Guidelines Financial

Guidelines
for the
Financial Governance
and Management of
Investment Projects
Financed by the
Asian Development Bank
Effective January 2002

Foreword
Financial analysis of ADB projects has been conducted ever since ADB was founded in
1966. To improve the uniformity, approach, and coverage of financial analysis, ADB issued
Guidelines for the Preparation and Presentation of Financial Analysis in 1989.
ADB has undertaken a review of the Guidelines to ensure that they reflect current ADB
policies, rules, and procedures, and developments in financial management and analysis
practices. In October 1999, a Bank-wide taskforce was appointed under the chairman-
ship of Francis B. Narayan, Lead Financial Management Specialist. The taskforce was
supported by a consultant. The review process, lasting over a year, was carried out in
consultation with all divisions and departments.
These revised Guidelines are the result of the review. They describe ADB’s philosophy,
policies, and approach to financial management of executing agencies and financial analysis
of investment projects. They have been prepared for the benefit of ADB staff and con-
sultants who evaluate financial management practices of executing agencies or under-
take financial analysis of investment projects.
The new title – Guidelines for the Financial Governance and Management of Investment Projects
Financed by ADB – reflects changes in ADB policies and procedures since 1989. The
Guidelines has been developed for the web. This hardcopy version is an abridged edition.
ADB deals with countries and sectors that are at different stages of development and that
have different resource and staff constraints. Recognizing these constraints, the Guide-
lines need to be applied in a realistic, practical, and flexible manner. ADB financial analysts
and financial management specialists have the discretion to determine the extent to which
the Guidelines will apply in particular circumstances.
The advice, directions and recommendations in the Guidelines should not be regarded
as a substitute for initiative. ADB staff should always exercise resourcefulness and imagi-
nation in reaching sound professional judgments.
MYOUNG-HO SHIN
Vice President (Region West)
November 2001
iii
Key Information on these Guidelines
What araree these Guidelines?

The Asian Development Bank (ADB) publishes the Guidelines for the Financial Governance
and Management of Investment Projects Financed by the ADB (the Guidelines). The Guide-
lines set out ADB’s requirements and procedures for the financial management of projects
financed by ADB, for instance, financial reporting, and auditing requirements. They also
provide guidance on how to apply these requirements.
When araree the Guidelines Updated?

The web-based Guidelines and the downloadable copy of the Guidelines are updated
every six months. A list of six-monthly changes to the Guidelines can be accessed online.
After reviewing these changes, users may decide to download an up-to-date copy of the
Guidelines from website at http://www.adb.org/documents/guidelines/financial.
What Recent Changes have been made to the Guidelines?

ADB’s 1989 Guidelines were reviewed and re-released in November 2001. The changes
to the 2001 Guidelines reflected developments in financial management practices, changes
in accounting and auditing standards, and harmonization efforts by the multilateral
development banks including ADB.
Who can I ask for help on the Guidelines?

If your question is related to a project or program, please contact the responsible ADB
project officer in the first instance. Otherwise, contact:
Francis B. Narayan
Lead Financial Management Specialist
Asian Development Bank
Manila, Philippines
General Information: [email protected]
Webmaster: [email protected]
Telephone (632) 632-6651
Fax (632) 636-2365
Postal: 6 ADB Avenue
P.O. Box 789, 0980, Manila, Philippines.
Guidelines for the Financial Governance and Management of Investment Projects Financed by ADB
iv
Acronyms
The following acronyms are used throughout these Guidelines. A fuller list of common
ADB acronyms is accessible at www.adb.org.
ADB Asian Development Bank

AfDB African Development Bank
APA Audited Project Accounts
BCBS Basle Committee for Banking Supervision (BIS)
BIS Bank for International Settlements
BTOR Back-to-Office Report
CAPA Confederation of Asian and Pacific Accountants
CFAA Country Financial Accountability Assessment (World Bank)
CFS Corporate Financial Statements
COSO Central Operations Service Office
CPA Certified Public Accountant
DMC Developing Member Country
DSAA Country Diagnostic Study of Accounting and Auditing
EA Executing Agency
EBRD European Bank for Reconstruction and Development
ED Exposure Draft
EIRR Economic Internal Rate of Return
ENPV Economic Net Present Value
EU European Union
FARAH Financial Accounting, Reporting & Auditing Handbook (World Bank)
FASB Financial Accounting Standards Board (United States)
FCDD Financial Charges During Development
FI Financial Institution
FIL Financial Institution Loan
FIRR Financial Internal Rate of Return
FNPV Financial Net Present Value
FOCC Financial Opportunity Cost of Capital
GAAP Generally Accepted Accounting Principles
GDP Gross Domestic Product
IA Implementing Agency (also PIU)
IADB Inter-American Development Bank
IAPC International Auditing Practices Committee (IFAC)
IAPS International Auditing Practice Statement (issued by IAPC)
IAS International Accounting Standard (issued by IASB)
IASB International Accounting Standards Board (formerly IASC)
IASC International Accounting Standards Committee
v
IEG International Education Guideline (issued by IFAC)

IES International Education Standard (issued by IFAC)
IFAC International Federation of Accountants
IFRS International Financial Reporting Standard (issued by IASB)
IMF International Monetary Fund
INTOSAI International Organization of Supreme Audit Institutions
IOSCO International Organization of Securities Commissions
IPSAS International Public Sector Accounting Standard (issued by IFAC)
ISA International Standard on Auditing (issued by IAPC)
MDB Multilateral Development Bank
MFI Microfinance Institution
MIGA Multilateral Investment Guarantee Agency
MOF Ministry of Finance
MRM Management Review Meeting
NGO Nongovernment Organization
OECD Organization for Economic Cooperation and Development
OIST Office of Information Systems and Technology
OM Operations Manual
PAI Project Administration Instructions
PAU Project Administration Unit
PCR Project Completion Report
PIU Project Implementing Unit (also IA)
PMU Project Management Unit
PPTA Project Preparatory Technical Assistance
PSC Public Sector Committee (IFAC)
REEA Revenue Earning Executing Agency
RETA Regional Technical Assistance
ROE Return on Equity
ROR Rate of Return
ROSC Report on the Observance of Standards and Codes (World Bank – IMF)
RRP Report and Recommendation of the President (ADB)
SAI Supreme Audit Institution
SFR Self-Financing Ratio
SI Sensitivity Indicator
SME Small or Medium-scale Enterprise
SOE Statement of Expenditure
SRC Staff Review Committee
TA Technical Assistance
TOR Terms of Reference
UNCTAD United Nations Conference on Trade and Development
WACC Weighted Average Cost of Capital
WTO World Trade Organization
vi
Contents
3.7. ADB Reports

1. Introduction to the Guidelines
Introduction 3.7.1. Introduction to ADB Reports
1.1. Introduction 3.7.2. The Project Preparation Report
1.2. Rationale 3.7.3. Report and Recommendation of
1.3. Objectives the President (RRP)
1.4. Structure 3.7.4. Miscellaneous ADB Reports
1.5. Project File
1.6. Guideline Updates 4. Financial Management of Executing Agencies
4.1. Financial Management Overview
2. User Instructions 4.2. Institutions and Systems
2.1. Overview 4.2.1. Introduction to Institutions
2.2. ADB Lending and Technical Assistance and Systems
2.3. Applying these Guidelines 4.2.2. Major Institutional Assessments
2.4. Project Types and General Treatments 4.2.3. Governance
2.5. An Overview of Project Processing Steps 4.2.4. Financial Policies
2.6. Step 1: Identification and Early Preparation 4.2.5. Country Diagnostic Studies of
2.7. Step 2: Loan Preparation Accounting and Auditing
2.8. Step 3: Project Examination 4.2.6. Executing Agencies (EAs)
2.9. Step 4: Loan Negotiations 4.2.7. Project Objectives
2.10. Step 5: Project Implementation 4.2.8. Revenue-Earning Projects
2.11. Step 6: Project Completion 4.2.9. Non-Revenue-Earning Projects
4.3. Financial Analysis
3. Pr eparing and Appraising Investment Pr
Preparing ojects
Projects
4.3.1. Introduction to Financial
3.1. Investment Projects Overview
Analysis
3.2. Possible Investment Projects
4.3.2. Financial Analysis Objectives
3.2.1. Possible Revenue-Earning Projects
4.3.3. Linkages with Cost Recovery
3.2.2. Possible Non-Revenue-Earning
and Tariffs
Projects
4.3.4. Preparing Financial Tables
3.3. Appraisal Checklists
4.3.5. Determining Fiscal Period Coverage
3.4. Forecasting
4.3.6. Forecasting and Financial Projections
3.4.1. Introduction to Forecasting
4.3.7. Forecasting Assumptions
3.4.2. Using the COSTAB Model
4.4. Measuring Performance
3.4.3. Preparing Project Cost Estimates
4.4.1. Introduction to Measuring
3.4.4. Determining Contingencies
Performance
3.4.5. Disbursement Profiles
4.4.2. Objectives of Measuring
3.4.6. Preparing Financing Plans
Performance
3.4.7. Computing Incremental Project
4.4.3. Performance Indicators
Cash Flows
4.4.4. Using Benchmarking Indicators
3.5. Preparing Financial Benefit-Cost Analyses
4.4.5. Selecting Indicators and Covenants
3.5.1. Introduction
4.4.6. Operating Indicators and Covenants
3.5.2. Determining the Discount Rate
4.4.7. Capital Structure Indicators
(WACC)
4.4.8. Liquidity Indicators
3.5.3. Calculating the Financial IRR and
NPV 5. Reporting and Auditing
3.5.4. Undertaking Sensitivity and 5.1. Financial Reporting and Auditing Overview
Risk Analyses 5.2. Accounting Standards and Policies
3.6. Loan Covenants 5.2.1. Introduction
3.6.1. Introduction to Loan Covenants 5.2.2. International Accounting
3.6.2. Operating Covenants Standards (IASs)
3.6.3. Capital Structure Covenants 5.2.3. ADB Accounting Policy Requirements
3.6.4. Liquidity Covenants
vii
5.3. Financial Reporting 5.6.10. Reviewing Audit Management

5.3.1. Introduction Letters
5.3.2. Content and Timing of 5.6.11. Audit Report Questionnaire
Financial Reporting
5.3.3. Accounting Statements and 6. Financial Institutions (FIs)
Financial Reports 6.1. FI Introduction and Overview
5.3.4. Interim Financial Statements 6.2. Reviewing FI Financial Management
and the Project Management 6.2.1. General Operational Issues
Report (PMR) 6.2.2. Policy Framework for FIs
5.3.5. Audited Project Financial and FI Loans
Statements 6.2.3. Treatment of Interest Rate Distortions
5.3.6. Annual Financial Statements for a 6.2.4. Treatment of Directed-Credit
Non-Revenue-Earning Project Programs
5.3.7. Annual Financial Statements for 6.2.5. ADB Policy on Subsidies
Revenue-Earning Projects and EAs 6.2.6. Eligibility Criteria for FIs
5.3.8. Supplementary Financial Statements 6.3. FI Investments
5.3.9. Designing Financial Reports for 6.3.1. Introduction
Revenue-Earning Projects 6.3.2. Investing in FIs
5.3.10. Designing Financial Reports for 6.3.3. Selecting Participating
Non-Revenue-Earning Projects Institutions
5.3.11. Examples of Model Financial 6.3.4. Appraising an FI Investment
Statements 6.4. Assessing FI Performance
5.4. Auditing Standards and Auditor Engagement 6.4.1. Introduction
5.4.1. Introduction 6.4.2. Assessing Microfinance
5.4.2. ADB Requirements Institutions (MFIs)
5.4.3. Auditing Procedures 6.4.3. Applying the CAMEL Framework
5.4.4. Auditor Selection and Appointment 6.4.4. Assessing FI Risks
5.4.5. Issues in Auditor Selection 6.4.5. Determining FI Credit Ratings
5.4.6. Selecting Auditors 6.4.6. Specialized FI Internal Controls
5.4.7. Terms of Reference for an Auditor 6.5. Appraisal Checklist
5.4.8. Contract or Engagement Letter 6.6. FI Reporting and Auditing Issues
of Auditor 6.6.1. Introduction
5.4.9. International Standards on 6.6.2. FI Financial Reporting
Auditing (ISAs) 6.6.3. FI Auditing
5.4.10. Government Auditors 6.6.4. MFI Financial Reporting
5.5. Reviewing Financial Reports and Auditing
5.5.1. Introduction
5.5.2. The Review Process: Late or 7. Knowledge Management
Unacceptable Financial Reports 7.1. Useful Websites
5.5.3. Compliance With Financial 7.2. Operations Manual (OM)
Performance Covenants 7.3. Project Administration Instructions (PAIs)
5.5.4. Communication with Government 7.4. International Accounting Standards (IASs)
Auditors 7.5. International Standards on Auditing (ISAs)
5.6. Reviewing Auditors’ Reports 7.6. Financial Review Checklist for RRPs
5.6.1. Introduction 7.6.1. Lessons from Past Projects
5.6.2. Auditors’ Reports and Opinions 7.6.2. Project Cost Estimates
5.6.3. Model Audit Opinions 7.6.3. Financing Plan (FP)
5.6.4. Compliance with Loan Covenants 7.6.4. Executing Agencies and
5.6.5. Compliance with ADB’s Requirements Implementing Agencies
5.6.6. Types of Auditors’ Opinion 7.6.5. Financial Projections
5.6.7. Materiality 7.6.6. Financial Analysis
5.6.8. Use of Technical Experts 7.6.7. Project Justifications
5.6.9. Statements of Expenditure 7.6.8. Accounting and Auditing
(SOE) and Imprest Accounts
viii
7.6.9. Procurements and 7.13.3. Debt-Equity Ratio (see 3.6.3.4)

Disbursement Arrangements 7.13.4. Capital Adequacy Ratio (see 3.6.3.6)
7.6.10. Finance-Related Risks 7.14. Model Liquidity Covenants
7.6.11. Assurances 7.14.1. Current Ratio (see 3.6.4.2)
7.7. Appraisal Checklist: Non-Revenue- 7.14.2. Quick Ratio Covenant (see 3.6.4.3)
Earning Project 7.14.3. Dividend Limitation (see 3.6.4.4)
7.8. Appraisal Checklist: Revenue-Earning Project 7.15. Commonly Used Ratios
7.9. Appraisal Checklist: Private Sector Project 7.15.1. Operating Indicators
7.10. Appraisal Checklist: Financial Institution 7.15.2. Capital Adequacy Indicators
7.11. Undertaking Sensitivity and Risk Analyses 7.15.3. Liquidity Indicators
7.11.1. Step 1: Identify the Key Variables 7.16. Model Financial Statements:
7.11.2. Steps 2 and 3: Calculate Service Organization
Effects of Changing Variables 7.17. Model Financial Statements:
7.11.3. Step 4: Analyze Key Variable Changes Manufacturing Organization
7.11.4. Undertaking Risk Analysis 7.18. Model Terms of Reference
7.12. Model Operating Covenants for an Auditor
7.12.1. Rate of Return (see 3.6.2.2) 7.19. Audit Report Questionnaire
7.12.2. Self-Financing Ratio (see 3.6.2.3) 7.19.1. Using the Audit Report
7.12.3. General Price Level (see 3.6.2.4) Questionnaire
7.12.4. Operating Ratio (see 3.6.2.5) 7.19.2. Authenticity, Form, and Timeliness
7.12.5. Breakeven Covenant (see 3.6.2.6) 7.19.3. Audit Opinion
7.13. Model Capital Structure Covenants 7.19.4. Matters Addressed
7.13.1. Debt Service Coverage 7.19.5. Auditor’s Opinion and Report
(Version A: Historical orientation) 7.19.6. Conclusion and Further Action
(see 3.6.3.3) (if any)
7.13.2. Debt Service Coverage
(Version B: Forecast orientation) Index
(see 3.6.3.3)
1. Introduction to the Guidelines
1.1. Introduction
1.1.1. The vision of the Asian Development Bank (ADB) is a poverty-free Asia and
Pacific region. ADB strives to be an effective partner for its Developing Member Countries
(DMCs) in Asia and the Pacific in responding to the challenges of achieving sustained
and equitable development, improving the quality of life and eradicating poverty. ADB
recognizes that sustained pro-poor growth, social development and good governance are
essential for poverty reduction. This vision reflects the belief that unleashing the potential
of the poor will substantially contribute to overall growth and enhance the quality of life
for all.
1.1.2. The Guidelines for the Financial Governance and Management of Investment
Projects financed by the ADB describe and explain ADB’s policies, procedures and approach
to the financial management of the investment projects that it finances, and to ensuring
the sustained operations of project entities. They replace ADB’s Guidelines for the Preparation
and Presentation of Financial Analysis that were published in 1989. In addition to including
relevant extracts from those Guidelines, they contain current state-of-the-art business
processes, and financial management and financial analysis practices adopted by ADB
and other multilateral development banks (MDBs) where the latter are in harmony with
ADB practices.
1.1.3. The requirements set out in these Guidelines are summarized in the Handbook
for Borrowers on the Financial Governance and Management of Investment Projects financed
by the ADB. The Handbook sets out the policies and procedures of ADB with respect to
the financial management of projects and EAs. It has been prepared for the benefit of
borrowers, EAs, auditors, financial analysts, financial management consultants, and others
whose work requires them to be familiar with ADB procedures.
1.1.4. ADB activities are guided by Policies (approved by the ADB Board) and
operationalized through the Operations Manual (OM). Implementation is guided through
the preparation of various guidelines. Furthermore, project implementation is undertaken
following the Project Administration Instructions (PAIs).
1.1.5. These Guidelines address the financial management of investment projects

with the exception of those that involve equity participations and venture capital that
ADB may assist in the private sector.
2 of 6 Introduction to the Guidelines
1.1.6. The Knowledge Management section of Guidelines (most of which is only

available from the web-based Guidelines) includes international standards and practices
recognized by ADB that are recommended by international bodies such as the Basle
Committee on Banking Supervision (BCBS) of the Bank of International Settlements (BIS)
and the International Accounting Standards Board (IASB).
1.1.7. These Guidelines have been developed as a web-based document, with a

search facility. There is provision to update these guidelines on a regular basis. The full web-
based guidelines can be accessed at www.adb.org/documents/guidelines/financial. This
hardcopy version of the Guidelines is an abridged version of the web-based guidelines.
It has been developed to improve access to the Guidelines, in particular by ADB borrowers
and development partners.
1.2. Rationale
1.2.1. These Guidelines represent one of several initiatives that ADB is taking to
support improved operational financial management and financial governance
arrangements. The following key factors are driving these initiatives:
• The 1966 ADB Charter requires ADB to take necessary measures to ensure that the
proceeds of any loan made, guaranteed or participated in by ADB are used only for
the purposes for which the loan was granted and with due attention to considerations
of economy and efficiency, and that ADB be guided by sound banking principles in
its operations. In accordance, ADB has adopted specific requirements for financial
reporting and management by its borrowing countries, including the borrower’s
executing agencies where applicable.
• The international community, as a whole, is supporting the development of
guidelines, standards, and codes in relation to good financial management and
governance arrangements. These guidelines, standards, and codes – to varying extents
– all involve accounting and auditing arrangements. They include Principles of
Corporate Governance (OECD); Code of Good Practices on Fiscal Transparency (IMF);
Code of Good Practices on Transparency of Monetary and Financial Policies (IMF);
Implementation of the Objectives and Principles for Securities Regulation Assessment
Surveys (IOSCO); International Accounting Standards (IASB); International Standards
on Auditing (IFAC); and Draft Banking Supervision Guidelines (BCBS).
• ADB issued OM 54 (Governance) in January 1997. OM 54 identifies four elements
of good governance: (i) accountability; (ii) participation; (iii) predictability; and (iv)
transparency. In particular, OM 54 states that ADB will focus on: improving public
financial management, and promoting transparency. In relation to transparency, ADB
will focus on the disclosure of information … and … encourage loan project executing
Introduction to the Guidelines 3 of 6
and implementing agencies to produce, or improve the quality of, annual reports
and to disseminate these more widely to the public at large.
• In accordance with Section 588 of the United States Foreign Assistance Act (FAA)
2001, the US Secretary of the Treasury must certify to the US Congress that ADB
is fulfilling the requirements of the FAA. Ten percent of the US Congressional
appropriation to ADB may be withheld in the absence of such certification. The
certification relates to ADB’s efforts regarding procurement reforms and financial
management reforms, including: (i) annual project audits by qualified independent
auditors; (ii) fraud and corruption investigations; (iii) assessments of recipient
countries’ financial management capabilities; and (iv) support to improve
transparency and financial management in recipient countries.
1.3. Objectives
1.3.1. The Guidelines are intended to deal with issues and techniques throughout
the project cycle. It was also decided that they should go beyond financial analysis to
include project, and entity, financial management as well as auditing norms. Furthermore,
they were to be relevant to both ADB staff and borrowers.
1.3.2. They were prepared with the view that at each stage of ADB’s project cycle
– which ranges from the identification of a project, followed consecutively by its
preparation, appraisal, negotiations, supervision and issuance of a completion report,
and, where appropriate, by a post-evaluation – specialized and appropriate financial
analysis and management techniques applicable to each sector in which ADB operates
must be used to generate financial analysis and management information. This includes,
where necessary, the prescription by ADB staff of the design and installation of suitable
financial systems by borrowers to assure ADB’s management that the project will have
reasonable and continuing prospects of financial and economic viability. The latter must
be confirmed by timely, accurate financial reporting by borrowers and by timely and
rigorous project supervision by financial analysts.
1.3.3. It was also considered that ADB’s project portfolio contains a wide array of
projects that require specialized financial management and measurement techniques,
ranging from public sector revenue-earning operations to non-revenue-earning ones such
as in the health and education sectors; from public and private sector financial institutions
(FIs) to public utilities and transportation, plus the many specialized elements of
agriculture. These financial management techniques include sectoral and project-specific
financial analysis, financial performance measurement, design, and operation of
institutional financial management systems, including accounting, financial reporting
and auditing, supported by the loan management and disbursement techniques.
1.3.4. ADB’s financial analysts, and borrowers’ financial staff, should have access
at any time to guidelines on all these aspects of project, and entity, financial management.
The aim, in this regard, is to ensure that each project and entity is financially well
maintained, and that borrowers and ADB staff have immediate access to identical
information and guidance on using these techniques.
1.3.5. The Guidelines have therefore been designed to provide a complete set of
reference and training materials to fulfill these requirements and to set up a knowledge
management base to enhance and sustain these necessary professional skills in ADB.
1.3.6. The Guidelines’ overall objective is to enhance the quality of ADB’s portfolio
by:
• establishing the norms for financial analysis and financial management of revenue-
earning and non-revenue- earning projects for use during the project cycle
•· defining the financial management requirements for projects and project entities of
borrowers, EAs and other organizations charged with efficient use of funds provided
by ADB
• explaining to borrowers the project and institutional financial performance
requirements of ADB to achieve successful implementation and the sustainability
of ongoing operations
• providing financial knowledge management for the guidance and training of ADB
staff and borrowers, and
• providing ready access to ADB’s project financial management requirements to all
interested parties.
1.3.7. The Guidelines’ specific purpose is to provide ADB management, staff and
borrowers with an understandable, comprehensive and transparent directory of standards
of financial analysis, and financial management for the implementation and operation of
projects, including:
• a summarized quick reference guide and detailed checklist on project financial

management for ADB staff
• a concise reference booklet for the use of borrowers on ADB’s requirements for the
financial management of projects and project entities, and
• a financial knowledge management base for ADB staff engaged in the project cycle.
1.3.8. The Guidelines aim, in this regard, to provide fundamental parameters,

designs and measurement techniques on which to construct the necessary institutional
and financial analyses of investment projects and, where appropriate, of EAs. They are
designed to achieve consistency in the presentation of findings and recommendations by
Introduction to the Guidelines 5 of 6
ADB staff and borrowers in studies, reports and documents for which these forms of
analysis are required.
1.3.9. The advice, directions, and recommendations in these Guidelines should

not be regarded as a substitute for initiative on the part of ADB staff, which should always
be exercised when situations arise that require resourcefulness, with imaginative and
sound professional approaches.
1.4. Structure
1.4.1. In addition to this introduction, the Guidelines comprise six principal parts
as follows.
1.4.2. Part 2 – User Instr uctions – describes ADB’s financing methods and how to
Instructions
apply these Guidelines to differing types of projects.
1.4.3. Part 3 – Pr eparing and Appraising Investment Pr

Preparing Projects
ojects – advises on the
key features that a borrower and a financial analyst need to know to participate in
the preparation, appraisal, implementation, and supervision of an investment project.
It includes appraisal checklists and describes the preparation of project cost tables
and other forms of financial tables. In addition, a draft form of each principal type
of legal covenant (necessary to support financial requirements in legal documents)
is provided.
1.4.4. Part 4 – Financial Management of Executing Agencies – advises on

institutional and systems requirements and relevant financial management considerations.
Furthermore, individual sections address key topics such as governance, anticorruption,
forms of implementing agencies, financial systems necessary to support investments and
to provide sound bases for financial analyses, and the principal techniques of performance
measurement.
1.4.5. Part 5 – Repor

Reporting
ting and Auditing – focuses on ADB’s requirements for financial
reporting and auditing of projects, EAs and IAs. It also includes examples of auditors’
opinions, a questionnaire to check the adequacy of financial statements, and draft terms
of reference for an auditor.
1.4.6. Part 6 – Financial Institutions (FIs) – describes the particular applicability

of these guidelines to FIs. Given ADB’s increased involvement with Small and Medium
Enterprise lending and microfinance, this part considers the specific application of the
Guidelines to financial institutions (FIs). In particular, the part provides guidance on:
(i) reviewing FI financial management; (ii) appraising FIs; (iii) measuring FI performance;
and (iv) FI reporting and auditing.
1.4.7. Part 7 – Knowledge Management – The 1989 Guidelines provided limited

resource materials. The Knowledge Management section of the revised web-based
Guidelines includes a wide variety of guidance materials. These include lists and
descriptions of accounting and auditing standards, and useful Internet sites. The section
also contains best-practice guidance and sector-specific case studies. Space and
presentation constraints limit the Knowledge Management Section of the abridged
hardcopy Guidelines to essential reference materials.
1.4.8. Please note that, for purposes of these Guidelines, unless otherwise indicated,
“Asian Development Bank” means the Asian Development Bank, the Asian Development
Fund and the Technical Assistance Special Fund. Also, unless stated otherwise, the
requirements for executing agencies also apply to implementing agencies.
1.5. Project File
1.5.1. These Guidelines mention a Project File. This permanent division file should
be maintained by the responsible Regional Division. While Regional Division Managers
are responsible for ensuring its continued relevance and security, they will normally
delegate these duties to the responsible financial analyst.
1.5.2. A Project file must contain all relevant financial information gathered during
fact-finding, appraisal, and project supervision (either originals or copies). This
information should include details of original and amended financial policy decisions
affecting the project and the EA; the assumptions and basic calculations underlying
financial analysis, for financial performance indicators, and for the design of financial
covenants. The file must also include copies of all computer files that may be used to
develop project-specific programs and analyses.
1.6. Guideline Updates
1.6.1. The Guidelines are available as a downloadable hardcopy document, via the
Internet (www.adb.org/documents/guidelines/financial), and on CD-ROM.
2. User Instructions
2.1. Overview
2.1.1. This part of the Guidelines begins by describing ADB’s operational lending
approaches (lending modalities). It then proceeds to describe how these Guidelines apply
to different ADB-financed projects, programs and sectors. The resulting classification
provides a basis for identifying step-by-step financial management requirements
throughout the project cycle. In doing so, by first referring to this part, readers can quickly
identify what needs to be done, by whom, and by when.
2.2. ADB Lending and Technical Assistance
2.2.1. ADB makes loans from its Ordinary Capital Resources (OCR) and from the
Asian Development Fund (ADF). The ADF is designed to provide loans on concessional
terms to Developing Member Countries (DMCs) with low per capita gross national product
(GNP) and limited debt repayment capacity. The small size and location of countries may
also constitute a criterion for ADF eligibility. The ADF is maintained by regular member
contributions. ADB also provides technical assistance from its own resources and from
special funds. These include the Technical Assistance Special Fund (TASF) and the Japan
Special Fund (JSF).
2.2.2. ADB’s charter permits it to make, participate in, or guarantee loans to its
DMCs, or their governments, to any of their agencies or political subdivisions, and to
public or private enterprises operating within such countries, as well as to international
or regional entities concerned with economic development in the region. Loans are made
only for projects or programs of high developmental priority.
2.2.3. ADB has four primary types of lending:
• Pr oject Loans
Project Loans. Among other things, project lending is aimed at developing energy,
agriculture, transport and communications, and other basic infrastructure as well
as health, education, and finance.
• Sector Loans
Loans. OM 5 (Sector Lending) sets out ADB policies in relation to sector lending.
Sector lending is a form of ADB assistance to a DMC for project-related investments
based on considerations relating to a sector or subsector as a whole in the DMC. The
purpose of a sector loan is to assist in the development of a specific sector (or subsector)
by financing part of an investment in the sector, planned by the DMC. A sector loan
is expected to improve sector policies and strengthen institutional capabilities.
2 of 12 User Instructions
– Sector lending is particularly appropriate when a large number of subprojects

in the sector (or subsector) are to be financed.
– Technical assistance may be given for project preparation, sectoral studies, and/
or institution building, prior to, or together with, the provision of the sector
loan. Sector loans are ordinarily given to well-established institutions with
experience in project implementation.
– Sector loan proceeds will be utilized primarily to meet the foreign exchange
costs of subprojects making up the loan. Recurring costs (e.g., fuel and essential
supplies) and local currency expenditures or subprojects may also be financed
under sector loans in accordance with relevant ADB policies (see OM 11).
– ADB lending terms are the same for sector and project loans.
• Pr ogram Loans. OM 6 (Program Lending) sets out ADB policies in relation to program
Program
lending. Program loans are given by ADB to assist a DMC in developing a sector (or
subsector) as a whole and improving a sector’s performance through appropriate
policy and institutional improvements over the medium to long term. Program loans
are given only to DMC governments. Advisory technical assistance may be attached
to a program loan to further study unresolved policy issues or to strengthen the
capacity of key sector institutions. Although program lending differs from project
lending in objectives, the procedural and administrative steps in processing a program
loan are generally the same as those for projects.
• Private Sector Loans, Equity
Equity,, and Guarantees
Guarantees. OM 7 (Assistance to Private Enterprise)
sets out ADB policies in relation to private sector lending. ADB assistance to the
private sector in DMCs is designed to help in resource mobilization and more efficient
use of investment funds for economic development. ADB support for the private
sector in DMCs aims to: (i) create a favorable environment for the private sector in
DMCs; (ii) strengthen financial institutions and capital markets; (iii) assist in
privatizing public sector enterprises; (iv) catalyze external and domestic resource
flows to infrastructure projects utilizing build-own-operate (BOO) / build-own-
transfer (BOT) modalities; (v) invest in selected, productive private enterprise in
accordance with sound banking principles; and (vi) assist economically attractive
and financially sound private sector projects that require ADB financial support to
complete the financing plan or to provide comfort to other lenders and investors.
ADB assistance may be provided in one or more of the following forms: (i) loans
to financial institutions to finance small- and medium-scale private enterprises;
(ii) direct loans to medium- and large-scale private enterprises; (iii) equity
investments in private enterprises including private financial institutions;
(iv) underwriting of issues of equity or debt instruments on national or international
securities markets; (v) assistance to infrastructure projects; (vi) equity investments;
and (vii) guarantees of the debt-service obligations of private enterprises with or
without counter-guarantee by the DMC government.
User Instructions 3 of 12
2.2.4. ADB’s Technical Assistance (TA) is classified into four development activities:
(i) project preparatory technical assistance (PPTA) for assisting in the preparation of one
or more projects, a program loan, or a sector loan, for financing by ADB and other external
sources; (ii) project implementation technical assistance for assisting in the
implementation, operation, and management of an ADB-financed project; (iii) advisory
technical assistance for financing institution-building; plan-formulation; and sector-,
policy-, and issues-oriented studies; and (iv) regional technical assistance (RETA), covering
more than one DMC. OM 18 (Technical Assistance) sets out ADB policies in relation to
technical assistance.
2.2.5. ADB encourages cofinancing. The cofinancing strategy comprises:

(i) maximizing the amount of cofinancing from other official funding agencies, and
(ii) increasing the flow of private capital through cofinancing to DMCs. The purpose of
this strategy is to maximize the impact of ADB’s assistance in the development of its
DMCs and to mobilize additional resources for such development. Cofinancing funds
come from (i) official funding agencies; (ii) export credit agencies; and (iii) commercial
finance institutions.
2.3. Applying these Guidelines
2.3.1. The provisions of these Guidelines apply to investment projects and project
executing and implementing agencies. Consequently, they mainly relate to identifiable
investment activities that have been undertaken with support from project, sector, and
private sector loans. However, the provisions of these Guidelines will also apply where
program loans include discrete, identifiable investment components.
2.3.2. The revised Guidelines apply to private sector operations (PSO). In this
respect, the Guidelines will be strengthened in future updates to take account of
developments in this area and to reflect the guidance provided in the Credit Risk Manual
that the Private Sector Group (PSG) is preparing.
2.3.3. These Guidelines are also relevant to PPTAs. PPTAs are designed and
implemented prior to the beginning of a program or project. These guidelines str ongly
strongly
recommend that PPTA resources be used (in part) to appraise the financial aspects of
projects and project executing agencies and, where necessary, to develop sufficient financial
management capacity to implement and manage the project.
2.4. Project Types and General Treatments
2.4.1. These Guidelines effectively classify projects, executing agencies, and

implementing agencies into two distinct groups: (i) non-revenue-earning; and (ii) revenue-
earning (including public sector, private sector and financial institutions). ADB, together
with other international financial institutions (IFIs), including the other multilateral
development banks (MDBs), is actively encouraging borrowers and EAs to adopt uniform
standards of accounting and financial reporting. However, some time will be required to
achieve a high level of uniformity.
2.4.2. In the case of non-revenue-earning EAs in the public sector, ADB expects
sound financial policies, adequate accounting records, proper internal control systems,
timely reporting to management, and sound and timely auditing.
Financial Analyst Discretion to Agree Accounting Standards

and Reporting Arrangements
2.4.3. ADB requires revenue-earning EAs to follow national accounting standards

and practices, with the eventual objective of moving towards IAS-compliant accounting
policies, as capacity allows and the situation warrants. ADB recognizes that, given the
varying levels of DMC development, it will take time to improve financial reporting
practices to international standards and best practices.
With regards to this, financial analysts should determine the extent to which
IASs are used as the basis for reporting during project processing, taking into account
the country’s capacity and capability.
In exercising this discretion, financial analysts are responsible for ensuring

that ADB’s funds are utilized for the purpose intended and in an effective and efficient
manner.
2.4.4. The following table illustrates these categorizations and associated treatments:
Sector: State-Owned (Public Sector) Private Sector
Type of Project,
Executing Agency
or Implementing Non-Revenue-Earning Revenue-Earning Private Sector
Agency:
Financial Institutions
Broad Guidelines • Sound financial policies • Move towards best practice private
Approach and • Adequate accounting records sector management, internal control
Requirements: and governance arrangements
• Proper internal control systems
• Ensure that ongoing operations are
• Timely reporting to management
sustainable
• Sound and timely auditing
• Compliance with National Accounting
• Gradual improvements in financial Standards
reporting as capacity allows
• Move towards reporting in
accordance with International
Accounting Standards (IASs)
2.5. An Overview of Project Processing Steps
2.5.1. Once a project is identified by agreement between a government and ADB,

it is processed and implemented. The various steps from project identification to
completion comprise what is known as the project cycle. Further details and indicative
timetables for the project cycle are available from www.adb.org/Projects/cycle.asp. The
steps in a typical ADB-financed project include project identification; fact-finding to
establish project feasibility; appraisal to assess project soundness and viability;
consideration and approval by ADB’s Board of Directors; and finally, project
implementation, within the guiding framework of ADB’s loan administration procedures.
Many ADB-financed projects are also subject to operations evaluation when completed.
2.5.2 The first step of project identification is generally undertaken during the
preparation of the Country Strategy and Program (CSP). CSPs are usually prepared every
five years for each DMC and are updated annually, in consultation with member
governments.
2.5.3. In appraising a project, its technical, financial, economic, social,

environmental, production, marketing, and management aspects, and loan conditionalities
are closely examined. This helps to pinpoint specific steps necessary to ensure its smooth
and efficient implementation and operation. ADB loans are often channeled through
existing agencies; government departments; semi-government and public enterprises;

and to the private sector, often through national development banks.
2.5.4. Loan approval by ADB does not mean that the amount of the loan is
immediately transferred to the borrower in a lump sum. The loan is disbursed to meet
expenditures under the loan agreement, as and when they are incurred. Specific procedures
are laid down in the loan documents and in ADB’s Loan Disbursement Handbook.
2.5.5. Normally, the loan documents allow 90 days for the loan to become effective.
The preparatory work for construction (including recruitment of consultants, preparation
of tender documents and detailed designs, procurement of equipment, and selection of
contractors for construction) may take from 12 to 18 months or longer. Usually, these
activities cannot begin until the loan becomes effective. However, certain preliminary
steps in the procurement of goods and selection of consultants can begin at an earlier
stage to speed up project implementation. Implementation time generally ranges from
two to five years and depends on the type and nature of the project. The progress of
project implementation is assessed by ADB review missions, which visit the project about
twice a year throughout the implementation period.
2.6. Step 1: Identification and Early Preparation
2.6.1. When compared with the needs of its borrowing members, ADB resources
are limited. Consequently, projects are selected carefully. Before any project is identified
for ADB financing, ADB staff review a country’s economy, particularly its national and
sectoral development programs, and determine the prospects for its success. Country
programming missions visit DMCs regularly to discuss topics of mutual interest with
government officials and select suitable projects for ADB assistance.
2.6.2. Since the levels of economic growth, and the priorities for development vary
from one DMC to another, ADB tries to select those projects which will most effectively
contribute to the economic and social development of the country concerned, in
conformity with the country and ADB strategies.
2.6.3. Once it is confirmed that the project investment is justified, ADB evaluates
the project. In some cases, especially in the smaller and less-developed DMCs, project
identification may require the help of outside experts. If so, ADB can provide technical
assistance to a country to help it identify and prepare a project for possible ADB financing.
The following table identifies relevant activities during project identification and early
project preparation.
Responsibility1 Project Type2
Consultants
and/ or Non-
Activity Financial Executing Revenue- Revenue- Private Financial
Analyst Agency General Earning Earning Sector Institution
• If project is not identified

in the Country Strategy
and Program (CSP), then
Concept Paper is prepared
for Management approval ' … … … … … …
• Possible project types … … 3.2 … … … …
• Begin preparing forecasts ' ' 3.4.1 … … … …
• Inform borrowers of ADB
accounting and auditing
requirements ' … 5.3 … … … …
• Undertake preliminary
consideration of EA/IA
financial policies and
financial management 4.2.1,
systems (OM 35 4.2.4,
[Identify unacceptable 4.2.4.4,
arrangements] ' … 4.2.6 4.2.9 4.2.8 4.2.8 6.2, 6.3
• Review accounting and 5.2, 5.3,
auditing arrangements ' … 5.4 … … … …
• Review earlier ADB
reviews of, and World
Bank certification of,
Executing and
Implementing Agencies ' … 4.1 … … … …
• Consider the information
requirements to support
financial analyses ' … 4.3 … … … 6.4
• Where available, review
Country Diagnostic Study
of Accounting and
Auditing (DSAA) ' … 4.2.5 … … … …
• Identify consulting
requirements for 2.3,
institutional strengthening ' … 4.2.2 … … … …
• Financial Analyst’s
responsibilities during
project appraisal ' … 4.2.4.2 … … … …
• Project Preparation Report ' … 3.7.2 … … … …
• Ensure that PPTA TORs
reflect financial
management needs ' … 3.7.2 … … … …
1
A “9” identifies who has the key responsibility each step. “…” indicates “not applicable”.
2
The section number where the requirements and related guidance can be located is provided in the table. “…” indicates
that no information is available, or that the general requirements apply to the project type.
2.7. Step 2: Loan Preparation
2.7.1. Loan preparation involves justifying the technical feasibility, economic

viability and financial soundness of a project. This preparation phase can be undertaken
by the government or any other agency, but ADB can also assist by providing technical
assistance grants to the government. Using the grants, ADB hires consultants to undertake
a project feasibility study. The consultants’ work is closely monitored by ADB staff and
the draft final report is reviewed at a meeting attended by representatives of the
government, ADB and the consultants. The following table identifies relevant activities
during loan preparation.
Consultants
and/or General Non-
Activity Financial Executing (All Revenue- Revenue- Private Financial
Analyst Agency Projects) Earning Earning Sector Institution
(i) Consultants’ Stage
• Obtain copies of annual

financial statements for five
previous financial years
(if possible) ' … … … 5.3.7 5.3.7 5.3.7
• Prepare Project Cost
Estimate Table ' ' 3.4.3 … … … 6.4
• Prepare Financing Plan ' ' 3.4.6 … … … …
• Forecast annual net cash flows ' ' 3.4.7 … … … …
• Prepare financial cost-benefit
analysis ' … 3.5 … … … …
• Undertake sensitivity and
risk analysis ' … 3.5.4 … … … …
• Review EA/IA financial
policies and financial 4.2.1,
management systems. 4.2.4,
Identify deficiencies and 4.2.4.4,
corrective actions (OM 35) ' … 4.2.6 4.2.9 4.2.8 4.2.8 6.3, 6.4
• Review financial objectives 4.3.1–
and cost-recovery systems ' … 4.3.3 … … … …
• Prepare financial tables 4.3.4–
(forecast financial statements) ' ' 4.3.7 … … … …
• Identify key financial
objectives and select
appropriate performance
measurement indicators and
covenants ' … … … 4.4 4.4 6.4
3
4
Consultants
and/or General Non-
• Consider governance aspects

(OM 54) ' … 4.2.3 … … … …
• Determine loan covenants
(Preliminary) ' ' 3.6, … … … 6.4
• Review accounting policies
(OM 43 and GP 43) ' ' 5.2.3 … … … …
• Determine financial reporting
requirements and timetable
(Preliminary) (OM 43 and GP 43) 6.6.1,
' ' 5.3 … … … 6.6.2
• Determine auditing
arrangements (Preliminary)
(OM 43 and GP 43) ' ' 5.3, 5.4 … … … 6.6.3
responsibilities during project
appraisal ' … 4.2.4.2 … … … …
• Complete Appraisal Checklist ' … 3.3 7.7 7.8 7.9 7.10
• Prepare First Draft of RRP ' … 3.7.3 … … … …
• Review RRP (Financial
Checklist) ' … 7.6 … … … …
(ii) Preparatory Reports
• Supervisory Actions (PAI 1.02) ' … 3.7.4.1 … … … …

