5. Economic and financial analysis
This is to include detailed analysis of the economic costs and benefits of the options under consideration and an analysis of the relative financial costs and benefits. The economic and financial analyses should use discounted cash flows in calculating the net costs and benefits of a proposal.
- All assumptions are to be transparent.
- Information on full lifecycle costs including recurrent costs is to be included.
- All the overall costs and benefits should be quantified where possible, including social and environmental costs and benefits.
- The discount rate applied to the net cash flows should be 5 per cent real before tax for very low risk projects (i.e. accommodation and related services). The use of discount rate in Partnerships Victoria process: Technical Note (July 2003) sets out the relationship between project risk and discount rate.
The source of cost and performance information used as a basis for the analysis and its likely accuracy needs to be covered. This would include whether revenue and cost information has been constructed using accepted methods and techniques prescribed by the agency, and / or accepted industry practice. In the event that estimates are used, the basis of those estimates needs to be disclosed.
As part of this economic assessment it is essential not just to consider quantitative measures but also to incorporate measures of a qualitative nature. This is particularly important because many social costs (such as increased pollution) and many social benefits (such as reduced mortality) can be difficult to quantify, much less to value in dollar terms. Furthermore, socio-economic benefits are the prime drivers for many investment choices in service areas of human services, education and law and order.
- A financial analysis is used to determine the costs and quantifiable risks (as identified in risk analysis and management in section 9) of a proposal from government’s perspective. It demonstrates the level of cost recovery expected.
- A financial analysis does not take into account any benefits to the beneficiaries that are not captured as a revenue stream of the proposal.
- Agency-specific business improvement initiatives need only consider agency costs and benefits (or cost savings).
- Whole-of-government or cross-agency initiatives must consider costs and benefits from a broader perspective and look to how participating agencies share the benefits, costs and risks.
- Benefits included in the cash flow analysis should be limited to direct benefits only; flow-on effects or unrelated factors can be mentioned but should not be included in the cash flow analysis.
Because the objectives of financial and economic analysis are different, it may be that a proposal is not seen as ‘financially viable’ (positive net present value) even when it is economically viable to government. Government proposals, which are economically viable when externalities, market imperfections are considered, will not always be financially viable on narrow cash flow considerations and will need to draw from funding sources.
One method of ranking these proposals is to prefer those proposals that meet the service needs at the minimum discounted cost, all other things being equal.
Another method, where economic benefits and costs cannot be reliably quantified, is to use a rating system. Comparisons and ranking of options (for example, a high/medium/low ranking-scale and weighted criteria reflecting the importance of the different benefits and costs being ranked) should be used to support the analysis. This ranking and weighting of socio-economic impacts allows non-monetary considerations to be compared with monetary impacts and may be important in areas of health, education and welfare where the market for the outputs from the asset proposal is not fully developed.
More detailed guidance can be found in sources such as chapters 6, 7 and 8 of the investment evaluation policy and guidelines.
For proposals requesting continued or additional funding (for a new phase, new module, or as a result of increased costs) evidence is required that the newly submitted information reflects any changes to the overall cost, benefit and risk.
This section requires further definition. Until further advised, projects should use the Infrastructure Planning and Delivery (IPD) branch investment evaluation analysis approach.