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Financial Management and Analysis of Projects : 4. Financial Management of Executing Agencies : 4.3. Financial Analysis
4.3.6. Forecasting and Financial Projections
4.3.6.1. Introduction and Overview
4.3.6.1.1. Forecasts, in the form of
annual financial projections over the period of implementation, and
for the period necessary to achieve a steady state, should be made
in nominal (current) prices (and tables should clearly so indicate)
using the year of appraisal as the base year of projection. For an
existing EA that operates facilities similar in nature to the proposed
project, the financial projections should include actual performance
for 2 or 3 years prior to project start-up. However, this may also
require the forecasting of performance for the year of appraisal and
loan negotiations/signing.
4.3.6.1.2. The objective of the actual
performance and forecasts in the previous paragraph is to provide
comparative performances, including establishing any trends and patterns,
with the forecasts for the proposed project.
4.3.6.1.3. The preparation of financial
projections should be an integral part of the PPTA consultants'
TOR. The TORs for project implementation consultants will include,
as part of project supervision, the monitoring of financial management
and internal control procedures of the applicable project or EA.
4.3.6.1.4. Forecasts normally should
be made in the local currency. An exception should be made when the
local currency is unstable, for example, due to high and erratic levels
of inflation, projections may be made using a stable currency, typically
the US dollar.
4.3.6.1.5. The use of current prices
is particularly important for the analysis of the Financing Plan which,
to be complete, must relate to all project costs, including physical
and price contingencies and, where appropriate, FDCC, and for appraising
debt service coverage and the effect of debt limitation covenants
(which govern contractual obligations which are fixed in nominal current
terms).
4.3.6.1.6. Forecasts in current terms
are usually based on the same price assumptions as in the project
cost estimates, at least through the construction period, as long
as such assumptions are relevant for the labor, goods and services
concerned. Appropriate price assumptions should be made for items
which are not involved in the project cost estimate or which need
to be priced on differing bases.
4.3.6.1.7. Forecasts are normally made
for the period covering the duration of project construction up to
at least the end of the third year of normal capacity (steady state)
operations. When debt service coverage is based on a multiyear moving
average, the projection should cover the final year of the moving
average. The objective should be 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.
4.3.6.1.8. Forecasts should normally
be made until a "steady state" has been reached, reflecting
normal utilization of the 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.
4.3.6.1.9. In cases of projects which
take many years to reach normal capacity operating rates (e.g., 15-orizon
of the forecasts for the enterprise as a whole to between 2 and 5
years beyond the completion of project construction, even though normal
operating levels may not have been reached.
4.3.6.1.10. Since it is necessary to
demonstrate the impact of grace periods on loans, the time frame should
include the first year or years of full debt servicing whenever feasible
for treatment of FIRR forecasting.
4.3.6.1.11.. As stated above, where
debt service coverage is based on a moving average calculation, the
time frame should be sufficient to cover the last year of the moving
average for the final year shown in the projections.
4.3.6.1.12.. In addition to this overview,
this section reviews the following topics in relation to forecasting
and financial projections: (i) using real prices, (ii) using constant
prices, (iii) using a stable foreign currency, and (iv) presenting
data.
4.3.6.2. Using Real Prices
4.3.6.2.1. Where the analysis is made
in real terms, its use must be fully justified and the impact of current
prices on the financing plan and other elements listed in the preceding
paragraph fully explained in the text and subtables.
4.3.6.2.2. Relative price changes resulting
from the differential effects of changing prices and inflation on
particular expenditure items and on the revenue stream are apt to
be overlooked when real terms are used. This can lead to distortions
in the analysis of a financing plan and in cash flow statements.
4.3.6.2.3. By contrast, forecasts in
current terms require the analyst to make specific judgments about
these effects. Therefore, forecasts in current price terms are preferred.
Such forecasts should be made on the basis of alternative scenarios
to illustrate a range of possible futures and uncertainties, and the
forces that are likely to shape them. The use of sensitivity analysis
on key variables is recommended.
4.3.6.3. Using Constant Price
4.3.6.3.1. Where an EA operates within
an established national system for adjusting costs and/or revenues
for inflation, or in countries where price and foreign exchange rate
movements are highly erratic, constant price forecasts may be used,
providing the impact of the conversion to current prices, particularly
on cash flows, is demonstrated.
4.3.6.4. Using a Stable Foreign Currency
4.3.6.4.1. An alternative method is
to prepare tables in current price terms using a more stable currency
with which the country has a consistent money market/foreign exchange
relationship, e.g., with the US dollar. Judgments on, and justification
for use of current and constant prices and the foreign exchange rates
used should be stated early in this section of the RRP.
4.3.6.5. Presenting Data
4.3.6.5.1. Projected Balance Sheets,
Income Statements, and cash flow statements of the project entity
should be shown in summary and detailed 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. Because the presentation and interpretation
of figures in periods of changing prices and inflation is both difficult
and risky, staff should assist readers whenever possible by highlighting
underlying trends in data, particularly where these may be obscured
by substantial rates of inflation.
4.3.6.5.2. For example, the cost of
wages paid by an EA over 3 years may have risen by 150%, apparently
matching commodity or other price rises of 140-160%. In fact, however,
government, or employers, may have restricted the growth of wage rates
(to, say, only 25%) during the period, with rising manpower numbers
accounting for the rest of the 150% increase. The long-run effect
may be that a wages "explosion" is due in the project
period, and this should be reflected in forecasts.
4.3.6.5.3. This kind of elucidation
of data is central to good analysis. In cases where changes exist
in significant elements of cost (e.g., labor, fuel) or revenues, the
analysis may be given in both current (nominal) terms and real (constant)
terms together with physical amounts (e.g., numbers of employees;
tonnes of oil consumed) and the implicit assumptions for future forecasts
should be explicitly stated.
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4.3.7. Forecasting Assumptions |
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