• Preparation of Cost Estimates ' … 3.7.4.1 … … … …
• Project Inception Mission
(PAI 6.02) ' … 3.7.4.1 … … … …
(iii) Project Budget Briefing
2.8. Step 3: Project Examination
2.8.1. Project feasibility, as presented in the consultants’ report, is then examined

by ADB, first through a fact-finding mission and then through an appraisal mission. The
mission teams, in consultation with the government, examine the project’s technical,
financial, economic, environmental and management aspects and potential social impact.
Loan terms and conditions are discussed. Following the examination in the field, the
appraisal mission team prepares a report and draws up a draft loan agreement for
negotiation. The following table identifies relevant activities during project examination.
3
4
Consultants
and/or General Non-
(i) Fact-finding Mission

policies financial management
systems, and auditing 4.2.1,
arrangements and identify 4.2.4,
deficiencies and corrective 4.2.4.4,
actions (OM 35, OM 43 and 4.2.6,
GP 43) ' … 5.3 4.2.9 4.2.8 4.2.8 …
• Review Appraisal Checklist ' … 3.3 7.7 7.8 7.9 7.10
• Update RRP ' … 3.7.3 … … … …
Checklist) ' … 7.6 … … … …
• Review Mission Report ' … 3.7.4.1 … … … …
(ii) Management Review
Meeting
(iii) Appraisal Mission

policies and financial
management systems and 4.2.1,
identify deficiencies and 4.2.4,
corrective actions (OM 35, 4.2.4.4,
OM 43 and GP 43) ' … 5.3 … … … …
• Review Appraisal Checklist ' … 3.3 7.7 7.8 7.9 7.10
• Update Project Cost
Estimates ' ' 3.4.3
• Update RRP ' … 3.7.3 … … … …
Checklist) ' … 7.6 … … … …
(iv) Staff Review
Committee (SRC)
(v) Board Consideration
5
6
2.9. Step 4: Loan Negotiations
2.9.1. After negotiations with the government, the loan proposal is submitted to
ADB’s Board of Directors for approval. The loan agreement is then signed by the ADB
President and representatives of the government and the executing agency. The loan
takes effect once certain conditions are met.
2.10. Step 5: Project Implementation
2.10.1. The project is implemented by the EA according to the agreed schedule and
procedures. Project consultants are recruited, the detailed engineering design and bidding
documents are prepared, machinery and equipment are procured, and civil works are
constructed and installed. ADB’s Regional Divisions review the implementation in close
coordination with the borrower and the EAs. ADB disburses the loan for approved
expenditures, as provided in the loan agreement. The following table identifies relevant
activities during project implementation.
Consultants General Non-

Activity or Financial Executing (All Revenue Revenue- Private Financial
• Update Project Cost Estimates ' ' 3.4.3 … … … …

• Review financial reports
(PAI 5.09) ' … 5.5 … … … …
• Review auditors’ reports
(PAI 5.09) ' … 5.6 … … … …
(I) Supervision Reports
• Review Mission Report (PAI 6.02) ' … 3.7.4.1 … … … …
• Loan Administration Mission
Report (PAI 6.03) ' … 3.7.4.1 … … … …
• Supervision Report (PAI 6.02) ' … 3.7.4.2 … … … …
• Progress Reporting (PAI 5.10) ' … 3.7.4.1 … … … …
• Provision of local-cost
financing by Borrower (PAI 5.08) ' … 3.7.4.1 … … … …
• Project administration
review (PAI 6.06) ' … 3.7.4.1 … … … …
• Examination of audited
accounts: APAs and CFSs
(PAI 5.09) ' … 3.7.4.1 … … … …
• Staff responsibilities for
day-to-day loan administration
(PAI 1.02) ' … 3.7.4.1 … … … …
7
8
2.11. Step 6: Project Completion
2.11.1. After the project facilities are completed and commissioned, ADB prepares
a project completion report (PCR) to document the implementation experience. ADB’s
Operations Evaluation Department evaluates projects on a selective basis. It prepares
project performance audit reports that assess project formulation and implementation;
economic, financial, and social benefits; and environmental impacts.
Responsibilitya Project Typeb
Consultants General Non-

Activity or Financial Executing (All Revenue- Revenue- Private Financial
(i) Completion Reports
• Project Completion Report 3.7.4.1,

(PAI 6.07) ' … 3.7.4.2 … … … …
a
b
3. Preparing and Appraising Investment Projects
3.1. Investment Projects Overview
3.1.1. ADB appraises (reviews) investment projects to ensure that they are
technically, financially and economically viable. It considers: (i) national, sectoral, and
local needs for the investment; (ii) economic and financial justifications for the proposed
project; (iii) sustainability; (iv) the extent to which the project contributes to human and
technological advancement; (v) good governance aspects; and (vi) whether ADB will be
fulfilling its own responsibilities as set out in the ADB Charter.
3.1.2. Investment projects are managed and implemented by EAs and IAs. Together
with the parts on Financial Management and Reporting and Auditing, this part aims to
provide financial analysts with comprehensive guidance on preparing and appraising
investment projects, based on the ADB Operations Manual and related guidance
documents. In addition to this overview, this part has six sections:
3.2 Possible Investment This section discusses potential revenue

Projects and non-revenue-earning projects.
3.3 Appraisal Checklists General appraisal checklists are provided

in the Knowledge Management section of
these Guidelines. This section discusses the
application of these checklists.
3.4 Forecasting This section describes ADB’s forecasting

requirements. It focuses on the preparation
of Project Cost Estimate Tables and
financial projections.
3.5 Preparing Financial ADB requires that projects be subjected to

Benefit-Cost Analyses financial benefit-cost analyses. This section
takes a step-by-step approach to describing
how these analyses should be conducted.
3.6 Loan Covenants The covenants in ADB loan agreements are

designed to support the achievement of
enterprise and project objectives. This section
discusses the applicability of covenants.
2 of 54 Preparing and Appraising Investment Projects
3.7 ADB Reports This section describes the purpose and

contents of the various reports that are
relevant to investment projects.
3.2. Possible Investment Projects
3.2.1. ADB maintains a three-year rolling program of investment projects. This

program forms a guide to the types of revenue-earning and non-revenue-earning projects
and sectors / subsectors that are likely to be involved.
3.2.2. The following lists of revenue-earning and non-revenue-earning projects

indicate the sectors and subsectors and the financial management expertise that the
Regional Departments may require over time. The lists exclude Technical Assistance. The
lists are updated as needed to reflect changes in the rolling program.
3.2.1. Possible Revenue-Earning Projects
3.2.1.1. The following indicative list of revenue-earning sectors, subsectors and project
activities is intended as a guide to the financial expertise that is likely to be needed
during project identification, preparation, appraisal and supervision. The list indicates
the sectoral and subsectoral experience likely to be needed from financial analysts.
• Sectors
Sectors: Airports, Gas, Harbors, Housing Finance*, Nonbank Financial Institutions*,
Plantations, Pumped Storage, Railways, Rural Savings and Credit Unions
Development*, Sanitation, Waste Management, Wastewater Treatment, Water
Conservancy, Water Supply and Sanitation.
• Subsectors
Subsectors: Buses, River Erosion Prevention, Toll Roads.
• Pr ojects
Projects
ojects: Electric Power, Flood Management, Grain Productivity, Irrigation,
Microfinance*, Road Transport, Rural Electrification, Rural Finance*, SME
Development*, Urban Development (e.g., water supply), Urban SME Business
Development*, Water Resources.
3.2.2. Possible Non-Revenue-Earning Projects
3.2.2.1. The following list of possible non-revenue-earning projects is intended as

a guide to the expertise that is likely to be needed. Advice from financial analysts may
be sought in relation to the cost-recovery aspects and efficiency improvement aspects of
some of these projects.
* Finance and Banking sectors
Preparing and Appraising Investment Projects 3 of 54
• Sectors
Sectors: Accountability Improvement, Economic Corridors Development, Ecosystem
Management, Environmental Improvement, Environmental Protection (acid rain),
Financial Sector, Governance and Legal Reforms, Information Technology
Development, Insurance and Pension Funds Development, Nutritional Improvement/
Poverty Alleviation, Public Administration, Public Works Development Program,
Rural Development, Rural Employment, Rural Employment and Income Generation,
Rural Renewable Energy, Social Action Program, Social Security Reform, Soil
Conservation, Women and Children Protection.
• Subsectors
Subsectors: Education Skills Transfer, Judicial and Legal Reform, Labor Retraining,
Land Administration, Teacher Training, Women in Development.
• Projects
Projects
ojects: Agriculture Development, Basic Education, Civil Service Reform, Coastal
Resources Management, Ecotourism, Health Services, Inter-regional System
Improvements, Natural Resources Management, Nonformal Education, Post-
Secondary Education, Rural Infrastructure, Rural Poverty Reduction, Rural
Productivity Enhancement, Social Sector Development, Urban Development (e.g.,
drainage), Urban Environment.
3.3. Appraisal Checklists
3.3.1. The Knowledge Management section provides general checklists for the
financial appraisal of a:
• Non-revenue-earning project (see section 7.7)

• Revenue-earning project (see section 7.8)
• Private sector project (see section 7.9), and
• Financial Institution (FI) (see section 7.10).
3.3.2. These checklists are general. Care should be taken in their application. Every
project will have differing objectives, sectoral and institutional structure, management,
and design and implementation approaches.
3.3.3. Revenue-earning projects may be in the public sector or in the private sector.
For the purposes of these checklists, private sector projects are defined as projects financed
by entrepreneurs, in the form of private and public companies. ADB supports private sector
projects with the intention of enhancing a country’s economic performance by the
production of goods and services, particularly for export, but also for local consumption.
3.3.4. Financial Institutions (FIs) range from large-scale apex institutions that service
multiple FIs, to industrial and agricultural FIs and microfinance organizations. Particular
consideration should be given to an FI’s characteristics when applying the general checklist.
3.4. Forecasting
3.4.1. Introduction to Forecasting
3.4.1.1. ADB needs reasonable forecasts of expenses, revenues, cash flows and other
financial items that are necessary to ensure that projects are delivered in a timely and
effective manner. But as forecasting is not an exact science, ADB requires its staff to work
alongside their counterparts in borrowers’ agencies during project identification,
preparation and appraisal to ensure that all reasonable efforts have been made to develop
meaningful forecasts. These forecasts should, ideally, be prepared by the borrower’s
agencies. However, where forecasts are prepared by ADB staff, or PPTA consultants, it
is essential that the borrower’s agencies take ownership of these forecasts.
3.4.1.2. ADB requires EAs to provide updated forecasts after loan signing and the
start of project implementation. These will be updated forecasts-to-completion or, in the
case of revenue-earning projects, updated forecasts for a specified period. The updated
forecasts provide early warnings of project problems so that timely corrective actions can
be taken. In the case of a revenue-earning project, the financial analyst will determine
the period during which EAs will be required to provide updated forecasts. This
requirement will be specified in the loan agreement. The exact period is at the discretion
of the financial analyst. This will normally be from between three to five years following
project completion (i.e., normally a total period of ten years).
3.4.1.3. During project preparation and appraisal, staff should carefully examine
project cost, revenue and cash flow estimates. The Project Officer is responsible for
ensuring that these base costs are realistic. The financial analyst and the project engineer
are responsible for examining the cost estimates in general. They are particularly
responsible for ensuring that: (i) the items included in the base cost are realistic; and
(ii) where items have not been included, this has been for sound technical, financial or
economic reasons.
3.4.1.4. The remainder of this section discusses: (i) the use of the COSTAB model;
(ii) the principal components of cost estimates and how these should be developed;
(iii) physical, price contingencies and risk contingencies; and (iv) disbursement profiles.
The section concludes with outline of a typical Project Cost Table and Financing Plan.
3.4.2. Using the COSTAB Model
3.4.2.1. The COSTAB (Standard Project Cost Table) computer model can assist
analysts to apply this Section of the Guidelines. It can be used to generate cost tables,
financing plans, and disbursement tables. COSTAB can also compute physical and price
contingencies, domestic and foreign interest charges, and financial charges during
development (FCDD).
3.4.2.2. The Office of Information Systems and Technology (OIST) will provide the
software, user manuals, and assistance to use the system, as necessary.
3.4.3. Preparing Project Cost Estimates
3.4.3.1. A Project Cost Estimates Table, that includes all project cost elements, should
be prepared at the PPTA stage. The Project Cost Estimates Table should be designed so
that it (i) provides an understanding of the principal project cost components during
appraisal, and (ii) provides useful information for project cost control purposes during
implementation. The information provided by the Project Cost Estimate Table is considered
at project appraisal and during implementation by the borrower, the EA and ADB.
3.4.3.2. The Project Cost Estimates Table outline that is provided below is suitable
for the main body of text in an RRP. Each line item can be broken down to provide
additional details. The COSTAB software enables different levels of project cost detail to
be presented to meet reporting needs (for instance, for the main text or the appendix of
an RRP).
3.4.3.3. The outline includes all standard loan disbursement categories.
Std Code Local % of Foreign % of % of

Costs Total costs Total Total Total
COMPONENTS ***
03 Civil Works 0.00 0 0.00 0 0.00 0
06 Survey, Investigation, Design,
Mapping 0.00 0 0.00 0 0.00
09 Research and Development
(Extension and Demonstration) 0.00 0 0.00 0 0.00
12 Institutional Development and
Strengthening 0.00 0 0.00 0 0.00
15 Equipment, Vehicles and Furniture
(Purchase and Maintenance) 0.00 0 0.00 0 0.00 0
18 Materials 0.00 0 0.00 0 0.00
21 Consulting Services 0.00 0 0.00 0 0.00 0
24 Training and Fellowships 0.00 0 0.00 0 0.00
27 Operations and Maintenance 0.00 0 0.00 0 0.00
30 Financing of Nongovernment
Organizations (NGOs) 0.00 0 0.00 0 0.00
… Implementation Assistance 0.00 0 0.00 0 0.00 0
… Land 0.00 0 0.00 0 0.00 0
… Capital Goods 0.00 0 0.00 0 0.00 0
… Incremental Administrative Costs 0.00 0 0.00 0 0.00 0
… Initial Working Capital 0.00 0 0.00 0 0.00 0
… Taxes and Duties 0.00 0 0.00 0 0.00 0
Base Costs as at ..(date).. 0.00 0 0.00 0 0.00 0
Contingencies ***
87 Physical 0.00 0 0.00 0 0.00 0
84 Price 0.00 0 0.00 0 0.00 0
81 Other (Identify) 0.00 0 0.00 0 0.00 0
SUB-TOTAL 0.00 0 0.00 0 0.00 0
Financing Charges During Development***
66 Interest 0.00 0 0.00 0 0.00 0
69 Other 0.00 0 0.00 0 0.00 0
0.00 0 0.00 0 0.00 0
TOTAL PROJECT COST AND
FINANCING REQUIRED 0.00 0 0.00 0 0.00 0
*** Footnotes to be used as necessary, particularly for contingencies’ explanations
3.4.3.4. ADB does not finance the costs of land, rights-of-way, and taxes and duties,
even though these costs are included in the base costs of a project.
3.4.3.5. An EA will normally have designers (engineers, architects, agriculturalists,

economists, etc). These designers will prepare the physical aspects and operational features
of the project. They are also responsible for ascertaining project costs, economic benefits
and for designing the program’s development and operations. These designers may be
staff of the borrower (including the EA), foreign consultants, local consultants, or some
combination of these three. Design costs may be met from a technical assistance loan,
or from the borrowers’ own resources. The design costs will normally be incurred prior
to project implementation, but there will be circumstances where the final design work
is ongoing during implementation and may form part of project costs.
3.4.3.6. The financial analyst’s role may range from satisfying themselves at appraisal
that the methods, data and assumptions used to determine project costs are credible and
justifiable, to assisting to assemble the data prepared by the designers to compile cost
estimates for the Financing Plan.
3.4.3.7. The base project cost estimate represents the appraisal mission’s (including
the financial analyst’s) best judgment of estimated project costs at a specified date, assuming
that:
• the qualities and quantities of works, goods and services and prices of inputs and
outputs relevant to the project have been developed as accurately as possible, using
wherever feasible, known factors which will not change during implementation,
and
• the project is to be implemented precisely as planned.
3.4.3.8. These assumptions that support the base cost estimates are made in order
to provide a firm basis of costs at one point in time, particularly to determine the total
amount of required financing. The RRP should provide these assumptions.
3.4.3.1. Local Costs
3.4.3.1.1. The Borrower is expected to cover local project costs since ADB normally
finances the foreign exchange component. In special circumstances ADB finances a portion
of local costs (see OM 11: Lending Foreign Exchange for Local Expenditures on Projects). For
ADF-funded projects, the lending policies of the respective ADF replenishment provide
a list of conditions that need to be met for projects to qualify for local cost financing.
3.4.3.1.2. The calculation of the amount of eligible local cost financing must reflect
the requirement that ADB does not finance taxes. The amount of local taxes imposed on
goods and services will vary within components and, when determining the estimated
amounts of taxes, the financial analyst should also have regard to the need to provide
a practical means of disbursing against local costs. This requirement means that the
financial analyst should agree with the borrower and the appraisal team on the estimated
amount of taxes (expressed as a percentage of total cost) likely to be levied by the
government and included in a local cost component that is eligible for reimbursement.
3.4.3.1.3. Determining this percentage for goods and services should be relatively
simple. For example, if VAT is levied at 15 percent, this percentage should be excluded
from the estimated cost of the goods or services. This calculation may be complicated
where the EA may be entitled to recover VAT from the yield of VAT levied on final products
or services. In such cases, the analyst should take this factor into account.
3.4.3.1.4. Where ADB agrees to finance salaries and wages, these will likely include tax
payments to government for income tax, health, social security, forms of unemployment
insurance, and other similar levies. The estimated amounts of these should be established
as percentages and excluded from the amounts of salaries and wages to be financed by ADB.
3.4.3.1.5. Once ADB and the borrower have reached agreement on these percentage
deductions, they should be reflected in the categories for disbursements in the legal
documents. This will enable disbursement claims by the borrower/EA to be appropriately
adjusted, where necessary, by the requisite percentages.
3.4.3.1.6. Borrower/EAs should be encouraged to make claims net of taxes (as

represented by the agreed percentages). The disbursement process will be expedited if
ADB does not have to make the appropriate adjustments.
3.4.3.1.7. Auditors should be informed of these percentage adjustments (to eliminate

taxes from disbursement claims). This is so they can ensure that claims are legitimate –
particularly when Statements of Expenditures (SOEs) are used.
3.4.3.2. Foreign Costs
3.4.3.2.1. As with local costs, ADB does not finance taxes and duties paid by a borrower/
EA on foreign costs. For direct purchases these are relatively easy to identify as line items
in quotations, bids, and invoices.
3.4.3.2.2. Where commodities are acquired indirectly, such as petroleum products

included in manufacture and various processes, it may be necessary to determine (as for
local costs above) an appropriate percentage that should be deducted from the total costs
of the goods or services received by the borrower/EA. The latter adjustment should be
reflected in the percentage of goods to be financed for the particular categories of
disbursements in the legal documents. OM 10 – Financing Indirect Foreign Exchange Costs
of Projects – provides further details on indirect foreign exchange costs.
3.4.3.3. Date of the Base Cost Estimate
3.4.3.3.1. The Date of the Base Cost Estimate should be specified in the RRP and should
not be earlier than six months prior to presentation of the loan for the project to the ADB
Board for approval. If this period elapses prior to Board presentation, the base cost should
be revised by indexation up to a period of 12 months from the date specified above. A
reappraisal of costs should be made if the presentation is to be made more than 12
months after the specified date.
3.4.3.3.2. The reliability of base cost estimates will reflect the amount of detailed
preparation work that has been undertaken before appraisal. For example, for a large
reservoir, or a major roll-on/roll-off harbor facility, the detailed engineering may be
completed before appraisal and the base cost estimate will have a correspondingly high
degree of reliability.
3.4.3.3.3. This applies to projects involving purchases of equipment that is of standard

design, in quantities that are precisely specified, such as telecommunications expansions.
Some projects may be appraised when there is much less detailed information available
about designs or quantities. In health care projects, for example, the exact locations and
the designs of clinics may not be known at the time of appraisal. The base cost estimates
in such cases may have been made by setting a target population to be served, allocating
the building space per 1,000 according to local norms, and estimating costs on a price-
per-square-meter basis obtained from actual costs of similar local clinics.
3.4.3.3.4. Similarly in some sector loans and agricultural projects, slum-upgrading

projects, minor water and sanitation systems projects, and highway improvement projects,
base costs may be estimated by extrapolation using unit prices derived from detailed
designs and specifications for sample areas and facilities which are representative of the
various project components.
3.4.3.3.5. Such bases for estimating are acceptable to ADB, provided that the appraisal
team is assured of the relevancy and currency of the data, and that, where necessary,
appropriate risk contingencies are provided.
3.4.3.4. Treatment of Financial Charges During

Development (FCDD)
3.4.3.4.1. Financial charges during development (FCDD) can include interest,

commitment charges and front-end fees. FCDD must be shown in the cost estimates table.
3.4.3.4.2. A brief discussion of FCDD should be included in an RRP appendix or

supplementary appendix. The discussion should summarize the rationale for including
FCDD in the project costs, detail the criteria used, and describe the calculation method.
The calculation method should follow that normally applied in computing interest charges
when forecasting Income Statements and Cash Flow Statements in the financial analysis
of an EA’s financial performance.
3.4.3.4.3. The period of charging FCDD against loan proceeds should be specified.
This period will normally be the same as, or less than, the project implementation period.
3.4.3.5. Requests for Retroactive Financing
3.4.3.5.1. The term “retroactive financing” refers to ADB financing of project

expenditures incurred and paid for by the borrower or recipient during or after appraisal
but before an ADB loan or technical assistance agreement becomes effective. OM 12
(Retroactive Financing) should be referred to in the first instance. As a general rule, no
funds can be disbursed for expenses incurred prior to the date of effectiveness of the loan
agreement. However, based on a prior agreement between ADB and the borrower, a special
clause authorizing the financing of certain expenses incurred before this date may be
included in the loan agreement. This clause will show the amount of the retroactive
financing, the category of expenses concerned, and the date from which the expenses
may be incurred.
3.4.3.5.2. The financial analyst should ensure that any borrower requests and
justifications for retroactive financing are recorded in the aides memoire prepared during
project identification, project preparation, and/or project appraisal, as well as in related
reports issued on return to Headquarters.
3.4.3.6. The Treatment of Taxes and Duties
3.4.3.6.1. As discussed in section 3.4.3, ADB does not finance taxes and duties that
are likely to be incurred in acquiring goods and services required for project
implementation. The financial analyst should advise the borrower and the EA of this
funding limitation, and ensure that the borrower/EA understand that their funding sources
must meet these obligations.
3.4.3.6.2. In some projects, goods and services costs include taxes and duties (including
customs duties), but the amount of these taxes and duties is not well defined. In these
cases, the percentage amount to be financed by ADB, for that category of goods and
services in the loan agreement, should be reduced by an amount estimated to equal the
amount of taxes and duties. For example, if cement costs include taxes and duties estimated
to represent 30 percent of the total invoiced price, ADB should only be obligated in the
category of goods that includes cement to finance 70 percent of the invoiced price.
3.4.3.6.3. Where there are multiple items in the same category, some of which bear no
taxes, and others that are charged at varying rates, the financial analyst must work with
the technical experts to prepare a cost analysis of the goods in order to estimate the
overall percentage reduction in ADB financing for the category concerned.
3.4.3.6.4. In some sectors, ADB may be invited to finance incremental salaries and
wages of the EA or of involved departments and agencies of government and local
organizations. In these cases also, these incremental costs often include taxes in the form
of income taxes, employer contributions to national insurance, social security
contributions, and similar employee benefits. These are not eligible for ADB financing
and should be eliminated from calculations of ADB financing of incremental (or any
other forms) salaries and wages. In this regard, it is important for the financial analyst
to work with the EA to establish a mechanism for claiming reimbursements from ADB
of expenses net of taxes and duties.
3.4.3.6.5. The costs of excluding taxes and duties should be kept to a minimum. As
such, formulas that are to be used should be agreed between the EA and ADB, and notified
to the external auditor, so that the external auditor may apply suitable tests to verify
Statements of Expenditure (SOEs) and direct payments.
3.4.3.6.6. It should be noted that ADB does not seek to exclude any small amounts
of indirect taxation on duties levied at secondary or tertiary stages of manufacture of
goods and services to be used by the project. For example, taxes on petroleum products
used in the manufacture of plastic containers would not be quantified and excluded.
However, taxes and duties on petroleum products purchased directly by the EA and
intended for project construction purposes should be excluded from invoices when
submitted to ADB for reimbursement.
3.4.4. Determining Contingencies
3.4.4.1. Contingencies in General
3.4.4.1.1. Contingencies are an integral part of the expected total project cost and
normally are necessary for all project items involving significant expenditures.
Contingencies cannot provide assurance against the effects of all possible adverse events
or conditions.
3.4.4.1.2. Contingency allowances should reflect probable (forecast) physical and price
changes and costs arising from special risks that can reasonably be expected to increase
the base cost estimate. All contingency allowances should be identified in cost tables
separately from base cost estimates and any special features relating to them should be
explained in the RRP text.
3.4.4.1.3. Separate estimates should be made of physical contingencies and of price

contingencies and shown as line items in the project cost table. For projects with several
major components, it is generally desirable to present contingency estimates separately
for each component as well as for the project as a whole. The text accompanying the cost
tables should discuss the physical factors, price changes and risk factors expected to
affect the project costs from the date of the base cost estimates specified in the RRP and
the completion of the project.
3.4.4.1.4. Where financing charges are included in the Project Cost Tables, contingencies
may be necessary to reflect possible increased costs of funds during project implementation
(outside of loan agreements that normally fix the interest rates on loans that may be used
to finance FCDD, etc). These increases in financing costs should be regarded as price
contingencies, but included in the financing charges and disclosed (with justification)
in the RRP.
3.4.4.1.5. Appraisal missions should confirm that: (i) the estimates produced for RRPs
specifically designate all physical and price contingencies as such; (ii) the amounts are
reasonable; and (iii) no contingencies are included in the base cost estimates. Note the
following exceptions:
• technical assistance projects

• financial institutions that propose to implement industrial and agricultural credit
projects, and
• sector and subsector adjustment loans.
3.4.4.1.6. In the case of technical assistance projects and industrial development finance
and agricultural credit projects – where the project is essentially a line of credit to help
finance a program defined in financial terms and without specific physical content –
contingency allowances should not be added separately.
3.4.4.1.7. Price contingencies should only be included for those sector/subsector loans,
where physical targets may have been broadly defined but the exact scope is not essential
to the success of the project (e.g., installation of 500 serviced sites as part of a rolling
program, or maintenance of rolling stock in railway workshops).
3.4.4.1.8. The text of the RRP should specify exceptions. The impact on such projects
of any shortfall in the expected amounts of works, goods or services should be tested
by sensitivity analysis.
3.4.4.2. Determining Physical Contingencies
3.4.4.2.1. Allowances for physical contingencies reflect expected increases in the base
cost estimates of a project due to changes in quantities, methods, and period of implementation.
Physical contingencies should be calculated in foreign and local cost terms, and expressed
as percentages of the foreign and local base costs in the project cost table.
3.4.4.2.2. The principal factors from which uncertainties arise in civil works and for
which provisions for physical contingencies should be made are: (i) the type of terrain
where the project is to be constructed, particularly (a) geologically difficult areas where
slips and slides are frequent but are difficult to predict, (b) areas of thick marine clay
deposits where the flooding potential is high, and (c) areas subject to frequent earthquakes;
(ii) the climatic conditions in the project area (e.g. the susceptibility to cyclones or the
likelihood of unusual rain or wind conditions); (iii) difficult access to the work site because
of long and poorly-maintained roads or railroads which may be subject to flooding,
landslides, etc.; (iv) the amount of field work that has been completed, particularly the
degree of thoroughness of borings and sub-surface exploration as well as the location and
testing of construction material sources (gravel, rock quarries, etc). Some projects covering
a large area or involving very long and deep excavations, such as tunnels, are so expensive,
or even impossible, to explore thoroughly in advance that it is prudent to assume some
risks of encountering poor conditions; (v) the consultant’s knowledge of local conditions
of materials and labor costs; (vi) the degree of precision with which the quantity estimates
have been prepared; (vii) the possibility of design changes during construction and the
addition of unforeseen items; and (viii) the quality of contract supervision.
3.4.4.2.3. Some of the main factors from which uncertainties arise with regard to
material and equipment components are: (i) the degree of precision with which quantity
estimates of needed material and equipment, including necessary spare parts, have been
prepared; (ii) the extent to which detailed specifications for material and equipment
have been set; and (iii) the extent to which equipment is to be purchased off-the-shelf
or on special order.
3.4.4.2.4. The extent to which the services can be accurately defined in advance is a
major cause of uncertainties with respect to the provision of services. If the extent of the
services can only be fully defined during the course of project implementation – for
example, in the case of site investigations for the design of a large command area irrigation
scheme – a relatively large contingency allowance for this portion of the services might
be reasonable.
3.4.4.2.5. ADB expects that physical contingencies would normally be between 5-10
percent; however, they would be higher for marine work, tunneling, dam construction
or road construction involving difficult soil conditions. Acceptable ranges of physical
contingencies will vary from sector to sector as well as for the various components of a
project. As an example, the allowances for civil engineering works for power stations
probably would be higher than those for the supply of materials or equipment for schools.
3.4.4.2.6. When physical contingencies are relatively large, for example, more than 10
to 15 percent overall, consideration should be given to further refinement of basic designs
and additional site investigations before appraisal in order to reduce uncertainties. In
any event, if the physical contingencies exceed five percent of the base cost, justification
should be made in the fact-finding BTOR (and Aide Memoire) and the RRP.
3.4.4.2.7. Higher contingency provisions, which must be fully justified in the RRP, are often
necessary to reflect extraordinary uncertainty inherent in works such as structural foundations
in difficult soils, pile driving, tunnels, dam foundations, rehabilitation of existing facilities,
where it is too costly, or impractical to further refine the quantity and cost estimates.
3.4.4.3. Determining Price Contingencies
3.4.4.3.1. Price contingency allowances reflect forecast increases in project base costs
and the physical contingencies due to changes in unit costs for the various project
components/elements beyond the date of the base cost estimates. Price contingencies
should be expressed as percentages of the base costs plus physical contingencies, separately
for the local and foreign expenditures of the project, and for the project as a whole.
3.4.4.3.2. Allowance for price contingencies has to provide for any expected price
increase during the project implementation period, from the date of the base cost estimate.
With respect to foreign cost components, the Central Operations Services Office (COSO)
will from time to time provide suggested price-escalation factors for internationally
procured goods and services. These price-escalation factors should not be applied
mechanically. If they are deemed to be inadequate or excessive, more appropriate factors
could be applied with the approval of the concerned regional director.
3.4.4.3.3. For local cost components, the expected price increases should be calculated
in accordance with the inflation rate in the borrowing country. COSO will from time to
time provide suggested escalation factors to be applied for local cost estimates, although
general ADB practice is to use the foreign inflation factors.
3.4.4.3.4. In determining the appropriate amount to be allowed for price contingencies,

the following key factors should be considered: (i) The Project execution period – this
is important not only for estimation of the cost of local resources but also for the
assumptions regarding exchange rate adjustments, including a realistic estimate of the
time between the date of the base cost estimate and the start of the construction or
implementation; (ii) In the absence of some rationale for modifying a COSO estimate in
a specific instance – which should be explained in the fact-finding BTOR and the RRP
– the inflation data should be consistently applied to all projects in that country; (iii) The
extent of expected annual increases in international prices of works, goods and services
to be used in the project; (iv) The extent to which local or foreign prices for particular
types of works, goods and services will follow general inflationary trends. For example,
when a construction industry is overextended or depressed, price trends may exceed or
be lower than the general movement of prices; similarly, technological improvements in
the production of some types of equipment have resulted in a much lower rate of price
increase than for international prices overall; and (v) The extent to which a large project
may have the effect of increasing the cost of local resources such as land, labor and raw
materials more rapidly than the general price escalation.
3.4.4.3.5. If, in the opinion of the financial analyst (and/or the mission), distortions
may occur due to significant differences between domestic and foreign inflation rates
and potential exchange rate adjustments, the issues, where necessary, should be referred
after discussion with the Operations Coordination Division, to the Regional Director.
This could pertain to those countries that are prone to frequent devaluation.
3.4.4.3.6. The allowance for price contingencies has to be worked out on an item-by-
item basis and has to be related to the terms of payment and the time when payments
become due and payable. The cumulative rate of price increase for a particular year has
to be calculated by compounding the estimated rate of price rise in prior years and one
half of the rate of price increase in the year concerned for application to the amounts to
be expended each year as per the base cost estimate. In the following example:
(i) procurement is assumed to commence one year after the date of the Project Cost
Table; (ii) Years Two to Six are years of implementation; and (iii) normally compound
interest tables would be used to calculate the increase for the years prior to procurement
before adding 50 percent of the latest (current) year’s inflation rate.
Example: Calculating Price Contingencies for Project Appraisal and Financial Projections
Rate of Inflation Inflation-adjusted

Base Cost + Physical from date on Base Cost + Increase
Contingencies in Project Physical due to
Year Project Cost Table Cost Table Calculation Contingencies Inflation
1 0 2.4% Year for negotiations, Board

approval signing, etc 0.00 0.00
2 50 2.4% 50 x (1+ 0.024) x (1+0.012) 51.81 1.81
3 100 2.4% 100 x (1+0.024) x
(1+0.024) x (1+0.012) 106.12 6.12
4 200 2.4% 200 x (1+0.024) x
(1+0.024) x (1+0.024) x
(1+0.012) 217.33 17.33
5 75 2.4% 75 x (1+0.024) x
(1+0.024) x (1+0.024) x
(1+0.024) x (1+0.012) 83.45 8.45
Totals 425 458.71 33.71
3.4.4.3.7. Governmental procurement procedures which award only fixed-price

contracts even when construction is over a number of years, or which set a ceiling on
the allowable price adjustment should be ignored when preparing project costs for ADB
financing. Bidders typically adjust for such practices by increasing their base bids and
the total cost including price contingencies is often not significantly different to the project
cost forecast by ADB.
3.4.4.3.8. Accordingly, in using estimates prepared on the basis mentioned in the previous
paragraph for comparative purposes in establishing the base cost estimates, care should be
taken to deduct any price contingencies implicitly included as part of the base cost.
3.4.4.4. Determining Risk Contingencies
3.4.4.4.1. The standard approach to the costing of a project requires that the cost of
land, equipment, goods and services should be based on current prices with allowances
for unknown physical conditions that may increase costs, and for inflation. But where
current prices cannot be determined until the borrower takes certain steps or decisions,
or certain events have occurred it may be necessary to include a risk contingency. An
alternative is to encourage the borrower to insure against risk, possibly by using the
Multilateral Investment Guarantee Agency (MIGA).
3.4.4.4.2. Risk contingencies are infrequently used because, wherever possible, the
financial impact of future events should be reflected either in base costs, or in physical
or price contingencies. Therefore a strong justification is required for their inclusion as
a separate line item in a cost table. Such justifications are typically used as a means of
explaining to ADB management that current circumstances pertaining to the costing of
the project make normal estimation techniques unreliable.
3.4.4.4.3. The provision of a separate line item is to ensure that the attention of ADB
management is deliberately drawn to the risk and its potential cost impact on the project;
and that the provision will not be used for any purpose other than the specific risk(s)
identified in the cost table. When ADB staff consider that certain conditions may be
present to a degree which makes the estimation of costs of future events/activities, (such
as biddings) particularly uncertain, a special item of “risk allowance” should be calculated
and shown separately from the physical and price contingencies. As an example, because
of uncertain political and economic conditions, foreign contractors may only offer bids
for work in a country at prices which include a premium for the unusual risks they
would face.
3.4.4.4.4. Any part of the “risk allowance” not needed after bids are received should
be cancelled, and not reallocated to the general contingencies. Suitable language should
be included in the loan agreement to this effect. A “risk allowance” contingency, if used,
should be included as a separate contingency item in the cost table and the reasons for
it, the amount, and possible cancellation should be explained in the text of the RRP and
in the loan agreement. This contingency should be included in the financial and economic
sensitivity analysis. In lieu of including a separate risk allowance, it may be preferable
to require the prospective borrower to complete the bidding process to the stage of bid
evaluation before the loan is made.
3.4.4.4.5. In the event that a borrower would insure a risk with the Multilateral
Investment Guarantee Agency (MIGA), the costs of the premium should be shown as a
line item in the Project Cost Tables.
3.4.5. Disbursement Profiles
3.4.5.1. ADB has gained considerable experience and information since it began its
operations with regard to the capacity and capability of borrowers and their EAs in the
various sectors to fulfill their commitments to construction schedules.
3.4.5.2. Disbursement patterns show that borrowers rarely meet these schedules,
and time (and cost) overruns are a consistent feature of many lending operations.
Therefore, the forecast construction period of a project should not vary greatly from the
average for similar projects executed in the same sector in the country concerned. The
financial analyst should obtain disbursement data for the country and sector in which
the project under development is located to develop a disbursement profile.
3.4.5.3. The adoption of realistic implementation and disbursement estimates based

on sector/country disbursement profiles should be reflected in the contingencies
allowances and the economic rate of return and financial internal rate of return calculations.
3.4.5.4. Base costs are typically estimated as part of a feasibility study and are refined
to take into account any further engineering and other detailed preparation work that
has taken place by the time of appraisal.
3.4.5.5. With large, complex projects, or in cases where there is little record of recent
procurement involving ADB projects in the country, the services of specialized cost
estimating firms, or quantity surveyors, or the advice of contractors or manufacturers
may be employed to confirm or modify base cost estimates.
3.4.5.6. During appraisal, the estimates should be adjusted and updated to take
account of any price changes in the period between their preparation and the base cost
date specified in the RRP.
3.4.6. Preparing Financing Plans
3.4.6.1. The Project Cost Table will provide as its bottom line, the total financing
required for a project. It is essential that the means of financing this total expenditure
is specifically defined in the appraisal report. The illustration and discussion of the
financing plan for a project to be implemented by a revenue-earning enterprise usually
consists of a summary – all in current terms – of:
• the project financing requirements and the external sources of finance from the cash
flow statement
• other capital and incremental working capital expenditures occurring during the
project development period
• incremental and initial operating costs to be incurred during the implementation
period, to be financed out of either project capital funding, or from local budgetary
provisions
• net income from any ongoing operations, and
• debt servicing.
3.4.6.2. In a non-revenue-earning entity, where there are rarely any internally

generated sources of funds, project financing is usually not related to the future financial
performance of the entity. In such cases, the illustration and discussion of the financing
plan would be confined to the project only and set out with the discussion on project
costs.
3.4.6.3. The text of an appraisal report requires a discussion of the financing plan.
In the case of a non-revenue-earning project, this is normally an extension of the discussion
of the Cost Estimates. In the case of a revenue-earning project to be implemented by an
executing agency, a summary financing plan may be included after the Project Cost
Estimates table. A detailed discussion on the financing plan (with a comprehensive table
showing the financing plan, where necessary) should be included as part of the Financial
Analysis Chapter. The following items should be covered, with detailed explanations,
where necessary, in an appendix to the report: (i) any cofinancing arrangements;
(ii) availability of internal funds, referenced as necessary to the cash flow statements;
(iii) the self-financing ratio, particularly when this is to be incorporated in an operating
covenant; (iv) equity contributions; (v) terms of loans, including interest rates (or
onlending rates, where applicable), grace periods, repayment periods, incidence of foreign
exchange risk, guarantee fees and interest during construction; and (vi) the dependability
of the financing plan in terms of firm commitments that have been received, the progress
of negotiations where loans or equity contributions have not been finalized, the availability
of additional sources of funds in the event of cost overruns or lower than expected
generation of internal funds, and a sensitivity analysis relating to the latter items.
3.4.6.4. Funds from all principal sources should be identified as line items in a
financing plan. Funds sources should be set out in terms of foreign and local currencies,
using the US dollar as the foreign currency, and grouped in the table under local and foreign
sources, including ADB loans, funds from other foreign lenders and donors, local loans,
local equity including government grants and subsidies, and internally-generated funds.
3.4.6.5. In cases where the EA is conducting an ongoing operation, as in the case of

a public sector enterprise, it may, or may not, be generating sufficient funds from ongoing
operations to support these activities. It is, therefore, advisable to include in the financing
plan either the net funding through the period of the financing plan that the agency will
generate, or the additional funding needs that it will require, to operate and maintain
its existing and new facilities. The sources of additional funding should be identified, for
example, subsidies from government. The financing plan should contain an explicit
reference to any contributions to investment to be made by the agency during
implementation, with specific reference to the acceptability to the ADB of a policy of
deficit funding by government, including any policy that, in effect, contributes to the
capital investment of the EA.
3.4.6.6. The following is an example of a typical summarized Financing Plan.
Local Foreign
Currency Exchange Total %
Funds Required
Proposed Project
Capital expenditures 0.00 0.00 0.00
Operating expenditures 0.00 0.00 0.00
Financial charges during development 0.00 0.00 0.00
TOTAL PROJECT REQUIREMENTS 0.00 0.00 0.00 100%
Sources of Funds
Proposed ADB loan 0.00 0.00 0.00
Other loans 0.00 0.00 0.00
Equity or capital contributions
Government 0.00 0.00 0.00
Other sources 0.00 0.00 0.00
Subsidies for operations 0.00 0.00 0.00
Internal cash generation 0.00 0.00 0.00
TOTAL SOURCES 0.00 0.00 0.00 100%
3.4.7. Computing Incremental Project Cash Flows
3.4.7.1. A project’s annual net cash flows should be forecast over the project life
(including the implementation period). Annual net cash flow is the difference between
annual cash receipts and annual cash payments. In cases where the project represents
incremental development – for instance, the extension of an existing power plant – flows
should be computed on an incremental basis (e.g., “with project scenario” and “without
project scenario”).
3.4.7.2. The cash flows should include all payments incurred to construct, operate
and maintain the project facilities over its useful life. The cash flows should be expressed
in real terms, that is nominal (current) costs as expressed in financial projections, excluding
any interest paid or received and any inflation elements included therein. All kinds of
taxes in the forms of customs and excise duties, value added taxes, similar levies and
income taxes should be included. The estimate of taxes on earnings should be based on
operating income (before financial expenses but after depreciation) generated from the
project and at the effective tax rate.
3.4.7.3. The capital cash flows should be reconcilable with the project cost estimates;
that is with the base costs and physical contingencies, but with the exclusion of price
contingencies and financial charges during development (FCDD). Price contingencies
are excluded because the FIRR is calculated in real terms (i.e., without the effects of price
escalation and/or foreign currency rate fluctuations). FCDD are excluded so that project
benefits can be compared against project costs – this effectively segregates the investment
decision from the financing decision. The benefits should include all cash receipts
(including subsidies) in real terms derived from project inputs and salvage (resale) values
receivable on asset disposals. Typically the enterprise-wide forecasting period for financial
analysis presentations won’t exceed five years beyond the completion of project
construction, even though normal operating levels may not have been reached; this will
not provide enough information to prepare a financial benefit-cost analysis for the project
investment on a discounted cash flow basis. This shortcoming may be overcome by
preparing an income statement forecast for the project in isolation up to the achievement
of capacity operations and assuming that the net cash flow is held constant thereafter.
If the project is one of several being executed by an EA (e.g., railways), separate projections
must be prepared.
3.4.7.4. Project cost streams are calculated using real terms. The relevance of
contingencies for the project financial analysis therefore depends upon whether or not
the contingencies reflect the use of additional real resources: (i) physical contingencies
represent the estimated cost of the expected additional real resources required and therefore
should be included in this analysis of all projects; (ii) price contingencies should be
excluded from a financial benefit-cost analysis; and (iii) risk contingencies, that may be
included in project cost estimates should be included where these represent the likely
cost of a physical risk, but excluded where they relate to a cover for the risk of changes
in prices (as for price contingencies in the previous paragraph). But it should be noted
that risk contingencies that relate to pricing of goods and services are often withdrawn
following receipt of bids. The results of these bids may require revisiting the financial
benefit-cost analysis.
3.4.7.5. Financial analyses such as cash flow projections or financing plans are to be
prepared in current price terms and should include all contingency allowances.
3.4.7.6. Exchange rates for converting currencies MUST be fixed at a particular date.
These rates must be consistently applied throughout the forecast period.
3.4.7.7. An example of a net cash flow calculation is shown in the table below (Note
that years 2006-2009 are not shown in this example). The project costs comprise:
(i) phased investment payments during 2001-2004; (ii) operation and maintenance costs
($1.40 per m³ water sold); (iii) sales taxes (1 percent on water sales, 3 percent on
connection fees); (iv) business and land taxes (lump sum of $100,000 per year); and
(iv) connection costs ($1,425 per connection).
3.4.7.8. A clear statement of assumptions should support the forecast cash flows.
The assumptions should state the exchange rates used for conversion purposes.
Furthermore, the assumptions must state whether the forecast cash flows have been
prepared in current or real terms. Where they have been prepared in real price terms,
the reasons for doing so must be stated clearly.
Net Cash Flows (2001: $’000s)
2001 2002 2003 2004 2005 2010-2031
Operating Cash Flows

