Economic and Financial Appraisal

Financial appraisal asks whether an infrastructure project can generate adequate cash returns and meet its financial obligations. Economic appraisal asks whether the project produces a net gain in welfare for society, including effects that do not appear in the project's accounts.

Perspective and valuation

The two appraisals differ mainly in whose costs and benefits they measure and how they value them.

• Financial appraisal examines cash inflows and outflows from the viewpoint of the project entity, investor or lender, using market prices and expected revenues.
• Economic appraisal adopts the viewpoint of the economy or society and values resources at their opportunity cost.
• Where market prices are distorted by taxes, subsidies or administered prices, economic appraisal may use shadow prices.

Treatment of project effects

Financial appraisal counts only effects that create actual receipts or payments for the chosen financial stakeholder. Economic appraisal also includes measurable effects on users and non-users.

• For a railway or metro project, fares and commercial income are financial benefits, while construction, operation and maintenance are financial costs.
• Economic benefits may include travel-time savings, lower vehicle-operating costs, improved safety, reduced congestion and environmental effects.
• Taxes, subsidies and similar transfer payments are generally separated in economic appraisal because they redistribute income within society rather than directly consume or create resources.

Indicators and decision use

Financial appraisal commonly uses financial net present value and financial internal rate of return, discounted at an appropriate financial cost of capital. Economic appraisal uses economic net present value, economic internal rate of return and benefit-cost ratio, applying an appropriate social discount rate.

• Financial appraisal tests profitability, affordability, debt-servicing capacity and bankability.
• Economic appraisal supports public investment choice by testing whether total social benefits exceed total social costs.
• A project can be economically desirable but financially weak when major benefits, such as time savings, cannot be captured as revenue; it may then require public funding or support.