyses 3.6. Loan Covenants 3.7. ADB Reports 3.7.1. Introduction to ADB Reports 3.7.2. Project Preparatory Technical Assistance Stage 3.7.3. Report and Recommendation of the President 3.7.4. Miscellaneous ADB Reports 4. Financial Management of Executing Agencies 5. Reporting and Auditing 6. Financial Institutions 7. Knowledge Management

Financial Management and Analysis of Projects : 3. Preparing and Appraising Investment Project

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3.7.3. Report and Recommendation of the President

3.7.3.1. RRP Contents (Project Loan)

The following table sets out the contents of an RRP (for a project loan) with explanations of the financial aspects. The Knowledge Management section of these Guidelines provides a general checklist for reviewing the financial aspects of an RRP see (section 7.6).

3.7.3.2. Past Financial Performance

3.7.3.2.1. Whenever the borrower or EA of a proposed loan is an existing agency, its past financial performance should be analyzed for at least the most recent 2 completed fiscal years, preferably based on audited financial statements for those years. The text discussion should note significant conclusions reached on past financial performance and the factors contributing to satisfactory or unsatisfactory results. Detailed analysis should center on any problem areas in the financial statements-balance sheets, income statements and cash flow statements.

3.7.3.2.2. For textual presentations, a financial summary table for the balance sheets, income statements and cash flow statements is often the most useful and space-saving form. However, separate summary tables are acceptable, particularly when used to reinforce a specific discussion in the text. These statements, where presented in the text in summary table form, should cover a period long enough to give an adequate picture of recent financial performance. In most cases, this will be 2 or 3 years, based on audited accounts for the fiscal years concerned.

3.7.3.2.3. For repeat borrowers/EAs, the period should cover from the date of signing of the last loan to the date of fact-finding and appraisal, with a table to show actual performance with the forecast in the previous RRP.

3.7.3.2.4. The subject headings in the summary tables may vary depending on the type of project and the particular focus of the text discussion. In general, however, the tables should highlight important relationships regarding the financial structure of the enterprise, its ability to generate funds, and its profitability.

3.7.3.3. Present Financial Condition

3.7.3.3.1. An EA's current condition may warrant separate discussion in the text, or may be described when referring to the past financial condition. If the analysis of the present financial condition is based on current budgets and not on confirmed actual performance, the report should comment on the validity of the data used. If these data are likely to form the basis for financial forecasts during the project period and thereafter, and if the analyst is unable to obtain firm knowledge of the present financial position, the projected data should be subjected to sensitivity analysis, using, as far as possible, data on confirmed past performance as bases for measuring and forecasting.

3.7.3.3.2. The discussion of the present financial position should highlight the strengths and weaknesses of the EA's finances and its performance of relevant activities. The reasons for weaknesses should be fully discussed along with proposed remedies for resolving these.

3.7.3.3.3. If necessary, requisite performance and remedial undertakings should be sought in financial covenants with staff judgments on the potential effectiveness of such remedies explained in the text.

3.7.3.4. Cost Recovery and Profitability

3.7.3.4.1. Where cost recovery and/or profitability are primary objectives, the financial consequences of policies, strategies, and practices relating to the entity's operations or trade should be set out, for instance: (i) policies on recovery of costs of its products and/or services, (ii) tariffs and charges levied, (iii) systems of establishing costs of products and/or services, (iv) inventory controls, and (v) possibility and extent of external regulation (e.g., by government).

3.7.3.4.2. Discussions of detailed costs, cost recovery and detailed revenue yields should be designed to support the overall financial analysis and any special issues, such as marginal cost pricing, which may be presented elsewhere in the report.

3.7.3.5. Other Strengths and Weaknesses

3.7.3.5.1. Finally, this section of the report should review any aspects of an EA's current financial affairs not discussed elsewhere. These could include: (i) financial management and accounting systems or financial reporting and auditing procedures to the extent that they are not reviewed in the implementation chapter; (ii) financial relationships between the borrower, the EA, and other involved EAs; (iii) financial aspects of an agency not reviewed and the reasons for their exclusion; or, (iv) in the case of a recently established agency, the staff's judgment on the feasibility and reliability of a borrower's proposals for financial operation of the EA.