Receipts:
• Water sales receipts
Domestic consumers 0 668 1,613 2,922 4,740 12,217
Government establishments 0 21 50 80 124 726
Private establishments 0 32 76 117 170 997
Subtotal 0 722 1,739 3,119 5,034 13,940
• Connection fees 0 2,552 3,068 3,689 4,436 0
Total operating receipts 0 3,273 4,807 6,807 9,470 13,940
Payments:
• Operation and maintenance 0 –410 –918 –1,534 –2,303 –4,281
• Sales taxes 0 –84 –109 –142 –183 –139
• Business/land tax 0 –100 –100 –100 –100 –100
• Connection payments 0 –2,424 –2,914 –3,504 –4,214 0
Total operating payments 0 –3,018 –4,041 –5,280 –6,800 –4,520
Net Cash Flows from Operations 0 255 766 1,527 2,670 9,420
Investing Cash Flows

Investments –7,184 –43,107 –64,660 –28,738 0 0
Net Cash Flows to Investments –7,184 –43,107 –64,660 –28,738 0 0
Net cash flows –7,184 –42,852 –63,894 –27,211 2,670 9,420
3.5. Preparing Financial Benefit-Cost Analyses
3.5.1. Introduction
3.5.1.1. ADB requires that financial and economic analyses be undertaken for projects.
Both types of analysis have the same objective – to assess whether the proposed investment
is viable. The concept of financial viability is not the same as economic viability. The
financial analysis of a project examines the adequacy of returns to the project-operating
entity and to the project participants, whereas economic analysis measures the effect of
the project on the national economy, as a whole.
3.5.1.2. For a project to be economically viable, it must be financially sustainable,

as well as economically efficient. If a project is not financially sustainable, economic
benefits will not be realized. Financial analysis and economic analysis are therefore
complementary.
3.5.1.3. While both types of analysis are conducted in monetary terms, the major
difference lies in the definition of costs and benefits. In financial analysis, all expenditures
incurred under the project and revenues resulting from it are taken into account. This
form of analysis is necessary to (i) assess the degree to which a project will generate
revenues sufficient to meet its financial obligations; (ii) assess the incentives for producers,
and (iii) ensure that demand or output forecasts on which the economic analysis is based
are consistent with financial charges or available budget resources. Economic analysis
attempts to assess the overall impact of a project on improving the economic welfare of
the citizens of the country concerned. It assesses a project in the context of the national
economy, rather than for the project participants or the project entity that implements
the project.
3.5.1.4. This part of the Guidelines describes ADB’s approach to preparing financial
benefit-cost analyses, which involves seven steps:
• Preparing project cost estimates (see section 3.4.3)

• Forecasting incremental project net cash flows (see section 3.4.7)
• Determining the appropriate discount rate (i.e., Weighted Average Cost of Capital
(WACC) serving as a proxy for the financial opportunity cost of capital (see section
3.5.2))
• Calculating the financial net present value (see section 3.5.3)
• Calculating the financial internal rate of return (FIRR) (see section 3.5.3)
• Undertaking risk and sensitivity analysis. The sensitivity analysis examines the likely
effect of changes in forecasting assumptions on the project’s financial viability (see
section 3.5.4)
3.5.1.5. The project RRP should describe how the project’s FIRR compares with
WACC. The RRP appendixes should include supporting analyses including sensitivity
analyses. The Knowledge Management section of the web-based Guidelines contains
Chapter 5 of the ADB Handbook for the Economic Analysis of Water Supply Projects. The
chapter is structured around a worked example of financial cost-benefit analysis for a
water supply project and should be read in conjunction with ADB’s Guidelines for the
Economic Analysis of Projects.
3.5.2. Determining the Discount Rate (WACC)
3.5.2.1. Financial Opportunity Cost of Capital (FOCC)
3.5.2.1.1. The net cash flows during the lifetime of the project (30 years) are discounted
at the financial opportunity cost of capital (FOCC) to show the project’s worth. The
financial internal rate of return (FIRR) calculated on the net cash flows shows the project’s
profitability.
3.5.2.1.2. The weighted average cost of capital (WACC) serves as a proxy for the FOCC
to assess the financial viability of projects. Although it is an accepted benchmark, it is
important to understand that the WACC may not fully reflect the FOCC in the market.
Although a project may generate sufficient returns to allow full recovery of all investment
and operations and maintenance costs while still yielding a small return on investment,
this return may not be sufficient incentive for the owner to make the original investment
or to maintain the investment.
3.5.2.1.3. Private foreign investors will be looking for returns on equity that also
includes an allowance for risks, such as political and economic. Private domestic investors
will also have alternative investments, whether they are in financial assets, other productive
activities or areas such as real estate. Government investment may be guided by whether
the funds are fungible (interchangeable), by the real cost of investment funds and the
economic benefits of the project. If funds are fungible, they may be more interested in
investing in projects with higher returns, economic and/or financial.
3.5.2.1.4. Finally, projects with low returns are riskier to implement and strain the
financial sustainability of the corporate entity (public or private) charged with its operation
and maintenance. Consequently, it is important to keep these issues in mind when
comparing the FIRR of a project against a benchmark such as the WACC. These issues
become particularly important as the role of government in the supply and operation
and maintenance of infrastructure services changes and private sector participation
becomes more prevalent.
3.5.2.2. Calculating the Weighted Average Cost of

Capital (WACC)
3.5.2.2.1. The discount rate to be used in financial benefit-cost analyses is the WACC.
The WACC represents the cost incurred by the entity in raising the capital necessary to
implement the project. Since most projects use several sources to raise capital and each
of these sources may seek a different return, the WACC represents a weighted average
of the different returns paid to these sources.
3.5.2.2.2. The RRP should include a demonstration of how the FIRR (which is in real
terms) compares with the WACC for the actual project
project
oject, also expressed in real terms. Both
FIRR and WACC should be measured on after-income tax bases. The following approach
should be taken to the WACC calculation. Reference is made to the sample calculation
shown below.
Step 1. Categorize financing components as shown in the table below. These

components should be taken from the Project Financing Plan as the WACC
is calculated only for the project – not for the organization as a whole.
Step 2. Estimate the Cost of Funds
Funds. Ascertain the actual lending (or onlending) rates,
even where these may not be the current market rates, together with the cost
of equity contributed as a result of the project.
• Government funds are not costless – they might be applied to purposes

other than the project, such as debt repayment or to alternative
investments. For simplicity, the average cost of government funds can be
calculated by dividing total government debt servicing by total public
debt.
• In estimating the cost of equity capital, the degree of business (industry)
and financial (bankruptcy) risks should be considered and an appropriate
risk premium over market borrowing rate should be added. The domestic
rate of inflation should be deducted from the nominal cost of equity.
Financial analysts may wish to refer to a corporate finance textbook for
conceptual guidance. 9 However, it should be recognized that these
methods were developed in countries with sophisticated capital markets
for which data is readily available. In most cases, only a small amount,
if any, of project financing will be provided by the organization. As such,
the estimate of the cost of equity capital is unlikely to unduly affect the
WACC. However, the means by which the estimate is developed should
be documented.
Step 3. Adjust for Corporate T ax

Tax
ax. Ascertain whether or not the interest payments
relating to each component are deductible for corporate tax purposes and,
if so, the level of the applicable tax rate. Adjust each component as
appropriate.
Step 4. Adjust for Domestic Inflation
Inflation. The estimated costs of borrowing and equity
capital should be adjusted for inflation to obtain the WACC in real terms.
9
See for instance: Brealey, Richard A. and Stewart C. Myers. 1999. Principles of Corporate Finance. 6th Ed. McGraw-Hill.
• For foreign-sourced loans, ADB requires that a premium for foreign

exchange risk is included in the WACC. On the other hand, foreign-
sourced funds are required to be adjusted for foreign inflation. To simplify
the WACC calculation, it should be assumed that the foreign exchange
risk premium exactly offsets the prevailing foreign inflation rate. As such,
neither of these factors need to be estimated and applied.
• ADB’s projected domestic inflation rate should be used for domestically-
sourced loans and equity.
Step 5. Apply the Minimum Rate T est

Test
est. Review the real cost of capital for each
component. Each component should be at least 4 percent. If not, replace the
derived value with 4 percent.
Step 6. Deter mine the W
Determine ACC
WACC
ACC. Apply the weighting percentage to each component
to derive the WACC.
Methodology for Calculating Weighted Average Cost of Capital (WACC)
Financing Component
ADB loan Foreign Domestic Government Equity

Loans Loans Funds Participation Total
A. Amount ($’000) 50,000 5,000 5,000 30,000 10,000 100,000

B. Weighting 50.00% 5.00% 5.00% 30.00% 10.00% 100.00%
C. Nominal cost 6.70% 6.70% 12.00% 7.00% 10.00%
D. Tax rate 40.00% 40.00% 40.00% 0.00% 0.00%
E. Tax-adjusted nominal cost
[ C x (1 – D ) ] 4.02% 4.02% 7.20% 7.00% 10.00%
F. Inflation rate … … 4.00% 4.00% 4.00%
G. Real cost [ ( 1 + E ) / ( 1 + F ) – 1 ] 4.02% 4.02% 3.08% 2.88% 5.77%
H. Minimum rate test [ H = 4.0%] 4.02% 4.02% 4.00% 4.00% 5.77%
I. Weighted component of WACC 2.01% 0.20% 0.20% 1.20% 0.58% 4.19%
Weighted Average Cost of Capital (Real) 4.19%
3.5.2.2.3. In this example, the project provides its own equity capital (10 percent) and
raises additional capital from local banks (5 percent), from foreign banks (5 percent),
from ADB (50 percent), and obtains a government grant (30 percent). Differing nominal
returns on each source of capital are assumed, including the expected return of 10 percent
on its equity to its shareholders.
3.5.2.2.4. Interest payments to ADB, to the local bank and to the foreign bank are
deductible from pretax income, with corporate taxes of 40 percent (60 percent of interest
payments to ADB and to the commercial bank remains as the actual cost of capital to the
project). Dividends paid to shareholders (if any) are not subject to corporate tax (although
they might be subject to personal income tax, which does not impose a cost to the entity).
3.5.2.2.5. In the example, the WACC in real terms amounts to 4.19 percent. This is
the discount rate to be used in the financial benefit-cost analysis of this particular project
as a proxy for the FOCC.
3.5.3. Calculating the Financial IRR and NPV
3.5.3.1. The profitability of a project to the entity is indicated by the project’s financial
internal rate of return (FIRR). The FIRR is also the discount rate at which the present
value of the net cash flows in financial terms (FNPV) becomes zero.
3.5.3.2. The following table provides an example of FIRR and FNPV calculations.
The table presents project receipts, payments, and net cash flows for the full project
period (30 years) where, for the purpose of the illustration, it has been assumed that
receipts and payments will remain constant from year 2006 onwards.
Example of FIRR and NPV Estimation (2001 prices: $’000s)
Year Payments Receipts Net Cash Net Cash

Flows Year Payments Receipts Flows
2001 7,184 0 -7,184 2017 4,520 15,800 11,280

2002 46,125 3,273 -42,852 2018 4,520 15,800 11,280
2003 68,702 4,807 -63,895 2019 4,520 15,800 11,280
2004 34,018 6,807 -27,211 2020 4,520 15,800 11,280
2005 6,800 9,470 2,669 2021 4,520 15,800 11,280
2006 2,810 6,306 3,496 2022 4,520 15,800 11,280
2007 3,193 7,795 4,602 2023 4,520 15,800 11,280
2008 3,604 9,535 5,931 2024 4,520 15,800 11,280
2009 4,045 11,568 7,522 2025 4,520 15,800 11,280
2010 4,520 15,800 11,280 2026 4,520 15,800 11,280
2011 4,520 15,800 11,280 2027 4,520 15,800 11,280
2012 4,520 15,800 11,280 2028 4,520 15,800 11,280
2013 4,520 15,800 11,280 2029 4,520 15,800 11,280
2014 4,520 15,800 11,280 2030 4,520 15,800 11,280
2015 4,520 15,800 11,280 2031 4,520 15,800 11,280
2016 4,520 15,800 11,280
Present Value (PV) @ 4.19% 198,877 201,437 2,560
FIRR 4.33%
FNPV @ 4.19 % + 2,560
Note: The calculation of the FNPV using WACC @ 4.33 % 0
is for illustrative purposes only FNPV @ 5.00 % – 10,744
FNPV @ 10.00 % – 54,623
FNPV @ 12.00 % – 61,774
3.5.3.3. The discount rate at which the present value of the net benefits becomes
zero works out to be 4.33 percent. This is the FIRR, which should be compared to the
WACC. If the FIRR exceeds the WACC, the project is considered to be financially viable.
If the FIRR were below the WACC, the project would only be financially viable if subsidized
by the government. In the example, the FIRR of 4.33 percent is above the WACC of 4.19
percent, and hence the project is financially viable.
3.5.3.4. The financial net present value (FNPV) shows the present value of the net cash
flows, or the project’s worth today. The discount rate to be used here is the WACC. A positive
FNPV indicates a profitable project; (i.e., the project generates sufficient funds to cover its
cost, including loan repayments and interest payments). If the FNPV, discounted at the WACC
of 4.19 percent, turns out to be positive, the project is earning an interest of at least the
required 4.19 percent. In the example, as the FIRR is 4.33 percent, the project earns an
interest of 4.33 percent. The project, thus, earns more than the required 4.19 percent interest,
recovers all investment and recurrent costs, and yields a very small profit.
3.5.3.5. A negative FNPV points to a project that does not generate sufficient returns
to recover its costs, to repay its loan and to pay interest. Note that, as a general principle
of discounting cash flows for the purpose of FIRR calculations, loan repayments and
interest payments are not considered part of the economic cost.
3.5.3.6. Discounted at the WACC of 4.19 percent, the FNPV of the project is
+$2,560,000. The project is thus financially profitable. If a discount rate of 4.33 percent
is used (equal to the FIRR), the FNPV (by definition) equals zero.
3.5.3.7. The example shows that if the discount rate used (4.19 percent) is below
the FIRR (4.33 percent), the FNPV is positive; vice versa, if the discount rate used (5,
10, 12 percent) is above the FIRR (4.33 percent), the FNPV is negative.
3.5.4. Undertaking Sensitivity and Risk Analyses
3.5.4.1. Financial benefit-cost analysis is based on forecasts of quantifiable variables

such as demand, costs, and revenues. The values of these variables are estimated based on
the most probable forecasts, which cover a long period of time. The values of these variables
for the most probable outcome scenario are influenced by a great number of factors, and the
actual values may differ considerably from the forecasted values, depending on future
developments. It is therefore useful to consider the effects of likely changes in the key variables
on the viability (FIRR) of a project. Performing sensitivity and risk analysis does this.
• Sensitivity Analysis shows to what extent the viability of a project is influenced by

variations in major quantifiable variables.
• Risk Analysis considers the probability that changes in major quantifiable variables
will actually occur.
3.5.4.2. The viability of projects is evaluated based on a comparison of its FIRR to

the financial opportunity cost of capital (FOCC). Alternatively, the project is considered
to be viable when the Financial Net Present Value (FNPV) is positive, using the selected
FOCC as discount rate. Sensitivity and risk analyses, therefore, focus on analyzing the
effects of changes in key variables on the project’s FIRR or FNPV, the two most widely
used measures of project worth.
3.5.4.3. Sensitivity analysis is a technique for investigating the impact of changes in

project variables on the base-case (most probable outcome scenario). Typically, only adverse
changes are considered in sensitivity analysis. The purpose of sensitivity analysis is to:
(i) to help identify the key variables that influence the project cost and benefit streams;
(ii) investigate the consequences of likely adverse changes in these key variables; (iii) assess
whether project decisions are likely to be affected by such changes; and (iv) identify
actions that could mitigate possible adverse effects on the project.
3.5.4.4. Sensitivity analysis needs to be carried out in a systematic manner. To meet

the above purposes, the following four steps are suggested:
• Step 1: Identify key variables to which the project decision may be sensitive.
• Step 2: Calculate the effect of likely changes in these variables on the base-case
IRR or NPV, and calculate a sensitivity indicator and/or switching value.
• Step 3: Consider possible combinations of variables that may change
simultaneously in an adverse direction.
• Step 4: Analyze the direction and scale of likely changes for the key variables
identified, involving identification of the sources of change.
3.5.4.5. The Knowledge Management section of these Guidelines provides further

information on each of these steps in the context of a numerical example. It also discusses
the use of risk analysis (see section 7.11). The information generated can be presented
in a tabular form with an accompanying commentary and set of recommendations, such
as the example shown below (Please note that this example is a simplistic illustration;
it focuses on just six variables – a proper sensitivity analysis will examine all the key
variables including all financial performance covenants).
Simple Sensitivity Analysis: Numerical Presentation
Item Change FNPV FIRR % SI (FNPV) SV (FNPV)
Base Case 126 13.7

Investment + 10% –211 9.6 13.3 7.5%
Benefits –10% –294 7.8 16.6 6.0%
Operating and maintenance costs + 10% 68 12.9 2.3 43.4%
Currency rate movements –20% –211 9.6 13.3 7.5%
Construction delays One year –99 10.8 NPV 178% lower

SI = Sensitivity Indicator, SV = Switching Value
3.5.4.6. Sensitivity tests are not without problems. Correlations among the variables
often pose serious difficulties. The usual technique of varying one variable at a time, keeping
the others constant at their expected values, is justified only if the variables concerned are
not significantly correlated; otherwise the related variables must be varied jointly.
Furthermore, sensitivity analysis may not identify any variable that, by itself, significantly
affects the overall result, even though a long list of variables is tested. This does not
necessarily mean that the project concerned is not risky as it ignores the effects of possible
joint variations. In such cases the sensitivity of the outcome to changes in several
combinations of variables that are expected to vary together must be explored, for example
revenues rather than price and quantity separately. But it should be noted that the greater
the degree of aggregation, the less useful is the information provided by the tests.
3.5.4.7. For financial analysis purposes, it may prove more useful to select features
of the financial structure of a project (or an EA) that are likely to prove highly sensitive
to costs or revenue flows and could cause early or midterm financial failure, even though
the financial rates of return may suggest satisfactory long-term performance. Examples
are debt service coverage, operating ratio and self-financing ratio. At the least, all financial
per for
perfor mance covenants stipulated for the pr
formance oject, together with the FIRR, should be
project,
subjected to sensitivity analyses
analyses.
3.6. Loan Covenants
3.6.1. Introduction to Loan Covenants
3.6.1.1. As discussed in section 4.4, various performance measurement devices have

been developed over time to enable owners, lenders and managers to assess enterprise
and project performance. To assist EAs to achieve their financial objectives, as well as
governmental economic objectives that are being supported by ADB loans, ADB seeks
assurance that the operational objectives of an EA agreed with the borrower, would be
met at least through the life of the project. The Office of the General Counsel (OGC)
translates these objectives into covenants. These covenants are designed to: (i) enhance
the financial performance of the entity; and (ii) ensure that the investment, including
ADB loan proceeds, is used effectively.
3.6.1.2. ADB asks its borrowers to perform or comply with certain covenants that
are considered essential to achieving the objectives and financial viability of the project
as described in the loan agreement in a manner that is consistent with ADB’s policies and
to ensure the financial viability of the entity. Covenants in loan agreements seek the
achievement of enterprise objectives. They are varied in nature, often addressing technical,
social and economic performance, in addition to financial performance. Financial
performance covenants can be broadly classified into two categories, namely financial
and management systems, and financial performance. Financial and management system
covenants usually address such specific problems as selling and marketing practices,
inventory control, installation and operation of accounting and costing systems, control
of labor and material costs, strategic and financial planning, budgeting systems, etc.
Financial performance covenants are designed to: (i) support socioeconomic development;
(ii) promote financial viability, satisfactory financial performance and prudent financial
management of an enterprise; (iii) development of local capability to manage without
external assistance not only under normal business conditions, but also in adverse
operating or trading circumstances; (iv) assist the enterprise to achieve a creditworthy
status to facilitate acceptance in capital markets; (v) protect the borrower’s and ADB’s
financial interests; and (vi) provide a basis for monitoring by regulatory agencies of
government, and ADB, of the financial performance of the enterprise. These are largely
complementary objectives, but trade-offs may be required between financial and
socioeconomic considerations.
3.6.1.3. There is frequently a need for a public sector enterprise to provide services
to lower income groups at or below the financial or economic cost. This raises issues of
whether an enterprise and a sector should be responsible for cross-subsidization; whether
the government should finance the costs through subsidies either to the enterprise or
directly to the beneficiaries; and whether the enterprise should be allowed to set lower
financial targets which recognize the inability of certain users to meet actual and/or
marginal costs. In the latter case, the setting of lower financial targets should not normally
be acceptable. If the financial targets are correctly designed their lowering can only risk
the future reliability of the enterprise to provide a quality of service or product to all
consumers. Such issues must be resolved as part of project preparation and discussed
in the RRP. Because financial performance indicators are used as the basis for measuring
the foregoing, it is essential that the most appropriate indicator(s) be selected for each
covenant for each project and enterprise.
3.6.1.4. The financial analyst and the project designers should ensure that, to the
extent possible, financial systems covenants and financial performance covenants are
complementary. They should be viewed as a comprehensive package designed to achieve
an integrated financial performance by the enterprise’s management.
3.6.1.5. A list of the proposed financial performance covenants, which have been
subjected to sensitivity analyses (see section 3.5.4), should be provided together with
the RRP.
3.6.1.6. Finally, to be consistent with a government’s socioeconomic objectives, before

the final formulation of financial performance requirements and of the related covenants,
appropriate cost recovery principles and efficiency improvements, and the fiscal impact
and distributional effects must have been weighed by the appraisal mission, particularly
by the financial analyst.
3.6.1.7. Some indicators and covenants, such as a dividend limitation covenant, which
are discussed in the following sections, are less extensively used by ADB than by other
lenders. However, to ensure that a financial analyst is well informed on their construction
and use, they also are described in the loan covenant section.
3.6.1.8. Whenever a date or month is needed in each of the succeeding model

covenants, it is to be understood that an appropriate date or month should be inserted.
This is to ensure that the review is conducted no later than the end of the first quarter
of a fiscal year and such review should be in respect of the fiscal year in which the review
is conducted and the succeeding year.
3.6.1.9. In cases wherein the borrowers may not have absolute control or discretion
over the level of tariffs or where an independent regulator regulates the sector, operating
covenants serve the same purpose. However, in addition to making applications to the
regulatory authority to increase tariffs and charges, the enterprise may need to take
alternative measures (such as tighter controls on operating expenditures) in order to
meet such covenants.
3.6.2. Operating Covenants
3.6.2.1. Introduction to Operating Covenants
3.6.2.1.1. To assist the governments of its member countries in the efficient management
of scarce resources, including the mobilization of revenues and savings, ADB recommends
to borrowers that their public and private sector revenue-earning enterprises be required
to meet a “reasonable portion” of their investment requirements from internally-generated
funds. Definitions of “reasonable portion” will vary between countries and sectors,
frequently based on a government’s policies for public sector EAs. It will also be dependent
on the latest performance of the EA, particularly if its current financial performance is
inadequate to support its operations, when the “reasonable portion” may need to be
substantially increased above current performance.
3.6.2.1.2. The principal legal instrument through which ADB seeks to assure such a
financial performance of a revenue-earning enterprise is a form of “operating covenant”.
The two principal forms of operating covenants are the Rate of Return and the Self-
Financing Ratios. Each specifies the minimum annual financial performance to be achieved
by a public sector enterprise in terms of either the rate of return on invested capital, or
the contribution to investment requirements to be generated from the enterprise’s
operations.
3.6.2.1.3. Competition has been limited in the market(s) in which such enterprises
operate (although there is evidence of an opening of many of these markets, at times as
a result of related ADB projects or programs in the same sector). Levels of output prices
may be adjusted by the enterprise’s management board (for example, Public Boards of
Management for Electric Power) or the Government may control or regulate tariffs and
charges through the concerned sector ministry, the Ministry of Finance or the Cabinet.
In such cases, operating covenants serve to require a management board or a government
to authorize tariffs and prices that provide for a satisfactory financial performance by the
EA or enterprise. Where an independent regulator regulates the sector, the enterprise
and/or the government may not have the same degree of discretion to adjust output
prices or tariffs and charges. In such cases, operating covenants serve the same purpose,
but the enterprise may need to take alternative measures (such as tighter controls on
operating expenditures) in order to meet such covenant, in addition to making applications
to the regulatory authority to increase tariffs and charges.
3.6.2.1.4. When the performance of the EA has been very poor, forms of operating
covenants used include the operating ratio covenant, or the break-even covenant.
Depending on the ratio specified, the operating ratio covenant may serve a variety of
financial objectives, but it is usually limited in its application, for example, ensuring that
earnings would at a minimum cover operating expenses including depreciation and, to
the extent possible, debt service requirements in excess of depreciation. The break-even
covenant has similarly limited objectives intended to ensure the continued operating
capability, solvency and financial viability of the public sector enterprise. It is used where
internally generated funds are not expected to contribute significantly to investment.
3.6.2.1.5. Operating covenants should contain provisions for periodic reviews by the
enterprise of the actions required to achieve compliance and for furnishing the results
of such reviews to ADB. Such reviews should be made at least annually before the beginning
of a fiscal year to permit the enterprise to take timely action. In some cases where financial
information is late in delivery, such reviews would need to be made on the basis of firm
estimates and the specific forecasts noted for revision when final data is available. In
highly inflationary economies, more frequent reviews (e.g., quarterly) may be needed.
3.6.2.2. Rate of Return Covenant
3.6.2.2.1. Under the rate of return covenant, an enterprise affirms that it will take all
actions necessary, including changes in its tariffs, rates and charges, for its revenues each
year to cover operating expenses and taxes, if any, and to earn an agreed return on its
invested capital. Section 4.4.6.2 provides guidance on the application of this covenant
and a model covenant is provided in Knowledge Management (see section 7.12.1).
3.6.2.2.2. This covenant is most frequently applied to public sector enterprises

constructing and operating projects in the sectors, which embrace agribusiness, electric
power, ports, telecommunications, gas or fuel pipelines, water supply and sanitation.
The rate of return covenant is generally less suitable for sanitation and sewerage projects,
because they have considerable difficulty in generating surpluses for investment or reserves
and therefore these projects are normally combined with those of water supply as part
of a water supply utility enterprise operation.
3.6.2.2.3. Competitive factors bear significantly on the financial performance of industry

(including oil and gas), therefore a specific rate of return covenant is used infrequently
in this sector; instead, a less precisely defined form of the rate of return covenant, the
general price covenant (see next paragraph), is usually used.
3.6.2.2.4. For railways, the rate of return on invested capital may be used but a
commonly used covenant is the operating ratio.
3.6.2.3. Self-Financing Ratio Covenant
3.6.2.3.1. A self-financing ratio covenant, a model of which is provided in Knowledge

Management (see section 7.12.2), directly addresses the need for sufficient internal cash
generation to finance consistently an agreed proportion of investment requirements.
Section 4.4.6.3 discusses the application of this covenant.
3.6.2.3.2. It is often used when a more direct approach to addressing cash generation
requirements is considered desirable. Borrowers often favor the covenant because it is more
readily understood, particularly by politicians and administrators; it is less costly to put in place
and maintain; it avoids setting aside funds which may occur with the rate of return covenant, but
it may be manipulated. This latter action may arise if a borrower deliberately decides to match its
annual investment plans to whatever level of net revenues becomes available, in order to comply
with the covenant. As an example, a borrower required to contribute 20 percent per annum to its
investment program from internally generated revenues, can comply by financing $100 million
from $20 million internally generated revenues, but is similarly in compliance by financing only
$25 million of investments with $5 million of revenues.
3.6.2.3.3. Despite the selection of an extended review period (three years) as the base
for determining investments, the objective of the covenant can be avoided by a borrower
failing to implement acceptable levels of annual investments, with the result that the
revenues required to be generated internally can be allowed to fall correspondingly. The
significant and likely impact of this default is a failure by the borrower to expeditiously
execute the project, directly due to the reduction of the level of investment agreed between
the borrower and ADB in the project implementation and financing plans.
3.6.2.3.4. A further problem associated with determining the self-financing ratio for
a covenant is the often-uneven nature of investment programs (i.e., the pattern of
investments can vary widely from year to year). A three-year investment pattern for a
public sector enterprise could be $10 million, $77 million, and $12 million. Such a
program with a three-year moving average would show for that period an average of $33
million. If the borrower was required to raise 30 percent from internally generated revenues
annually, the result would be a surplus in year one of $23 million, a shortfall of $21
million in year two, with parity arriving only in year three. Under these circumstances
it may be difficult for a borrower to justify politically the raising of charges to yield a very
large surplus in year one. While it may forecast to complete $77 million in year two, this
may be treated as a dubious estimate by a government that is hard-pressed for resources.
3.6.2.3.5. This example makes the case for smoothing several years’ performances, but
does not provide a ready or politically realistic justification for tariff and charges increases
for an as yet unaccomplished investment program.
3.6.2.4. General Price Level Covenant
3.6.2.4.1. The model covenant provided in Knowledge Management (see section 7.12.3)
illustrates the possible formulation of this type of covenant, the drafting of which should
be carefully adapted to the circumstances of the particular project. The main purpose of
the covenant is to set forth the agreed criteria applicable in determining prices, and to
provide for consultation with ADB. Because it is not feasible to be precise, the criteria
should be expressed in general terms.
3.6.2.5. Operating Ratio Covenant
3.6.2.5.1. An operating ratio covenant requires a public sector enterprise to set its
tariffs and rates at levels that meet a specified operating ratio test (see section 3.6.1.9).
The covenant may also state a minimum reduction in the operating ratio to be achieved
by a specified date, as part of an agreed effort to improve operating efficiency and,
in some cases, eliminate uneconomic services. Section 4.4.6.4 discusses the
application of this covenant and a model is provided in Knowledge Management
(see section 7.12.4).
3.6.2.5.2. This covenant is normally used only where it is not feasible to use a rate of
return or cash generation approach – for example, for an entity which has been incurring
substantial operating losses and whose objective is to eliminate such losses. It may also
be used for a revenue-earning entity that is likely to be restricted by government from
generating appropriate amounts of capital for future expansion purposes. It is usually
necessary to supplement an operating ratio covenant with agreements by the concerned
government to provide necessary funds to offset operating deficits until they are eliminated,
to cover any deficiencies in meeting debt service obligations, and to assist in financing
capital needs.
3.6.2.5.3. A variant, the working ratio covenant is sometimes used to emphasize the
degree of coverage of cash operating expenses. It excludes depreciation and similar non-
cash items from expenses.
3.6.2.6. Breakeven Covenant
3.6.2.6.1. A breakeven covenant is designed to achieve financial viability in its most

limited sense. There are two breakeven variations: revenue (accrual) breakeven; and cash
breakeven. This section, and the model covenant, refers to the former variation. The
covenant requires the entity to take all measures necessary, including adjustments in its
rates, for revenues to cover operating expenses, adequate maintenance, taxes if any, and
the greater of depreciation or debt service requirements. The objective of this analytical
tool is to measure a revenue-earning enterprise’s efforts to breakeven, without losses, and
without providing any surpluses for investment, dividends, etc.
3.6.2.6.2. This approach is occasionally used for transportation and similar projects
that follow the principle of funding their capital requirements predominantly through
borrowings or grants, and also receive operating subsidies. It is infrequently used for the
public sector, and is unlikely to be used for private sector projects. It compares the total
revenues of an enterprise to the operating expenses plus the amount by which debt
service requirements exceed the provision for depreciation.
3.6.2.6.3. The major risk in the use of this tool is that the borrower/EA may become
complacent if a break-even is achieved, and will fail to pursue more aggressive revenue-
earning policy to provide for the gradual removal of all subsidies. This tool should not
be introduced without a detailed justification at fact-finding, and in the RRP. A detailed
breakeven analysis, displaying the effects of changes in volume on the breakeven point(s),
and on profitability and cash flows should be developed.
3.6.2.6.4. The RRP should include a forecast of when a self-financing ratio should be
introduced, and if debt service is not being met completely, or at all, the steps which the
government and the enterprise propose to take to recover debt service from consumers
through the charging system(s) of the enterprise.
3.6.2.6.5. Section 4.4.6.5 discusses the application of this covenant and a model is
provided in Knowledge Management (see section 7.12.5).
3.6.3. Capital Structure Covenants
3.6.3.1. Introduction to Capital Structure Covenants
3.6.3.1.1. ADB uses four capital structure covenants; (i) debt service-coverage ratio;
(ii) debt-equity ratio; (iii) absolute debt limitation; and (iv) capital-adequacy ratio. These
covenants shape the capital structure by limiting the debt that may be incurred in relation
to annual cash flows, the amount of equity capital, or absolute annual amount.
3.6.3.1.2. The capital-adequacy ratio covenant seeks to ensure that the equity of a
financial institution will at least be adequate to meet its losses. Some form of debt limitation
covenant, usually either the debt service coverage or debt-equity ratio, should be used
for projects involving revenue-earning entities. The debt limitation covenant complements
an operating covenant to provide assurance that fixed debt service obligations will be
met even when the broader financial objectives of the operating covenant are not.
3.6.3.1.3. Where an operating covenant is not appropriate, the debt limitation covenant
serves as the main covenant promoting financial viability. Exceptions to the use of both
types of covenant would be where an entity is financed predominantly through borrowing,
and earnings may reasonably be expected always to be sufficient to meet debt service
obligations; for example, where a public utility project, usually in the water supply or
sewerage sector, funds virtually all of its capital requirements through borrowings and
its financial performance is regulated by a breakeven covenant.
3.6.3.1.4. When dealing with entities that are likely to pay dividends, it may be advisable
to use a dividend limitation covenant to complement a debt limitation covenant.
3.6.3.1.5. Capital structure covenants serve to assure the continued solvency and
financial viability of revenue-earning enterprises by imposing prudent limits on their
long-term borrowing. If an EA does not incur debt after entering into such a covenant,
or refrains from further borrowing after a period of compliance with the covenant, even
though the performance criteria agreed to in the covenant subsequently may not be
complied with, (for example if the debt service-coverage ratio falls below 1), the EA is
not in default of the covenant until it again commences to incur debt.
3.6.3.1.6. The limits of a covenant should be set so as to enable debt service obligations
to be met under adverse as well as normal business conditions, taking into account business
and financial risks.
3.6.3.1.7. The distinction between debt and equity is not always clear. For instance,
preference shares have many characteristics of debt while convertible notes might be
treated as equity. Furthermore, derivatives and other financial instruments add layers of
complexity. To this end – for the purposes of formulating covenants – a cautious approach
should be taken by including any difficult-to-classify instruments in the definition of
debt.
3.6.3.2. Short-Term Debt and Financing Leases in the

Capital Structure
Short Term Debt
3.6.3.2.1. ADB’s standard definition of the term “debt”, as applied in the design of
capital structure covenants, is any indebtedness of the borrower maturing by its terms
more than one year after the date on which it is originally incurred. This limits the
application of the covenant to what is usually referred to on a balance sheet as long-term
debt, and it excludes short-term debt usually shown on a balance sheet as part of current
liabilities – though current maturities of long-term debt are part of current liabilities, by
definition they are part of the long-term “debt” covered by capital structure covenants.
This exclusion is appropriate when short-term debt is incurred as a source of working
capital, since any limitation on such uses that is considered necessary can be covered by
a liquidity covenant (see section 3.6.4). However, if the current portion of long-term
debt is included in the definition of debt for purposes of a capital structure covenant,
it should still be retained as a current liability for purposes of a liquidity covenant.
3.6.3.2.2. Consideration should sometimes be given to the need to refine the definition
of “debt” or to use a supplementary covenant to cover some short-term loans that are:
(i) being continuously rolled over, or (ii) used as “bridging funds” pending receipt of the
proceeds of sale of equity or long-term debt. In the former case, if the amounts involved
are likely to be significant, they should be included within the definition of debt covered
by the covenant or be covered by a complementary limitation on short-term debt. In the
latter case, the need will depend on the judgment as to the likelihood and timing of the
replacement by long-term debt or equity. When in doubt, the overall objective should
be used as a guide; viz., if the borrower’s recourse to long-term debt needs to be restrained,
no alternative facility in the form of short-term debt should be admissible, unless suitably
defined, categorized and counted in part, or in total, as long-term debt for purposes of
the covenant.
Financing Leases
3.6.3.2.3. Some institutions use finance leases to acquire the use of assets; the final
ownership of the asset being dependant upon the terms of the lease.
3.6.3.2.4. A finance lease effectively places all the risks upon the lessee, and therefore
it is reasonable to interpret the existence of such a lease and its associated lease payments
as debt and debt service respectively, for purposes of the capital structure of EAs with
which ADB works. Therefore where an EA has entered into, or proposes to enter into
finance leasing agreements, the value of the lease and the annual lease payments should
be included in the capital structure and the debt servicing requirements of the agency
for purposes of covenants in loan agreements.
Restricting the Use of Loan Funds
3.6.3.2.5. Capital structure covenants have the inherent limitations that although
they are primarily intended to constrain the amounts of borrowing, they do not regulate
the use to which any permissible borrowing can be put, (nor do they ensure that
existing debt will be serviced, if further borrowing is not incurred). Also, planning
and implementation of new projects having substantial debt requirements sometimes
delay the completion of ongoing projects, by preempting the use of scarce loan resources.
If there is substantial concern that a revenue-earning entity is likely to embark on
additional projects of questionable merit, a supporting covenant may be needed to
restrict the enterprise to investments, which are economically justified and financially
appropriate. Such limitations, however, are generally not needed or advisable, and
should be employed only exceptionally and usually limited to the implementation
period of the project.
3.6.3.3. Debt Service Coverage Covenant
3.6.3.3.1. Models of debt service coverage covenants are provided in Knowledge

