This presentation discusses various tools and techniques of financial analysis for urban infrastructure projects.

1. Financial Analysis of an
Infrastructure Project
Ravikant Joshi
Advanced PG Diploma in Urban Management
YASHADA – Pune
21st November 2014

2. Financial Analysis of an Infrastructure Project
Introduction
Financing of Infrastructure Project
Financial Analysis – Introduction
Financial Analysis of an Entity
Financial Analysis of an Infrastructure Project

3. Financial Analysis of an Infrastructure Project
Introduction

4. Introduction
Need to know about three things
What is project or infrastructure project and what is its
project life cycle ?
How urban infrastructure project is financed?
What is financial analysis, types of financial analysis,
techniques of financial analysis ?

5. Project - Defined
Two defining features of a project:
A unique output or set of objectives
A limited time frame
Formal definition: A project is
a complex process (or work) made up of interrelated tasks,
with the purpose of achieving a pre-determined set of objectives, and
to be completed within a limited and pre-determined time frame and
budget.
Project Management Institute defines projects as a “temporary endeavor
taken to create a unique product or service”
Note: This definition applies not only to project as a whole, but to
every subproject and contract package within it

6. Project, Project Life Cycle and Financial Analysis
 Project initiation and assessment
 Prefeasibility analysis - financial viability /sustainability analysis – entity
based financial analysis and quick analysis of cost and revenue model of
project.
 Preliminary project structuring – (detailed financial analysis of project
using various methods)
 Detailed project preparation – (detailed financial plan about equity, debt,
revenue mobilisation through user charge, cost control, grants available,
pubic contribution etc)
 Bid management, procurement
 Project construction and monitoring
 Commencement of operations
 Project Appraisal

7. Project Finance Life Cycle
Operations &
Monitoring
Drafting of financing documents
Implementation &
Monitoring
Resolution of due
Diligence issues
Preliminary project assessment Due diligence
Issue of LOI
Issue of term sheet
Term sheet negotiations
Term sheet signing
Financial closure Project completion
Project identification
Debt servicing

8. Financial Analysis of an Infrastructure Project
Financing of Infrastructure Projects

9. Financing Infrastructure – Ways and Means
 Own Capital Resources – (revenue surplus + capital cost recovery +
betterment charges + sale of assets)
 Borrowing –
External – World Bank, ADB, IMF, IBRD
Internal – Development Financial Institutions, Commercial Banks,
special purpose institutions & from individuals and institutions in the
form of saving schemes
 Capital Grants, Development Assistance
 Accessing Capital Market
Equity
Debt (Treasury bills*, Public Bonds, Municipal Bonds)
 Project Financing
 Public Private Partnership
 Public Private People (Community) Partnership
 Deficit Financing*

10. Financing of Needs/Infrastructure
Public
Resource
Private
Resource
Social
Resource
Public
Needs/
Infrastru
cture
Private
Needs/
Infrastru
cture
Social
Needs/
Infrastru
cture
Tax, User Charges, Market Operations
Market Operations
Self Help, Self Reliance, Self Financing

11. Financing Infrastructure – Conventional Sources
Conventional
Internal /
Own Revenue
External
Tax
Non-Tax
Capital
Govt. Loans
Transfers
Grants
Non-Conventional /
Alternative
Commercial
Loans
Public- Private
Partnership
Resources
Pricing
Mechanism
Accessing
Capital Market
Land as
Resource
Social Capital
through
community
participation
Extr Borrowing

12. Financing Infrastructure - Alternative Sources
Alternative Sources
Loan
Financing
Private Sector
Participation
Pricing
Accessing
Capital Market
Commercial
Banks
Infrastructure
Banks
Development
Fund
Specialised
Intermediaries
Leasing Contracting Franchising BOO, BOOT,
BOLT
Concession
Service
Management
User Charges
Tariff Reforms
Equity Market
Debt Market
Municipal
Bond
Infrastructure
Bond
Pooled Finance
Community
Participation

13. Financing of Infrastructure
Revenue
Internal /
Own Revenue
External
Tax
Non-Tax
Capital
Loans
Transfers
Grants
Expenditure
Cost
Efficiency
Productive
Use of
Resources
Municipal Finance

