Financial and Economic Analysis of

Projects
PDC Training Manual
 Outline
• Why financial and Economic Analysis ?

• What is project Analysis ?

• Financial Analysis

• Economic Analysis
 Why Financial and Economic Analysis?

• All entities (firms, NGOs, governments, etc.) face the problem of allocating
limited resources to their best use:

• Firms: may be credit constrained, may be constrained in terms of forex access

• NGOs: limited by the resource they can raise
• Governments: limited by the resource they can raise through tax, borrowing.
In addition, governments are constrained by availability of land, forex, etc.

• This raises the question: How do we determine the best use of limited resources?
 Why Financial and Economic Analysis?

• The best use of resources can differ based on the entity under consideration:

• Firms: Objective may be maximizing profit, improving their market share, etc.
• Governments: social welfare?

• Whatever the objective is, one must convert the desired outcome in to measures
that can be compared across potential uses.

• Project analysis is a way of accomplishing this task. i.e. it is a system of

generating outcome measures that can be compared across potential uses of
resources.
 What is Project Analysis?

• Project analysis: assesses the benefits and costs of a project and reduces
them into a common yardstick.

• Projects with the highest benefit compared to cots are expected to be

implemented compared to those that are below them based on this criteria.

• The next question: How to assess benefits and costs?

• In the subsequent discussion, we assume that a project has passed through

sound technical evaluation stage
 Financial Analysis

• Financial analysis is concerned with commercial or private profitability of

projects.

• In financial analysis, a project’s impact is judged based on cash flow

consideration of the project (revenue and cost) and we compare the returns
of potential projects along this line.

• Benefits and costs are calculated based on market prices that are actually
paid or received by a project
 Economic Analysis
• Economic analysis is carried out from the perspective of the entire economy. It
assesses overall impact of a project on the welfare of all the citizens of the
country.

• Benefits and costs are calculated based on economic prices, also called “shadow
prices”.

• Two major sources of deviation of market (financial) prices from

economic(shadow) prices are: price distortions and nonmarketed outputs/inputs.

• Price distortions: taxes, subsidies, price control, etc.

• Non-traded outputs: public schools, externalities, etc.