Management (see sections 7.13.1 and 7.13.2). The two key issues to be decided in
formulating the debt service ratio covenant are (i) whether to base it on historical or
forecast earnings, and (ii) what particular ratio to require as the minimum acceptable
coverage. A good rule to follow is to allow the enterprise reasonable flexibility in making
financing arrangements without requiring ADB’s frequent approval for new borrowings.
This factor must be balanced against the need to maintain prudent limits on the enterprise’s
debt service obligations. Section 4.4.7.6 describes the application of this covenant.
3.6.3.3.2. As a general rule, the covenant should be on the historical earnings basis if
it is expected that the test could be met on this basis for the reasonably foreseeable
future, or that the need to seek ADB approval for an exception would occur no more
frequently that about once every several years.
3.6.3.3.3. The forecast basis should be used when it is likely that during a year there
would be many occasions for incurring debt obligations, which would otherwise require
prior ADB approval. This is particularly relevant for an enterprise that has a large
investment program containing many projects, with long implementation periods and
a need to arrange many borrowings to finance the program. It may also be advisable to
use the forecast basis in highly inflationary conditions to ensure that tariffs and rates are
moved in concert with interest rates.
3.6.3.3.4. A ratio typically recommended for this covenant is 1.5, but it can vary from
as low as 1.2 to as high as 2.0 or more depending on industry averages, or how stable
or cyclical the earnings of the EA are judged to be. Where business risks are similar the
appropriate ratio would be lower when using historical earnings than with forecast
earnings. However, it is essential that the financial analyst be prepared to justify the ratio
recommended, particularly the excess requirement over 1.0. Any “mark-up” over 1.0
must be quantified in terms of the amount it is estimated to provide, and the proposed
application of the funds, (working capital, reserves, investment purposes, dividends,
etc). It is not sufficient to either select a “comfortable” or non-controversial figure, or to
continue using a ratio already in a legal agreement for previous operations of the borrower.
Section 4.4.7.6 describes the application of Version A (Historical orientation) and Version
B (Forecast orientation) of the Debt Service Covenants.
3.6.3.3.5. Capital structure covenants have a limited use, in that they are not
intended to perform as revenue-generating covenants. They serve only to restrict
the borrowing capacity of EAs. The debt service coverage ratio covenant may be
adapted to include a forecasting provision that would require an EA to institute
mandatory adjustments to tariffs, or rates (if within its discretion, or to make the
necessary applications for increases, if not). ADB staff should seek the advice of
OGC before discussing with a borrower/EA the possible application of such a modified
capital structure covenant.
3.6.3.4. Debt: Equity Ratio Covenant
3.6.3.4.1. The debt-equity ratio covenant is simple to understand and administer, and
is consistent with the need to maintain a sound capital structure without unduly restricting
the entity’s ability to make its own routine financing decisions. It is pertinent to note that
for this form of covenant, debt need not be defined in the same way as for the debt
service coverage covenant. For the latter, the definition applies to the entire amount of
the long-term debt, and the applicable debt service obligations, as of the date of signing
the contract for the debt. Section 4.4.7.7 describes the application of this covenant and
a model is provided in Knowledge Management (see 7.13.3).
3.6.3.4.2. For the debt-equity ratio, the definition of debt may be framed in terms of
debt outstanding. This provides the entity some flexibility in phasing additions to its
equity capital to match the timing of expected drawdowns of debt.
3.6.3.4.3. Defining debt in terms of the amount outstanding is appropriate for the
debt: equity ratio covenant only when it is deemed feasible for an enterprise to apply the
test each time it intends to draw down debt and, when necessary, call on its shareholders
for additional equity capital before the increase in debt outstanding. This is most likely
to be the case for financial intermediaries, which can generally limit their commitments
to lend funds to the availability of resources in hand. Application of the drawdown concept
is likely to be inappropriate in other sectors where use of borrowed funds cannot readily
be interrupted if there is a failure to meet a debt limitation test for a particular drawdown
of a loan. For similar reasons, application of the drawdown concept is generally not
appropriate or feasible under the debt service coverage test.
3.6.3.4.4. The debt: equity ratio covenant is occasionally used for established entities
when the borrower has overriding objections to the use of a debt service coverage covenant.
Since the major shortcoming of the debt: equity ratio covenant is that it disregards the
terms and conditions of the debt and their impact on the debt service burden, it may be
advisable when using this form of covenant to add a limitation on medium-term debt;
e.g., limiting the amount of debt incurred with a term of issuance of less than ten years
to some ten or fifteen percent of total capitalization.
3.6.3.5. Debt Limitation Covenant
3.6.3.5.1. An absolute debt limitation covenant limits the amount of debt that may
be incurred annually to a stated amount (expressed in absolute terms or as a proportion
of the total capitalization) and requires ADB concurrence before exceeding this limit.
This covenant is used infrequently and only where debt service coverage or debt-
equity covenants cannot be applied. Consequently no example is provided, as each
covenant should be uniquely drawn. Section 4.4.7.8 describes the application of this
covenant.
3.6.3.5.2. The typical case when this covenant is used involves a public authority whose
capital structure consists entirely or predominantly of debt, because of statutory
requirements that all externally provided investment funds be advanced in the form of
borrowing from government.
3.6.3.5.3. The limit for new debt is fixed at a relatively small amount which together
with the internally generated funds which are likely to be available, allows the borrower
to carry out minor plant replacements or improvements, but which requires the borrower
to consult with ADB whenever it plans a major expansion.
3.6.3.5.4. Although this form of covenant is simple to administer, it has substantial

disadvantages. It is related to a stated amount of debt without consideration of its terms
and without taking into account changes in an enterprise’s financial requirements or debt
servicing capacity; and it severely restricts an enterprise’s freedom of action.
3.6.3.5.5. A preferable approach would be to agree that a substantial part of any loan
by the government to the public sector enterprise would be subordinated and treated as
quasi-equity capital, thus permitting the use of either the debt service coverage or debt
equity ratio covenants. The project team should ensure that it is legally possible to create
a subordinated debt. There may be restrictions or regulations of the government, which
affect its ability to have its debt treated as quasi-equity.
3.6.3.6. Capital Adequacy Ratio Covenant
3.6.3.6.1. This covenant is normally applied to financial institutions (FIs). It is used

to compare the adequacy of an institution’s available equity to meet losses that may be
incurred by losses of financial assets. For this purpose, equity is defined in a similar
manner as in the debt-equity ratio covenant, but with the addition of any provisions for
bad and doubtful debts (loss provisions). However, the definition of assets will need to
be defined on an institutional basis. Section 4.4.7.9 describes the application of this
covenant and a model is provided in Knowledge Management (see 7.13.4).
3.6.3.6.2. Local market and lending conditions will materially affect the quality of assets
and staff must reach agreement with the borrower on the risk factors applicable to each
class of assets.
3.6.3.6.3. This classification of risk by reference to groups of assets-at-risk may need

to be varied over the life of a loan, and therefore it will be necessary to introduce regular
reviews to determine any required revisions from time to time. In addition, judgment
will be needed to determine a safe margin above the potential loss level of assets-at-risk
prescribed in the covenant. Normally this is unlikely to be less than 1.00, when equity
will at least absorb all potential losses, as calculated in accordance with methods specified
in minutes to loan negotiations.
3.6.4. Liquidity Covenants
3.6.4.1. Introduction to Liquidity Covenants
3.6.4.1.1. Liquidity covenants are intended to assure that an enterprise maintains

sufficient working capital (i.e., an excess of current assets over current liabilities) to meet
its current obligations in a timely manner and conduct its operations effectively, without
financial constraints.
3.6.4.1.2. Their limitations are that the data used for the ratio is a “snapshot” figure,
usually as at the end of a fiscal period – and, as such, are capable of manipulation. They
are generally used only when working capital requirements are significant, as in the case
of most industrial and agro-industrial projects, where the enterprise’s management may
use limited resources to fund capital expenditures to the detriment of operating expenses.
By contrast, these covenants are not normally needed in projects where working capital
needs may be relatively small, such as utilities and railways.
3.6.4.1.3. The cash needs of such projects are adequately covered through operating
covenants, supplemented, as necessary, by other covenants dealing with working capital
issues, such as timely collection of accounts receivable.
3.6.4.1.4. The Current ratio and Quick ratio covenants require the borrower to maintain
a specified minimum liquidity ratio and to undertake corrective actions if the actual ratio
falls below the prescribed level. The quick ratio covenant excludes the cost of inventories
at the date of the balance sheet.
3.6.4.2. Current Ratio Covenant
3.6.4.2.1. The advantages of the current ratio covenant are that: (i) it is simple and
easily understood by borrowers; (ii) it is based on an accurate and objective test; (iii) it
can be based on readily defined accounting principles and calculated from standard
financial statements; and (iv) in most cases it provides a fair representation of short-term
solvency of the borrower. Section 4.4.8.2 describes the application of this covenant and
a model is provided in Knowledge Management (see 7.14.1).
3.6.4.2.2. However, this covenant will only be an adequate test of liquidity if the
covenant design provides for: (i) periods of falling sales and consequent declining internal
cash generation, when the borrower may find it difficult to convert inventories to cash
at reasonable prices; (ii) a suitable analysis of inventories, because some items may be
non-saleable (for example, they may be spare parts or obsolete products not written off)
and because a minimum level of inventories must be retained to continue operations;
and (iii) a suitable analysis of accounts receivable; and seasonal variations in working
capital requirements and interim peaks for debt maturities during the year. These problems,
although serious in some projects, can be overcome either by making appropriate
allowances when determining the acceptable ratio, or by using the quick ratio test. The
borrower should be asked to calculate and confirm compliance with the current ratio at
intervals throughout the fiscal year (e.g., in quarterly or semi-annual reports; or whenever
requested by ADB).
3.6.4.2.3. This covenant requires consistent and close monitoring to ensure that
unacceptable management and accounting practices are not being followed to give the
appearance of compliance. For example, accounts receivable may be overstated because
of inadequate provisions for bad debts.
3.6.4.2.4. In some instances, it may be necessary to introduce supporting covenants

that specifically address such key issues as the size of short-term debt, or levels of
inventories and receivables.
3.6.4.3. Quick Ratio Covenant
3.6.4.3.1. The quick ratio covenant is similar to the current ratio covenant, except that
inventories are excluded, to focus on the most liquid items in the financial statements.
Section 4.4.8.2 describes the application of this covenant and a model is provided in
Knowledge Management (see 7.14.2).
3.6.4.3.2. It gives a much clearer view of the “cash” position of the enterprise. After
taking that benefit into account, this covenant still has the shortcomings associated with
the current ratio.
3.6.4.3.3. While any selected covenant must be framed to reflect the objectives of the
borrower and the project, it is probably desirable when a decision has to be made between
the current and quick ratios, to select the latter and to require at least a three-monthly
submission of information; and introduce a performance covenant to address control of
inventories. In this way the cash position can be examined closely and regularly.
3.6.4.4. Dividend Limitation Covenant
3.6.4.4.1. The dividend limitation covenant with a dividend limitation test prohibits
the borrower from declaring a dividend the payment of which would cause the current
ratio (or quick ratio) to fall below a specified minimum. Section 4.4.8.3 describes the
application of this covenant and a model is provided in Knowledge Management (see
7.14.3).
3.6.4.4.2. The minimum level of current ratio specified in this covenant may be higher
than the minimum required under the current ratio covenant discussed in section 3.6.4.2
because decisions on whether to pay dividends are often discretionary, and a stricter
standard of prudent financial management can thus be applied to this context. Therefore,
the borrower is asked not to make voluntary payouts of cash to its stockholders until it
has taken further measures to establish and maintain the liquidity essential for operations.
3.7. ADB Reports
3.7.1. Introduction to ADB Reports
3.7.1.1. A financial analyst has the responsibility to ensure that ADB’s reports and
documentation relating to a project, from its inception through to its evaluation, represent
the facts and best professional judgments of the analyst with respect to all aspects of
financial management, financial appraisal, accounting, financial reporting and auditing
with respect to the project, the EA, the borrower, and all concerned organizations and
persons.
3.7.1.2. The objective is to ensure that the cycle of investment lending is well
documented throughout, with adequate justifications for all actions to be taken or actually
taken.
3.7.1.3. Given the wide range of lending operations and the variety of borrowers,
their institutions and the actual projects, it is inevitable that from time to time, some
innovative documentation may be necessary to describe and justify procedures undertaken.
3.7.2. The Project Preparation Report
3.7.2.1. A critical element of preparation is identifying and comparing technical and

institutional (and financial) alternatives for achieving the project’s objectives. Preparation
typically requires feasibility studies that identify and prepare preliminary designs of
technical and institutional alternatives; compare respective costs and benefits; and examine
the most viable option from technical, financial, and economic viewpoints.
3.7.2.2. Although this section rrefers

efers to financial analysts, many of the financial
assessment tasks should be under taken as par
undertaken partt of the PPTA. As such, the financial analyst
PPTA.
must thor oughly rreview
thoroughly eview the PPTA TORs to ensur
PPTA ensuree that they rreflect
eflect these rrequir
equir ements.
equirements.
3.7.2.3. For the financial analyst, in order to contribute to the RRP, this means
researching possible first-stage project costs, working with technical experts to prepare
cost estimates (including rough contingencies) and preparing initial cost analyses. To
support this work, the financial analyst should review the prospective EA’s capacity to
develop and maintain adequate project/EA accounts, and the availability of suitable
auditing skills to provide timely audit reports and opinions.
3.7.2.4. If the preliminary review indicates that the project appears “bankable” and
addresses sector priorities, the necessary data to support detailed technical, financial, and
economic analyses of alternative options should be collected and analyzed. This step should
identify a preferred option, for which an indepth feasibility analysis will be conducted and
a preliminary project design prepared. The preliminary design will be reviewed by ADB staff
and, when finalized, will provide the basis for design studies. ADB staff will appraise these
studies. It is important for ADB to ensure that the preparation report format conforms to the
RRP format and contains all information required for appraisal.
3.7.2.5. To assess the viability and sustainability of the project, internal ADB reviewers
(that may include a Management Review Meeting (MRM) and a Staff Review Committee
(SRC)) will, among other things, examine and consider: (i) the realism of the project cost
estimates; (ii) the realism of the financing plan (which must indicate the contributions
of the beneficiaries, ADB and the cofinanciers, if any); (iii) the soundness of the proposed
accounting and internal control procedures; (iv) the workability of organizational
arrangements for project implementation, as well as monitoring and evaluation
mechanisms; and (v) the realism and implications of the financial, economic and risk
analyses.
3.7.2.6. In cases where the borrower has asked ADB (or other agencies) to assist in
project preparation, the financial analyst’s responsibilities will depend on the skill and
experience of those who have prepared the project’s financial aspects. At a minimum, the
analyst is expected to ensure that all issues are examined comprehensively and that
proposed solutions are realistic, and to report accordingly.
3.7.3. Report and Recommendation of the President

(RRP)
3.7.3.1. RRP Contents (Project Loan)
3.7.3.1.1. The following table sets out the contents of an RRP (for a project loan) with
explanations of the financial aspects. The Knowledge Management section of these
Guidelines provides a general checklist for reviewing the financial aspects of an RRP (see
section 7.6).
I. THE PROPOSAL
II. INTRODUCTION
III. BACKGROUND
IV. THE PROPOSED PROJECT
A. Rationale
B. Objectives and Scope
C. Technical Justification
D. Cost Estimates Section 3.4.3 provides guidance on preparing project cost
estimates. These should be presented in this section in
summary form. Additional details should be provided in
an appendix.
E. Financing Plan Section 3.4.6 provides guidance on preparing the financing
plan. It should specify the amounts of the foreign exchange
and local currency costs financed by ADB, the government,
and other agencies, including in-kind contributions by ben-
eficiaries, if any. Indicate provisions for contingencies, the
nature of the government’s contribution, and the
government’s assurance concerning any shortfall in the fi-
nances required. Provide reasons for changes, if any, from
ADB’s guidelines. Mention any cofinancing arrangement
(concluded or expected). Indicate (in the appendix) the mag-
nitude of physical contingencies as percentage of the base
costs and of the inflation factors used for both the foreign
exchange and local currency costs in estimating price
contingencies.
Justify why local cost financing exceeds the percentage lim-
its for the country concerned, based on country and project
considerations. Include other standard references to the
borrower of the loan, the maturity and grace periods, as
well as the lending rate.
F. Implementation Describe the following features and other related aspects

Arrangements of project implementation according to the relevant OM sec-
tions: (i) procurement; (ii) consulting services; (iii) disburse-
ment policies; (iv) reports, accounts, and audit (including
the project completion report); (v) retroactive financing
(including its justification); (vi) benefit monitoring and
evaluation (BME); and (vii) lending and relending policies.
Minimize routine details in the main text, but explain spe-
cial features, particularly departures from the norms, if any.
Give tabular presentations with brief descriptions, where
appropriate.
G. The Executing Agency Where ADB has previously lent to the EA, information on
compliance with financial, audit and any operating cov-
enants should be provided. Subsequent analyses in the
Chapter should emphasize comparisons of covenanted fore-
cast performance with actual performance. Assess the EA’s
past record in project implementation (where applicable),
especially its involvement in ADB-assisted projects and its
capability with regard to the project. Give particular atten-
tion to institutional capability in the case of a sector loan
proposal. The assessment of the institutional capability in
Chapter III (Background) should demonstrate that appro-
priate sector policies and institutions are, or will be, in
operation. Analyze the EA’s capacity in this section.
Give a detailed description of an EA only when it is en-
gaged in an ADB project for the first time, when it is the
beneficiary of institutional strengthening measures, or when
it is the borrower. Otherwise, briefly describe the EA’s ca-
pability in the main text, and provide details on its strengths
and weaknesses and its financial evaluation in an appen-
dix. The appendix may include an organization chart. Where
applicable, give a detailed financial evaluation of the EA.
When TA is provided to address an EA’s institutional weak-
ness, provide a brief statement on the need addressed, with
a cross-reference to the more detailed description of the TA
under the Technical Assistance subhead in this chapter.
H. Environmental and
Social Measures
I. Technical Assistance
J. Policy Issues
V. PROJECT JUSTIFICATION
A. Financial and Economic Focus on general financial and economic analyses without
Analyses repeating information from Background, Rationale, or Tech-
nical Justification. Give a realistic assessment of the “with”
and “without” project situations. Follow the standard ADB
methodology for financial and economic analysis and for
sensitivity and risk analysis. Where applicable, compare the
projected financial and economic internal rates of return
with those achieved in similar projects post-evaluated by
ADB.
The various project risks and related issues should be ad-
dressed in this section. Risk analysis need not be confined
to data assumed in the economic analysis. Institutional or
other constraints will also constitute a risk that should be
addressed by the project and discussed after Implementa-
tion Arrangements.
B. Environment
C. Social Dimensions
D. Impact on Poverty
E. Risks
VI. ASSURANCES
VII. RECOMMENDATION
APPENDIXES
Cost Estimates
Financial and Economic Analyses
Financial Statements (of public utilities, incorporated companies, and other entities)
3.7.3.2. Past Financial Performance
3.7.3.2.1. Whenever the borrower or EA of a proposed loan is an existing agency, its

past financial performance should be analyzed for at least the most recent two completed
fiscal years, preferably based on audited financial statements for those years. The text
discussion should note significant conclusions reached on past financial performance
and the factors contributing to satisfactory or unsatisfactory results. Detailed analysis
should center on any problem areas in the financial statements – balance sheets, income
statements and cash flow statements.
3.7.3.2.2. For textual presentations, a financial summary table for the balance sheets,
income statements and cash flow statements is often the most useful and space-saving
form. However, separate summary tables are acceptable, particularly when used to reinforce
a specific discussion in the text. These statements, where presented in the text in summary
table form, should cover a period long enough to give an adequate picture of recent
financial performance. In most cases, this will be two or three years, based on audited
accounts for the fiscal years concerned.
3.7.3.2.3. For repeat borrowers/EAs, the period should cover from the date of signing
of the last loan to the date of Fact-Finding and appraisal, with a table to show actual
performance with the forecast in the previous RRP.
3.7.3.2.4. The subject headings in the summary tables may vary depending on the
type of project and the particular focus of the text discussion. In general, however, the
tables should highlight important relationships regarding the financial structure of the
enterprise, its ability to generate funds, and its profitability.
3.7.3.3. Present Financial Condition
3.7.3.3.1. An EA’s current condition may warrant separate discussion in the text, or
may be described when referring to the past financial condition. If the analysis of the
present financial condition is based on current budgets and not on confirmed actual
performance, the report should comment on the validity of the data used. If these data
are likely to form the basis for financial forecasts during the project period and thereafter,
and if the analyst is unable to obtain firm knowledge of the present financial position,
the projected data should be subjected to sensitivity analysis, using, as far as possible,
data on confirmed past performance as bases for measuring and forecasting.
3.7.3.3.2. The discussion of the present financial position should highlight the strengths
and weaknesses of the EA’s finances and its performance of relevant activities. The reasons
for weaknesses should be fully discussed along with proposed remedies for resolving
these.
3.7.3.3.3. If necessary, requisite performance and remedial undertakings should be

sought in financial covenants with staff judgments on the potential effectiveness of such
remedies explained in the text.
3.7.3.4. Cost Recovery and Profitability
3.7.3.4.1. Where cost recovery and/or profitability are primary objectives, the financial
consequences of policies, strategies, and practices relating to the entity’s operations or
trade should be set out, for instance: (i) policies on recovery of costs of its products and/
or services; (ii) the tariffs and charges levied; (iii) the systems of establishing costs of
products and/or services; (iv) inventory controls; and (v) the possibility and extent of
external regulation (e.g., by government).
3.7.3.4.2. Discussions of detailed costs, cost recovery and detailed revenue yields should
be designed to support the overall financial analysis and any special issues, such as marginal
cost pricing, which may be presented elsewhere in the report.
3.7.3.5. Other Strengths and Weaknesses
3.7.3.5.1. Finally, this section of the report should review any aspects of an EA’s current
financial affairs not discussed elsewhere. These could include: (i) financial management
and accounting systems or financial reporting and auditing procedures to the extent that
they are not reviewed in the implementation chapter; (ii) financial relationships between
the borrower, the EA, and other involved EAs; (iii) financial aspects of an agency not
reviewed and the reasons for their exclusion; or, (iv) in the case of a recently-established
agency, the staff’s judgment on the feasibility and reliability of a borrower’s proposals for
financial operation of the EA.
3.7.3.6. Future Financial Performance
General Content
3.7.3.6.1. This review may begin with an analysis of the financing plan for the project
and the EA’s operations and investment program over the project period. Irrespective of
the presentational style of the section and the sectoral format used, the substantive
discussion should focus on the agency’s estimated future earnings and financial position.
Financing Plan
3.7.3.6.2. A principal objective of financial analysis is determining the adequacy of a

financing plan. The summarized content of these plans should be consistent with data
in the cash flow statement.
Projected Financial Forecasts
3.7.3.6.3. Projected balance sheets, income statements and cash flow statements of the
EA should be shown in summary tables, so as to permit comparisons between past and
forecast data and to allow for ready identification of trends. The data should be consistent
with demand and disbursement forecasts elsewhere in the report. Forecasts should
normally be made for a period covering the duration of project construction up to at least
the end of the third year of normal capacity operations. The aim is to provide adequate
data on the profitability and debt servicing ability of the enterprise in relation to the
investments to be undertaken under the project.
3.7.3.6.4. Forecasts should normally be made until a “steady state” has been reached,
reflecting normal utilization of project facilities. If a substantial financial change is forecast
within the life of the loan that would seriously affect the “steady state”, the text should
specifically discuss the impact of such a change on the financial condition of the EA. If
possible, the projections should be extended to cover such an event; for example, the
completion of a delayed and parallel dam-building project for a mixed hydro/coal-burning
power utility some seven years after project completion of a coal-fired station, that could
reduce the coal consumption until power consumption demand again exceeded the hydro
station’s capacity.
3.7.3.6.5. The text should generally discuss: (i) financial objectives of the project and
where applicable, the project entity; (ii) future cost recovery/profitability, including
assumptions made about physical volumes, prices, tariffs and costs, etc.; (iii) systems of cost
recovery, tariff regulations, user charges and credit provision; (iv) ability to meet debt service
obligations and to finance capital expenditures; (v) adequacy of future financial position in
relation to capital structure (debt as a percentage of total capitalization) and working capital
(quick or current ratio); (vi) major risks and uncertainties not discussed in the Economic
Analysis discussion which might affect the forecasts presented; and (vii) recommended
covenants, action plans and any measures judged necessary for the improvement of
financial performance. These might include covenants on minimum levels of earnings,
operating cost reductions, or restrictions on the incurrence of additional debt, the
establishment of revised or new tariffs, or of targets to be achieved by the borrower.
3.7.3.6.6. Financial criteria to be applied to sub-projects or components that will be

appraised and if appropriate, approved after Board presentation of the main project,
should be established and discussed the main body of the RRP, and if necessary, detailed
also in an Appendix.
Proposed Cost Recovery and Potential Profitability
3.7.3.6.7. In the case of established EAs, this review may continue the discussion of
past and present performance. The text should describe the agency’s practices or proposals
(either agreed, or to be confirmed in legal agreements) at least during the project period
and the early operating period. The discussion of cost recovery should also indicate the
expected real increases in costs and the required real increases in tariffs during the forecast
period. Any tariff studies to be undertaken should be noted. Justification of the use of
subsidies should be mentioned, and a program presented for their reduction or elimination
over time.
3.7.3.6.8. Financial objectives, together with an operating covenant or other financial

covenants designed to promote their achievement, should be explained. Specific indicators
to be used in monitoring financial performance should be explained, if necessary. The
performance of comparable institutions in the sector and country should be briefly
reviewed to establish any key factors which could affect cost recovery and profitability
in case where there is no past performance on which to base projections. In such cases,
inputs, outputs and performance estimates will be based entirely on assumptions and
targeted performance. It is essential, therefore, to express a judgment on the adequacy
and reliability of the factors on which the forecasts are based.
3.7.3.6.9. This section of the RRP should also discuss the impacts on an agency’s forecast
financial statements of changes to prices and/or tariffs (and related government policies).
The rationale for pricing of goods and/or services to be provided under the project and
actual or potential government intervention in the price or rate-making process may be
relevant to economic analyses and project justification. These may be discussed in the
economic analysis section of the RRP.
3.7.4. Miscellaneous ADB Reports
3.7.4.1. Introduction to Miscellaneous ADB Reports
3.7.4.1.1. ADB requires information on the financial performance and status of EAs,
and on their financial management, accounting and auditing systems at various times in
the project cycle. Typical reference points are: (i) Fact-Finding and appraisal mission
Back-to-Office reports with appendixes, including Memoranda of Understanding with
borrowers and EAs; (ii) Project Briefs with appendixes; (iii) Management Review Meetings;
(iv) Staff Review Committee Meetings; (v) Project Administration Back to Office Reports
(vi) PAC Meetings; (vii) PCR and PPAR preparation.
3.7.4.1.2. The structure, format and content of the reports to be made for these meetings
and for the permanent record (the Project File) will vary according to the objectives of
the particular mission or meeting.
3.7.4.1.3. The Project Administration Instructions (PAIs) provide considerable guidance

on the principles and extent of the financial and institutional information required. The
following PAIs should be reviewed to ensure that the requisite financial and institutional
data are made available as required:
PAI 1.02 Staff Responsibilities for PAI 6.02 Internal Procedures and Reports
day-to-day Loan Administration (Project Inception Mission;
PAI 1.05 Preparatory Supervision Actions – Review Mission; and Project
Project Administration Completion Report Mission)
Memorandum PAI 6.03 Internal Procedures and Reports
PAI 3.02 Procurement – Reports of Project Administration
PAI 5.07 Project Administration Activities – Missions
Project Cost Overruns PAI 6.06 Project Administration –
PAI 5.08 Project Administration Activities – Project Administration Reviews
Provision of Local Cost Financing PAI 6.07 Internal Procedures and Reports –
by Borrower Project Completion Report
PAI 5.09 Submission of Audited Project
Accounts and Financial
Statements
3.7.4.1.4. The compilation of information, including financial analysis and financial

forecasting, for the various meetings and reports listed in this subsection should be based
on the advice and guidance provided throughout these guidelines.
3.7.4.2. Project Completion Report (PCR)
3.7.4.2.1. PAI 6.07 governs the preparation of Project Completion Reports (PCRs).
PCRs should be prepared by the EA. A final PCR is then prepared in accordance with
PAI 6.07. In some cases, PCR preparation may require information and technical expertise
from a financial analyst.
4. Financial Management of Executing Agencies
4.1. Financial Management Overview
4.1.1. The primary objective of the financial management process is to optimize

financial and economic benefits from an investment. Financial management comprises
multiple processes, including financial accounting, management (and cost) accounting,
assets accounting, cash and money markets accounting, financial reporting, internal
controls and internal audit, with external audit providing a report and opinion on the
reported financial status and performance. Each of these processes, including financial
management itself, should incorporate subprocesses and techniques, including
management, forecasting, strategic planning, planning and budgeting, procurement,
disbursements, control and communications.
4.1.2. The objective of this Part of the Guidelines is to assist a financial analyst to
examine institutional and systems requirements and to prepare appropriate financial
analyses. These are needed to support an investment from its inception through
completion, and where necessary, through the life of the loan or credit. In addition this
part will also help the analyst define efficient forms of performance measurement for use
in monitoring project implementation and obligations undertaken by a borrower.
4.1.3. The general objective of ADB appraisals of EAs and IAs is to ensure that they
are technically, managerially and financially capable of efficiently and effectively
implementing proposed projects or programs. The specific appraisal objectives are to: (i)
develop criteria on which to decide whether institutional capacity (in terms of financial
management) is sufficient to justify loan approval; (ii) identify the institution’s development
needs (in terms of financial management) – both project related and long term – that
should be addressed either as a project component or by technical assistance; and
(iii) confirm that the financial management system is sustainable.
4.1.4. Together with the parts on Investment Projects, Reporting and Auditing,
and Financial Institutions, this part is aimed at providing the financial analyst with a
comprehensive view of financial management of projects, based on ADB’s Operations
Manual and related guidance documents. In addition to this introduction, Financial
Management has three parts:
2 of 90 Financial Management of Executing Agencies
4.2 Institutions and Systems This part describes techniques for examining the
various institutions and agencies of borrowers,
particularly as they impact on the financial
management of projects.
4.3 Financial Analysis This part describes forecasting and financial analysis
in relation to executing agencies.
4.4 Measuring Performance This part is mainly applicable to the executing

agencies of revenue-earning projects. It describes
the financial performance measurements that can
be used to assess the performance of the EA in
achieving the financial objectives of the project.
4.1.5. Each of the financial management processes and techniques that these
Guidelines describe must be tied directly to the physical components and operational
elements of the investment project.
4.1.6. ADB appraisal of borrowers, EAs and/or PIUs is not usually necessary where
the World Bank has already appraised these clients. In these cases, ADB accepts the
World Bank certification unless there is fundamental disagreement, which must be justified
with full reasons.
4.2. Institutions and Systems
4.2.1. Introduction to Institutions and Systems
4.2.1.1. The Operations Manual 35 sets out ADB policy with respect to the need for
the examination of the EA’s financial management systems at project preparation and
appraisal. This is to form an assessment of the financial policies and the capacity of the
financial management systems practiced or proposed by the borrower or EA to support
project implementation and operation.
4.2.1.2. The EAs should be capable of providing correct and timely information on
the progress of project implementation and, where appropriate, on its operation. ADB
has also to be assured that the expenditures incurred on a project will in fact be used
for the purposes stated in the loan agreement.
4.2.1.3. The identification, preparation and appraisal activities to be undertaken by a

financial analyst prior to loan negotiations should be adequate to comply with the requirements
Financial Management of Executing Agencies 3 of 90
of OM 35 (particularly Sections 2, 6 and 7). Identification and preparation of an investment

project requires a financial analyst to obtain a detailed knowledge of the institutions and
systems that are, or will be used for implementation and where appropriate, future operation.
This task includes, among other things, acquiring the knowledge and ability to determine
at, or before appraisal and preparation of the RRP, whether or not the financial management
system(s) proposed by the borrower and the EA will be sustainable from project start-up,
through implementation, and where appropriate, for the operation of the project.
4.2.1.4. The financial analyst should make recommendations to the borrower and
ADB on the minimum changes to be made in financial governance, including financial
management, considered necessary to assure efficient and effective delivery of the proposed
project from start-up. The financial analyst should define to the EA and ADB those elements
of a financial management system that either should be put in place before start-up, or
within a defined time after start-up. This is to enable the financial management system
to operate at full efficiency. The elements identified may constitute components that are
to be financed as part of the project, and completed in accordance with a timetable
acceptable to ADB.
4.2.1.5. The financial analyst should advise ADB in all cases where, in their judgment,
the level of financial governance proposed by the EA would be inadequate to sustain the
proposed project or the financial viability of the entity – especially if no defined
modifications are to be set in place either before start-up, or within a reasonable period
of time following start-up.
4.2.1.6. The objectives of preparing and appraising institutions and systems are as
follows: (i) to assess the institution’s capacities in regard to project implementation (in
the case of project preparation) or in regard to performing its sectoral role (in the case
of sector reviews); (ii) to understand the role and significance of an institution within
the overall political, executive, and institutional/systems environment, including its likely
capability and capacity to influence decisions that will be beneficial to its project
implementation; (iii) to ensure that the proposed project is likely to be acceptable at the
highest decision-making (including political) levels; (iv) to ensure that it will be tailored
to the technical and managerial capacities of the agencies; (v) to identify the specific
institutional deficiencies regarding financial management that should be addressed prior
to appraisal; (vi) to develop specific institutional strengthening measures with regards
to financial management; and (vii) to define to the EA the appropriate project management,
implementation, and where appropriate, operational arrangements for the project.
4.2.1.7. The extent of a financial appraisal will depend upon the extent and type of
dealings ADB has with the concerned EA, the EA’s experience in implementing projects,
and the extent and nature of previous institutional strengthening. An appraisal’s scope,
pertaining to financial management activities, should include: (i) analyzing the EAs’
structure and management framework with regards to financial management; (ii) assessing
the agency’s resources, including the number, quality and technical capabilities of its
staff, the extent of financial and budgetary support it obtains, the nature of technology,
equipment, software in use; (iii) assessing the agency’s operating results (preferably for
a five-year period) and identifying specific performance shortfalls or variances. After
this, a diagnosis of performance shortfalls should be undertaken to identify specific
institutional deficiencies and related institutional strengthening interventions. The
institutional deficiencies should be classified into those pertaining to the management
framework and those due to resource constraints.
4.2.2. Major Institutional Assessments
4.2.2.1. For longer term and more comprehensive institutional strengthening of

financial management, a detailed examination, with recommendations for improvements
should preferably be part of the periodic country/sector reviews normally undertaken by
ADB, or as a discrete and independent exercise by itself undertaken at the request of the
concerned agency/government.
4.2.2.2. Specific consultant TORs should be included for the appraisal of the
concerned EAs’ financial management arrangements. The consultants recruited must
specialize in financial management. Their experience must relate to the operations of the
agency concerned. Usually two to three person-months’ time is sufficient to conduct an
institutional assessment of financial management arrangements and recommend corrective
actions if required.
4.2.3. Governance
4.2.3.1. The ADB’s governance policies are operationalized through OM 54. This
OM was developed from ADB’s Paper on Governance: Sound Development Management.
It is recommended that this Paper also be studied to appreciate the thrust of ADB’s policy
on Governance as set out in OM 54.
4.2.3.2. ADB regards questions of governance from the standpoint of their relation
to the effectiveness with which development assistance is used, the impact of development
programs and projects, and the absorptive capacity of borrowing DMCs. However, ADB’s
analytical framework for addressing governance issues draws a distinction between
elements of good governance and the specific areas of action (e.g., public sector
management), in which they could be promoted or their existence enhanced. Accordingly,
ADB has identified the four basic elements of good governance: accountability,
participation, predictability, and transparency.
4.2.3.3. A financial analyst, or any staff member or consultant engaged by ADB to

define the financial management and analysis requirements of a project, the project’s EA
and any associated organizations must take into account ADB’s policy on good governance.
This would also include ADB’s definitions and the approach to supporting its DMCs in
achieving that goal through its operations. By defining the above key elements of good
governance, and drawing attention to the linkages between these four elements, ADB
makes clear that sound development management is critical for ensuring adequate returns
and efficacy of the programs and projects it financed and that these should be used to
underpin its good governance policy.
• OM 54 proposes that ADB will enhance accountability by focusing on public sector

management, public enterprise management, public financial management, and civil
service reform.
• Under par ticipation
participation
ticipation, ADB will support involvement of beneficiaries and affected
groups in development programs and projects; the development of closer interfaces
between public and private sectors; decentralization of economic functions
(particularly to local government units); and cooperation with NGOs.
• As regards pr edictability
predictability
edictability, ADB emphasizes enhancement of effective legal and
regulatory regimes for economic development and capacity building of institutions
responsible for the administration and enforcement of such laws and regulations
including training of legal personnel.
• Disclosure of information, as stressed in OM54 is the principal focus of ADB’s support
for transpar ency
transparency
ency, ranging from national-level data (statistics, etc) to annual financial
reporting by EAs.
4.2.3.4. While ADB intends to provide specialist support to advise on, and to assist
in project preparation and implementation for financial management-related components,
it will remain the responsibility of each financial analyst to prepare, appraise and supervise
each element of the project. This should be done in a manner that is fully responsive to
ADB’s governance policy. While it is recognized that accurate information on transparency,
in particular, may be limited or not available with respect to a proposed project in the
early stages of design and development, the financial analyst should still encourage the
EA and any PPTA consultants to ensure full disclosure of all institutional, systems, and
financial management aspects by the time final documentation of the project is available
for appraisal.
4.2.3.5. OM 54 and the policy paper are extensive in their scope, their proposed
assistance and definitions, together with a forecast of ADB’s commitments, to not only
assist the DMCs, but also to ensure that ADB itself can be held equally responsible for
upholding its governance tenets.
4.2.3.6. ADB’s Policy Paper on Good Governance also stresses the need to be vigilant
with respect to corruption and fraud. To further assist financial analysts and others
concerned with corruption avoidance, the Knowledge Management section of the web-
based Guidelines contains useful reference materials on anti-corruption.
4.2.4. Financial Policies
4.2.4.1. ADB Policy
4.2.4.1.1. ADB requires that a project be designed, developed, and operated (among
other factors) within the framework of the financial policies, strategies and systems
prescribed by those institutions of the government concerned which are responsible for
national and sectoral economic and financial planning.
4.2.4.1.2. The project should respond to a clearly defined objectives, including among
others, sustainable economic goals; execution based on the least cost solution; time-
bound delivery of benefits; and financial viability. ADB has a broad interpretation of
financial viability in this context. It implies at an optimum, the ability of a project to
replicate itself, to finance day-to-day operations and maintenance, and to service its debt.
As a minimum, financial viability should represent the provision of adequate funds to
finance day-to-day operations and maintenance. The provision may come from either
the operations of the project itself and/or from government budgetary support, this will
be sufficient to assure ADB that a partial revenue earning or a non-revenue- earning
investment will generate the target levels of economic benefits through its working life.
Exceptions to the For egoing

Foregoing
4.2.4.1.3. Circumstances may exist at fact-finding of a project where the prescribed

financial policies, strategies and systems of the governments concerned in part, or as a
whole, may contain defects not acceptable to ADB and which may affect the design and
execution of the project. In such conditions, the design of the project should formulate
means of eliminating these defects in the financial policies, strategies and systems of the
government concerned to enable the financial analyst to confirm at appraisal that the EA’s
financial management systems will be sustainable.
4.2.4.1.4. This means that the financial policies, strategies and systems of the
government must be adequate to underpin the EA’s financial management systems, and
will support the project and the EA from project start-up, through implementation, and
where appropriate, during the operation of the project.
4.2.4.1.5. The project should include as covenants in the legal agreements, steps to be
undertaken by the government in applying policies, strategies, and systems acceptable
to ADB. These steps should support the project from the start of implementation through
its working life. Also, policy dialogue should be conducted to remove concerns or
unacceptable policies and practices.
4.2.4.2. Financial Analyst’s Responsibilities
4.2.4.2.1. The financial analyst has to obtain sufficient information to assure ADB during
fact-finding and by appraisal that a project will be developed and operated within a
framework of governmental financial policies, strategies and systems. And they should
be assured that said framework is fully aligned with ADB’s policy.
4.2.4.2.2. ADB typically uses various covenants in loan agreements, including financial
performance covenants, to reinforce these assurances.
4.2.4.2.3. Following project inception, the financial analyst is required to continually

assure ADB management that the above framework will facilitate the accomplishment of
project targets.
4.2.4.2.4. The financial analyst should also draw the management’s attention to any change,
which has occurred, or could occur, in financial policies or strategies or systems, (including
failure to comply with financial covenants) which could reduce project effectiveness.
4.2.4.3. Executing Agencies (EAs)
4.2.4.3.1. A project may be designed and/or implemented by an EA, which acts solely
as a vehicle for its development, prior to its transfer on completion to an operating agency.
4.2.4.3.2. More frequently, particularly in the case of semi-autonomous public sector

enterprises, the agency is the project executing and operating agency, and is typically
referred as the EA in ADB documentation.
4.2.4.3.3. EAs typically have as their primary objective the timely delivery of an
operational project, with parallel objectives of economizing and effectively using human,
physical and financial resources.
4.2.4.3.4. Operating agencies’ objectives should center on efficient operation by the

effective use of such resources to achieve economic objectives with capabilities to: (i) adjust
inputs and outputs to respond to changing objectives; and (ii) constantly measure the
impact and use of inputs and outputs.
4.2.4.3.5. A public sector enterprise, as a project executing and operating agency,

combines the two roles above, and embraces all the objectives, normally with better
opportunities to adjust project development to meet changing operating objectives as
implementation proceeds.
4.2.4.3.6. Identification and confirmation of the objectives of the project and those of
the implementing and operating agency, and the proposed and/or actual means of achieving
them, are the key tasks of the financial analyst.
4.2.4.3.7. While financial aspects of these matters should attract the financial analyst’s
principal attention, they must be intellectually aware of, and capable of responding to
other factors. These may be related economic and technical objectives, techniques of
design and implementation, and the operation of the project, together with the impact
of any related, ongoing facilities and activities with which the project will be linked.
4.2.4.3.8. These may include parallel investments in the same or other sectors that are
to be appropriately linked to achieve common economic objectives. For example, the
construction of water supply and sewerage facilities by different EAs, or by the same
agency drawing on differing sources of funding, should have common economic, financial
and environmental objectives. These should primarily be related to achieving appropriate
standards of public health, including in particular recognition of the financial impact
which good health has upon the earning capacity of the population concerned.
4.2.4.4. Financial Policies and Strategies for Projects

and EAs
4.2.4.4.1. The majority of ADB’s operations are in the public sector. Therefore, project
EAs and the projects that they design and implement must conform not only to their own
policies, (where these are acceptable to ADB) and to their prescribed systems, but also
to the various economic, technical and financial policies and strategies of their superior
authorities or controlling bodies. This also applies, almost without exception, to semi-
autonomous public sector enterprises.
4.2.4.4.2. An example of an exception could be a development bank (an FI) that is

incorporated as a public company with the government having 51 percent nominal financial
interest. It’s an exception since it has its own Articles of Incorporation which allows it to
adopt its own policies, strategies and systems, and be managed by a Board on which the
government is either not represented or is represented in a minority position only.
4.2.4.4.3. Governmental structures vary widely, therefore it follows that a wide range
of superior or controlling authorities of EAs exist. Therefore, the financial analyst must
obtain a detailed working knowledge of such authorities’ financial policies and strategies,
as well as of their financial systems of budgeting, allocations, allotments, and accounting.
4.2.4.4.4. The example below states a case where government may be encouraged to
review its financial policy with regard to a particular enterprise. A result of the financial
analyst’s examination of the financial policy in detail recognizes that the public sector
enterprise could, in fact, be strengthened by increasing its self-financing ratio, and by
the government withdrawing some of its financial support over time.
Example of Policy Adjustments to Improve