14. Financing Infrastructure Project
Own
Funds
Reforms
Recovery
of CAPEX
& OPEX
Funding
OPEX
Funding
CAPEX
FI
Funds
Multi-lateral
agency funds
Grant
Funds
FundingDevelopmentIdentification
Infra
Projects
Capital
Market
Govt. Guarantee, mortgage, collateral security, ratings
Project Revenue
Budgetary
Resources
Efficiency
Gains
Cost
Reduction
User
Charges
Taxes
Administrative Community
Participation
Political Will
Policy, e-governance, accounting, capacity building reforms
P3&P4
Fiscal

15. Financial Analysis of an Infrastructure Project
Financial Analysis - Introduction

16. Financial Analysis - Introduction
Financial analysis is the first process or starting point of
financial management. Whether it is setting up a new
business; expanding or diversifying a business; reviving a
stagnant or declining business; or simply running the business
or infrastructure project
Financial analysis is a continuous process of measuring and
monitoring of an organisation’s/ULB’s financial condition
and/or of an infrastructure project
Two types of financial analysis / two approaches of financing
Entity analysis (balance sheet approach)
Project analysis ( project finance approach)

17. Financial Analysis - Introduction
Financial analysis refers to an assessment of the viability,
stability and profitability of a business (or an organisation),
sub-business or project.
Financial analysis is a process that can be used to
Better understand the LG’s financial condition—the forces
that affect it and the obstacles associated with measuring it,
Identify existing and emerging financial problems, and
Develop actions to remedy these problems.

18. Financial Analysis - Introduction
From another point of view financial analysis can be
used in a several way, more significantly for -
Identifying underused revenue sources;
Projecting revenue and expenditure trends into the future
Assessing debt-carrying capacity of local governments;
Evaluating the impact of rate changes in local fees and
licenses; and
Improving cost efficiency of local services

19. Aspects/Components of Financial Analysis
Financial Analysis looks at
External economic conditions – inflation, employment, interest
rates, economic growth, etc.
Political culture, governmental policies, legal framework, etc.
Internal economic conditions/practices like repeated use of one-
time revenue resources, i.e., reserves, or sale of assets
One-time accounting changes
Internal borrowings
Possibilities of deferring a large amount of current costs to the
future, deciding on maintenance and pension, ignoring long
range or full life cost of a liability – purchasing assets, examining
long-term costs

20. Financial Analysis - Introduction
Maintain
existing service
levels
“financial condition can be broadly defined as a organisation’s
ability to finance its operations on a continuing basis. More
specifically, financial condition refers to a organisation’s ability to
(1) maintain existing service levels, (2) withstand local and regional
economic disruptions, and (3) meet the demands of natural
growth, decline, and change.”
Withstand local
and regional
economic
disruptions
Meet demands
of natural
growth, decline
and change
Useful in getting answers to three crucial questions which sum
up financial condition and sustainability of ULB

21. Evaluating Financial Condition – some basic truths
 Most financial problems do not develop suddenly
 A decline in revenues
 An increase in expenditure pressures,
 Decreasing cash and budgetary surpluses
 A growing debt burden
 The accumulation of unfunded liabilities
 The erosion of capital plant
 A decline in tax base or an increase in the need for
public services

22. Financial Analysis of an Infrastructure Project
Financial Analysis of an Entity

23. Financial Analysis of Entity
Revenue Generation Analysis - how well an urban local
government is tapping the revenue potential and what is the
cost of increasing revenues.
Expenditure Control Analysis - cost (direct and indirect) of
providing the services and upward – downward movement in
the it
Financial Balance - comparison of revenues to expenditures

24. National /
State
Legislation
Fiscal Domain Local
Income (Revenue &
Capital Base)
Revenue Generation Expenditure Control
Functional Domain
(Responsibility for
Services)
Collection
Procedures
Efficiency
Local Revenue
Collected
Local
Resources
Actual Service
Provided
Cost of Local
Services
External Resources
Governmental
Transfers
Local Revenues
Local
Expenditure
Borrowing
Local Cost
Factors
Administ
rative
Cost
Loan Repayments
Surplus or Deficit
Surplus or Deficit Surplus or Deficit
Financial Balance

25. Common techniques of financial analysis
 Horizontal Analysis - focuses on changes from one year to the next -
 What was the amount of change from one year to the next?
 What was the percentage change from one year to the next?
 Vertical Analysis - focuses on the various items listed up and down the
page of a financial statement for a given year. - what portion does
each item contribute to the whole?
 by converting all numbers to percentages, it is much easier to compare
differently sized entities
 Trend Analysis – is a horizontal analysis it looks at changes over time.
Examines changes over several years to see where an entity is headed.
It provides greater amount of information