3.7.3.6. Future Financial Performance

General Content

3.7.3.6.1. This review may begin with an analysis of the financing plan for the project and the EA's operations and investment program over the project period. Irrespective of the presentational style of the section and the sectoral format used, the substantive discussion should focus on the agency's estimated future earnings and financial position.

Financing Plan

3.7.3.6.2. A principal objective of financial analysis is determining the adequacy of a financing plan. The summarized content of these plans should be consistent with data in the cash flow statement.

Projected Financial Forecasts

3.7.3.6.3. Projected balance sheets, income statements, and cash flow statements of the EA should be shown in summary tables, to permit comparisons between past and forecast data and to allow for ready identification of trends. The data should be consistent with demand and disbursement forecasts elsewhere in the report. Forecasts should normally be made for a period covering the duration of project construction up to at least the end of the third year of normal capacity operations. The aim is to provide adequate data on the profitability and debt servicing ability of the enterprise in relation to the investments to be undertaken under the project.

3.7.3.6.4. Forecasts should normally be made until a "steady state" has been reached, reflecting normal utilization of project facilities. If a substantial financial change is forecast within the life of the loan that would seriously affect the "steady state", the text should specifically discuss the impact of such a change on the financial condition of the EA. If possible, the projections should be extended to cover such an event; for example, the completion of a delayed and parallel dam-building project for a mixed hydro/coal-burning power utility some 7 years after project completion of a coal-fired station, that could reduce the coal consumption until power consumption demand again exceeded the hydro station's capacity.

3.7.3.6.5. The text should generally discuss: (i) financial objectives of the project and, where applicable, the project entity; (ii) future cost recovery/profitability, including assumptions made about physical volumes, prices, tariffs and costs, etc.; (iii) systems of cost recovery, tariff regulations, user charges, and credit provision; (iv) ability to meet debt service obligations and to finance capital expenditures; (v) adequacy of future financial position in relation to capital structure (debt as a percentage of total capitalization) and working capital (quick or current ratio); (vi) major risks and uncertainties not discussed in the Economic Analysis discussion which might affect the forecasts presented; and (vii) recommended covenants, action plans, and any measures judged necessary for the improvement of financial performance. These might include covenants on minimum levels of earnings, operating cost reductions, or restrictions on the incurrence of additional debt, the establishment of revised or new tariffs, or of targets to be achieved by the borrower.

3.7.3.6.6. Financial criteria to be applied to subprojects or components that will be appraised and if appropriate, approved after Board presentation of the main project, should be established and discussed the main body of the RRP and, if necessary, detailed also in an Appendix.

Proposed Cost Recovery and Potential Profitability

3.7.3.6.7. In the case of established EAs, this review may continue the discussion of past and present performance. The text should describe the agency's practices or proposals (either agreed or to be confirmed in legal agreements) at least during the project period and the early operating period. The discussion of cost recovery should also indicate the expected real increases in costs and the required real increases in tariffs during the forecast period. Any tariff studies to be undertaken should be noted. Justification of the use of subsidies should be mentioned, and a program presented for their reduction or elimination over time.

3.7.3.6.8. Financial objectives, together with an operating covenant or other financial covenants designed to promote their achievement, should be explained. Specific indicators to be used in monitoring financial performance should be explained, if necessary. The performance of comparable institutions in the sector and country should be briefly reviewed to establish any key factors which could affect cost recovery and profitability in case where there is no past performance on which to base projections. In such cases, inputs, outputs, and performance estimates will be based entirely on assumptions and targeted performance. It is essential, therefore, to express a judgment on the adequacy and reliability of the factors on which the forecasts are based.

3.7.3.6.9. This section of the RRP should also discuss the impacts on an agency's forecast financial statements of changes to prices and/or tariffs (and related government policies). The rationale for pricing of goods and/or services to be provided under the project and actual or potential government intervention in the price or rate-making process may be relevant to economic analysis and project justification. These may be discussed in the economic analysis section of the RRP.

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