Opportunities for Market Participation
In an ADF member country, the Government sought ADB’s assistance to finance part of
the cost of a project to be executed by an enterprise intended by government to become
involved in open-market trading, particularly the capital market.
The government traditionally has onlent ADF funds at about one percent under market
rates, and provides from its own resources (revenues or loans) about 15 percent of the
capital resources needed, leaving the entity to provide the remaining five percent from
its own resources.
The debt-equity ratio of the entity is weak at 78:22, and examination reveals that only
4 percent of the total capital structure has been self-financed by the enterprise in recent
years. Furthermore, in the past two years, the government has been increasingly unable
to meet its commitments to finance its share of projects as agreed with ADB, and therefore
its commitment to this proposed project is insecure.
4.2.4.4.5. At fact-finding, the financial analyst and the Project Officer should discuss
overall financial planning with the enterprise, the sector and key economic and finance
ministry officials. Focus should be made on the need to immediately improve the
enterprise’s debt-equity ratio, particularly if it is to start market operations in the near
future.
4.2.4.4.6. Upon advising the government to adjust the cash-based self-financing ratio
over the maximum of a two-to-three-year period to about 20 percent, the enterprise
should automatically commence a program of reforming its debt-equity ratio by providing
self-generated contributions. As such, the government will then be relieved from making
any input after about three years.
4.2.4.4.7. The analyst should seek commitments from the government and the
enterprise that the self-financing ratio will be increased for this and future projects,
(whether financed by ADB or not). This is to bring the debt-equity ratio, closer to 60:40
by the end of project implementation. At that level, the enterprise is likely to have
substantially greater opportunities of participating in the capital markets as the new project
comes on line.
4.2.4.4.8. As a result of the financial analyst’s methodical scrutiny of the institutional

structures, unforeseen issues and problems are revealed, therefore preventing future
hindrance in implementation and operations. The working knowledge gained by the
analyst in the review of the policies and strategies, and their effectiveness would be essential
in the following stages.
4.2.4.4.9. It must be ascertained during appraisal that the institutional and financial
management systems of the EAs are capable of implementing the strategy. This would
include assuring the sustainability of the financial management systems from start-up.
4.2.4.4.10. The financial analyst must be able to specify the nature and form of the
analysis to be prepared by the EA. This should be in a manner that will enable the analyst
to determine whether the financial objectives of all involved are credible. They should
also be able to identify factors to which the proposed implementation and operations
may prove financially sensitive.
4.2.5. Country Diagnostic Studies of Accounting

and Auditing
4.2.5.1. In order to assist its DMCs to introduce and operate the most effective financial
management systems, ADB may from time-to-time, undertake a Country Diagnostic Study
of Accounting and Auditing (DSAA) in collaboration with the host government.
4.2.5.2. Each DSAA is designed to address and understand the financial management
characteristics and issues of a country. Experienced ADB staff and/or consultants will
conduct the study and a draft of the results will be shared with the government prior
to publication of the final document. A DSAA supports the achievement of ADB’s country
accountability and financial management objectives including:
• fiduciary responsibilities, by identifying the strengths and weakness of institutional

accountability in the public and private sectors and the risks that these may pose
to the use of ADB funds, and
• development objectives, by facilitating a common understanding of the country’s
financial management arrangements in the public and private sectors by the
borrower, EAs, and ADB and any involved development partners, thus facilitating
the design and implementation of capacity-building programs.
4.2.5.3. ADB may from time-to-time participate with the World Bank to conduct
joint studies for a country. The TORs may be common, or provided separately by each
organization to its staff and/or consultants, as appropriate.
As of June 2001, DSAAs had been completed for: During 2001, further DSAAs are being conducted on:
• Cambodia • Azerbaijan
• China, People’s Republic of • Fiji
• Mongolia • Marshall Islands, and
• Pakistan • Sri Lanka.
• Papua New Guinea
• Philippines
• Uzbekistan, and
• Viet Nam.
4.2.5.4. These studies can be accessed at www.adb.org/governance/govpub.asp.
4.2.6. Executing Agencies (EAs)
4.2.6.1. Introduction
4.2.6.1.1. ADB categorizes EAs as forms of organization that may undertake any
combination of the following activities in the public and private sectors: (i) design of a
project; (ii) implementation of a project; or (iii) operation of a project.
4.2.6.1.2. An efficient EA is critical to the success of implementing and, in many cases,

operating a project. Therefore it is essential that the management of an EA and its superior
management (for example, a ministry or government department), be fully informed of
ADB’s objectives and requirements for project implementation and operation.
4.2.6.1.3. Equally important, ADB staff are required to ensure that the objectives,
polices, strategies and management of an EA are completely aligned with ADB’s policies
and strategies for a project before recommending its processing to loan negotiations.
4.2.6.1.4. EAs are broadly classified into the following three types:
• public sector agencies, which include country/government technical line agencies

and state/provincial arms of such technical agencies, and local governments
• statutory bodies, public sector enterprises, or government-owned bodies such as
agricultural and industrial credit banks, fertilizer corporations and the like; and
• private sector organizations like commercial banks; public utilities; oil, gas and
minerals companies; telecommunications; farmers’ entities and associations; etc.
4.2.6.1.5. EAs are also classified as revenue-earning and non-revenue-earning. The

term revenue-earning encompasses EAs and projects to be implemented and/or operated
by it, which are commercially oriented enterprises whether in the private or public sector.
Revenue-earning would also cover public sector institutions, which generate substantial
revenues either by consumer charges, or forms of sector-specific local taxation (property
tax-based levies for water supplies, drainage, etc.), or both. Examples are public sector
enterprises, commercial and industrial enterprises, public utilities, telecommunications,
industrial and agricultural credit banks, parastatal, and municipal government utility
operations.
4.2.6.1.6. Non-revenue-earning projects are usually implemented and operated by

public sector EAs whose financial support derives predominantly from central, provincial,
state and/or local government budget allocations, and for whom there may be no cost
or only partial cost recovery, often accomplished indirectly.
4.2.6.1.7. Non-revenue-earning EAs include the above forms of governments’ ministries

and departments, and project EAs under their control in such sectors as poverty alleviation,
agriculture, education, highways, population, and health. An EA may have a tiered
management in the form of a Project Management Unit (PMU), with the latter having one
or more Project Implementing Units (PIUs). In such cases, the EA is responsible to the
borrower and ADB for the successful implementation of the project, including delivery
of all financial reports and auditors’ reports and opinions in accordance with agreed
timetables.
4.2.6.1.8. A principal concern of ADB is the efficiency of the financial management

and accounting systems of EAs, as an integral part of project preparation, appraisal and
implementation, and supervision. This concern is extended to the efficient operation of
the elements of the government agency charged with project implementation, even in
cases where project objectives initially do not include the improvement of the agency’s
financial and/or management performance.
4.2.6.1.9. Some projects may have as the primary or sole objective the improvement
of the operation of a government ministry (for example, a Ministry of Finance), a
department or an agency, or of a segment of the economy, such as the capital markets.
Such projects are normally classified as non-revenue-earning, even though the reforms
may impact significantly on revenue-earning performance of the economy.
4.2.6.1.10. Enterprises (as compared to non-revenue-earning EAs), as project

implementing and operating agencies, combine the two roles above, and embrace all the
objectives, normally with better opportunities as implementation proceeds.
4.2.6.2. Determining the Status and Roles of EAs
4.2.6.2.1. An EA is likely to be subject to regulation by laws, regulations and rules that

are administered by superior authorities, typically ministries or departments.
4.2.6.2.2. Departments in particular, that have forms of control over EAs, may
themselves be agencies of state or provincial governments that also are the subjects of
superior central administrations.
4.2.6.2.3. Therefore, extent of an EA’s autonomy and/or control by superior authorities

at all levels of a national government’s hierarchy should be established. This in order to
determine its authority and ability to formulate and implement financial policy, and to
design and install financial management systems, (and thereby indirectly to determine
how much time may be needed for making changes).
4.2.6.2.4. To resolve these concerns, answers should be sought to the following

questions:
• Is the EA fully autonomous (for example, can it legally exist in its own right by the
laws of the country without government control)?
• Can it contract, and sue and be sued in its own name?
• Can it determine its own financial policies?
• Is it government-controlled? If so, what is the extent of that controls and influence
on financial policies and accounting requirements?
• Is there a specified national code or chart of accounts?
• Is it a government agency? If so, does the EA’s management have any powers to
decide financial policy, determine its own accounting systems and financial
management rules, or does government prescribe these? For example, there could
be separate accounting rules for public sector enterprises.
• Is the project to be executed by a part only of an EA?
• Is it necessary or desirable to require a separation of accounts and/or funds for that
part of the EA only, and would such a step be feasible?
4.2.6.2.5. It is possible that an EA may not have a definitive view of related governance,
particularly the actual superior levels of control. In such circumstances, it may be prudent
to seek the advice of the government auditor.
4.2.6.2.6. Government auditors are often well informed on national legislation and of
the powers and duties of the agencies for which they have the responsibility for auditing.
4.2.6.3. Appraising an Executing Agency
Introduction
Introduction
4.2.6.3.1. This section covers the following areas:
• Overall Objectives
• Appraisal Methodology
• Designing the Institution Development Proposal
• Types of Institution Development Interventions
• Costing of the Institutional Strengthening
• Implementation Strategies
• Risks
Overall Objectives
4.2.6.3.2. The overall objective of appraising an EA is for ADB to satisfy itself that the
concerned agency does in fact have the technical, managerial, and financial capacity to
implement the proposed project or program efficiently and effectively. An appraisal’s
specific objectives, from the financial management perspective, are to:
• Develop criteria on which to decide whether to postpone loan approval until financial
management arrangements are strengthened appropriately.
• Assist in identifying the institution’s specific development needs (in terms of financial
management), both project related as well as long term, that are to be addressed
either as a project component or as an independent TA.
• Assist in arriving at appropriate project organization management and coordination
arrangements, with regards to financial management and reporting.
4.2.6.3.3. The appraisal of EAs for purposes of project planning should take place
during project feasibility studies. For longer term and more comprehensive institutional
strengthening, the appraisal should preferably be part of periodic sector reviews normally
undertaken by ADB or a discrete and independent exercise by itself undertaken at the
request of the concerned agency/government. Include specific TOR for Consultants for
the appraisal of the concerned EAs during project feasibility studies for project-related
purposes or during sector reviews for any independent assistance planned for institutional
strengthening. Consultants should be from the specializations of institution development
and the technical expertise related to the operations of the agency concerned.
Appraisal Methodology
4.2.6.3.4. An agency’s capacity to achieve results mainly depends on: (i) its structural
and managerial ability to effectively and efficiently employ its resources; and (ii) the
extent of resources mobilized in the form of financial budgets, the number and quality
of staff, and the extent and type of materials and equipment. In relation to financial
management, the appraisal and assessment of EAs should comprise the following four-
steps:
4.2.6.3.5. Step 1
1: Analyze the EA’s Structural and Management Framework:
• Examine the organization’s structure with regards to financial management. This

will include an analysis of how functions are distributed and distinguished, how
roles, responsibilities and authorities are delineated and apportioned both vertically
and horizontally, what are the key lines of command etc. Also included should be
an analysis of links with collaborating agencies also operating in the sector concerned.
• Examine the agency’s main administrative and management systems and procedures,
in relation to financial management. These should include operational planning
and programming systems, financial management and budgetary processes,
management information and monitoring systems.
4.2.6.3.6. Step 22: Assess Institutional Resources (Inputs)
• Assess the number, qualifications and experience of financial management staff at

all key levels.
• Assess for all relevant periods, the extent of financial support available in terms of
investment budgets and operating budgets. These should be described by major
items, as well as by allocations made to various operational units, both functional
as well as geographical.
• Assess the adequacy of agency accounting information systems.
4.2.6.3.7. Step 33: Assess Institutional Results (Outputs)
• Develop agency consolidated financial statements (against budgets) for each

functional area, for relevant operating periods, and for geographical agency units
(if these exist).
• Also develop consolidated financial statements for past operating periods (including
growth trends, if possible) and compare these against similar agencies (comparator
agencies may be similar agencies in other countries where the sociopolitical
environment, the cultural context, the geographical dimensions of operation are
similar).
• Identify financial performance shortfalls or variances by comparing current
performance with targeted performance, past performance-growth trends and, if
feasible, with the performance of comparator organizations.
4.2.6.3.8. Step 44: Analyze Performance Shortfalls
• Develop a diagnostic analysis of linkages between identified financial performance

shortfalls/variances and deficiencies in the agency’s resource availability and
management framework. This should be done in collaboration with the agency’s top
management. These analytical findings should be agreed with the agency’s
management.
• Together with the agency’s management, develop alternative institution-building
interventions, with regards to financial management arrangements. These should
be prioritized and based on an alternatives-analysis, using criteria such as cost,
envisioned scope of impact, degree of risk, ease of implementation, etc.
Design the Institution Development Proposal
4.2.6.3.9. Types of Institution Development Interventions, with regards to financial

management:
• When planning and designing institution development proposals (based upon project
preparation), staff should keep in mind that institutional strengthening can be targeted
at resource enhancement or management upgrading or both depending on the needs
identified. As a general rule, resource enhancement should be resorted to first, if
this option is available, since this can be achieved more easily and quickly.
• The caveat however, is that resource enhancement is normally only a short-term
solution to institutional deficiencies and should preferably be supported by more
basic institutional changes or upgrading. Changes in or upgrading of policies,
strategies, structures, administrative and management systems, etc. are far more
difficult to achieve, requires strong institutional support and commitment, and
consequently a more extended time frame. On the other hand, they have a more
lasting and permanent impact on institutional efficiency and effectiveness.
4.2.6.3.10. A general checklist of the types of institutional strengthening that may be

focused upon in an institution-building proposal is given below.
• Resource Enhancement
— Staffing: enhance staff availability; reallocate staff resources; upgrade staff skills
(training);
— Budgets: enhance operating budgets; reallocate funds by item; and
— Technology: enhance availability of equipment and materials; improve quality
of equipment; introduce new types of software.
• Management Upgrading
— Policies and Strategies: review, revise, change priorities, adjust funding

allocations, adjust strategic emphasis, build research and analytic capability,
enhance “market” or “sector” information system, etc.;
— Organization Structure: change and reassign roles and responsibilities change
lines of authority, revise position descriptions and position hierarchies, establish
task groups, create coordination mechanisms, strengthen linkages with
collaborating agencies, etc.;
— Administrative and Management Systems and Procedures: revise, upgrade,
simplify, reorient basic systems and procedures such as: planning and
programming, financial management, operations monitoring, information
feedback, personnel management and compensation, incentive systems, etc.; and
— Leadership Style: revise methods of communication, methods of involving staff
at all levels, build openness and willingness to innovate, etc.
Costing Institutional Strengthening
4.2.6.3.11. If part of a project, the institution strengthening measures should preferably

be consolidated into a discrete component to facilitate project administration. The costs
relating to such a component would usually include (i) consultant services; (ii) civil
works (e.g., training center), equipment, (iii) training expenses and (iv) administration
overheads (e.g., for the training center). Some of these costs could be recurrent costs that
will continue to be incurred even after project/TA completion.
4.2.6.3.12. In such a case careful consideration should be given to whether ADB should
fund such costs during project/TA implementation: if so, to what extent; and does the
government have the capacity to meet such recurrent costs after project/TA completion.
Given ADB’s tight TA budget, the availability of cofinancing or funding from other donors
should be examined.
Implementation Strategies
4.2.6.3.13. Implementation strategies will necessarily depend on the type of institution

development interventions planned. However, staff should bear in mind the following
when planning and scheduling the implementation of institution development
interventions with the agency concerned.
• Institutional strengthening measures, and especially those, which relate to the

upgrading of the management framework, have to be implemented in a gradual and
phased manner. Like a person, an institution takes time to learn, adopt and adjust
to new and revised forms of behavior; and
• Experience has indicated that it is very useful to make use of implementation
workshops. These are carefully structured discussion sessions of small groups of
concerned institutional staff held periodically. Their primary objectives would be as
follows: (i) creating awareness and recognition of the need to change, revise and
upgrade; and developing the commitment to do something about it; (ii) action
planning to ensure the active involvement of all concerned and to facilitate briefing
of what is required; and (iii) reviewing implementation to assess progress and impact,
and to accordingly adjust the direction, focus, schedule, etc., of the institutional
strengthening program.
Risks
4.2.6.3.14. Some of the major risks that should be taken into account when planning
institutional strengthening measures (in relation to financial management arrangements)
are as follows:
• In the case of resource enhancement – do not create dependency.

• In the case of management upgrading – do not create disorientation by introducing
too many changes too quickly.
• Do not overlap or conflict with already ongoing institutional strengthening initiatives.
4.2.6.3.15. Institutional strengthening programs should also always be proposed and

undertaken by ADB with caution, care and a great deal of responsibility. This is because
the longer-term risk-potential with institution-building programs is usually greater than
those related to the transfer of capital and investments. Furthermore, these types of
program can create dependency or result in the transfer of inappropriate technology.
4.2.6.3.16. If not done in a circumspect and phased manner, attempts to revise or upgrade
the management framework can create serious institutional disorientation, especially if
prior commitment at all levels has not been ensured for the changes being implemented.
4.2.6.3.17. External financing agencies tend to view “their” project as the most critical.
Consequently, institution-building activities can be implemented in a parallel rather than
a complementary manner. This usually confuses, rather than assists, the institution
concerned. In the longer term, the results of a misguided institution-building program
can consequently be quite the opposite than what was originally envisaged. It is therefore
always necessary and essential to proceed cautiously and with an action-learning format
that is structured to include phasing, review, and consequent program readjustments in
an ongoing cyclic process.
4.2.6.3.18. The extent of an appraisal will depend upon the extent and type of dealings
ADB has with the EAs concerned, the experience of the EA in implementing projects and
the extent and scope of institutional strengthening previously undertaken by ADB or
other external financing agencies.
4.2.7. Project Objectives
4.2.7.1. A project should respond to clearly defined objectives, including among

others, sustainable economic goals; financial objectives; achievement based on the least
cost solution; time-bound delivery of benefits; and financial viability.
4.2.7.2. ADB has a broad interpretation of financial viability in the context of project
design and development. It implies at an optimum, the ability of a project to replicate
itself, to finance day-to-day operations and maintenance, and to service its debt. As a
minimum, financial viability should represent the provision of adequate funds to finance
day-to-day operations and maintenance. The provision may come from either the
operations of the project itself and/or from government budgetary support, this will be
sufficient to assure ADB that a partial revenue-earning or a non-revenue-earning investment
will generate the target levels of economic benefits through its working life.
4.2.7.3. In addition, primary aims should be the extent to which the inclusion of
financial and institutional components of a project that can enhance good governance,
either of the EA and the project itself, or of any related/adjacent institutional elements.
4.2.7.4. For projects to be developed, implemented and operated by public sector

institutions, ADB requires that a project be designed, developed and operated (among other
factors) within the objectives and framework of the financial policies, strategies and systems
prescribed by those institutions of the government concerned. These are government
institutions responsible for national and sectoral economic and financial planning.
4.2.7.5. For private sector projects to be developed implemented and operated by

private sector institutions, ADB requires that a project be within the objectives and
framework of the financial policies, strategies and systems prescribed by the Articles (or
a similar statutory document) of the company or organization. Furthermore, this should
be within, and in conformity with, national and sectoral economic and financial planning
objectives
4.2.7.6. Identification and confirmation of project objectives and those of its

implementing and operating agency, and the proposed and/or actual means of their
achievement, are key tasks for the financial analyst.
4.2.7.7. While financial aspects of these matters should attract the financial analyst’s
principal attention, they must be intellectually aware of, and capable of responding to
other factors. These may be related economic and technical objectives, techniques of
design and implementation, and the operation of the project, together with the impact
of any related, ongoing facilities and activities with which the project will be linked.
These may include parallel investments in the same or other sectors that are to be
appropriately linked to achieve common economic objectives. For example, the
construction of water supply and sewerage facilities by different EAs, or by the same
agency drawing on differing sources of funding, should have common economic, financial
and environmental objectives. These should primarily be related to achieving appropriate
standards of public health, including in particular recognition of the financial impact
which good health has upon the earning capacity of the population concerned.
4.2.8. Revenue-Earning Projects
4.2.8.1.1. The public and private sectors are likely to operate many forms of revenue-
earning entities. Section 3.2.1 contains a listing of typical revenue-earning entities. The
delivery of goods and services by these institutions can embrace many different activities
and components, and therefore this listing should not be considered as comprehensive:
4.2.8.1.2. All public and private sector revenue-earning institutions operate under forms
of law, usually substantially defined within regulations and rules. The form of law will
differ extensively between public and private sectors.
4.2.8.1.3. Institutions may operate under the control or guidance of a particular

ministry of department such as a Ministry of Energy, Department of Agriculture, etc.
Their control/guidance activities typically impact nationwide and other ministries and
departments of government are likely to be involved. For example, a Ministry of Transport
is likely to be involved in reviewing and granting permissions for long distance water,
gas, oil pipelines construction. Typical examples are Ministries (or Departments) of
Economic Development, Finance/Treasury, Trade and Industry, Environmental

Protection and Consumer Protection.
4.2.8.1.4. Laws, government regulations and/or rules (in relation to financial

management) under which an entity operates should be examined, and the entity’s
observance or non-observance of them should be identified, so as to determine any possible
effects on the project cycle. Introducing new legislation or amending any existing laws
may require considerable time. Advice of the Office of General Counsel and the concerned
Operations Coordination Division should be sought if it appears that legislative changes
may be required. If introduction of legislation proves necessary, it should be made the
subject of a realistically dated loan covenant.
4.2.8.1.5. Statutory powers or requirements may relate directly to the entity’s operations
(e.g., power to fix tariffs and levy charges for products or services) or they may define
criteria within which an entity may operate (e.g., banking laws which define borrowing/
lending limits).
4.2.8.1.6. Detailed financial or accounting requirements may not be part of specific

legislation relating to the entity or in the entity’s “charter” but may be addressed in general
laws to which the EA’s “charter” may refer.
4.2.8.1.7. Most revenue-earning EAs are autonomous, or have a high degree of

autonomy, with powers to determine financial policies and the design and operation of
financial management and accounting systems. Some state-owned enterprises, on the
other hand, may be required to conform to a national accounting plan or chart of accounts.
Such plans and charts are sometimes not conducive to providing adequate information
for project and EA management.
4.2.8.1.8. The following is a checklist of items to be considered when reviewing these

arrangements. The reviews may take place at the time of project identification, preparation,
or appraisal. As a general rule, the earlier these reviews take place the greater the
opportunities for corrective or initiating actions for new systems.
• Statutory requirements for accounting • Centralized or decentralized accounting

and financial reporting systems
• Status of the entity (autonomous or under • Management accounting
government control) • Corporate planning and budgeting and,
• Accounting policies and practices in force budgetary control
• Financial regulations • Accounting systems
• Management and control • Financial management and internal
control and, internal audit systems
• Data processing – unless integrated in • Financial staff: management, competence,

above systems and training
4.2.8.2. Entity Status
4.2.8.2.1. Therefore, extent of an EA’s autonomy and/or control by superior authorities

at all levels of a national government’s hierarchy should be established. This in order to
determine its authority and ability to formulate and implement financial policy, and to
design and install financial management systems, (and thereby indirectly to determine
how much time may be needed for making changes). The following questions should be
resolved:
• Ascertain and describe in detail the status • Is it a government agency? If so, does the
of the entity within its system(s) of entity’s management have any powers to
governance; decide financial policies and accounting
• Is it fully autonomous (for example, can systems, or does government prescribe
it legally exist in its own right by the laws these? For example, there could be
of the country without government separate accounting rules for state-owned
control)? enterprises.
• Can it contract, and sue and be sued in • If it is a private sector enterprise, is its
its own name? governance satisfactory? Who makes
• Can it determine its own financial financial policy/strategy and who executes
policies? these?
• Is it government-controlled? If so, what • Is the project to be executed by a part only
is the extent of that control and influence of an entity? If so, has that part the
on financial policies and accounting necessary legal authority to do so?
requirements? If not, does it have an • Is it necessary or desirable to require a
adequate set of Articles or statutory form separation of accounts and/or funds for
of incorporation to operate in the private that part only, and would such a step be
sector? feasible? Would this increase operating
• Is there a specified code of chart of costs?
accounts?
4.2.8.3. Planning and Budgeting
4.2.8.3.1. Long, medium, and short-term planning should be the primary elements in
financial management. Long and medium-term plans are usually referred to as corporate
planning and require different planning approaches, often characterized by “rolling
program” techniques, or “indicative planning only”. Compared to the short-term budgeting
and budgetary control procedures, which are normally based on annual plans. In addition,
examination of planning and budgeting systems adopted by an EA should focus on the
emphasis placed on operational efficiency compared to routine fiduciary and revenue

control. Answers to the following groups of questions may provide an adequate overview
of the corporate planning and budgetary systems.
• Characteristics of Planning Is there a review system for tariffs,

Is there overall corporate planning? prices and charging mechanism?
What is the time span of corporate Is there a review system for capital
plans? expenditures?
How are corporate plans expressed? Do the corporate plans and annual
Are corporate plans summarized in budgets identify specific managerial
financial terms (pro forma annual responsibilities for implementation and
financial statements and balance review?
sheets)? • Timetables for Planning and Budgets
Are overall financial plans supported What is the timetable for preparation
by appropriate subsidiary budgets and approval of corporate plans and
(revenues and operating expenditures, annual budgets
capital expenditures, and debt/equity Does the timetable allow sufficient time
proposals)? for generation of all inputs and
What are the critical monitoring management reviews of corporate plans
indicators in corporate plans? and annual budgets (consider the
• Responsibility for Planning extent of centralization/
Who prepares and approves corporate decentralization of the entity)?
plans and annual budgets? Who prepares and controls these
timetables?
4.2.8.4. Accounting Policies
4.2.8.4.1. The acceptability of an EA’s accounting policies, including standards of

financial reporting and general accounting practices, should be examined. If these policies
do not conform to accepted international or national standards and practices, which
makes comparison and performance evaluation difficult, the EA should be informed of
any required modifications. In addition the EA should also be notified of the latest date
for the modification’s introduction (e.g., before project implementation commences, or
by a date to be specified in a covenant).
4.2.8.4.2. On the other hand, if only minor items are involved (e.g., methods of
apportioning overheads or valuing inventories), as long as these variances are quantified
and revealed in the annual financial statements and the auditor’s report, their continued
use may be acceptable.
4.2.8.4.3. At loan negotiations, where financial covenants are incorporated in the loan
agreement, the accounting standards that will be used as the basis for measurement of
financial performance should be defined.
4.2.8.4.4. If variances exist from acceptable accounting form and practices they should
be discussed with the entity’s auditor, if possible, before requesting a change in practices.
The auditor should be asked by the EA to address these subjects in the opinion and
report on the annual financial statements.
4.2.8.5. Financial Regulations
4.2.8.5.1. The underpinning of a sound accounting system is a regularly updated set

of financial regulations. These are usually designed to define the objectives of, and
responsibilities within, a financial management and accounting system. Regulations should
also clearly define who is responsible for the implementation and updating of financial
regulations.
4.2.8.5.2. The provision of new regulations or the improvement of existing ones should
preferably be sought before loan negotiations.
4.2.8.5.3. Assistance to introduce or improve regulations and systems should be

encouraged where necessary, by seeking Bank consideration of a proposal for technical
assistance to the borrower or EA.
4.2.8.6. Accounting Systems
4.2.8.6.1. ADB requires that appropriate systems of accounting and control be installed
and operational for a project, and where applicable, an EA.
4.2.8.6.2. Any issues or special requirements relating to the development of these

systems, particularly during project preparation, should be referred to the Regional
Director. If these are not resolved before appraisal, these should be referred to in the
Appraisal Mission Issues Paper.
4.2.8.6.3. To ensure accountability for project implementation funds, each project

should have an adequate accounting and internal control system for recording and
reporting project-related financial transactions from the time that project expenditures
commence (which could be before Board approval to the loan).
Ther
Theree ar
aree no exceptions to this rrequir
equir ement.
equirement.
4.2.8.6.4. Specifically, the system should:
• Be simple to operate; modern, efficiently managed, and fully

• Require staff to operate with minimum responsive to the needs of management
supervision, and have the necessary of the EA and the proposed project;
personnel trained to operate the system • Have adequate internal checks and
from project start-up; controls; be able to balance financial data
• At a minimum, provide records of frequently and to report project financial
project expenditures, receipts or results at intervals and within the time
monies and funds flow generally from frame required by ADB;
the date of first transactions, including • Where needed, meet requirements for
expenditures incurred prior to project Statements of - Expenditure (SOEs) or
approval which might be eligible for Imprest Fund records; and
inclusion in disbursement claims • Be capable of expansion, when necessary,
(retroactive financing); to meet the increasing demands for
• Where available, have data processing and financial data arising from expanding
information technology systems that are project activities or entity operations.
4.2.8.6.5. Where ADB is also concerned with the financial performance and status of
the EA, the latter should provide adequate financial management and accounting systems
and reporting procedures for both the project and the EA responsible for project
implementation from the start-up of the project. However, in cases where an EA’s systems
need upgrading or expansion to meet the requirements above, ADB may consider
approving the use of assistance as a project component. Such assistance does not exempt
the EA from providing accounting and internal control systems capable of meeting the
requirements with regard to the project accounting and reporting. Given ADB’s tight TA
budget, the availability of cofinancing or funding from other donors should be examined.
Centralized and Decentralized Accounting Systems
4.2.8.6.6. A financial analyst may be confronted with an inefficient accounting system.

The borrower may suggest a local freestanding system that would be more effective if it
would be merged with large central systems with their enhanced facilities. Or it may be
a centralized system would work more efficiently if it would be detached from the core
system, and establish a semi-autonomous accounting unit.
4.2.8.6.7. Large industrial and commercial organizations, or large state-owned

enterprises, may operate centralized financial management and accounting systems. In
many such systems, all information generated at operational levels (e.g., project sites) is
transferred to a central location for making payment to contractors, etc., for data
processing; and for compilation of accounting records.
4.2.8.6.8. Delays and loss of data can result, which affect, inter alia, prompt and accurate
reporting to ADB by the EA. In addition difficulties may arise when the external auditor
is required to provide a separate report and opinion on the project operations and on
the EA.
4.2.8.6.9. Conversely, decentralized systems, which permit local financial operations,

usually require more extensive controls and more staff with related difficulties of obtaining
good management.
4.2.8.6.10. Therefore, before recommending financial management and accounting

systems changes to a borrower on project (and, where applicable, EA), it is prudent to
examine the advantages and disadvantages of existing and proposed systems with regard
to the efficiency of centralized or decentralized operations.
4.2.8.6.11. Key factors to be considered are the competence of management, security,

internal controls, communications and the availability of trained staff to provide routine
quality performance, but also the ability to address non-standard operations, for example,
what to do when something goes wrong.
4.2.8.6.12. The financial analyst should be aware that there are snags and pitfalls when
deciding how to resolve these situations. One solution may require that a consultant
should be engaged under appropriate TORs to recommend most effective alternative
system requiring the least cost. Another solution, dependant on the role and responsibilities
of the EA, could be to recommend the hiring of an accounting firm to provide the necessary
financial information during the period of project implementation. Or financial analysts
can study the system(s) in detail and recommend their own solution for consideration
by the EA.
4.2.8.6.13. Whatever optimum solution is recommended, it must be acceptable to the

management of the EA. If management does not accept the proposed system, it is unlikely
to be successful, despite its potentially successful attributes.
4.2.8.7. Financial Management and Control
4.2.8.7.1. To judge the effectiveness of an organizational structure, the following should

be reviewed to judge their suitability to support project implementation and operation
and the extent of their observance in practice:
• By-laws of the entity;

• Executive orders (if any);
• Statements of objectives and policies;
• Organizational structure;
• Control environment, internal control and internal auditing;
• The need to furnish financial information on an entity’s performance to concerned
parties within and external to, the EA and the extent of the achievement of such
dissemination; and
• The impact of management and control systems on the operation of the financial
management and accounting systems should be examined by seeking answers to
the following:
— What is the background and experience of those who represent the finance
function on the Board of Management?
— Who in management reports on financial performance to the entity’s owners?
— Who reports on finance to the management? What is the status of this official?
— In what form and how frequently does management publicize its decisions on
financial policy?
— In what form and how frequently does management requires and receives
information about financial performance-type of reports and distribution of
such to various levels of management?
— What are the control systems and linkages between top management and
financial management, and between other managers and the financial managers?
— Do the answers to questions above add up to a system acceptable to ADB for
project implementation? If not, can they be amended in a timely manner to
facilitate project implementation?
4.2.8.8. Internal Audit
4.2.8.8.1. The following is an extract from the International Organization of Supreme

Audit Institutions (INTOSAI’s) Advisory Document on “Standards for Internal Controls”:
72. … internal control is a management tool. It is management’s responsibility to implement and

monitor the specific internal controls for its operations. Even in countries where specific controls
are set out in legislation, a manager has no less a responsibility for implementing and monitoring
those controls. All managers should realize that a strong internal control structure is fundamental
to their control of the organization, its purpose, operations, and resources. They should accept
responsibility for it.
73. To design, establish, and maintain an effective internal control structure, managers should
understand the objectives to be achieved. Legislation can provide a common understanding of the
internal control definition and objectives to be achieved. It can also prescribe the policies managers
are to follow to implement and monitor their internal control structures and to report on the
adequacy of those structures.
74. Management often establishes an internal audit unit as part of its internal control structure.
While internal auditors can be a valuable resource to educate and advise on internal controls, the
internal auditor should not be a substitute for a strong internal control structure.
78. Management can also use its internal audit unit to help monitor the effectiveness of internal
controls. The closeness of internal auditors to the day-to-day operations usually places them in
a position to continually assess the adequacy and effectiveness of internal controls and the extent
of compliance. The internal auditors have a responsibility to management for reporting any
inadequacies in the internal controls and any failure of employees to adhere to them and
recommending areas needing improvement. In addition, they should establish procedures for
following up on previously reported internal and external audit findings to ensure that managers
have adequately addressed and resolved the matters brought to their attention.”
4.2.8.8.2. The above advice was developed for use in public sector institutions, but
the key principles are equally applicable to private sector operations, except for the
suggestion that legislation may be necessary to underpin the provision of internal controls.
The key principles are:
• It is management’s responsibility to implement and monitor the specific internal

controls for its operations
• While internal auditors can be a valuable resource to educate and advise on internal
controls, the internal auditor should not be a substitute for a strong internal control
structure; and
• Management can also use its internal audit unit to help monitor the effectiveness
of internal controls. The closeness of internal auditors to the day-to-day operations
usually places them in a position to continually assess the adequacy and effectiveness
of internal controls and the extent of compliance.
4.2.8.8.3. Internal audit units and operations are most likely to be found in public and
private sector enterprises. The units may be centrally located with a mandate to monitor
the operation and efficiency of all units throughout the area of operation of the enterprise.
Exceptions may occur in very large operational units, where sub-units of an enterprise’s
internal audit group may have a high degree of autonomy.
4.2.8.8.4. It is unlikely that a non-revenue-earning PIU would have an internal audit

unit specifically installed, although a central unit of a ministry or department of
government may have been awarded the responsibility to review and monitor internal
controls of the PIU.
4.2.8.8.5. ADB’s primary concern is to be assured that internal controls not only exist
but also are the subjects of regular review and monitoring for efficiency and responsiveness
to current operations. Therefore, if an enterprise has an efficient means of achieving this
objective, the engagement of a specific internal audit unit may not be appropriate.
4.2.8.8.6. Where reviews and monitoring of ongoing operations of an enterprise are

inefficient, ADB should discuss with senior management of the enterprise the need to
introduce improvements, one of which may be the use of an internal audit operation.
Such a recommendation will require an expert to advise and evaluate a cost/benefit study
prepared for that purpose.
4.2.8.9. Financial Regulations
4.2.8.9.1. Financial regulations are usually designed to define the objectives of, and
responsibilities within, a financial management and accounting system. They may form
part of Standing Orders or Operating Rules or be a preface or appendix to a Manual of
Accounting, or they may be restricted to limited definitions of budgetary accounting or
internal auditing responsibility within an entity. They may range from government statutory
regulations to financial managers’ informal rules with no legal status, and should facilitate
the examination of the financial management systems by defining their structure and
subsystems, and by designating responsibilities.
4.2.8.9.2. Regulations, if any, should be reviewed for their form and content and for
their observance. Normally, before appraisal, the extent to which Financial Regulations
satisfactorily address the following should be examined:
• Basic financial policies regarding revenues • Planning and budgeting, including

and expenses medium to long-term investment
• Appropriation of surpluses/treatment of planning
deficits • Budgetary control
• Accounting organization • Bidding procedures

• Recording of assets and inventories • Payment procedures
• Inventory control • Form and timing of production of
• Depreciation rules financial statements and balance sheets
• Debt management • Internal checks and controls
• Billing and debt collection • Internal audit
• Write-offs • External audit
4.2.8.9.3. Regulations should also clearly define who is responsible for their
implementation. The provision of new regulations or the improvement of existing ones
should preferably be sought before loan negotiations. Assistance to introduce or improve
regulations and systems should be encouraged through a project technical assistance
component.
4.2.8.10. Management Accounting
4.2.8.10.1. A management accounting system should collect and promptly report

financial and related statistical information on all aspects of the operating performance
of an agency’s operations to the various management levels, supplying each level with
the necessary details at the appropriate times.
4.2.8.10.2. The management accounting system should produce the annual and periodic
financial statements, including the statements for audit. It should incorporate procedures
for recording current budgeting and financial planning data, record keeping and reports,
and cost accounting (including cost control and analysis) for recording costs. Desirably,
but not mandatory, it should use activity-based costing to report detailed costing of all
activities of the EA by allocating the maximum amounts of management, supervision
and maintenance costs to each activity as costs of production. Such a system, which is
often best illustrated in chart form, should include adequate internal checks, controls
and internal auditing.
4.2.8.10.3. In the absence of a chart of a management accounting system, an organization

chart of the entity’s operating structure should be obtained or drawn up by the financial
analyst. This should be suitably redrafted to illustrate the areas of management served,
or to be served during project implementation by the management accounting system.
The chart should show the linkages between the system and the management center of
the EA, and to a central organization, if the agency or system is a decentralized unit. The
chart should also show the main and subordinate activity areas. The following is a
hypothetical example.
4.2.8.10.4. Organizations have many differing forms of management - in some the

Controller may not have a responsibility for Programming and Budgeting:
Controllership Treasury
Programming & Budgeting Cash Collection
Financial Accounting Payments
Costing, etc. Banking Operations
Billing, Receivables Debt Management
Inventory/control
4.2.8.10.5. Finally, it should show established posts/salary levels, and posts occupied
and vacant. The borrower should be notified of any concerns about inadequacies, or
changes required in the management accounting system to achieve satisfactory project
implementation.
4.2.9. Non-Revenue-Earning Projects
4.2.9.1.1. The following topics, relating to non-revenue-earning projects, are examined

in this section:
• Financial Management and Accounting Systems

• Government Accounting
• Executing Agency (EA)
• Planning and Budgetary Control
• Financial Accounting and Costing
• Internal Control Systems
4.2.9.2. Financial Management and

Accounting Systems
4.2.9.2.1. For non-revenue-earning EAs, the design and installation of the initial
financial management system should usually provide for the necessary accounting
procedures throughout project implementation.
4.2.9.2.2. However, to save expenses, it may be useful to design and install a system
that can be readily converted for use during implementation. At project preparation the
financial analyst should either ensure that an existing system would be adequate for the
intended purposes or not. If the system is inadequate the EA should design and install
a system that will be operational when the project starts, and can be expanded, if necessary,
as the demands on it increase.
4.2.9.2.3. In non-revenue-earning projects, financial management and accounting

systems should be kept simple. An analytical cash book (showing the sources of funds)
with payments-out classified by project activity and payee, could form, a satisfactory
basic accounting tool with which to begin operations. It could be supplemented by
additional documents (e.g., asset registers, contract registers, inventory systems) as the
needs for these arise during implementation.
4.2.9.2.4. The staff required to carry out initial operations could also be minimal; one
or two competent account clerks or bookkeepers may be enough for each operational
center until full-scale operations commence. Their supervisor could initially be the project
manager, assisted if necessary by an accounting technician or an accountant.
4.2.9.2.5. A basic system should include internal controls, which divide responsibility
between those who approve budgets, authorize allotments, approve budgeted
expenditures, make payments from cash resources, keep the books of account, and
reconcile cash and bank balances with the books of account. If the staff is not large enough
to meet this minimum division of responsibility, devices to provide minimum security such
as requiring two persons to execute each action jointly, should be used (e.g., two signatures
on checks; two responsibility levels for posting account books and balancing).
4.2.9.2.6. Government departments or agencies implement most non-revenue-earning

projects. The checklist that follows is designed to facilitate examination of typical
government budgeting, accounting and internal control systems, and should be read in
conjunction with Reviews of Revenue-Earning EAs. The latter contains detailed
recommendations for reviews applicable to both forms of projects.
4.2.9.3. Government Accounting
4.2.9.3.1. Most non-revenue-earning projects will be executed by entities that are part
of a government, or government-controlled, government-sponsored bodies (e.g.,
cooperatives). Any existing financial regulations on the operation of financial management
and accounting systems should be reviewed to ensure their compatibility with ADB’s
requirements. Any amendments to regulations should be made only to strengthen an EA’s
internal systems, in addition to supporting the project.
4.2.9.3.2. Before each project is started, the financial analyst must achieve a complete
understanding of the principles, rules and operations of the management, accounting
and budgetary systems. Government systems may include what appear to be overly
bureaucratic prepayment checks; repetitive bookkeeping at different levels and locations;
performance delays caused by a seeming lack of delegated responsibility; and “old-
fashioned” regulations.
4.2.9.3.3. Dismantling existing checks and balances in systems, without (a)

understanding the consequences; and (b) substituting adequate new measures - without
the necessary trained staff to implement them - can cause more trouble than the existing
deficient systems. Improvements in government budgetary and accounting systems should
only be recommended and implemented when the analyst, the operating staff and the
government (and the government auditor in many countries) are mutually satisfied that
the changes are beneficial and operable. There should be assurance that adequately trained
staffs are available to operate the new systems.
4.2.9.3.4. As the largest collectors and distributors of funds in a country, governments

require sound financial management systems, with mandated methods of budgeting and
accounting. The Cash accounting basis has been the normal accounting practice for most
governments (as compared to the Accrual basis for commercial practice, including
parastatals).
4.2.9.3.5. An EA, which is part of a government administration, would normally adopt

the government’s systems of budgeting and accounting, unless the government and ADB
staff can agree that a specialized form of project accounting would be beneficial to the
government. Therefore analysts should recognize and report in the Aides Memoire and
BTORs of the Identification and Preparation missions (as well as in the RRP) that the
systems to be used are adequate and acceptable to ADB.
4.2.9.3.6. The responsibility for government accounting and budgeting services varies
among countries, and must be determined as part of project identification, in order that
missions can identify locations of the authorities for obtaining agreement to modifications
to a particular system. An Accountant- or Comptroller-General may be responsible, or
in other countries, the Ministry of Finance may determine the budgetary and accounting
practices.
4.2.9.3.7. Because there is no consistency, analysts must not assume (i) that the system
with which they are familiar in one country also applies identically in another and (ii)
that EA staff are fully conversant with the responsibility-levels and authority in their own
country. (The Auditor-General’s Office or equivalent may be the most reliable source of
information on the subject).
4.2.9.3.8. The senior financial staff of a recognized government accounting service

should hold responsible roles (e.g., accountants-general), from which they can influence
the development and maintenance of sound accounting practices.
4.2.9.3.9. The existence of these services cannot, however, be taken to imply that
government practices are automatically sound and acceptable for prospective EAs.
Prescribed government practices may have been unofficially modified at the local level
because they are too detailed, misunderstood or ill supervised.
4.2.9.3.10. Analysts should familiarize themselves with the precise roles which
responsible officials play in controlling and monitoring the performance of accounting
in government before seeking their assistance on specific project accounting matters.
4.2.9.3.11. The term “accountant” in government often has a very different meaning or
interpretation from “public accountant” in the private sector. An accountant-general may
be a designation for an official post, whose incumbent may have little or no knowledge
of finance and accounting.
4.2.9.4. Executing Agency (EA)
4.2.9.4.1. The status of an EA should be established to determine, in particular, its

ability to:
• budget for and obtain budget approvals for required funds;