26. Common techniques of financial analysis
Ratio Analysis - the ratio of one statistic or measure to another.
Ratios are calculated to arrive at an absolute factor or a ratio,
which can be compared with the similar ratio in different
periods.
Ratios related to Revenue Income
Ratios related to Revenue Expenditure
Ratios related to Capital Receipts.
Ratios related to Capital Expenditure
Ratios related to liquidity, profitability, sustainability etc.
Financial ratios should be used with caution

27. Failure of Conventional Financial Analysis Systems
Budget, balance sheet and other financial statements fails to
provide multiyear perspective of emerging good or bad
Financial Condition of an organisation/a municipal body
Maintenance costs that are being postponed.
Accumulated unfunded pension liabilities or employee benefit
liabilities.
Reductions in purchasing power caused by inflation.
Decreasing flexibility in the use of monies that results from unfunded
central government mandates.
Erosion of plants, machinery, buildings, other capital assets.
Impact of economic and demographic changes to changes in
revenue and expenditure rates.

28. Framework for Evaluating Financial Condition
 Need to ask following questions -
 Can a municipal body/an organisation continue to pay for
what it is now doing?
 Are there reserves or other ways for financial crisis?
 Is there enough financial flexibility with an organisation to
adjust to change?
 If a municipal body/an organisation can meet these
challenges, it is having a sound condition

29. Financial Analysis of an Infrastructure Project
Financial Analysis of an Infrastructure Project

30. What is Project Finance? What is Project
based financial analysis?
“Project Finance is a technique of non-recourse or
limited recourse financing in which the project
lender principally look to the cash flow of a single
project as security for their long-term loans.”
Project based financial analysis uses those
techniques which analyse cash flow of the project
and financial viability of the project over the period
of time.

31. Financial Analysis of Infrastructure Project
Techniques for financial analysis of projects -
Break-even analysis
Net- present value Analysis
The internal rate of return (IRR)
Fiscal Impact Analysis
Cost-benefit Analysis
Sensitivity Analysis

32. Break – even analysis
 Deals with cost-volume relationship.
 Very useful for allocation of resources to various activities and determining the financing
needs to accommodate the changes in volume.
 Knowledge of cost behaviour helps to minimise costs and maximise returns.
 Fixed Cost, Variable Cost, Contribution (sales – Variable Cost) ,
 Profit – Volume Ratio = contribution (sales – variable cost) / sales
 A business is said to be breakeven when its revenues (sales) exactly match all costs. In case of
ULBs, individual operations like water supply system, sewerage system, gas supply services
may have their own break even points. It is a no profit no loss situation and it is at this point
that all costs-fixed and variable are recovered through sales. It is calculated as
 Break even point in units = Fixed cost/Contribution per unit
 Break even point in sales = (Fixed cost/Contribution per unit) * Selling price per unit
 Margin of Safety = the difference between break even volume of sales and the actual sales
being achieved in other words Profit = margin of safety * P/V ratio

33. Net Present Value Method
 The sum of the present values of the individual amounts in the income stream.
 Each future income amount in the stream is discounted, meaning that it is divided by a
number representing the opportunity cost of holding capital from now (year 0) until the
year when income is received or the outgo is spent.
 Opportunity cost - either how much would have earned investing the money or how
much interest you would have had to pay if you borrowed money.
 Discount Rate
 The fiscal discount rate = is the government’s cost of borrowing.
 The social discount rate = roughly equal to the opportunity cost of capital, weighted
according to the source of investment capital.
Year 0 1 2 3 4 5 6
Income amounts $1200 $200 $200 $200 $200 $200 $200
Discounted Income (@ 5%) $1014 190 181 173 165 157 149

34. Net Present Value Method
 Higher income amounts make the net present value higher. Lower
income amounts make the net present value lower.
 If profits come sooner, the net present value is higher. If profits come
later, the net present value is lower.
 Changing the discount rate changes the net present value. For an
investment with the common pattern of having costs early and profits
later, a higher discount rate makes the net present value smaller.
 Single project, unconstrained budget, ‘go’ or ‘no go’ decision - Do not
undertake projects whose NPV is less than zero, unless you are willing to
‘lose money’ to achieve a non-economic objective.
 Alternative projects, constrained budget, a ‘best set’ decision - Given a
choice among alternative projects, maximize the total NPV.

