Economic and Financial Analysis of Water Supply and Sanitation Project
Economic and Financial Analysis of Water Supply and Sanitation Project
Economic and Financial Analysis of Water Supply and Sanitation Project
Demand for water depends on the price charged, a function of the cost of water supply which, in
turn, depends on demand. This interdependence requires careful analysis in all water supply
operations. Safe water should be generally provided at an affordable price and using an
appropriate level of service matching the beneficiaries’ preferences and their willingness to pay.
Purpose:
The purpose of the economic analysis of projects is to bring about a better allocation of scarce
resources. Projects must relate to the sectoral strategy and also to the overall development
strategy of the country.
In a water supply project, the goal may be “improved health and living conditions, reduction of
poverty, increased productivity and economic growth, etc.”.
The basic difference between the financial and economic benefit-cost analyses of the project is
that the former compares benefits and costs to the enterprise in constant financial prices, while
the latter compares the benefits and costs to the whole economy measured in constant economic
prices. Financial prices are market prices of goods and services that include the effects of
government intervention and distortions in the market structure. Economic prices reflect the true
cost and value to the economy of goods and services after adjustment for the effects of
government intervention and distortions in the market structure through shadow pricing of the
financial prices. In such analyses, depreciation charges, sunk costs and expected change in the
general price should not be included. In financial analysis, the taxes and subsidies included in the
price of goods and services are integral parts of financial prices, but they are treated differently
in economic analysis. Financial and economic analyses also differ in their treatment of external
effects (benefits and costs), favorable effects on health etc. Economic analysis attempts to value
such externalities, health effects and nontechnical losses.
The financial benefit-cost analysis will includes the following eight steps:
(i) determine annual project revenues;
(ii) Determine project costs;
(iii) Calculate annual project net benefits;
(iv)Determine the appropriate discount rate (i.e., weighted average cost of capital serving as
proxy for the financial opportunity cost of capital);
(v) Calculate the average incremental financial cost;
(vi)Calculate the financial net present value;
(vii) Calculate the financial internal rate of return; and
(viii) Risk and sensitivity analysis.
4. Project revenues, costs and net benefits are determined on a with-project and without-project
basis. They are estimated in constant prices for a selected year typically using the official
exchange rate at appraisal. The revenues of the project comprise of entirely user charges, that is,
no government subsidies are included.
Financial Revenues
The focus of the financial benefit-cost analysis is on the financial benefits and costs of the
project intervention. Hence, the project’s water sales revenues are determined on a with-project
and without-project basis. In this way, the contribution of the project to the total revenues of the
utility is estimated.
The project revenues are usually determined for different groups of users, such as households,
government institutions and private commercial/industrial establishments. Each may have a
different consumption pattern, may be charged a different tariff and may respond differently to
tariff increases.
Project Costs
Project cost estimates are typically will be worked out in detail. The following
main categories are distinguished:
(i) Investments;
(ii) Operation and maintenance; and
(iii) Re-investments during the life cycle.
Again, the costs should be attributed to the project on a with-project and without- project basis.
Only the additional costs due to the project should be taken into account. The basis to attribute
costs to the project should be the formulated with project and without-project scenarios.
. Investments
The breakdown of an investment cost into foreign and local currency components will
distinguished to establish the foreign exchange implications of the project and counterpart
financing requirements. Following the general principles of discounting according to which costs
and benefits are entered in the analysis in the year in which they occur, interest during
construction (IDC) is excluded from the costs used in the financial benefit-cost analysis.
Operation and maintenance
15. The elements of O&M costs may include:
labor;
electricity;
chemicals;
materials;
overhead;
raw water charges;
insurance;
other.
Reinvestments
Different project investment assets have different lifetimes and need replacement within the
project lifetime. The cost of those reinvestments needs to be included in the project’s benefit-cost
calculation.