• furnish funds promptly for project implementation and operation and maintenance;
• institute, operate or amend financial accounting systems to respond to ADB
requirements;
• provides the necessary staff, with requisite skills, for project implementation; and
• institute satisfactory internal and external controls and audit arrangements.
4.2.9.4.2. To the extent that any of the above requirements is outside the agency’s
jurisdiction, analysts should conduct the examination with the responsible institution(s)
to ensure either their agreement to fulfill the requirements promptly or to delegate to the
agency the right(s) to implement them during the project period.
4.2.9.5. Planning and Budgetary Control
4.2.9.5.1. The reviews relating to annual budgets and budgetary control recommended
in section 4.2.8.3 are also appropriate as far as they apply to a non-revenue-earning
project. Experience with these projects, however, emphasizes the importance of
determining the budgetary system that will apply during the project period.
4.2.9.5.2. At Project Identification, staff should be satisfied that they fully understand
the system and that they have obtained (or can obtain at negotiations) agreement on the:
(i) budget procedures to be used by an EA and/or by controlling institutions which
give higher level approvals and which will ensure timely and adequate project
implementation; (ii) timing of all budget framing and approval operations to ensure
annual allocation and release of funds, and (iii) timing of release of counterpart funds
provided in budgets.
4.2.9.5.3. If a borrower’s fiscal year in which the project is due to begin starts before
the date of loan effectiveness, it is essential to ensure that the budget for project start-
up (including the costs of operating the EA and its accounting system, and of engaging
auditors) is available for the initial fiscal year.
4.2.9.5.4. The availability of such provisions should be confirmed in the RRP. If there
are no budget provisions, the RRP should describe how the project would be funded
pending budget authorization.
4.2.9.6. Financial Accounting and Costing
4.2.9.6.1. It is preferable that an EA maintains at least the records specified in section

4.2.9.8, but in some accounting systems (particularly those of governments) many such
records – particularly control accounts - may not be maintained. Typical government
accounts may reflect only budget heads for services.
4.2.9.6.2. A project or project component may utilize only one line in an expenditure
“block,” or it may even be contained with other items in a one-line entry. Unless ADB
staff make early requests for more detailed reporting, project subcomponent expenditures
may be impossible to control when the project starts. When a government budgetary and
accounting system is to be used, it is useful to decide the details of project expenditures
for which regular reporting will be required, and whether these can be introduced into
the accounting or costing system without difficulty.
4.2.9.6.3. If they cannot, then the borrower and/or the entity should be asked to
establish a subsystem to meet ADB’s accounting and financial reporting requirements. An
EA should be encouraged to use the resultant totals of a subsystem to support or reconcile
the data in the standard system; i.e. the subsystem should become an integral costing
system of the main accounting system.
4.2.9.6.4. EA systems must be capable of clear and timely disclosure of: (i) cumulative
and annual project costs by components agreed on between ADB and the EA for each
project; (ii) operating costs by budget heads analyzed in sufficient detail to provide control
of incremental current expenditures; and (iii) the basis for all types of claims for
disbursement of ADB loans.
4.2.9.6.5. The first item above is particularly important in government accounting,

where asset records covering a period of years are not often maintained. It is also important
that the analyst ensures that the auditor will provide an audit opinion and report in a
form satisfactory to ADB if non-standard systems are introduced.
4.2.9.6.6. ADB may agree to finance incremental recurrent expenditures, i.e.,

expenditures above a particular level established at an agreed time with a borrower.
Government accounting systems may not distinguish between base and incremental
expenditures, particularly in the case of salaries, wages and related overheads. It is therefore
necessary to coordinate with an EA the formulation of adequate means of identifying
both budgetary provisions and accounting data that can provide for and report on these
expenditures. The following steps could be taken:
• estimate at appraisal the incremental current expenditures, and associate their

incidence with the tracking of implementation of physical inputs/outputs of the
project and reimburse a fixed percentage of total actual expenditures from each
agreed category of incremental expenses;
• establishing appropriate accounting for special heads of expenditure, subcodes,
subsystems and special reports;
• agreeing on accounting for only the main heads of expenditure concerned and
developing a formula for periodic application to total expenditures under those
budget heads to obtain a reasonable apportionment of incremental expenditures;
and
• continuously revising base and incremental costs.
4.2.9.7. Internal Controls
4.2.9.7.1. Any system to support a project should include basic internal control
measures. If the internal checks and control systems are not satisfactory, and the
effectiveness of the external audit is not established, then the project should not be allowed
to proceed until the borrower and/or EA has agreed to strengthen the internal control
systems.
4.2.9.7.2. Government auditors are normally responsible for the audit of the EAs that
perform non-revenue-earning projects. Therefore it may be appropriate to seek their
advice and experience with regard to the efficacy of internal controls in a particular system.
Their involvement may help to introduce any necessary tightening of controls, as well
as encouraging their active involvement in surveillance of the systems for project
implementation. The financial analyst may best achieve this by providing the government
auditor with a copy of the loan agreement immediately after its signing and discussing
the audit requirements.
4.2.9.8. A Simple System for a

Non-Revenue-Earning Project
4.2.9.8.1. The following is a simple system for a non-revenue-earning project. It should

be modified as necessary to meet the requirements of each project as well as the adequate
and timely delivery of required financial information to the borrowers and ADB.
• Project Entity Bank Account Record, by categories of expenditures

• Project Entity Cash Payment Record, by categories of expenditures
• Record of Project Expenditures incurred but not paid by categories of expenditures
• Record of Project Expenditures by Third Parties by categories of expenditures
• A Summary of the above to produce Total Project Expenditures by categories of
expenditures
• Record of Sources of Project Financing including ADB (and other lenders) Loan
Disbursement Claims
4.2.9.8.2. In addition, it is desirable that a simple General Ledger be used to record

at regular intervals the totals of payments (by week or by month) using checks and cash,
and funds received. This ledger, in addition to establishing summary accounts for the
above transaction accounts, should include accounts for: assets; liabilities; contracts;
and currency transactions.
4.2.9.8.3. Corrections and adjustments to the data entered in the basic records can be
made at any time prior to entries being summarized in General Ledger entries. Changes
to be made on data already recorded in the General Ledger will need special entries in
that ledger, preferably through the use of a Journal.
4.2.9.8.4. ADB’s Loan Disbursements Handbook is available from the Knowledge

Management section of the web-based Guidelines. The Loan Disbursements Handbook
provides guidance for financial analysts on Imprest Accounts, Statements of Expenditures,
and Accounts and Audit generally for projects.
4.3. Financial Analysis
4.3.1. Introduction to Financial Analysis
4.3.1.1. This Financial Analysis Section contains methods of preparing and assembling
data for financial analysis. The analysis is to provide a quantitative and qualitative
examination of the financial operations of revenue-earning and non-revenue-earning
projects in the public and private sector and, where appropriate, EAs (It may be noted
that for non-revenue-earning agencies, an analysis of the EA is rarely required).
4.3.1.2. This quantitative and qualitative examination is designed to: (i) assess the
financial viability of a proposed investment in a project; (ii) assess the financial viability
of a project, including during implementation, at commissioning and after completion;
(iii) illustrate the financial structure of an EA, and its existing and potential financial
viability, including the financial efficiency and effectiveness of its operations with and
without the project; (iv) assess the adequacy of the financing plan for the project; and
(v) advise on methods of improving the financial viability and efficiency of an EA including
the appropriateness of tariffs, prices and cost recovery generally, and on the financial
arrangements, conditions or loan covenants which should be required as conditions of
ADB financing, and the extent of a borrower’s compliance therewith.
4.3.1.3. This section illustrates, in particular, approaches to the analysis of revenue-

earning projects and EAs, because these are the most complex forms of analysis likely
to be required. The illustrations of sound financial management and analytical practices
herein should be modified to meet the requirements of each project. They are not intended
to substitute for the financial analyst’s judgment as to the best method of presentation
in each case, nor are they intended to define precise financial measurement criteria for
a project or, where applicable, an EA.
4.3.2. Financial Analysis Objectives
4.3.2.1. Introduction and Objectives
4.3.2.1.1. This section examines the following topics:
• Financial objectives of a public sector project

• Financial objectives of a private sector project
• Using financial analysis to identify achievement indicators (Using financial analysis
to generate financial indicators to demonstrate efficiency in the achievement of
objectives)
• Economic objectives.
4.3.2.1.2. The primary objective of financial analysis is to forecast and/or determine

the actual financial status and performance of a project and, where appropriate, of the
EAs. This is to enable ADB to combine that information with all other pertinent data
(technical, economic, social, etc.) in order to assess the feasibility, viability, and potential
economic benefits, of a proposed or continuing lending operation.
4.3.2.1.3. A secondary objective is the provision of technical assistance to a borrower

and an EA to enable them to make similar assessments for the project and to apply the
techniques to other non-ADB investments.
4.3.2.1.4. A tertiary objective is to encourage borrowers and EAs to make any necessary
changes to their institutional and financial management systems to facilitate the generation
of appropriate data to support good financial analysis.
4.3.2.1.5. The objectives of financial analysis as set out above are intended to measure
the achievement of financial objectives of a borrower, the project to be (or being) financed,
and its EA.
4.3.2.2. Financial Objectives: Public Sector Project
4.3.2.2.1. Public sector projects are classified as revenue-earning and non-revenue-

earning.
Revenue-earning Projects
4.3.2.2.2. A principal objective of revenue-earning projects is the achieving of financial

viability of revenue-earning EAs (REEAs). This has two purposes. First, to enable self-
sustainability and to achieve a degree of autonomy in their day-to-day operations to
encourage better management. Second, to relieve governments from as much of the
financial burden as possible associated with the continuous provision of scarce public
funds.
4.3.2.2.3. The provision of these latter funds contributes to the scope of the government
budget deficit and is therefore likely to be inflationary. Increased taxation, borrowing
and/or reduction of other forms of public expenditure may finance them.
4.3.2.2.4. The pursuit of certain financial goals by a REEA can also be seen as a means
of stimulating managerial efficiency. If financial viability were to be ignored, the incentive
to hold down costs may be weakened, if not removed. Adequate levels of (real, i.e., cash)
revenues earned from the sale of their services should enable REEAs to have a satisfactory
financial performance. It generally indicates an ability to generate sufficient revenues to
cover operating and maintenance costs, renew assets, service debt, pay dividends on
equity capital, where appropriate, and finance a reasonable proportion of their capital
expenditures from internally generated funds.
4.3.2.2.5. REEAs are sometimes required to generate additional revenue in order to

supplement national resources for investment. Experience in some DMCs, however,
suggests that the continuing financial losses made by many REEAs may not make them
satisfactory tools for resource mobilization, unless government is willing to enforce the
use of effective tariffs and revenue collection.
4.3.2.2.6. Tariffs should permit a level of financial performance that would enable a
REEA to operate efficiently and on a continuous basis, providing that the collection of
revenues continues to be efficient.
4.3.2.2.7. Financial analysis is used at the design and appraisal stages of a project to
define financial performance. Throughout implementation and commissioning, it is used
to measure, by use of financial indicators, the EA’s performance in delivering the project
according to design estimates. Financial analysis is used to measure the operational
performance and achievement of financial objectives. The analysis should examine; (i)
ongoing operations during project implementation (where these are present); and (ii) the
combined performance of ongoing operations and the new project following
commissioning through the life of the ADB loan.
Non-Revenue-Earning Projects
4.3.2.2.8. A principal objective of non-revenue-earning projects is the achievement of

the financial and economic goals of a project. This has three purposes. One is to enable
the project to deliver the forecast benefits at the price(s) estimated at time of design and
financial and economic evaluation. A second objective is to achieve a degree of efficiency
in the EA’s implementation operations to encourage better management of the development
of the project. A third objective is to minimize the government’s financial cost to reduce
as much as possible of the financial burden associated with the continuous provision of
scarce public funds.
4.3.2.2.9. As for revenue-earning projects, financial analysis is a key tool in defining

and measuring the achievement of financial objectives.
4.3.2.3. Financial Objectives: Private Sector Project
4.3.2.3.1. The financial objectives of a private sector project are similar to those of a
public sector revenue-earning project, except that the owners, stakeholders and
management of the enterprise are substituted for the government. Unlike governments
that may have access to temporary funds to sustain a financially ailing public utility EA,
the owners and management of a private company are quickly judged by market forces
as to their financial capability and competence.
4.3.2.3.2. One result could be that project financial failure, either during
implementation or during operation, would deter actual and potential investors to the
point of withdrawing all financial support. Therefore effective and efficient use of financial
analysis to define and apply the most appropriate performance indicators is imperative.
In addition, the continued utility and effectiveness of indicators should be continuously
reviewed to ensure that management obtains the most effective information for decision-
making throughout implementation and operations.
4.3.2.4. Using Financial Analysis to Identify

Achievement Indicators
4.3.2.4.1. The financial performance of a public and private sector EA should normally
be measured by the use of at least one indicator selected from the range of the following
groups of indicators derived from the financial analysis of a project and its EA: (i) operating;
(ii) capital structure; and (iii) liquidity.
4.3.2.4.2. ADB seeks to agree with a borrower on the covenanted use of one or more
key indicators. In addition, the borrower/EA should be asked to agree to the use of non-
covenanted indicators in periodic financial reporting.
4.3.2.4.3. This means that if only one indicator from one of the three categories of
indicators above would be the subject of a loan covenant, the remaining indicator or
indicators from each group above recommended by the financial analyst should be the
subject of periodic reporting.
4.3.2.4.4. Additional indicators should be developed whenever necessary to measure

specific performance.
4.3.2.5. Economic Objectives
4.3.2.5.1. The efficient allocation of resources is an important consideration in pricing

policy, particularly for REEA services. Financial analysis is used to describe the impact
of such a policy.
4.3.2.5.2. It is desirable in DMCs where the alternative is the additional output that
could have been generated and which the countries could ill-afford to give up.
4.3.2.5.3. Economic theory suggests that efficient allocation of resources is achieved

when price equals the marginal cost of supplying the service, that is, the increment to
the total system cost of producing and delivering an additional unit of output under
specified circumstances.
4.3.2.5.4. Some outputs of an REEA’s service are often valued highly by a majority of
consumers and exceed the cost of supplying it. Other uses are less valuable, and the
quantity consumed for these uses will depend on the price charged by the REEA. For
an efficient allocation of scarce resources, consumption should be encouraged when its
valuation by consumers exceeds the added cost of supply, and discouraged whenever it
is not the case.
4.3.2.5.5. This balancing of added benefits with added costs may be achieved by
establishing prices equal to the marginal costs of supply and relying on consumers to
equalize benefits and costs at the margin. In other words, the cost-benefit analysis is
decentralized and each consumer is left to decide what quantity they would like to consume
and when.
4.3.2.5.6.. Economic theory also suggests that important divergences between social
costs and benefits on the one hand, and market price on the other (due for example to
external effects) should be taken into account, and that public enterprise investments
should be evaluated in terms of opportunities for investment or consumption foregone
elsewhere in the economy.
4.3.3. Linkages with Cost Recovery and Tariffs
4.3.3.1.1. Readers are recommended to review the Table of Contents of ADB’s Guidelines
for Economic Analysis when addressing Cost Recovery. In particular, reference should
be made to Appendix 22: User Charges, Cost Recovery, and Demand Management: An
Example for Piped Water.
4.3.3.1.2. Efficient cost recovery impacts on economic and financial analysis of projects,
and it is essential for the financial analyst to have a comprehensive understanding of the
issues. Not least, the analyst must ensure that the cost element of cost recovery is the
lowest economic and financial cost commensurate with the highest levels of efficiency
of performance. Recovery of unreasonable costs must be avoided.
4.3.3.1.3. Both financial and economic project analyses are closely related, and in
practice both involve, among others, the calculation of internal rates of return. Both
types of analysis are conducted in monetary terms, the major difference lies in the definition
of costs and benefits.
4.3.3.1.4. Financial analysis evaluates the commercial viability of a project from the
viewpoint of the project entity; that is, all expenditures incurred under the project and
revenues resulting from it are taken into account. This form of analysis is necessary to
assess the degrees to which a project will generate revenues sufficient to meet its financial
obligations.
4.3.3.1.5. In practice, it is typically necessary to establish the financial viability and

profitability of the project and of its parent public or private sector enterprise by
determining all expenditures of the latter with the project, and the total revenues earned
(and collected) from all sources.
4.3.3.1.6. The principles of financial cost recovery should be based on one or more
of the following, as appropriate to the project, public or private sector enterprise, and
sector concerned: (i) full-cost recovery; (ii) cost reductions commensurate with increased
efficiency to reduce demands on revenues; (iii) a need to generate contributions to ongoing
and/or future investments; (iv) achievement of income redistribution and/or generation
of additional income for specific beneficiaries; (v) the minimization of waste which low-
cost recovery policies tend to promote; (vi) the containment of demand where essential
goods and services are in short supply; (vii) the need to raise additional public sector
revenues; and (viii) the encouragement of financial discipline and efficient management.
4.3.3.1.7. Factors or criteria to determine full-cost recovery include: (i) recovery of

long-run or short-run marginal costs, as appropriate to the EA and/or sector; (ii) the
need to cover total financial costs where these exceed those above; (iii) the extent of
additional fiscal resources requirements over and above the two factors above, for purposes
of income redistribution within the sector; for related sectors; or for general budget
support; and (iv) incremental financial costs (and the reasonableness thereof) for
achievement of the third factor above.
4.3.3.1.8. Although, ADB’s cost recovery principles center on full-cost recovery, it

recognizes that in some cases, financial, distributional, and national fiscal considerations
may require a flexible approach, albeit compatible with promoting efficient operation of
the public sector enterprises responsible. Such cases may involve health and other social
sectors, and projects involving the introduction of new techniques, etc., where less than
full-cost recovery may be desirable in the short or medium term. However, whenever
less than full-cost recovery is proposed, this must be disclosed and justified in the Aides
Memoire and BTORs of a fact-finding or appraisal mission, and in the RRP.
4.3.3.1.9. Where an activity, such as sewerage operations, may appear to have difficulty
in achieving full-cost recovery, it should be linked whenever possible with an allied activity
or service of the enterprise to achieve such performance. In the case of sewerage, its
principal activity is wastewater removal, which can be directly related to water
consumption. An integrated tariff policy to recover water supply and sewerage costs
should be developed which would achieve at least full cost recovery. Similar activities
include rural electrification for irrigation systems which can be recovered through the
overall tariff structure by cross subsidies; rural roads which can be recovered through
adjustments to vehicle import or operating taxes.
4.3.3.1.10. These latter cases typically give rise to valid concerns where the technical
problems and costs of installing and operating charging mechanisms could exceed benefits.
The Knowledge Management section of the web-based guidelines provides a copy of the
useful OECD publication Best Practice Guidelines for User Charging for Government Services.
4.3.3.2. Cost Recovery Systems: Introduction
4.3.3.2.1. Private sector entities, because their primary financial objective is to earn a
return on invested capital, would be expected to seek full-cost recovery, albeit they may
from time-to-time charge less-than-full-cost as a means of encouraging development and
introduction of new products.
4.3.3.2.2. For public sector entities, there is no absolute rule as to a sector/subsector

when less-than-full-cost recovery may be acceptable. A useful guide is provided in ADB’s
Subsidies Paper. This recommends sectors and circumstances when subsidies may be
acceptable, and therefore less-than-full-cost recovery can be proposed for a project.
4.3.3.2.3. Generally there are two options available for full-cost recovery, namely the
pricing by user charges of products and services produced (typically using tariff-structured
charges); and benefit taxes that are levied directly (wherever possible), or indirectly, on
beneficiaries. Vehicle or gasoline tax, and land taxes, are typical benefit taxes.
4.3.3.2.4. The selection and use of the appropriate mechanisms should be a matter of
practical convenience, e.g. where a system is already in place and which either works,
or could be made to work with minimum investment; rather that enforcing a principle.
In water supply utilities, it is frequently a principle that domestic water consumers should
always pay for water by measured consumption.
4.3.3.2.5. However, where by local practice a property-value based water tax can yield
the necessary revenues, this may be a more suitable mechanism. (This may occur where
the availability of groundwater is sufficiently abundant to prevent the installation of
metering systems, which are the most effective form of recovering the cost of water supply
benefits.)
4.3.3.2.6. Similarly recovery of domestic refuse collection costs may be more readily
recovered through a general municipal property tax, but removal and disposal of trade
wastes can often be charged direct to beneficiaries, typically using a price per container
per collection. However, while expediency for achieving efficient recovery as suggested
above is desirable (and useful in many cases), the use of pricing as a means of limiting
or redirecting consumption must be actively considered.
4.3.3.2.7. A property tax based water charge will not inhibit consumption. Therefore
in conditions of constrained supply and high long-run marginal cost, the recovery
mechanism adopted should contribute materially to the attainment of objectives; in this
case by charging on a consumption basis, and restraining consumption and thus deferring
the need for future investments. This particular approach requires that
(i) metering systems are efficient; (ii) illegal connections are prevented; and (iii) the tariff
structure effectively constrains high consumption levels by incremental pricing.
4.3.3.2.8. In some sectors, traditional arguments are sometimes used to claim that
pricing of a commodity is impossible for reasons of unacceptable costs. These must,
however, always be demonstrated. For example, failure of irrigation systems to effectively
measure and price water consumption continues to result in overbuilding of such systems
in some countries, with resultant misallocation of resources.
4.3.3.2.9. It is frequently argued that the costs of installation and maintenance exceed
the building costs, but these should be fully demonstrated during project fact-finding,
and justified in the Identification/Preparation Aides Memoire/ BTORs and the RRP.
4.3.3.2.10. It should be noted that user charges might, in some cases, inhibit the
attainment of objectives. Charges for sewer connections, while having merits as a revenue
source, may deter potential users from making connections. This may be overcome in
some municipalities by imposing penal property taxes payable until sewer connections
are made. Excessive industrial power line and connection charges have caused industrialists
to install generators with loss of the benefits of scale of production, while high domestic
connection fees typically encourage illegal connections.
4.3.3.2.11. The equity principle must be observed. Public utilities sometimes favor
providing services to the more affluent sections of a population, partly on the grounds
that cost recovery is likely to be more effective, and that delivery to, and servicing of
these domestic consumers is generally more simple and cost-effective. However, research
into these situations often shows that the poor, ill-serviced population are paying, and
will continue to pay, considerably more per liter for their limited supplies of water, either
by bottles, or through tankers or venders, than the more affluent sections who are already
served (albeit insufficiently) or will be provided with water supplies by the proposed
project.
4.3.3.2.12. Social benefit must not be sacrificed for financial expediency. Sound project
design should call for an equitable distribution of benefits, including the use of cross-
subsidies, where necessary, to provide the largest volume of benefits to the most deprived
sectors of the population concerned.
4.3.3.3. Cost Recovery Systems: Social Sectors

and Services
4.3.3.3.1. In sectors that support the delivery of social services, including poverty relief,
health services, education, agriculture extension, etc., cost recovery is not normally sought
because they have been regarded as public services to be financed from general taxation.
While this practice is likely to continue for many years, particularly for the poorest sections
of a population, increasing pressures on national budgets may force the development of
forms of user charges.
4.3.3.3.2. While some may be introduced to reduce budget deficits, others may be
used to cut back demand for frivolous or unnecessary services or to re-direct demand
for services for which a section of the population could pay. But because user charges
applied in such sectors will probably have the effect of demand reduction, their
introduction needs to be designed with much care.
4.3.3.3.3. Income and social studies may be needed to identify and to target the elements
of services and population groups to be addressed.
4.3.3.3.4. User charging assessment and collection methods should be examined for
feasibility and costs, as part of cost/benefit studies to determine viability of such schemes.
Comparing the demand, supply, and costs of ongoing, parallel private sector schemes
that provide similar service can develop validity tests of such studies. As an example,
private sector fee-paying education facilities sometimes rival state systems, which may
be of lower quality due to lack of funding.
4.3.3.3.5. Measurement of likely demand for equivalent-level state schemes may reveal
the feasibility of charging for partial, or all, services in a particular stream of training.
without undue hardship, especially if the constraint is lack of facilities instead of consumer
resources.
4.3.3.4. Cost Recovery Systems: Summary
4.3.3.4.1. The financial analyst must be aware of the underlying economic principles
of cost recovery, and:
• contribute to the design of projects which achieve full cost recovery for the sectors
in which ADB specifies this criteria
• be prepared to participate in the design of appropriate recovery systems, or utilize/
modify existing systems to achieve efficient recovery
• keep in mind the various impacts that cost recovery systems generate, in order to
avoid adverse side effects; and
• in those sectors for which cost recovery has not normally been sought, be prepared to
develop charging systems which can enhance poverty reduction and social development.
4.3.3.5. Tariff Policy
4.3.3.5.1. ADB does not have a prescriptive policy on formulation and operation of
tariffs for public and private sectors. It relies on the skill and experience of ADB staff and
experienced consultants to develop appropriate tariffs for revenue-earning EAs, and to
report their findings and recommendations in RRPs and Supervision Reports.
4.3.3.5.2. An October 2000 ADB Workshop identified the following as the most
intractable issues and problems (in descending order of intensity) likely to be encountered
in formulating tariffs for electricity utilities: (i) Country differences; (ii) Lack of
commonality among definitions; (iii) Achieving consensus among politicians,
administrators, economists, engineers, and financial analysts, etc; (iv) Country political
differences; and (v) Ownership.
4.3.3.5.3. In 1985, the African Development Bank published its policy on tariffs and
cost recovery. This document is available from the Knowledge Management section of
the web-based Guidelines. While many years have passed since its publication, much of
the advice and guidance relating to tariffs and cost recovery continues to be relevant. The
emphasis is primarily on the sufficiency of revenues to finance operations and debt service,
and perhaps there may be insufficient reference to the need to develop means of cost
reduction to avoid increasing tariffs and rates.
4.3.3.5.4. Readers are also recommended to review the Table of Contents of ADB’s
Guidelines for Economic Analysis when addressing Cost Recovery and Tariff Policies.
The Knowledge Management section of the web-based Guidelines also contains a
PowerPoint presentation on Principles of Tariff Design. The presentation sets out the
principles to be explored and applied when developing a tariff for a public/private utility.
4.3.4. Preparing Financial Tables
4.3.4.1.1. As a reminder, reference should be made to the Glossary of Terms and

Definitions when preparing presentational material for ADB reports involving financial
data. This will ensure consistent presentation across ADB, and also encourage borrowers
to use such terms and their interpretations in the interests of improving financial
management.
4.3.4.1.2. Footnotes should be used to explain little-used terms or terms of an

ambiguous nature. Cross-referencing should be used within any report, and between the
document and any Attachments or Appendixes. The Knowledge Management section of
the web-based Guidelines provides an Excel Workbook containing examples of Summary
Tables and Detailed Tables of Balance Sheets, Income Statements and Cash Flow
Statements.
4.3.4.2. Preparing Summary Financial Tables
4.3.4.2.1. Summary tables may be used to display the key elements of financial analysis
in its various presentational forms. This may take the form in one consolidated summary
of the financial history, current performance and status and forecast performance of an
EA, together with trends and definitive data, ratios, and performance indicators.
4.3.4.2.2. Summary tables should be inserted adjacent to the textual material in a report
to which a summary table refers. Past, present and future performance, and status data
may be combined in one summary.
4.3.4.2.3. The use of summary tables should not be substituted for detailed tables in
an Appendix to a report where the latter are necessary to disclose significant information
to support a project and loan. Conversely, the presentation of lengthy summary tables
in the Financial Chapter of an RRP covering many years of past and future performance
may be confusing to readers.
4.3.4.2.4. The optimum presentation is the one that conveys the maximum information
in the minimum of space, without sacrificing accuracy and intelligence.
4.3.4.2.5. The Knowledge Management section of the web-based Guidelines provides

examples of summary tables, including a:
• Balance Sheet
• Income Statement
• Cash Flow Statement, and
• Financial Summary.
4.3.4.2.6. The examples provided are for a service-type organization and for a
manufacturing organization. The examples should be modified appropriately to reflect
the nature of each project or EA.
4.3.4.3. Preparing Detailed Financial Tables

examples of detailed tables, including a: (i) Detailed Financing Plan, and (ii) Project Cost
Table. As in the case of the summary statements above, the formats are not sector-specific
and for presentation in an Appendix to an RRP, they should be drawn up to reflect the
financial reporting characteristics of the sector concerned.
4.3.4.3.2. Supplementary information may be given in additional tables (e.g., to

demonstrate a tariff structure and the revenue streams which the components are forecast
to generate – all of which may be presented as a single line entry “Revenues” in an Income
Statement). The adopted format should best demonstrate the potential for achievement
of project objectives.
4.3.4.4. Demonstrating Past (Actual) and Future

(Forecast) Performance
4.3.4.4.1. Detailed financial statements may be prepared to illustrate: (i) past

performance; and (ii) forecast future performance. Alternatively, these sets may be
combined in statements extending from two to three years before Board presentation
through the completion of a project, or through the years required to reach full capacity.
A primary concern is to be able to display the results of at least two years audited annual
financial statements as the basis for the forecasting. This latter combined format, however,
may make it difficult to provide adequate and consistent referencing to subsidiary data.
4.3.4.4.2. The principal recommended presentations relate to projects and their

revenue-earning EAs. These presentations while illustrating the performance of the EA
should also specifically display the status and performance of the project while under
implementation and in operation.
4.3.4.4.3. Presentations are required to demonstrate the performance and status of

non-revenue-earning projects, and where appropriate, their EAs. There are no standard
presentations for the wide range of these non-revenue-earning projects and agencies, but
a possible example is provided in a Model Project Financial Statement for non-revenue-
earning projects and agencies.
4.3.4.4.4. The examples of formats referred to in this section reflect principles of good
presentation, but are not intended as rigid models. They should be applied in a flexible
manner, and will vary in content and arrangement to meet the requirements of a particular
project or sector.
4.3.4.4.5. These statements should be compiled in accordance with International

Accounting Standards (IASs) even though in structure they may reflect the accounts
classifications and financial reporting methods of the EA under appraisal. Alternatively,
tables can be prepared on the basis of the local accounting standards used by the EA,
but the text or footnotes must disclose the deviations from IAS, and the impacts on the
financial statements (i.e., the differences in reported data that arise by reason of adopting
the local standards compared to IAS).10
4.3.4.4.6. In an EA whose accounts and procedures do not conform to these standards;

or to the country’s generally accepted accounting practices (GAAP) which is acceptable
to ADB; or where the latter GAAP are inappropriate for presentation of financial analysis,
actual and forecast data should be presented on the basis of the staff’s judgment of
reasonable practice. Where the presentation departs from the EA’s existing procedures,
the report should explain the changes made.11
4.3.4.4.7. Where restatement is extensive, however, during future supervision,

comparison of actuals with forecasts may be impossible without preparing an additional
set of forecasts reflecting the entity’s accounting practices; these forecasts should be
included in the Project File.
4.3.4.4.8. ADB recognizes and uses IASs for financial analysis and presentational
purposes. Because ADB prefers the use of IASs, these normally should form the basis of
its financial covenants.12 Therefore, if presentations of financial information are made in
RRPs and other project-related documentation, such as an Aide Memoire, in which the
data is not compiled on the basis of international standards, the definitions to be used
in determining financial performance to measure compliance with financial covenants
must be based either on: (i) the accounting standards used in the RRP and which are also
used as the basis for the financial covenant ratios, and this fact should be duly noted in
10
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the minutes of loan negotiations for purposes of measuring compliance; or (ii) the financial
covenants’ ratios should be based on IASs, and the factors necessary to convert local
standards to IASs for purposes of measuring compliance with the covenants should be
stated in the minutes of loan negotiations.
4.3.4.4.9. When preparing a financial statement, which illustrates past, present and
forecast performance, a decision may need to be made on the most appropriate subsidiary
presentations to support data, recommendations and conclusions in the RRP. The objective
should be to present data in the clearest possible form; this may be feasible only by using
a combination of methods (annotations, footnotes, or separate appendixes). In that event,
explicit and clear indicative referencing should be used to ensure that readers are not
misinformed and are easily directed to supporting information.
4.3.4.5. Preparing Income Statements
4.3.4.5.1. Income statements can be presented in summary or in detail, depending on

the requirements for the presentation in the form of report (for example, the RRP). The
following matters should be considered when preparing detailed income statements:
• data for each year are to be defined as Actual or Forecast

• presentations normally should follow the accounting and financial reporting format
adopted by the EA, and
• operating revenues and operating costs presentations will vary widely by sectors,
and should detail the specific forms of revenue and costs typically used in the sector.
Significant variations in format may occur:
— where an agency has inventories produced and held for sale

— when the operating revenues section should show the gross profit arising from
gross sales revenues after meeting the cost of sales; and the operating revenues
section should show the gross profit arising from gross sales revenues after
meeting the cost of sales
— where an agency chooses to present the operating expenses under objective
headings (e.g., bulk storage of water, transmission, distribution, etc., all of which
include labor, materials, transport, fuel, etc.)
4.3.4.5.2. These latter categories are often presented as subjective headings, without
reference to the objective headings. Either presentation may be acceptable, depending
on the objectives of the agency and the project.
4.3.4.5.3. The following information and analyses should be provided with the income
statement:
• unit volume: the basis for volume forecast should be described and related to the
EA’s output capacity and market demand
• operating revenues: describe significant past and expected changes in selling prices,
tariffs and composition of sales mix
• operating costs: analyze past trends, and give assumptions for projections in each
operating cost category (for example: examination of numbers and types of staff
and unit costs; expected costs trends of goods and services; or percentages of revenues
or assets where these are the appropriate bases for the forecasts)
• depreciation rates: these may be addressed as balance sheet information
• non-operating section: describe any significant past experience and give assumptions
for the forecasts of other income and expenses; relate forecast interest expenses to
loans outstanding
• taxes on income: give the basis for income tax charges; in public utilities or other
sectors where taxes on income are normally presented as part of operating costs,
the presentation shown in the table need not be adhered to
• appropriations from new income: state basis for past appropriations and any
assumptions on future dividends, etc.
4.3.4.5.4. The following comparators and ratios are useful for analyzing income
statement information:
• Growth rates
• Working ratio
• Operating ratio
• Gross profit as percentage of revenues
• Net income as percentage of revenues
• Operating income or net income as percentage of revenues, and
• Return on average invested capital.
4.3.4.6. Preparing Cash Flow Statements
4.3.4.6.1. A summary cash flow statement should allow users to ascertain how an entity
raised the cash it required to fund its activities and the manner in which that cash was
used. Cash flow statements classify cash flows during the period from operating, investing,
and financing activities. ADB prefers that cash flows are prepared using the Direct Method
(i.e., cash flow components are shown directly, such as cash receipts and payments to
employees and suppliers, rather than being derived from the income statement and balance
sheet). Where the direct method of presenting cash statements is used, a note that
reconciles net surplus to net operating cash flows should be provided.
Example of Cash Flow Statement Presentation
20X1 20X2 20X3 20X4

($’000s) Actual Forecast Forecast Forecast
OPERATING CASH FLOWS
Receipts
Sales of goods and services 35,134 36,868 39,466 41,397
Interest received 1,070 835 834 901
Payments
Employees -12,615 -13,043 -13,428 -13,917
Suppliers -19,750 -20,920 -20,848 -21,167
Interest paid -2,507 -2,516 -2,561 -2,502
Other payments -369 -490 -1,088 -1,684
Net Cash Flows from Operating Activities 963 734 2,375 3,028
INVESTING CASH FLOWS
Receipts
Sales of fixed assets 250 125 68 59
Sales of investments 1,983 57 1,071 244
Payments
Purchases of fixed assets -1,469 -2,459 -2,808 -3,181
Purchases of investments -130 -55 -102 -98
Net Cash Flows from Investing Activities 634 -2,332 -1,771 -2,976
FINANCING CASH FLOWS
Receipts
Proceeds from borrowing 275 1,477 353 56
Payments
Repayment of borrowings -1,900 .. -953 -105
Distributions / dividend payments .. .. .. ..
Net Cash Flows from Financing Activities -1,625 1,477 -600 -49
CASH AND CASH EQUIVALENTS
Net increases/(decreases) for period -28 -121 4 3
Balances as at 1 January 230 210 93 97
Currency changes on opening balances 8 4 .. ..
Balances as at 31 December 210 93 97 100
Reconciliation to Income Statement

Net Surplus per Income Statement 1,449 765 2,205 2,829
Items included in net surpluses but not in
net cash flows from operations:
Unrealized net foreign exchange gains -66 -87 .. ..
Asset movements
Depreciation 791 872 918 926
Gains/(losses) on sales of assets -7 3 .. ..
Other non-cash items
Movements in employee benefit liabilities -936 110 864 1,134
Movements in working capital
Decrease/(increase) in receivables -62 30 -69 -34
Decrease/(increase) in inventories -63 -55 -19 -31
Decrease/(increase) in work in progress -59 -773 -751 -513
Decrease/(increase) in prepayments .. .. .. ..
Decrease/(increase) in receivables 41 -3 -613 -1,256
Increase/(decrease) in payables -125 -128 -160 -27
Net Cash Flows from Operations 963 734 2,375 3,028
4.3.4.6.2. The following list identifies matters that may need to be considered when
preparing cash flow statements.
• data for each year: should be defined as “Actual” or “Forecast”

• a total column: in order to reconcile the statement with the financing plan, a total
column should be inserted to show the aggregate cash flows during project
implementation period
• capital expenditures: for the proposed project, reference should be made to the
detailed tables showing project cost by year, or to other supporting data in the
Project Costs section of the RRP. The following items should be shown separately:
— the total expenditures on assets;

— financial charges during development (FCDD) (from whatever sources); and
— working capital where significant, and particularly for start-up industrial and
manufacturing projects.
4.3.4.6.3. The separation of the first and third items should facilitate reconciliation with
the project cost table and the addition of FCDD should be reflected in the financing plan.
• Borrowings: data on the ADB loan should be directly related to the data in the
table(s) in the RRP showing the detailed schedule of disbursements. Estimates of
funds available from other sources should be consistent with the information
contained in the discussion of the financing plan. In more complicated financing,
the funds statement should be supported by a supplementary schedule showing the
forecast disbursement of other loans and equity investments;
• Short-term loans to finance working capital: working capital requirements may be
shown net of short-term loans, in which case a footnote indicating the amount of
short- term financing being used should be added. On the other hand, such short-
term financing may be shown separately as a source of funds with a corresponding
increase in working capital needs;
• Debt service: the actual payments estimates of interest and debt repayment should
be consistent with the terms of debt explained by notes attached to the balance
sheet. Where several loans are involved, an interest expense and debt repayment
schedule could be used. Interest payments should be net of financial charges during
development (FCDD);
• Equity contributions: these should be classified as amounts contributed by
shareholders, the government and consumers, where appropriate. Reference to
retained earnings as part of the resource mobilization and cash generation may
be appropriate;
• Cash should contain an amount estimated to reflect operational needs. If cash
surpluses are planned, for example, as a result of advance long-term borrowing, the
balances may be added to a “short-term investments” account, to distinguish the

operational cash needs from the more financially related, tactical funds needs. The
use of a short-term investment account is advisable when the surplus cash balances
are large and the interest income significantly affects income. If the cash surplus is
not planned and not due to fluctuations resulting from management decisions, a
separate “cash surplus” account may be used, especially if the balances are large.
“Short-term borrowings” may be used as a “balancing liabilities account”, if the
funding needs temporarily exceed the funds sources.
4.3.4.6.4. The following are typical comparators and ratios for use in a cash flow
statement:
• Debt service coverage, based on the total of loan interest and principal repayments,
including interest incurred on work in progress if this is to be financed from net
income and not from capital receipts (loan/equity);
• Growth rates; and
• Percentage of capital expenditure financed by internal sources.
4.3.4.7. Preparing Balance Sheets
4.3.4.7.1. A summary balance sheet may be included in the text of a report,

appropriately referenced to its sources in the appended tables. It should highlight critical
features of an entity’s financial structure, such as its liquidity position, or trends in the
growth of fixed assets, equity, and long-term debt.
4.3.4.7.2. The detailed balance sheet should include a detailed listing of matters that
may need to be referred to in the report and referenced in the summary table. The following
should be considered when preparing this detailed financial statement:
• Data for each year should be defined as Actual or Forecast.