35. Internal Rate of Return (IRR)
 The IRR is the discount rate that makes the NPV of the project zero.
 The underlying formula for the IRR is the same as for the NPV. If you
know the discount rate, you can calculate the NPV and vice versa.
 But it is not an ideal replacement of NPV, the mathematics of the IRR
calculation, however, is not based on a proof and a formula.
 An IRR higher than the standard discount rate indicates that you should
go ahead with the project, and when you are choosing among alternative
projects, a higher IRR is preferred.
 If project A earns an IRR of 15 per cent, for example, whereas the ordinary project
earns 10 per cent, then project A is an attractive investment.
 But a simple comparisons between IRRs may be misleading if the projects
are not the same size.
 More than one value of the IRR will solve the equation,

36. Fiscal Impact Analysis
 connect planning and local economics by estimating the public costs and
revenues that result from property investments.
 New development leads to new revenues and new costs - fiscal impact
analysis enables the comparison of new revenues to new costs.
 If new revenues exceed new costs, the fiscal impact is positive. ULB can meet new
demands for services/can provide a tax reduction for existing taxpayers.
 If new revenues fall short of new costs, the fiscal impact is negative. ULB must raise
taxes to meet new service demands or reduce the quantity or quality of existing
services.
 At the macro level, to analyze growth as it affects an entire jurisdiction,
such as a county or city.
 At the micro level, to determine the effects of specific projects on the
overall community.

37. Fiscal Impact Analysis
Analysis helps decision-makers link planning to the local annual budget.
Removes myths and helps to minimize the emotionalism that can
accompany public debate.
Can show that not all growth in the community is positive at its present
rate.

38. Cost – Benefit Analysis
 Used by governments to evaluate the desirability of a given intervention.
 Analysis of the cost effectiveness of different alternatives in order to see whether the
benefits outweigh the costs.
 Aim is to gauge the efficiency of the intervention relative to the status quo.
 weighing the total expected costs against the total expected benefits of one or more
actions in order to choose the best or most profitable option.
 Benefits and costs are often expressed in money terms, and are adjusted for the time
value of money (present value)
 Closely related other formal techniques include
 cost-effectiveness analysis,
 economic impact analysis,
 fiscal impact analysis and
 Social Return on Investment (SROI) analysis.

39. Cost – Benefit Analysis
 Application of Technique – differs country to country, sector to sector, as per
nature of project because of the types of impacts that are included as costs
and benefits within appraisals, the extent to which impacts are expressed in
monetary terms, and differences in the discount rate adopted
 NPV (net present value)
 PVB (present value of benefits)
 PVC (present value of costs)
 BCR (benefit cost ratio = PVB / PVC)
 Net benefit (= PVB - PVC)
 NPV/k (where k is the level of funds available)
 Different shareholder value cost and benefits differently
 A high discount rate implies a very low value on the welfare of future
generations, which impacts on the desirability of interventions to help the
environment.

40. Sensitivity Analysis
 The outcome is typically influenced by several uncertain factors.
 Important to know how ‘sensitive’ the outcome is to changes in those
uncertain factors.
 Help to know the extent of the uncertainty and risk is in the program.
 A step in building deterministic model, follow three stage process
 Build a deterministic model using single ‘best’ values (base values) for the input
variables.
 Explore the outcome’s sensitivity to each input variable and then take action to reduce
the risk of uncertainty where possible.
 Make a full risk analysis using probabilities for many variables simultaneously.
 Types of sensitivity analysis
 Gross sensitivity
 Two-variable sensitivity analysis

41. Financial Analysis of
Infrastructure Project
Thank you

42. Lack of Willingness to Pay/to Charge-The negative cycle
Low investment
Poor services
Citizens
unhappy
Unwillingness
to pay
Unwillingness
to charge
Low income
The Crux of
Financing
Infrastructure
Known as Low Equilibrium Trap

43. Need to Create - A Positive Cycle
Higher Investment
Improve
services
Increase citizen
satisfaction
Higher willingness
to pay
Levy realistic
charges
Increase
income A Way Out/
Solution to
Financing
Infrastructure

44. Financing Infrastructure – Negative to Positive Cycle
Low Level
Investment
Poor services
Citizens
unhappy
Unwillingness
to pay
Unwillingness
to charge
Low income
High Level of
Investment
Improve
services#
Increase
citizen
satisfaction
Higher
willingness to
pay
Levy realistic
charges
Increase
income
Mobilise Resources through
augmentation & cost efficiency
Negative
Cycle
Positive
Cycle
Willingness to Charge,
Enforcement, Governance
# needs system reforms, operational efficiency, customer orientation