• Surplus cash: where it is assumed that material amounts of funds may be accumulated
and available for other capital projects or paid as dividends, the forecast balance
sheet should show such cash separately.
• Long-term debt: should be shown in detail, if necessary. Distinguish between local
and foreign debt. Current maturities of long- term debt should be deducted and
shown under Current Liabilities.
• Current assets and liabilities: working capital requirements should be based on the
entity’s practices, together with any changes due to the project; operational cash
requirements should be illustrated; and projected cash surpluses or shortfalls should
be explained.
• Intangible assets and long-term investments: the basis of forecasts should be stated
– particularly any valuation of goodwill on acquisition of other executing enterprises,
or justification for the realization and use of long-term investments.
• Fixed assets: the basis for estimating additions to fixed assets in relation to the
construction program, revaluation of assets, and any anticipated property retirements
should be in accordance with IASs or otherwise explained.13 Transfers of capital
expenditures to the “plant under construction” and “plant in service” accounts may
be based on the assumption that a certain percentage of capital expenditures is
“booked” to plant in service each year. In other instances, the transfers may be
based on a detailed completion schedule. It is often useful to provide a subsidiary
schedule to the balance sheet, showing the transfers from capital expenditures to
plant under construction and plant in service, together with the basis for such
transfers.
• Accumulated depreciation: rates and bases for depreciation should be stated.
Alternatively, they may be shown with the Income statement or in an Assumptions
Appendix. Any substantial changes in accumulated amounts (e.g., due to revaluation
of assets) should be explained.
4.3.4.7.3. Comparators and ratios for use in a balance sheet include:
• Asset turnover • Rate of return on net fixed assets in

• Growth rates operation
• Quick ratio • Accounts receivable outstanding on a
• Current ratio daily basis (number of days, etc.)
• Debt as percentage of total • Inventory outstanding on a daily basis
capitalization • Net tangible assets as percentage of long-
term debt.
4.3.4.8. Preparing Financial Summaries
4.3.4.8.1. The use of a financial summary is an acceptable alternative to the main

statements – balance sheet, income statement and cash flow statement. It must however,
display the vital elements of each of these summary statements.
4.3.4.8.2. The normal size and content of the traditional income and cash flow statement
and the balance sheet would not permit the production of a combined detailed statement
for all main financial statements, and therefore the financial summary statement has
been developed as an alternative.
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4.3.4.9. Preparing Financial Tables using

Spreadsheet Models

spreadsheet models that can be used to prepare financial tables. The models include
summary and detailed tables, including:
• Balance Sheets
• Income Statements
• Cash Flow Statements
• Financing Plans, and
• Financial Summaries.
4.3.4.9.2. Using these tables requires a working knowledge of financial accounting

and financial analysis. The generic or model tables may be modified by users by changing
the line item titles and the column titles to reflect the nature and form of the financial
statements of the EA with which they are working. However, care should be taken to
respect accounting conventions, particularly the use of subtotals and grand totals in each
table to ensure that the financial data of line items that should be incorporated therein
is appropriate. Each detailed and summary financial statement can be accessed in the
model.
4.3.4.9.3. When a user is satisfied with the contents of a statement or statements, these
should be saved to the user’s own hard disk or floppy disk. When the Page is closed, the
tables (templates) revert to their original state.
4.3.4.10. Preparing Financing Plans
4.3.4.10.1. The Cost Estimates Table provides as its bottom line, the total financing
required for a project. It is essential that the means of financing this total expenditure
is specifically defined in the RRP. The illustration and discussion of the financing plan
for a project to be implemented by a revenue-earning enterprise usually consists of a
summary – all in current terms of: (i) the project financing requirements and the external
sources of finance from the cash flow statement; (ii) other capital and incremental working
capital expenditures occurring during the project construction period; (iii) incremental
and initial operating costs to be incurred during the implementation period, to be financed
out of either project capital funding, or from local budgetary provisions; (iv) net income
from any ongoing operations; and (v) debt service.
4.3.4.10.2. In a non-revenue-earning project, where there are rarely any internally

generated sources of funds, project financing is usually not related to the future financial
performance of the entity. In such cases, the illustration and discussion of the financing
plan would be confined to the project only and set out with the discussion on project costs.
4.3.4.10.3. The text of an RRP requires a discussion of a financing plan. In the case of
a non-revenue-earning project, this is normally an extension of the discussion of the
Project Cost Estimates. In the case of a revenue-earning project to be implemented by
an EA, a summary-financing plan may be included after the Project Cost Estimates table.
A detailed discussion on the financing plan (with a table showing a detailed financing
plan, where necessary) should be included as part of the Project Chapter in the RRP. The
following items should be covered, with detailed explanations, where necessary, in an
Appendix to the RRP:
• Any cofinancing arrangements;

• Availability of internal funds, referenced as necessary to the cash flow statement;
• The self-financing ratio, particularly when this is to be incorporated in a financial
performance covenant;
• Equity contributions;
• Terms of loans, including interest rates (or on lending rates, where applicable),
grace periods, repayment periods, incidence of foreign exchange risk, guarantee
fees and financial charges during development; and
• The dependability of a financing plan in terms of firm commitments that have been
received, the progress of negotiations where loans or equity contributions have not
been finalized, the availability of additional sources of funds in the event of cost
overruns or lower than expected generation of internal funds, and a sensitivity
analysis relating to the latter items, and any critical items listed above.
4.3.4.10.4. Funds from all principal sources should be identified as line items in the
financing plan. Funds sources should be set out in terms of foreign and local currencies,
using the US dollar as the foreign currency, and grouped in the table under local and
foreign sources, including ADB loans, ADF, and TA; funds from other foreign lenders and
donors; local loans, local equity including grants and subsidies from government, and
internally generated funds. In cases where the EA is conducting an ongoing operation,
as in the case of a public sector enterprise, it may, or may not, be generating sufficient
funds from ongoing operations to support these activities. It is, therefore, advisable to
include in the financing plan either the net funding through the period of the financing
plan that the agency will generate, or the additional funding needs, which it will require,
to operate and maintain its existing and new facilities. The sources of additional funding
should be identified, for example, subsidies from government.
4.3.4.10.5. The financing plan should contain explicit references to contributions to be

made by the agency during implementation, with specific reference to the acceptability
to ADB of a policy of deficit funding by government, particularly any policy that contributes
to the capital investment of the EA.
4.3.5. Determining Fiscal Period Coverage
4.3.5.1.1. Forecasting financial performance is frequently a hazardous task for the

financial analyst. The records of past performances may not always be available, nor
reliable, and a current less-than-satisfactory performance may be one of the reasons for
proposing the project. Political, inadequate human resources, and natural disaster
problems, among others, can influence future performance.
4.3.5.1.2. Despite these hazards, the financial analyst is required to develop financial
information relating to a project and, where appropriate, the EA for a period of time that
will allow ADB’s management and the borrower to form judgments, at the least, as to past
and current capabilities, and the most desirable, minimum financial performance that
must be achieved to allow the project to be viable. It will not help the borrower or ADB
for a financial analyst to forecast financial success in order to bring a project to the ADB
Board, when all the sensible indications are that such success is unlikely. The latter has
too often been the cause of unsuccessful projects.
4.3.5.2. Fiscal Period Coverage:

Revenue-Earning Projects
4.3.5.2.1. For revenue-earning projects and their EAs, financial analysis needs to be
based on a reasonable period of confirmed past financial status and operating performance
of the EA. The current financial status and performance will be a useful guide to the
capability and capacity of the executing agency to deliver the project.
4.3.5.2.2. With the information gained from the current and past performances,
forecasts should be prepared of the financial status and performance likely to be achieved
during implementation, and for a meaningful early period of operation following
commissioning of the project. This applies particularly in cases where the EA will
implement and operate the project as part of its ongoing operations, such as an existing
electric power generating utility or a water supply and sewerage utility.
4.3.5.2.3. There can be no definitive periods of performance measurement, and the

chosen years for each project and EA must be selected on the basis of the financial analyst’s
judgment of the period(s) that are likely to be the most informative for an accurate and
reliable justification for the project and use of the particular EA.
4.3.5.2.4. As a general rule, it is unlikely that a period of less than two years of actual
confirmed (audited) performance immediately prior to implementation, together with
the implementation period and not less than three years of full operation following final
commissioning would provide a satisfactory, reliable sample.
4.3.5.2.5. Some projects include components that have protracted implementation

periods, for example, dams and forestry. For some the implementation period often can
only be defined by the success of the project, for example, oil and gas wells exploration.
Other components are often commissioned within one or two years of the commencement
of implementation. Usually it is necessary to provide a financial picture of the completed
project, including at least three years of full operation, and therefore, in such a case, the
period of detailed analysis may cover 12-15 years or more (two years past, two years on
existing operations, say six years for implementation and three years after project
completion).
4.3.5.2.6. The word “detailed” has been emphasized here because, by comparison, for
purposes of the Financial Internal Rate of Return (FIRR) the financial inflows and outflows
for the full period of the life of the investment must be determined, but for FIRR purposes,
the analytical requirements are not so complex.
4.3.5.3. Fiscal Period Coverage:

Non-Revenue-Earning Projects
4.3.5.3.1. Normally for non-revenue-earning projects, the financial analysis should

address only the financial requirements of the project itself, in the form of the Financing
Plan, and the operating costs for up to five years following completion.
4.3.5.3.2. Unless the EA is also to be the subject of some form of financial performance
reform as part of the project, there is no requirement to provide past performance data,
unless this is material to support project justification.
4.3.5.3.3. Similarly future performance should normally focus on project execution

and include only those costs of the EA for which financing must be assured to ensure
the successful implementation of the project.
4.3.6. Forecasting and Financial Projections
4.3.6.1. Introduction and Overview
4.3.6.1.1. Forecasts, in the form of annual financial projections over the period of
implementation, and for the period necessary to achieve a steady state, should be made
in nominal (current) prices (and tables should clearly so indicate) using the year of
appraisal as the base year of projection. For an existing EA that operates facilities similar
in nature to the proposed project, the financial projections should include actual
performance for two or three years prior to project start-up. However, this may also
require the forecasting of performance for the year of appraisal and loan negotiations/
signing.
4.3.6.1.2. The objective of the actual performance and forecasts in the previous
paragraph is to provide comparative performances, including establishing any trends
and patterns, with the forecasts for the proposed project.
4.3.6.1.3. The preparation of financial projections should be an integral part of the

PPTA consultants’ TOR. The TORs for project implementation consultants will include,
as part of project supervision, the monitoring of financial management and internal control
procedures of the applicable project or EA.
4.3.6.1.4. Forecasts normally should be made in the local currency. An exception should
be made when the local currency is unstable, for example, due to high and erratic levels
of inflation, projections may be made using a stable currency, typically the US dollar.
4.3.6.1.5. The use of current prices is particularly important for the analysis of the
Financing Plan which, to be complete, must relate to all project costs, including physical
and price contingencies and, where appropriate, financing costs during development
(FDCC), and for appraising debt service coverage and the effect of debt limitation
covenants (which govern contractual obligations which are fixed in nominal current terms).
4.3.6.1.6. Forecasts in current terms are usually based on the same price assumptions
as in the project cost estimates, at least through the construction period, as long as such
assumptions are relevant for the labor, goods and services concerned. Appropriate price
assumptions should be made for items which are not involved in the project cost estimate
or which need to be priced on differing bases.
4.3.6.1.7. Forecasts are normally made for the period covering the duration of project
construction up to at least the end of the third year of normal capacity (steady state)
operations. When debt service coverage is based on a multi-year moving average, the
projection should cover the final year of the moving average. The objective should be
to provide adequate data on the profitability and debt servicing ability of the enterprise
in relation to the investments to be undertaken under the project.
4.3.6.1.8. Forecasts should normally be made until a “steady state” has been reached,
reflecting normal utilization of the project facilities. If a substantial financial change is
forecast within the life of the loan that would seriously affect the “steady state”, the text
should specifically discuss the impact of such a change on the financial condition of the
EA. If possible, the projections should be extended to cover such an event.
4.3.6.1.9. In cases of projects which take many years to reach normal capacity operating
rates (e.g., 15-20 years for forestry projects), it is acceptable to limit the time horizon
of the forecasts for the enterprise as a whole to between two and five years beyond the
completion of project construction, even though normal operating levels may not have
been reached.
4.3.6.1.10. Since it is necessary to demonstrate the impact of grace periods on loans,

the time frame should include the first year or years of full debt servicing whenever
feasible for treatment of FIRR forecasting.
4.3.6.1.11.. As stated above, where debt service coverage is based on a moving average
calculation, the time frame should be sufficient to cover the last year of the moving
average for the final year shown in the projections.
4.3.6.1.12.. In addition to this overview, this section reviews the following topics in
relation to forecasting and financial projections: (i) using real prices; (ii) using constant
prices; (iii) using a stable foreign currency; and (iv) presenting data.
4.3.6.2. Using Real Prices
4.3.6.2.1. Where the analysis is made in real terms, its use must be fully justified and
the impact of current prices on the financing plan and other elements listed in the preceding
paragraph fully explained in the text and subtables.
4.3.6.2.2. Relative price changes resulting from the differential effects of changing prices
and inflation on particular expenditure items and on the revenue stream are apt to be
overlooked when real terms are used. This can lead to distortions in the analysis of a
financing plan and in cash flow statements.
4.3.6.2.3. By contrast, forecasts in current terms require the analyst to make specific
judgments about these effects. Therefore forecasts in current price terms are preferred.
Such forecasts should be made on the basis of alternative scenarios to illustrate a range
of possible futures and uncertainties, and the forces that are likely to shape them. The
use of sensitivity analysis on key variables is recommended.
4.3.6.3. Using Constant Prices
4.3.6.3.1. Where an EA operates within an established national system for adjusting

costs and/or revenues for inflation, or in countries where price and foreign exchange rate
movements are highly erratic, constant price forecasts may be used, providing the impact
of the conversion to current prices, particularly on cash flows, is demonstrated.
4.3.6.4. Using a Stable Foreign Currency
4.3.6.4.1. An alternative method is to prepare tables in current price terms using a

more stable currency with which the country has a consistent money-market/foreign
exchange relationship, e.g., with the US dollar. Judgments on, and justification for use
of current and constant prices and the foreign exchange rates used should be stated early
in this section of the RRP.
4.3.6.5. Presenting Data
4.3.6.5.1. Projected balance sheets, income statements and cash flow statements of the
project entity should be shown in summary and detailed tables, so as to permit
comparisons between past and forecast data and to allow for ready identification of trends.
The data should be consistent with demand and disbursement forecasts elsewhere in the
report. Because the presentation and interpretation of figures in periods of changing
prices and inflation is both difficult and risky, staff should assist readers whenever possible
by highlighting underlying trends in data, particularly where these may be obscured by
substantial rates of inflation.
4.3.6.5.2. For example, the cost of wages paid by an EA over three years may have
risen by 150 percent, apparently matching commodity or other price rises of 140-160
percent. In fact, however, government, or employers, may have restricted the growth of
wage rates (to, say, only 25 percent) during the period, with rising manpower numbers
accounting for the rest of the 150 percent increase. The long run effect may be that a
wages “explosion” is due in the project period, and this should be reflected in forecasts.
4.3.6.5.3. This kind of elucidation of data is central to good analysis. In cases where
changes exist in significant elements of cost (e.g., labor, fuel) or revenues, the analysis
may be given in both current (nominal) terms and real (constant) terms together with
physical amounts (e.g., numbers of employees; tonnes of oil consumed) and the implicit
assumptions for future forecasts should be explicitly stated.
4.3.7. Forecasting Assumptions
4.3.7.1. Financial forecasting requires analysts to make assumptions, even though as

many factors as possible in an analysis should be based on researched and actual empirical
performance data.
4.3.7.2. A new project will require assumptions to be made by its designers and by
the analyst regarding input costs, quality and quantities for both investment purposes
and for operations and maintenance. Therefore it is essential that the analyst should list
all assumptions, and the base date of the data, used in compiling the analysis in an
Appendix to the RRP, as well as in the Project File.
4.3.7.3. The basis for assumptions should also be indicated, and in cases where an
assumption is critical, and possibly contentious in nature, the grounds or basis for its
adoption must be stated in the RRP text. An efficient management of an EA should be
continuously monitoring costs and prices. Therefore, to be assured that this takes place,
the financial analyst should request the EA to provide an annual review, as a contribution
to project supervision, of the validity of key (critical) assumptions used (e.g., inflation
rate, forecast costs of principal imports-like petroleum products, cement).
4.3.7.4. The listed assumptions in an RRP appendix and Project File should be used
as a key supervision tool, by requiring the EA, as part of the financial reporting
requirements to provide annual updates of specific (critical) assumptions requested by
the financial analyst. By this means the financial analyst can maintain a continuous review
of the factors on which the financial projections were based, and obtain early warning
signals of potential deviations from the forecasts.
4.3.7.5. In the event that the borrower or EA is unable to provide the necessary data
for updating, the analyst is responsible during supervision for obtaining the requisite
data and preparing an annual revision to the Assumptions Appendix of the RRP.
4.4. Measuring Performance
4.4.1. Introduction to Measuring Performance
4.4.1.1. Revenue-earning projects operate in the public and private sectors of member
countries’ economies. The advice in this subsection is broadly applicable to institutions
in both sectors. However, there are good reasons for applying performance measurement
to the operations of a non-revenue earning project particularly to measure the efficiency
of its use of a project’s resources, including human resources.
4.4.1.2. ADB encourages the application of financial performance measurement

techniques to revenue-earning EAs that implement and operate projects financed using
ADB loans, and which typically apply these factors in the designs of their primary cost
recovery mechanisms. More specifically, they apply to all revenue-earning enterprises for
which financial performance necessary to achieve the project objectives agreed between
the borrower and ADB needs to be covenanted in legal agreements.
4.4.1.3. However, because each sector contains subsectors which may not be mutually
compatible, either in their fiscal and social objectives, or in detailed aspects of their
accounting treatment and financial reporting, sector-specific guidance may be provided
in supporting guidelines at a later date by ADB. Nevertheless, this subsection does
provide examples from different sectors to explain its concepts, and these may be used
by ADB staff as guidance for financial performance measurement techniques in these
sectors.
4.4.2. Objectives of Measuring Performance
4.4.2.1. ADB’s objectives in using performance measurement techniques as a key

element in the management of projects is to: (i) provide the managements of the borrower,
the EA and ADB with an effective means of measuring the progress of a project, of its
many components, and the adequacy and timeliness of provision and use of funds;
(ii) regularly assess the potential for achieving the technical, financial, and economic
objectives of the project; (iii) determine the form and nature of corrective actions necessary
to achieve targets measured by performance indicators, and (iv) assist in defining new
or modified performance measures that may be more effective, and to replace those that
are ineffective.
4.4.2.2. The Office of General Counsel takes the key financial performance objectives
agreed with a borrower and an EA at appraisal and loan negotiations and translates these
into financial covenants in loan agreements. Loan covenants, with the relevant performance
indicators incorporated in the text, are established among other things, as a means of
assuring the regular (normally annual) measuring of, among other things the: (i) the
enhancement (or otherwise) of specified sector(s) of the national economy concerned;
(ii) the impact of the project on the community concerned; (iii) the impact of the project
on key concerns, such as poverty relief, environmental protection; (iv) the extent to
which the investment (including ADB’s loan proceeds) is utilized effectively; (v) the extent
to which the ADB’s loan, other lenders or donors funds, and the government’s counterpart
contribution each are effectively used for the purposes intended, and (vi) the efficiency
and effectiveness of the management of the EA in managing the project.
4.4.2.3. In addition to covenanted indicators, ADB will seek to agree with the EA
concerned that other non-covenanted performance indicators will be subject to periodic
reports to ADB.
4.4.3. Performance Indicators
4.4.3.1. The private sector in member countries, in particular, has developed various
performance measuring devices to enable managements and stockholders to understand
and/or be assured as to the performance of enterprises. The use of a number of these
techniques is feasible in public sector enterprises, and, of course, in private sector
enterprises which are financed by ADB.
4.4.3.2. Performance measurement ratios or indicators are an effective and concise

means of transmitting financial information, particularly when used to compare time-
bound performances. An inherent danger in the use of performance ratios and indicators
lies in the brevity of the descriptions used, and sometimes of the information on which
they are based.
4.4.3.3. These indicators are intended to convey information quickly and succinctly,
but users may be misinformed unless they are provided with a clear understanding of
the bases of the data used to compile the indicators and of any changes that occur to
cause sudden fluctuations. As examples, the term “debt” can mean all debt both long and
short term, or only long-term debt; or it can mean the historical value of foreign debt
on its acquisition at local currency conversion rates at the date of acquisition; or it can
mean the current value expressed in current US dollars etc.
4.4.3.4. A debt service coverage indicator may change significantly if the structure
of interest rates falls sharply by reason of substitution of low-interest-bearing debt for
high-interest-bearing debt.
4.4.3.5. Ratios and indicators should be displayed on a financial report or its tables
in such a manner that readers can quickly appreciate the significance of the information
and are left in no doubt as to the basis of the information used to generate a ratio or
indicator. This means that financial analysts must include in their documents, particularly
the financial projections, and in the Project File, the assumptions used in compiling
financial ratios and indicators.
4.4.3.6. The guidance on specific indicators provided in this section relates to specific
indicators. It is provided to assist staff in determining the most appropriate ratios and
indicators to use when measuring performance, including the most suitable methods for
their compilation and incorporation in financial covenants.
4.4.4. Using Benchmarking Indicators
4.4.4.1. The use of benchmarks (or benchmarking) is a widespread practice of

establishing a clearly defined performance measurement or indicator. They are used in
most public and private sector organizations, by all forms of industry and commerce,
and by military organizations. Dictionary definitions of a benchmark include a standard,
a criterion, a standard of comparison, an indicator, a measuring stick, a yardstick, a
barometer, a frame of reference, a gauge or index, (e.g., a Plimsoll line on a sea-going
vessel). Often a benchmark is intended to denote optimum performance requirements,
sometimes it is intended to set a minimum standard below which performance must not
be allowed to fall.
4.4.4.2. Revenue-earning enterprises in the public and private sectors have

benchmarks, some are set for them by governing, regulatory, and advisory bodies; some
they set themselves to establish local parameters of performance.
4.4.4.3. While regulators of utilities for some countries have tried to set national
benchmarks, these have rarely proved to be practical and in countries such as the US
(that has State regulators), UK and Australia, the regulators for telecommunications, water,
electricity and gas have chosen to determine benchmarks for individual companies or
regional groupings of companies. This is because each organization (and project) is unique.
4.4.4.4. Benchmarks for non-revenue-earning projects are more difficult to establish.

Non-financial mechanisms need to be used to indicate performance. Benchmarks/
indicators such as “Mortality per million of population under age 45”; of “Percentage
reduction in traffic accidents in urban areas”, are typical.
4.4.4.5. The multilateral development banks have tended to avoid the use of the
word “benchmark” in favor of “indicator”. A “benchmark” is regarded as having primarily
an engineering connotation – a standard of performance that must be achieved or must
succeed, whereas an “indicator” for use by these banks has come to be regarded as a form
of measurement to determine progress towards project objectives.
4.4.4.6. The characteristics, or elements/ingredients of a performance indicator can

be agreed between a borrower/EA and ADB at project appraisal and the resulting formula
can generate a benchmark or indicator that the project is designed to achieve. Throughout
implementation, and often during the operational period of a project, the performance
of each defined characteristic or element is applied to the formula to provide the most
recent measure of performance. The result is to be compared with the benchmark or
performance indicator agreed between the parties at appraisal.
4.4.4.7. For the financial analyst this means that – in addition to the traditional
financial performance indicators – supplementary benchmarks or indicators may need
to be agreed with the borrower.
4.4.4.8. It is good practice to select no more than about 12 benchmarks or indicators.

While 12 is not an absolute rule, the use of more can be confusing, and less may not
provide the necessary wide coverage. About half this number should focus on
implementation, and the remainder on outcomes and impact for use in project supervision
and evaluation.
4.4.4.9. The Knowledge Management section of the web-based Guidelines provides

a copy of the World Bank’s Handbook on Performance Monitoring Indicators. This includes
a detailed description of approaches to the compilation of performance indicators and
about 15 pages of indicators for nine sectors.
4.4.5. Selecting Indicators and Covenants
4.4.5.1.1. This section provides advice and guidance on the selection of performance
indicators and financial covenants that are likely to advance and secure efficient and
effective financial viability and financial integrity for the wide range of EAs that seek
funding of revenue-earning projects from ADB. This section does not apply to Financial
Institutions (FIs). Specific advice and guidance on FIs is provided in section 6.4.
4.4.5.1.2. Recommending a specific performance indicator and a related financial

covenant for a project in each sector or subsector is not feasible due to the prevailing
wide range of sectors, subsectors and country conditions. This section is intended to set
out key issues that may be encountered and possible solutions that the financial analyst
should consider.
4.4.5.1.3. The advantage of using financial covenants is that ADB expects the borrower
and EA to make every effort to comply with the terms thereof to assure the financial
viability and integrity of the project and the EA.
4.4.5.1.4. Financial analysts should encourage EAs to recognize that it is very useful
for their management and the borrower (and ADB) to provide non-covenanted
performance indicators in periodic and annual financial reports, and their regular review
by management and ADB can often provide critical information on an entity’s operational
progress and financial performance.
4.4.5.1.5. Performance is represented by indicators that are usually characterized by

ratios expressed as relationships (e.g., percentages; relating absolute numbers) between
two items of information (e.g., debt- equity).
4.4.5.1.6. The multilateral development banks (MDBs), including ADB, use ranges of
indicators drawn from the three categories below, with associated financial covenants,
namely: (i) operating indicators; (ii) capital adequacy indicators; and (iii) liquidity
indicators. ADB uses indicators selected from these ranges to measure EA performance.
4.4.5.1.7. The reference to the MDBs in the discussion above is intentional because it
is important for financial analysts to recognize that they may be operating with an EA
where another MDB has either already established performance and covenanted criteria,
or may be seeking to do so. In such cases, the financial analyst needs to understand the
rationale for the MDB’s selections, and if possible, in the interests of the borrower and
ADB, to agree with their use. In the event of failure to agree with the MDB, an issue
should be notified to the Project Officer, borrower, the EA, and the MRM.
4.4.5.1.8. International commerce and industry, in addition to also using many of the
above indicators, also select from a wide variety of other indicators in order to measure
financial, production, processes, and service performance.
4.4.5.2. Questions before Selecting Performance

Indicators and Covenants
4.4.5.2.1. The following checklist should be consulted when selecting performance

indicators and covenants:
• What is the basis for the available • Which indicators and covenants could
financial management and financial be the most appropriate to achieve
analysis data? correction (or prevention)?
• Is it transparent, accurate, reliable, and • For ongoing operations of an EA, what
the subject of an auditor’s report and are the deficiencies in cash
opinion, or prepared by a consultant management performance for at least
with a reliable financial management the past two years (using audited
track record? annual financial statements)?
• What are the current, or in the case of • How should they be corrected?
a “greenfield project”, the most likely, • Which indicators and covenants could
financial performance weaknesses that be the most appropriate to achieve
should be given priority for correction correction?
(or prevention)?
• What changes are necessary to ensure • If not, what performance levels are
an adequate capital structure (debt/ they proposing, and which financial
equity including reserves) for the EA? performance indicators should be used
• How can they be affected? to support their proposed operational
• What should be the time scale to performance upgrading?
achieve correction? • Does (or will) the EA have a financial
• Which indicators and covenants could management system from the date of
be the most appropriate to achieve project start-up capable of accurately
correction? reporting the financial performance
• Do the levels of revenue generation data required in a timely manner?
and collection need upgrading, • Does the EA have a track record of
prioritize the steps to achieve: (i) short- submitting interim financial reports and
term improvements; and (ii) long-term audited annual financial statements?
improvements? • Should this track record be improved?
• Which performance indicators If so, how?
should be included in periodic • Does (or will) the EA have a
performance reports (i.e., not subject management system capable of
to covenants)? developing and efficiently responding to
• Will ADB’s sector operational experts the results of each proposed financial
or consultants confirm that each level indicator and financial covenant?
of operating costs are, or will be, • Does the EA have qualified and
operating at optimum efficiency and experienced personnel who can
effectiveness? interpret and monitor performance
against the indicators or covenants?
4.4.5.3. Objectives of the Use of Financial Indicators

and Covenants
4.4.5.3.1. The primary objective is to achieve and or sustain the financial viability and
integrity of public and private sector projects and EAs that are financed by ADB. Borrowers
and ADB that jointly agree on the achievement of this objective at loan negotiations
recognize that its accomplishment may extend at least over the period of project
implementation, commissioning and achievement of a steady state of operations. This
period will probably cover a minimum of five years.
4.4.5.3.2. Meaningful performance and financial forecasting over extended periods of

time is not possible. Projected financial performance information can only be indicative,
rather than realistic. There will be inherent risks that not only the designed project content
and performance may change, but that the prevailing financial and economic conditions
in which the project is to be constructed and operate will change. Recognition of the
inherent risk means that ADB’s and a borrower’s agreed definition of the type of financial
indicators and financial covenants with their specific measurement criteria at loan
negotiations must change as physical, financial and economic conditions change in the
future. The following references to PAI 5.03 are included to draw attention to ADB’s
facilities to address the modification of a performance covenant under changing
circumstances.
4.4.5.3.3. PAI 5.03, Part B (Review of Covenants) recommends that ADB staff should
report on the continued validity of special loan covenants (such as those used to prescribe
financial performance) and, as standard practice, attach to the BTOR an appendix detailing
the status of compliance with all covenants. In addition, PAI 5.03 (Part C: Follow-up
Actions) addresses a borrower’s failure to comply with loan covenants and recommends,
according to circumstances, that staff should consider whether the covenant should be
amended; whether an extension be granted; whether alternative measure should be
introduced; or whether the covenant should be waived or deleted. It should be noted
that a borrower may continue to comply, but the performance required may have changed
to become more severe or constraining (for example, increased efficiency of inputs and/
or outputs), thus reducing the validity of the covenant concerned. In such cases, ADB
staff should also use the provisions of PAI 5.03 to introduce more meaningful performance
requirements into a covenant.
4.4.5.3.4. The financial covenants should also enable reviewers to specify an agreed
date or dates for subsequent reviews. The covenants should provide for earlier review
in the event that the borrower/EA is not in compliance with the covenant at any time.
4.4.5.4. Financial Viability and Integrity of Projects

and EAs
4.4.5.4.1. The achievement of this goal requires that the EA meets targets of physical,
economic, and financial performance as specified in the RRP and agreed with ADB at
loan negotiations. Specific definitions of financial viability and integrity should be defined
in the RRP. These may be extensive, but as a minimum should include one indicator
selected from each of the following ranges: (i) revenue indicators; (ii) capital structure
indicators; and (iii) liquidity indicators.
4.4.5.4.2. The selected indicators should be the subject of financial covenants where
agreement is essential to achieve the objectives and financial viability of the project and/
or the EA. Non-covenanted indicators should be agreed with the EA and included in the
reporting requirements provided by ADB to the EA at project start-up. Where appropriate,
additional indicators should be included, either within covenants, or in ADB’s financial
reporting requirements.
4.4.5.5. Cash Requirements
4.4.5.5.1. Most operating and capital adequacy indicators are formulated on the basis
of accrual information. This means that they may not adequately disclose an EA’s liquidity
(actual cash) position. An exception is the cash-based Self Financing Ratio Covenant that
provides a definition of cash availability for performance.
4.4.5.5.2. ADB’s experience shows that lack of, or insufficient, cash are a major cause
of nonperformance by EAs. Therefore, a liquidity indicator, preferably the Quick ratio
or “acid test”, should be provided for each project, but note that this is a “snapshot” view
at one point in time (e.g., balance sheet date). This “snapshot” defect can be substantially
overcome by calling for a periodic report to provide a table of month-end quick ratio
results for the preceding 12 months (or such other appropriate period).
4.4.5.6. Managing Operating Costs
4.4.5.6.1. ADB recommends to borrowers that their public and private sector revenue-
earning enterprises should be required to meet a “reasonable portion” of their investment
requirements from internally generated funds, after providing for costs of operation and
maintenance, taxes, incremental working capital, debt service and any dividend
requirements. The generation of this “reasonable proportion” is heavily dependant on
the relationship between operating costs and operating revenues. The smaller the share
of revenues consumed by operating expenses, the larger the amount available for meeting
taxes, incremental working capital, debt service and any dividend requirements with the
residual to provide the “reasonable portion” of investment requirements.
4.4.5.6.2. It is critical that there should be an effective measure of performance for the
level of operating revenues consumed by operating costs. This measure is the Operating
Ratio. An alternative indicator which should only be used to bring stability to a financially
ill-managed EA is the breakeven ratio and covenant.
4.4.5.6.3. Each of the projects listed in section 3.2.1 should be asked to provide an
operating ratio in periodic and annual reports, and where necessary, in parallel with an
operating ratio covenant.
4.4.5.6.4. In addition to seeking an overall reduction in costs, it may be necessary to

select one or more categories of costs to seek specific reductions. Levels of salaries and
wages frequently require specific indicators. There can be other costs, such as fuel,
transportation, management and administration, etc., that should be the focus of the EA’s
and ADB’s attention by use of indicators.
4.4.5.6.5. Where an operating ratio indicator is to be installed using a financial covenant

and it is proposed that the levels of operating costs should decline in real terms over a
defined period, the covenant should define the appropriate performance indicator(s)
and the selected years of covenanted performance.
4.4.5.7. Managing Operating Revenues
4.4.5.7.1. Where there is a need to assist an EA to improve its revenue generation,

either in parallel with operating cost improvements, or with respect to improving operating
revenues only, the Operating Ratio should also be used with appropriately designed
performance indicators and the respective years of recommended performance.
4.4.5.7.2. Indicators should be used to show the performance of each revenue category
(e.g. domestic, commercial, industrial, etc. or passenger traffic, freight traffic, etc.). Typical
indicators are “Percentage Growth in Revenues” and “Gross Profit Margin” together with
billing performances (number of consumers billed by billing periods, or annually).
4.4.5.7.3. Where an operating ratio indicator is to be installed using a financial covenant

and it is proposed that the levels of operating revenues should increase in real terms over
a defined period, the covenant should define the appropriate performance indicator(s)
and the respective years of covenanted performance.
4.4.5.8. ADB Policy on Asset Revaluation
4.4.5.8.1. ADB and the other MDBs have, in the past, accepted the use of both historical
cost accounting, and modified historical cost accounting (where assets are revalued on
a regular basis). Both these accounting methods are consistent with International
Accounting Standards. ADB and the other MDBs will seek to agree a consistent policy
position on the revaluation of assets, or otherwise, as part of the harmonization exercise.
4.4.5.8.2. In the meantime, and in keeping with general ADB practice, asset revaluations
should be undertaken where that is the standard practice of the particular country.
However, if asset revaluations are undertaken: (i) the whole class of assets should be
revalued at the same time (e.g., land); (ii) a robust methodology should be applied that
accords with generally acceptable practices (e.g., as applied by the International Valuers’
Association) – the use of price indices and other less robust revaluation methods should
not be used; and (iii) the assets must be revalued on a regular basis (e.g., every three years).
4.4.5.8.3. With regards to the calculation of Rate of Return, this should be based upon
the value of assets at depreciated historical cost, unless the economy is hyperinflationary
(see IAS 29 for a discussion).
4.4.5.9. Managing Funds for Investment and / or

Reserves
4.4.5.9.1. The Rate of Return on Net Fixed Assets is appropriate under low inflationary
conditions. When inflation is forecast to exceed 7 percent per annum over the five years
from the date of loan effectiveness, the practice has been to require a periodic revaluation
of assets.
4.4.5.9.2. Where a self-financing ratio covenant is proposed, ADB’s current version

calls for cash generation (rather than funds generation). This change was made to reflect
the need for an EA to be able to meet its commitments in cash with the objective of
encouraging contractors and suppliers to provide timely support for the project. However,
this modification will only be successful if the EA effectively meets the terms of the
covenant, by generating cash to support self-financing.
4.4.5.9.3. Each of the projects listed in section 3.2.1 should be asked to provide either
(i) a rate of return on unrevalued net fixed assets; or (ii) self-financing ratio indicator,
in periodic and annual reports. One, or both of these indicators may be included as
financial covenants.
4.4.5.9.4. The objective of using both indicators in covenants would be to try to ensure
that the EA generates sufficient cash to at least meet the self-financing ratio. This latter
ratio should be established at a level that is estimated to correspond to the funds required
to support the rate of return indicator.
4.4.5.10. Assuring Capital Adequacy
4.4.5.10.1. All capital has a cost, even in circumstances where a government may waive
interest or dividends on equity (grants), or where a donor may provide a grant. This
latter case represents the cost to another worthy cause that didn’t benefit from the grant
proceeds and had to forego the benefit, and possibly find an alternative at a cost.
4.4.5.10.2. Capital primarily comprises equity, loans, and grants. Typically the highest
cost is equity, due to the risk of a failing investment. Loans are normally at a lower cost
than equity although short-term funds in high risk/inflationary conditions may exceed
long-term equity cost (but under such conditions, the latter may not be available).
4.4.5.10.3. An EA that seeks capital should minimize its capital costs by seeking the
lowest cost selections between loans and equity; the latter can be either obtained from
investors or from retained earnings (which are frequently measured by the return on
investments).
4.4.5.10.4. The effectiveness of such a policy is typically judged by the debt-equity

ratio. While it may be argued that a revenue-earning EA that is controlled and funded
by government should not be concerned about the level of its debt, recognize that such
loans usually are part of a government’s borrowing ceiling, and , as such, may deprive
other government agencies of scarce funds.
4.4.5.10.5. When redistribution of resources is a key element of ADB’s policy for the
country concerned, a revenue-earning entity should be encouraged to generate revenues
to make surpluses available for redistribution by government, providing the EA is able
to retain sufficient funds to assure its own financial viability and integrity.
4.4.5.10.6. A debt-equity ratio will vary according to an EA’s financial policies and perhaps
the government’s also, where the entity is in the public sector. The long-term aim should
be to sustain a level of cost of capital that virtually balances between the two sources of
funds. A 60:40 debt-equity ratio should imply that the cost of equity is about 1.5 times
that of loan interest rates – or (say) 12 percent for equity to 8 percent for loan interest
per annum. If the equity proportion in the indicator should exceed the level of debt, this
can mean that the EA should be seeking an improved return on its capital.
4.4.5.10.7. Delinquent payers with a poor capital structure, and poor earnings records
will attract high loan rates. As an example, a public sector water utility with a high level
of government equity and loans from MDBs and similar concessional lenders will have
serious difficulty in breaking out of that pattern. Unless EAs can develop a record of
timely settlements and earnings growth that will attract lower cost loans, availability of
venture equity will be scarce, should it seek privatization.
4.4.5.10.8. ADB therefore encourages its borrowers to achieve satisfactory debt-equity

ratios and debt-service coverage performance as a means of attracting other lenders to
replace ADB as a lender of last resort.
4.4.5.10.9. In addition, ADB may wish to limit the debt that a borrower/EA may incur,
sometimes to encourage the use of equity, usually through internal cash generation, but
also to prevent an EA from borrowing for non-capital purposes, such as supporting
declining operating revenues.
4.4.5.11. Deciding on Indicators
4.4.5.11.1. The financial analyst should:
• Identify all factors that could prevent, or limit the effectiveness of, financial
sustainability of the project and of the EA’s own performance. Using these factors,
determine the most efficient financial and nonfinancial performance indicators that
would reflect increases in exposure to financial failure.
• Recommend financial performance indicators that would give early warning of actual
or approaching financial management failures by selecting at least one financial
performance indicator from each of the revenue, capital adequacy and liquidity
financial indicators referred to above, plus any necessary additional financial
performance indicators.
• Establish recommended dates of performance achievement and review where the
EA will be required to adjust financial performance during project implementation
and operation.
• Recommend those financial performance loan covenants that should cause the
borrower and the EA to take action to limit or remove the exposures.
• Insist that all forms of financial management weaknesses be either eliminated before
that time, or that the financial commitments of the proposed project be scaled down
to levels that the EA would be able to sustain (because an EA’s financial management
system must be sustainable from the date of start-up).
• Develop a rationale for the use of each indicator selected for inclusion in the RRP.
4.4.6. Operating Indicators and Covenants
4.4.6.1.1. Before commencing a detailed review of the various measurement

methodologies, it is appropriate to set out ADB’s objectives in using such techniques. The
private sector in member countries, in particular, has developed various performance
measuring devices to enable managements and stockholders to understand and/or be
assured as to the performance of enterprises. The use of a number of these techniques
is feasible in public sector enterprises, and, of course, in private sector enterprises that
are financed by ADB.
4.4.6.1.2. To assist an EA in achieving its financial objectives, as well as the government’s

economic objectives which may be supported by an ADB loan, ADB wishes to be reassured
that the operational objectives of an EA and, where appropriate in the public sector,
agreed upon with the borrower, will be met at least through the life of the project.
4.4.6.1.3. These objectives are translated into covenants by the General Counsel and
are established, among other things, to enhance the national economy concerned and to
ensure that the investment (including ADB’s loan proceeds) are utilized effectively.
4.4.6.1.4. Performance measurement ratios or indicators are an effective and concise means
of transmitting financial information, particularly when used to compare time-bound
performances. An inherent danger in the use of performance ratios and indicators lies in the
brevity of the descriptions used, and sometimes of the information on which they are based.
As indicators they are intended to convey information quickly and succinctly, but users may
be misinformed unless they are provided with a clear understanding of the bases of the data
used to compile the indicators and of any changes that occur to cause violent fluctuations.
4.4.6.1.5. Typically ADB loan/project agreements provide the necessary definitions,

but care should be taken when comparing indicators between ADB-financed projects
and non-ADB-financed operations, where the definitions may not be readily available.
As examples, (a) the term “debt” can mean all debt both long and short term; or only
long-term debt; or it can mean the historical value of foreign debt on its acquisition at
local currency conversion rates at the date of acquisition; or it can mean the current
value expressed in current US dollars etc.; and (b) a rate of return on net fixed assets
in operation indicator may change significantly if inflation becomes severe and there is
no corresponding revaluation of assets.
4.4.6.1.6. Ratios and indicators should be displayed on a financial report or its tables
in such a manner that readers can quickly appreciate the significance of the information
and are left in no doubt as to the basis of the information used to generate a ratio or
indicator. This means that financial analysts must include in their documents, particularly
the financial projections, and in the Project File, the assumptions used in compiling
financial ratios and indicators.
4.4.6.1.7. The guidance in this section is intended to assist staff in determining the
most appropriate revenue performance ratios and indicators to use, and the most suitable
methods for their compilation and incorporation in financial covenants.
4.4.6.2. Rate of Return (ROR)
4.4.6.2.1. Section 3.6.2.2 discusses the application of this indicator in relation to

investment projects. The conventional concept of a rate of return is a measure of the
efficiency of the use of operational assets, or alternatively, a measure of the return on
invested capital compared to other opportunities to invest in the market place. This is
particularly true at the margin (i.e., it is illogical to invest in assets if their yield is less
than that obtainable for alternative uses of capital).
4.4.6.2.2. The cost of capital is also proxy for when a utility should, or should not, put
its money in the money market instead of buying an asset. But the application and use
of the rate of return concept has been broadened in its application to the measurement
of performance of public sector enterprises.
4.4.6.2.3. The Rate of Return on Net Fixed Assets in Operation is a common financial
performance indicator used in industry and commerce, and particularly by utility
regulating agencies that seek to limit private sector profit maximization at the expense
of unprotected consumers. Its application by multilateral development banks (MDBs) in
their financial covenants has been the opposite of that adopted by regulatory agencies.
The latter have always sought to keep rates and prices of utilities within fixed limits,
whereas the MDBs have treated the indicator as a minimum (i.e., the borrower should
either achieve or exceed the indicator specified in a covenant). This alternative use,
particularly in cases where the target is set too low, may result in the achievement of less
than the effect desired by MDBs (as a measure of the efficiency of the use of invested
capital) or justified on economic grounds, by encouraging politicians and managements
to believe that as long as they achieve the specific “target”, the financial health of an
enterprise will be assured.
4.4.6.2.4. In practice the rigid adoption of the prescribed target under inflationary
conditions, in particular, or in times of financial stringency, may result in an adverse
impact on long-term performance by providing insufficient resources for investment and
reserves, with resultant damage to the quality of the service and/or product. The rate of
return for ADB purposes is the relationship between the net operating income and the
net fixed assets in operation, and expressed as a percentage.
4.4.6.2.5. Expressed in other words, it is the net yield or return after tax achieved by
the net assets in operation in an operating period. A rate of return indicates the return
which should be achievable on invested productive capital of an enterprise in the country
concerned; or the reasonable rate of return to the enterprise which it could obtain from
average interest rates or returns for the similar amounts of capital invested in the market
place (long-term borrowings and equity) which are usually higher than interest rates
payable on long-term borrowings available to public sector enterprises and institutions.
The definition of “reasonable” in these circumstances is a judgment call, and reference
should be made to similar returns on investment elsewhere in the economy of the country
concerned, or at the current interest rate structure, after making allowances for differences
in the business risks and terms of comparable investments.
4.4.6.2.6. Net operating income after taxes is represented by operating income less
operating expenses. Operating expenses include adequate maintenance and provision
for depreciation, usually on a straight-line basis at a specified rate or rates; but interest
and other financial charges are not included as part of operating expenses (a detailed
definition of all elements is included in the draft covenant). Capital invested in fixed
assets normally is the average for the year of the net value of an enterprise’s fixed assets
(Refer to 4.4.5.8 for a discussion of ADB policy on asset revaluation). Invested capital
may also include adequate working capital, particularly for enterprises that require a
relatively high proportion of working capital to conduct operations.
4.4.6.3. The Self-Financing Ratio (SFR)

investment projects The self-financing indicator, sometimes referred to as contribution
to expansion, or contribution to investment, or cash generation, measures the net internal
cash generation generated by an enterprise which is available for investment (expansion)
purposes, usually to contribute to its investment program, particularly the proposed
project.
4.4.6.3.2. It is typically defined as a percentage of specified capital expenditures that

are to be financed after meeting operating expenses, debt service, taxes, dividends,
increases in working capital, and other significant cash outflows excluding capital
expenditures. As such, a self-financing ratio indicator directly measures the adequacy of
internal cash generation to finance consistently an agreed proportion of investment
requirements. However, a self-financing ratio, as for all performance ratios, should be
determined on the basis of discussions of financial policy with the enterprise, the sector
and center/state economic and financial ministries/departments’ officials.
4.4.6.3.3. It should be logical; it should not be a “traditional” number which has been
used in the past, or is in the ongoing loan covenants, etc. It should be a carefully measured
ratio which will directly support current and future policy objectives.
4.4.6.3.4. The percentage of internal cash generation to be specified is usually derived

from the financing plan and financial projections for the period under consideration
(which typically may be the project construction period plus three to five years beyond
completion), after reflecting policy decisions (agreed by ADB) on equity financing versus
debt financing, and debt servicing principles.
4.4.6.3.5. The principal method of determining this percentage is by comparing the

net funds generated in a given year to the average capital expenditures for a representative
period. This should consist of three years, including the year just past, the current year,
and the next following year. The data for the current year and the next following year
should be supported by a firm budget.
4.4.6.3.6. The often uncertain nature of future investment programs may make it
necessary to provide for periodic reviews of the percentage(s) of internal cash generation.
When a self-financing ratio indicator is used, the rate of return indicator for the enterprise
should also be estimated and its adequacy should be judged on the basis of the
considerations stated in that Section.
4.4.6.3.7. The financial analyst should encourage the policy-makers in an enterprise

and the government concerned to address the issue of what should happen when
investments decline, i.e., when the funds generated through the use of a self-financing
ratio are greater than the yield specified in a loan agreement. For example, if a self-
financing ratio of 20 percent generated about $20 million equivalent annually for an
enterprise, and the investment program declined to about $40 million annually, or even
to less than the yield of the ratio, what should the policy be vis-à-vis this “surplus” and
the self financing ratio itself.
4.4.6.3.8. Two matters should be actively pursued. First, the enterprise should be
encouraged to meet as much of its capital development requirements (asset financing)
as possible, and therefore even if the ratio reached 100 percent, the benefit would accrue
to the enterprise, its consumers and to the government, particularly if foreign loans were
no longer needed. Second, either the government has undoubtedly provided equity in
the past for the development of the enterprise (and therefore the sector concerned) and
is entitled to receive payment for the use of that capital in the form of dividends – or
even in the form of repayment of capital contributions to re-employ the resources in
other less fortunate sectors, or enterprises within the same sector. Or, in cases where the
self-financing ratio is a sector-specific policy, this repayment of capital, or the payment
of dividends on equity of government, could commence once the balance of funds in
excess of the yield of the specified self-financing ratio, even though the enterprise was
still incurring debt, on the grounds that this “surplus” represented the funds available
for distribution within the sector.
4.4.6.3.9. However, the self-financing ratio will continue to present the financial analyst
with a paradox: (i) the higher the assessed risk, the higher the self-financing ratio required
by prudent creditors; but (ii) weaker enterprises probably have higher risks and probably
are unlikely to afford a high self-financing ratio - with the result that only limited
investments are possible, thus contributing to (and not allaying) inherent weaknesses
with the inevitable adverse impact on the community, the economy and government
generally.
4.4.6.4. The Operating Ratio

investment projects. The objective of an operating ratio is to measure operating efficiency.
It should be used to address the efficient use of manpower, materials, transport, and
other factors of production. It should not be used to measure cash flow requirements.
4.4.6.4.2. The operating ratio indicator expresses operating expenses, including

adequate maintenance and depreciation, as a percentage of revenues. It is easily understood
and calculated from income statement data. The lower the ratio, the better is the borrower’s
financial performance; a ratio up to 100 means that revenues are sufficient to meet
operating expenses (a ratio of 80 means that operating expenses consume 80 percent of
revenues).
4.4.6.4.3. It does not provide for financial obligations for debt repayment or
contributions for expansion, except indirectly to the extent that revenues fund
depreciation. It is difficult to design an operating ratio indicator to achieve the objectives
of a return on investment indirectly. In the event that the operating ratio at project
preparation is inadequate, or is already low (below 100), the financial analyst should
discuss with the project engineer and the enterprise the efforts which should be made
to improve the ratio without increasing revenues by increases in charges.
4.4.6.4.4. There may be a need for supplemental loan covenants that address physical
performance, or for an action plan linked with the covenanted operating ratio, to improve
efficiency in the enterprise (e.g., water and/or sanitation employees per 1,000 house
connections).
4.4.6.5. Break-Even Ratio

investment projects. The breakeven indicator, which is infrequently used, compares the
total revenues of an enterprise to the operating expenses plus the amount by which debt
service requirements exceed the provision for depreciation. The objective is to measure
an enterprise’s efforts to breakeven, without providing any surpluses for investment,
dividends, etc.
4.4.6.5.2. It is typically used by transportation enterprises (buses, trams) which are

frequently heavily subsidized, where the indicator can be used by these institutions to
measure their efforts to obtain sufficient revenues, exclusive of subsidies, to match
operating expenses and debt service.
4.4.6.5.3. This indicator, and a covenant which may be used to support its use, should
not be introduced without a detailed justification at fact-finding, and in the appraisal.
The justification should include a detailed breakeven analysis, displaying the effects of
changes in volume on the breakeven point(s), and on profitability and cash flows.
4.4.6.5.4. The discussion should include a forecast of when a self-financing ratio should
be introduced, and if debt service is not being met completely, or at all, the steps which
the government and the enterprise propose to take to recover debt service from consumers
through the charging system(s) of the enterprise.
4.4.7. Capital Structure Indicators
4.4.7.1.1. Public sector and private enterprises need an appropriately balanced,

adequate capital structure, even though for the former, the objective of return on capital
may be tempered by socioeconomic policy considerations.
4.4.7.1.2. It would be possible to provide all the capital of a public sector enterprise
as equity and thus avoid all financial risks. This is undesirable since this would forego
the benefits of the financial discipline associated with the obligation to service debt.
Limits on the liability of public sector enterprises to contract additional debt also prevent
the use of borrowings to postpone cost reductions, (or increase of charges) to maintain
earnings at an adequate level.
4.4.7.1.3. It is also an oversimplification to view the equity capital in a public sector

enterprise as having no recognizable financial cost because the funds used have an
opportunity cost regardless of where they are invested. Also the cost of capital is a legitimate
cost that owners/consumers should pay, regardless of whether there is no debt in the
structure of the enterprise. Moreover, in a public sector enterprise, earnings must be in
excess of debt service obligations (and/or dividend payments on equity) to provide a
safety margin, and to provide additional funds for investment. The previous paragraph
is a typical commitment entered into by an enterprise to enable it to continue to incur
debt, particularly to draw down the ADB’s loan.
4.4.7.1.4. The enterprise can use these funds for its capital requirements or to pay
dividends that the government can apply for other developmental or fiscal needs. Capital
structure indicators serve to indicate an assurance (or otherwise) of the continued solvency
and financial viability of revenue-earning enterprises by imposing prudent limits on their
long-term borrowing. However, they are not designed as revenue-generating indicators
and thus cannot be used as operating covenants.
4.4.7.2. Capital Structure as a Debt Limiter
4.4.7.2.1. An EA that does not incur debt after agreeing to use a capital structure
indicator, or refrains from further borrowing after a period of compliance, even though
the agreed performance criteria subsequently may not be complied with, is not in breach
until it again commences to incur debt.
4.4.7.2.2. The limits of the indicator should be set so as to enable debt service obligations
to be met under adverse as well as normal business conditions, taking into account business
and financial risks.
4.4.7.3. Capital Structure and Risk Management
4.4.7.3.1. Business risk refers to the inherent uncertainties, or variability of expected

returns, related to the nature and type of business activity of a particular enterprise. The
financial risk is the additional risk inherent in the obligations associated with borrowings
(interest and debt repayment) which must be met irrespective of the results of operations.
4.4.7.3.2. The foreign exchange risk is an extension of the financial risk when the obligations
associated with borrowings (interest and debt repayment) that must be met irrespective of
the results of operations are expressed in a currency other than the local currency.
4.4.7.3.3. The principal foreign exchange risk arises when the local currency declines
in value against the foreign currencies in which the obligations must be paid, resulting
in the cost (or value) of the obligation being increased by reason of the additional local
currency required to purchase the requisite amount of foreign exchange to meet the
obligation.
4.4.7.3.4. If the local currency increases in value against the foreign currency obligation,
the borrower requires less local currency to purchase foreign exchange to meet the
obligation (and therefore, in this case, there is no foreign exchange risk).
4.4.7.3.5. A well-managed entity with a low business risk will have a fairly dependable
cash flow and can assume higher financial risks in the form of a large proportion of debt
to equity in its capital structure. This would apply, for example, to a public utility with
a relatively steady and increasing demand for its services, little competition from other
sources of supply, and fairly dependable production facilities. On the other hand, an
entity which may be subject to wide variations in demand and prices, such as a steel
company or a coffee estate, is likely to have substantial swings in its cash flow from year
to year. It should therefore have a relatively conservative financial structure with low
fixed financial obligations.
4.4.7.4. Inflation and the Capital Structure
4.4.7.4.1. The risk of inflation is another factor that affects the cost of capital and
decisions on capital structure. Although inflation may lower the burden on servicing
outstanding debt at fixed terms, it may increase the financial risk associated with loan
capital, since the earnings of an enterprise may not keep pace with inflation.
4.4.7.4.2. The interest payable on long-term loans at fixed terms may include a
substantial inflation premium over the returns lenders would otherwise accept for the
business and financial risks they are assuming. Alternatively, long-term loans may be
available only if loan amounts and repayments are indexed for changes in the value of
money, or if the interest rate varies with the current cost of borrowings.
4.4.7.4.3. The impact of inflation on financial risk is greatest when only short- or
medium-term funds are available, and the enterprise is exposed to the risk of being
unable to refinance at maturity or of having to pay higher interest rates for renewal. The
risks associated with borrowings under inflationary conditions, therefore, must be carefully
appraised in determining a prudent capital structure. Inflation also increases the working
capital requirement of enterprises.
4.4.7.4.4. The negative effects of inflation often outweigh the positive effects of lower
debt service, and after a few years, the impact may be of under-capitalization.
4.4.7.5. Equity versus Debt
4.4.7.5.1. Equity investors because they are subject to the prior claims of lenders and
have no fixed promises of returns, will usually expect a higher return on their capital
than lenders. Like lenders, equity investors will accept lower or higher returns when
they judge the risks to be low or high. They will consider their risk to be lower when
equity is high in relation to debt, and vice versa.
4.4.7.5.2. Thus, when a private enterprise is being established, or is raising funds for
expansion, the capital invested ideally should be structured so as to balance the lower
financial costs of loan funds against the higher costs of equity capital and provide for
long-term financial stability at minimum cost.
4.4.7.5.3. Differences in the capital structure of enterprises in the same industry or in

industries with similar business risks may reflect varying management judgments on the
trade-off between security and risk, or an unwillingness to adequately fund replacements
or expansion, all subject to limitations imposed by protective covenants agreed with
lenders.
4.4.7.6. Debt Service Coverage

investment projects. The debt service coverage ratio measures the extent of the coverage
of an enterprise’s debt service by its internal cash generation over a defined period.
4.4.7.6.2. A performance of one means that there is precise coverage, while a

performance in excess of one (e.g., 1.3) indicates a margin of safety in covering debt,
plus yielding surplus funds for investment, etc. This indicator recognizes that the terms
of a debt are more significant that the amount in measuring borrowing capacity. Except
for Financial Institution Indicators, the debt service coverage ratio is used for revenue-
earning enterprises in all sectors, particularly for public utilities, transportation, and
industry, including agro- industry. There are two versions of this indicator: (i) based on
historical earnings; and (ii) on estimated future earnings.
4.4.7.6.3. Version (i) is based on historical earnings. It can address either the latest
completed fiscal year or a more recent 12-month period. It is more objective and certain
than version (ii) which is based on estimates of future earnings. In calculating the internal
cash generation, (i) permits an adjustment to be made for changes in sales prices introduced
during the year as though they were in effect throughout the year. Nevertheless, this
version (i) may be constraining because it gives no credit for the earning power of the
investments to be financed by the proposed loan, or any other expected increases in
earning power (ADB’s loan agreement clause “Except as ADB shall otherwise agree” may
be used to overcome this problem, where appropriate).
4.4.7.6.4. Conversely, an EA that fails to implement a project within the grace period
of the related loan can be faced with debt servicing demands that cannot be met by the
unfinished investment, which is not yielding revenues.
4.4.7.7. Debt-Equity Ratio

investment projects. The debt-equity ratio represents the relative proportions of these
two sources of funds in the capital structure of an entity. This ratio is not appropriate
for measuring financial institution (FI) performance.
4.4.7.7.2. If a capitalization of $240 million is financed by long-term debt of $180

million and by equity of $60 million, the debt-equity ratio would be presented as 75:25.
This conventional presentation is normally used for all sectors except financial institutions
(FIs).
4.4.7.7.3. The debt-equity ratio indicator is normally used only for new enterprises,
such as a “greenfield” industrial plant, where for lack of an earnings record, application
of the debt service coverage covenant is not practicable.
4.4.7.7.4. Except for FIs, the debt-equity ratio helps to maintain a satisfactorily balanced
financing plan in an enterprise’s early years, but a debt service coverage should be used
also, because this is likely to become a more meaningful measure as output commences.
It should then supercede the debt-equity ratio covenant after the first year or two of
operations.
4.4.7.7.5. The considerations determining the magnitude of the debt-equity ratio are
the same as those discussed for debt service coverage. It is generally inappropriate to
have a debt-equity ratio higher than 60:40, but flexibility is permissible, depending on
the sector or industry concerned, on the degree of capital intensity, and on the level of
debt service commitments entered into.
4.4.7.7.6. Where the latter are not severe, a higher ratio may be admissible. For example,
where the loan principal is repayable at the end of the term and inflationary conditions
prevail; or the interest rate is fixed at a low level; or the prospects for continued intensive
borrowing are negligible, giving prospects of declining debt- equity ratios.
4.4.7.7.7. Lower ratios than this are preferable for enterprises whose earnings are subject
to wide fluctuations. Higher ratios, normally not greater that 70:30, may be acceptable
for enterprises with very dependable earning power. However, there are a number of
public sector enterprises, which are funded almost entirely by government debt, where
the debt-equity ratio is 90:10 and sometimes 100:0.
4.4.7.7.8. In terms of sound commercial and financial management practice, such ratios
are meaningless, but because the enterprises concerned are, in effect, government
“departments”, there may be no adverse performance effects, save that debt service could
reach unmanageable proportions should the governments concerned ever seek to recover
real interest rates. However, in many of these cases, the “debt” is often non-repayable,
and interest rates are usually kept low. The indicator in these circumstances has no
credibility.
4.4.7.7.9. It should be noted, however, that one of ADB’s long-term objectives for
enterprises of this type is, as a minimum to achieve self-financing status, and as an
optimum, to achieve privatization. For either option, an unbalanced debt-equity structure
of 90:10 or higher will mean that the enterprise will be regarded in the capital markets
as not creditworthy, and until it can adopt a structure around 60:40, is unlikely to attract
institutional lenders.
4.4.7.7.10. However, an important side issue arises from the highly leveraged enterprises
referred to above. While it may be reasonable to accept their status in terms of an
abnormally high debt-equity ratio, the financial analyst must recognize that these
enterprises are operating on free or very “cheap” capital.
4.4.7.7.11. ADB considers, generally speaking, that enterprises should pay for the use
of capital, and that a reasonable interest rate should be levied. If this capital is not
transferred in the form of loans and is injected instead as equity, this too has a price –
probably a higher price than loan funds if it were sought in the money market. Therefore,
the analyst should actively encourage the payment to government for this form of capital
injection.
4.4.7.7.12. Any issues should be discussed at Project Preparation, and the RRP should
contain a clear statement on the treatment proposed, and justification therefore,
particularly if the market price of funds is not to be levied by government.
4.4.7.8. Debt Limitation

investment projects. The typical case when this restriction is sought through a loan
agreement is when a public authority whose capital structure consists entirely or
predominantly of debt, because of statutory requirements that all externally provided
investment funds be advanced in the form of borrowing from government.
4.4.7.8.2. It is used infrequently and only where debt service coverage or debt-equity
covenants cannot be applied, primarily because the latter ratio is meaningless. For example,
the equity may be zero, when all liabilities are in the form of government loans.
4.4.7.8.3. An absolute debt limitation covenant limits the amount of debt that may be
incurred annually to an amount agreed between the borrower and ADB, and is either a
specified amount expressed in absolute terms, or specified as a proportion of the total
capitalization. The borrower would require ADB concurrence before exceeding this limit.
4.4.7.8.4. The limit for new debt is fixed at a relatively small amount, which, together
with the internally generated funds that are forecast to be available, permits the borrower
to carry out minor plant replacements or improvements without consulting ADB.
Whenever the borrower plans a major expansion it must consult with ADB. This form
of covenant has substantial disadvantages. It is related to a stated amount of debt without
consideration of its terms and without taking into account changes in an enterprise’s
financial requirements or debt servicing capacity; and it severely restricts an enterprise’s
freedom of action.
4.4.7.8.5. A more constructive solution would be to agree with the borrower that a
substantial part of any loan by the government to the public sector enterprise would be
subordinated and treated as quasi-equity capital. This would permit the use of the debt
service coverage or debt-equity ratio covenants.
4.4.7.9. Capital Adequacy Ratio

investment projects. The capital adequacy ratio indicator is used extensively in commercial
banking, and is now being applied to most Financial Institutions (FIs). Section 6.4.3.1
describes the development, calculation, and application of this indicator in detail.
4.4.8.1.1. Liquidity indicators are intended to measure the adequacy of an enterprise’s

working capital, i.e., an excess of current assets over current liabilities, to meet its current
obligations in a timely manner and conduct its operations effectively without financial
constraints. These indicators were generally used only when working capital requirements
were significant, as in the case of most industrial and agro-industrial projects. However,
the inability of many EAs to collect and manage their cash resources has brought these
indicators into increased attention and popularity.
4.4.8.1.2. While these indicators were not normally used for projects where working
capital needs were considered to be relatively small, they are increasing being deployed,
particularly as non-covenanted reporting requirements.
4.4.8.1.3. The Current Ratio and Quick Ratio define a specified minimum liquidity
ratio and corrective actions will be necessary when the actual ratio falls below the
prescribed level.
4.4.8.1.4. The Quick ratio (or acid test) is the preferred indicator because it ignores
inventories that are frequently not readily realizable in public utilities (e.g., large water
main pipes and electrical transformers that are stored for emergency use).
4.4.8.2. Current / Quick Ratios
4.4.8.2.1. Sections 3.6.4.2 and 3.6.4.3 discuss the application of these indicators in
relation to investment projects.
Current Ratio
4.4.8.2.2. The current ratio is the ratio of current assets to current liabilities as of the
date of the balance sheet. It is the measure of the adequacy of working capital and short-
term liquidity, since it indicates the extent to which short-term obligations are covered
by assets that are capable of being converted to cash in a period roughly corresponding
to the maturity of the obligations.
4.4.8.2.3. Current assets normally include cash, marketable securities, and other assets,
such as accounts receivable, inventories, and prepaid expenses, which in the ordinary
course of business are expected to be converted into cash in the next year. Current liabilities
are those which would or could become due and payable in the next year, including
accounts payable, short-term notes payable, customer advances and deposits accrued
taxes and expenses, dividends payable and current maturities of long-term debt.
4.4.8.2.4. The acceptability of a current ratio depends on the type of production and
selling operations and the characteristics of the market for the output.
4.4.8.2.5. A ratio of less that 1.0 is generally unacceptable and usually a ratio
substantially above 1.0 is deemed necessary. For example, an enterprise subject to seasonal
or fluctuating demand for its output, or irregular timings of inventory acquisition/build-
up, should have a current ratio high enough to carry the necessary inventories of goods
in process and finished and saleable output pending actual sales – possibly as high as 4.0.
4.4.8.2.6. An enterprise such as a public utility, with steady inflows of funds from
monthly billings and a good record for prompt collection, may operate with a current
ratio as low as 1.0, or even marginally lower. An enterprise which has to transport at its
own time and expense large quantities of inputs and finished goods for long distances
will likewise require a high ratio.
Quick Ratio
4.4.8.2.7. An alternative and better test of liquidity is the quick ratio. The basic difference
between this and the current ratio lies in the treatment of inventories, which are the least
liquid of current assets and are also those on which losses are most likely to occur if
business conditions are adverse.
4.4.8.2.8. The quick ratio is calculated by deducting inventories from current assets
and dividing the remainder by current liabilities. In other respects this form of covenant
possesses similar advantages and disadvantages as the current ratio.
4.4.8.2.9. A quick ratio of at least 1.0 is usually prescribed. The current and quick
ratio indicators have a serious deficiency in that they present the status of an enterprise
at a point in time, and not its regular performance.
4.4.8.2.10. Distortions frequently occur, such as the case of enterprises relying on

customers’ advance payments for large delivery contracts, which if they do not take place,
cause major shortfalls in cash, or if they occur as contracted, may make the ratio far
higher than the actual consumption of inputs warrant.
4.4.8.2.11. It is feasible using this indicator to “window-dress” the enterprises’ financial

status for presentational purposes at the reporting date.
4.4.8.2.12. The intention of covenanting this indicator is to require a borrower to not

operate below the covenanted level. However, in practice it can be very difficult to
determine defaults during a year. Therefore the most useful application of this indicator
is to request an enterprise to provide a graphic presentation of a series of status indicators
at, say, monthly, or weekly intervals for each year. In this way, the effective liquidity
position can be better determined.
4.4.8.3. Dividend Limitation

investment projects. The dividend limitation indicator, with a dividend limitation test,
establishes the point at which the borrower is prohibited from declaring a dividend, the
payment of which would cause the current ratio (or quick ratio, if that is the selected
test basis) to fall below a specified minimum.
4.4.8.3.2. The minimum level of current ratio may be higher than the minimum required
under a Current Ratio indicator because decisions on whether to pay dividends are often
discretionary, and a stricter standard of prudent financial management can thus be applied
to this context. Therefore, a borrower should be asked (through a covenant) not to make
voluntary payouts of cash to its stockholders until it has taken further measures to establish
and maintain the liquidity essential for operations.
5. Reporting and Auditing
5.1. Financial Reporting and Auditing Overview
5.1.1. This part of the Guidelines addresses the financial reporting by, and auditing
of, projects, project EAs , and project implementing agencies (IAs). It also advises on the
selection and terms of reference of public and private sector auditors, particularly in
relation to the qualifications and competence of government auditors. Arrangements for
monitoring and reviewing financial reports and auditors’ reports are explained in detail.
A checklist is provided for reviewing auditors’ reports.
5.1.2. Together with Part 3 (Preparing and Appraising Investment Projects) and
Part 4 (Financial Management of Executing Agencies), this part aims to: (i) provide financial
analysts with detailed guidelines to enable them to advise governments, EAs, and IAs on
ADB’s financial reporting and auditing requirements; and (ii) facilitate the identification
of inadequate financial reporting and auditing performance by EAs, IAs and auditors.
5.1.3. It is based on the Operations Manual (OM), Project Administration

Instructions (PAIs), and related guidance documents. Part six of these guidelines provides
specific guidance on particular financial reporting and auditing issues for Financial
Institutions (FIs). In addition to this introduction and overview, this part has five sections:
5.2 Accounting Standards This section describes accounting standards

and Policies and their applicability to financial reports
on ADB-financed projects.
5.3 Financial Reporting This section outlines ADB financial

reporting requirements for ADB-financed
projects.
5.4 Auditing Standards and This section describes auditing standards

Auditor Engagement and their use in the audit of the financial
reports of ADB-financed projects.
5.5 Reviewing Financial Project Administration Instruction 5.09 sets

Reports out ADB requirements for monitoring
financial reporting. This section discusses
the process of reviewing financial reports
and outlines actions that should be taken
2 of 48 Reporting and Auditing
where financial reports are overdue or are

inadequate.
5.6 Reviewing Audit Reports This section provides guidance on reviewing

auditor reports. It includes an audit report
questionnaire.
5.2. Accounting Standards and Policies
5.2.1. Introduction
5.2.1.1. The preparation and reporting of accounting information varies widely among
countries and contributes to a substantial lack of transparency and consistency in financial
reporting. This means that precise interpretation of public and private sector financial
statements can be a daunting process. At best, they may be misleading; at worst, they
may be fraudulent. A serious ADB concern is the accurate interpretation of the financial
position and performance of its borrowers and EAs. It is even more important for investors
and those charged with the safeguarding of trading operations in stock exchanges,
brokerage houses and banks to have confidence in reported financial performance and
position.
5.2.1.2. In recent years, there has been significant progress in the availability and
usage of internationally-consistent accounting standards. First, the International
Accounting Standards (IASs) issued by the International Accounting Standards Board
(IASB) were developed to the point where they presented a viable, and arguably preferable,
alternative to nationally-developed accounting standards. Second, most developed and
developing countries are in the process of either harmonizing their accounting standards
with IASs or adopting IASs directly. Financial analysts should be conversant with the
status of these developments.
5.2.1.3. ADB, together with other international financial institutions (IFIs), including
the other multilateral development banks (MDBs), is actively encouraging borrowers
and EAs to adopt uniform standards of accounting and financial reporting. In this respect,
ADB recommends that revenue-earning EAs report in accordance with IAS-compliant
accounting policies. 14 However, some time will be required to achieve a high level of
uniformity. In the case of non-revenue-earning EAs in the public sector, ADB expects
sound financial policies, adequate accounting records, proper internal control systems,
timely reporting to management, and sound auditing practices.
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Reporting and Auditing 3 of 48
5.2.1.4. This section discusses ADB’s approach to the application and use of
accounting standards and policies by borrowers.
5.2.2. International Accounting Standards (IASs)
5.2.2.1. Differences in financial reporting practices and accounting standards can be

significant between countries. The factors that influence the development of accounting
practices and the differences between countries in terms of these practices include the
nature of a country’s legal system, the prevalent providers of finance, the influence of
taxation, and the strength of the accountancy profession.
5.2.2.2. The International Accounting Standards Board (IASB), which superseded

the International Accounting Standards Committee (IASC) on 1 April 2001, promulgates
IASs. The IASB’s objectives are to: (i) develop, in the public interest, a single set of high
quality, understandable and enforceable global accounting standards that require high
quality, transparent and comparable information in financial statements and other financial
reporting to help participants in the world’s capital markets and other users make economic
decisions; (ii) promote the use and rigorous application of those standards; and (iii) bring
about convergence of national accounting standards and IASs to high quality solutions.
IASs are appropriate for private sector reporting and for reporting by government business
enterprises, including public utilities (e.g., electricity, gas, water and sanitation, and
telecommunications). The Knowledge Management section of these guidelines provides
a list of IASs. Further information is provided at www.iasc.org.uk and at www.iasplus.com.
5.2.2.3. Surveys of national accounting standards show that most countries are
aligning their accounting standards with IASs. Some countries have adopted IASs
completely. In particular, the G7 Group of nations has pledged to align their accounting
standards with IAS and the European Union has decreed that all member countries should
adopt IASs for listed company reporting by 2005. The status of country-adoption of IASs
can be examined at the IASB’s website (www.iasc.org.uk).
5.2.2.4. In 1998, the IMF was charged with monitoring the country adoption and
usage of IASs. Consequently, countries will be under pressure to adopt some form of
accounting standards in close harmony with IAS, if not the complete IAS package of
standards. The G7 expects the IFIs, including ADB, to contribute to advancing the use
of IAS in their member countries. These contributions may be by requiring use of IASs
in financial reporting to ADB, and by providing assistance in appropriate cases to modify
systems and build capacity.
5.2.3. ADB Accounting Policy Requirements
5.2.3.1. Requirement to Meet International Standards
5.2.3.1.1. Financial analysts need to fully understand IASs. They also need to be
reasonably familiar with the accounting standards in use in the countries in which they
operate. In this respect, financial analysts should review Country Diagnostic Studies of
Accounting and Auditing (DSAAs), where they have been prepared (see section 4.2.5).
More particularly, financial analysts should become familiar with the accounting policies
used by the EAs and IAs that manage ADB-financed projects. This will enable analysts
to recommend approaches that will: (i) provide ADB with adequate information to
understand the efficiency of the management of borrowers’ investments; and (ii) contribute
to narrowing differences between IASs and national accounting standards.
5.2.3.1.2. ADB will seek to agree with the borrower, EA and PIU on the acceptable
accounting standards and policies governing the preparation of financial statements not
later than at loan negotiations. Financial statements for private sector companies and
organizations, and for revenue-earning public sector EAs, should be prepared in
accordance with accounting policies that are consistent with IASs.15 Alternatively, ADB
may accept audited annual financial statements of projects, EAs and IAs that are based
on national or other defined standards, provided that the Notes to the Financial Statements
include realignments and adjustments of the financial information in the audited annual
financial statements to provide a report in accordance with IASs. In relation to non-
revenue-earning projects in the public sector, ADB expects sound financial policies, proper
accounting records, proper internal control systems, timely reporting to management,
and sound auditing practices.
5.2.3.1.3. ADB therefore recommends that all public and private sector revenue-earning
EAs and IAs should move to account and report for projects financed by ADB on the
basis of accounting policies consistent with IASs current at the date of loan negotiations,
or any other date(s) in the project implementation period agreed between ADB and the
borrower. Borrowers, EAs or IAs should adopt IAS-compliant accounting policies by an
agreed date.16 Until this time, financial statements should be prepared in accordance
with a set of accounting policies acceptable to ADB and noted in the Minutes of Loan
Negotiations.
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rangements (see paragraph 2.4.3)
5.2.3.2. Timetable to Introduce Acceptable

Accounting Policies
5.2.3.2.1. ADB expects that public and private sector revenue-earning project financial
reports will be prepared on the basis of IAS-compliant accounting policies.17
5.2.3.2.2. In some cases, national accounting standards and practices will not conform
to accepted international standards.
5.2.3.2.3. Where only minor items are involved (for instance, overhead-allocation
methods or inventory-valuation policies), the continued use of these standards and
practices may be acceptable so long as the variances are quantified and disclosed in the
Notes to the Financial Statement and in the Auditor’s Report.
5.2.3.2.4. ADB recognizes that some time will be required for borrowers, EAs and IAs
to adopt IAS-compliant accounting policies and will negotiate with existing borrowers
on a project-by-project basis for the timing of their introduction.
5.2.3.2.5. In these instances, financial analysts should coordinate with the Supreme
Audit Institution (SAI) of the borrowing country, the EA and the PIU, to determine required
modifications of accounting policies and the required date for their introduction. The
introduction date of the revised policies and practices may be included as a loan covenant,
or as a requirement prior to the commencement of project implementation activities.
5.2.3.2.6. ADB will develop a timetable for each borrower and EA in the private sector
and for each public sector revenue-earning EA for the complete adoption of accounting
policies that are consistent with IASs, or to local standards that are similar to IASs.18 In
this respect, financial analysts should review the action plans developed as part of the
Country Diagnostic Studies of Accounting and Auditing (DSAAs), where they have been
prepared (see section 4.2.5).
5.2.3.3. Statements on Accounting Standards

and Policies
5.2.3.3.1. Financial analysts should pay close attention to the text or wording of
statements made by EAs in the financial statements on the accounting standards and
policies used to prepare the reports. Attention should also be given to auditors’ comments
on the accounting standards and policies used.
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5.2.3.3.2. It is common for financial statement preparers (i.e., EAs) and external auditors
to use vague phrases, such as “approved standards”, “official local standards”, and
“international standards”. Analysts should insist on the accurate description of both
accounting standards and policies used to compile the financial statements and the
definition of the auditing standards applied by the auditor.
5.2.3.4. ADB Reports on Accounting Standards

and Policies
5.2.3.4.1. ADB reports relating to project identification, preparation, appraisal (RRP)

and supervision should describe the current status of application and use of IASs in the
country concerned, and by the EA and/or PIU. 19 The reports should include
recommendations, or commentaries on, timetables and associated steps by ADB to
encourage borrowers, EAs and IAs to adopt IAS-compliant accounting policies.
5.2.3.5. Example of Accounting Policies
5.2.3.5.1. Accounting policies are the specific principles, bases, conventions, rules and
practices adopted by an entity in preparing and presenting financial statements. Financial
statements must include a Statement of Accounting Policies. In the case of non-revenue-
earning EAs, Statements of Accounting Policies are likely to be simplistic (for instance,
they may cover only cash-recognition policies).
5.2.3.5.2. The following table provides guidance on General Accounting Policies.

Particular Accounting Policies should set out the policies applicable to revenues, expenses,
assets and liabilities. It is highly recommended that financial analysts review the model
set of IAS-based accounting policies and financial statements available at www.iasplus.com.
An IAS disclosure checklist is also available from this website.
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Issue Details Example
Reporting Entity The accounting policies should These are the consolidated financial
clearly define the reporting entity. statements of ABC Limited and its subsidiar-
ies: DEF Limited, GHI Limited and JKL
Limited.
Reporting Period The reporting period should be These financial statements apply to the
stated. financial year ended 31 December 20X2.
Legislative Basis The legal basis under which the These financial statements have been
financial statements have been prepared in accordance with Article 123 of
prepared should be clearly stated. the Companies Act 20X1.
Accounting Policy Basis The accounting policy basis should These accounting policies are based upon
be stated. the International Accounting Standards
(IASs) issued by the International Accoun-
tants Standards Board (IASB as at 30
September 20X2. Where no IAS has been
issued on specific topics, the accounting
policy is based on other authoritative
sources
Measurement Base The measurement base used to These financial statements have been
prepare the financial statements prepared using the accrual basis of
should be described. accounting. The measurement base applied
is historical cost adjusted for revaluations of
assets.
Changes in Changes in accounting policies There have been no material changes in

Accounting Policies should be noted. accounting policies during the financial
year.
Going Concern There should be a clear statement The financial statements have been
as to whether or not the entity is prepared on a going concern basis.
a going concern.
Indirect Taxes and The treatment of indirect taxes Revenue and expense items are recognized
Duties and duties should be clearly net of VAT. The net amount receivable in
stated. respect of VAT is included as part of
accounts receivable. Assets are recorded
net of VAT if the tax is recoverable.
Issue Details Example
Comparatives Where there have been changes of Where there is any change of format or
format or presentation from one presentation from one accounting period to
accounting period to the next, the next, comparatives are to be restated,
comparatives should be restated, and that fact disclosed in the notes to the
and that fact disclosed in the financial statements together with any
notes to the financial statements explanation necessary for the reader to
together with any explanation understand the changes that have occurred.
necessary for the reader to
understand the changes which
have occurred.
Basis of Combination Where consolidated financial Controlled entities are consolidated using
(Consolidation) statements have been prepared, the purchase method of combination.
the combination basis should be Corresponding assets, liabilities, revenues
stated. and expenses are added together line by
line. Transactions and balances between
these sub-entities are eliminated on
combination.
Related Parties The policy applied to the disclo- There were no related party transactions
sure of related-party transactions during the financial year.
should be stated.
Foreign Currency The basis for recording foreign Foreign currency transactions are measured
currency transactions and and recorded in United States Dollars (USD)
translating these transactions and using the exchange rate in effect at the
balances should be stated. date of the transaction. However, where
short-term transactions are covered by a
forward exchange contract, the forward
rates specified in those contracts have been
used to translate the transactions into USD.
At the end of each reporting period any
foreign currency monetary balances (being
money held and assets and liabilities to be
received or paid in money) have been
translated into USD using the spot
exchange rate in effect on that date.
Exchange differences, arising when there is
a change in the exchange rate between the
transaction date and the date of settle-
ment, have been recognized as either
revenues or expenses.
5.3. Financial Reporting
5.3.1. Introduction
5.3.1.1. This section describes the required form and timing of reports on the financial
position and performance of projects and, where applicable, of EAs and IAs. ADB seeks
to agree with borrowers, EAs and/or IAs at loan negotiations to receive, for each project,
interim and annual audited financial statements acceptable to ADB in respect of each
fiscal year (OM 43 and GP 43).
5.3.1.2. In cases where an ADB TA grant is provided in parallel with, and linked to, an
ADB loan to a borrower for the same project operation, the provisions for financial reporting
and auditing set out in this part of the Guidelines will apply. Depending on the obligations
agreed upon by ADB and the borrower and its EAs and IAs on the progress of a project, ADB
typically requires the submission of periodic progress reports, including financial reports,
covering: (i) the progressive interim, annual, and final costs of a project; (ii) where
appropriate, the financial performance and financial position of an EA or PIU; (iii)
accountability for the funds, including ADB loans, provided for project implementation;
(iv) the bases for disbursements of proceeds of ADB loans; (v) the extent of compliance with
financial and related covenants, and (vi) the effectiveness of project-related financial
management and accounting systems as specified by ADB and agreed to by the borrower.
5.3.1.3. Early in the project processing cycle, preferably at project identification, the
financial analyst should inform borrowers, EAs and IAs of the project accounting and
auditing requirements. Commitments are to be sought, as confirmed in a subsequent
Aide Memoire and in the loan agreement as to the nature, form and manner of compliance,
and the timing of the appointment of the auditor. Where necessary, commitments are to
be detailed in the minutes of loan negotiations. The appointment of auditor should be
made either before the date of ADB loan approval or the start-up date of the project.
5.3.1.4. Borrowers and EAs should be reminded of the need to inform other concerned
entities or persons on ADB’s reporting requirements including: (i) a government ministry
responsible for the performance of an EA, and for assigning or appointing the auditor;
(ii) a government auditor mandated by law to audit the accounts of the EAs or IAs;
(iii) private or commercial auditors acting on behalf of, or in substitution for, a government
auditor; and (iv) a principal or holding company having financial responsibility for the
EAs or IAs. Early notification of ADB requirements to the above responsible authorities
is essential to enable the Project Officer to assess the likely prospects for compliance
prior to, and during, appraisal. This will also allow the Project Officer to comment on
the expected performance and quality of financial reporting and auditing in the RRP and,
if necessary, in the project identification and preparation BTORs.
5.3.1.5. Reports on project identification, preparation, appraisal (RRP) and

supervision should include a reference to the accounting standards and policies adopted by
the borrower’s EA and PIU, and their acceptability to ADB. Any modifications that will be,
or have been, made to financial reporting requirements should be communicated to ADB.
5.3.2. Content and Timing of Financial Reporting
5.3.2.1. ADB recognizes that many project financial statements, particularly those
prepared for non-revenue-earning projects, are of a “special purpose nature”. Consequently,
ADB requires that financial information submitted by non-revenue-earning entities adhere
to an appropriately designed format acceptable to ADB.
5.3.2.2. The following fundamental principles should apply to all interim and annual
financial statements on projects issued by a borrower: (i) disclosure of full accountability
for all funds of the borrower, other donors and lenders, and ADB; (ii) compliance with
loan covenants and ADB requirements for project management; (iii) adequate disclosure
of all material information; and (iv) a true and fair view, or a fair presentation in all
material respects, of the financial performance and status of the project (and where
applicable, of the EA/PIU).
5.3.2.3. In addition, the following fundamental principles apply to annual financial

statements only: (i) a clear statement on the accounting policies and accounting standards
adopted; and (ii) the results of an independent review of the financial accounts and
financial management systems by an auditor acceptable to ADB.
5.3.2.4. Interim and annual financial statements relating to each project should be
presented in the English language and show sufficient information to identify separately
the transactions relating to the reporting year and the cumulative transactions from the
date of start-up (PAI 5.10 refers). This applies particularly to those expense and revenue
categories contained in the loan agreement and/or RRP and revisions thereto. The reporting
year includes a part-year from the start-up date to the end of that fiscal year, and a part-
year from the start of the fiscal year in which a project is closed, to the date of closure
(PAI 5.10 refers). “Date of start-up” means the date of the first financial transaction that
is the subject of the Project Cost Table and/or the project operating costs and revenue
forecasts referred to in the RRP. Therefore the date of start-up could include the date
when costs that were approved for retroactive financing were incurred (e.g., design costs
or mobilization expenses) (PAI 5.10 refers).
5.3.2.5. In a case where there are no financial transactions in the first fiscal year (or
part thereof), if an Imprest Account has been established with ADB funds, this transaction
must be reported in the annual financial statements, even where there have been no
withdrawals therefrom (PAI 5.10 refers). In the event that a PIU or EA was established
and local counterpart funds were expended (e.g., on salaries and wages) but no project
implementation occurred, the first year’s annual financial statements should be provided
to ADB showing the operating costs of the PIU/EA (PAI 5.10 refers).
5.3.2.6. Audited annual financial statements of non-revenue-earning EAs are required

in the English language for each fiscal year of project development and implementation,
including the year of final commissioning of the project. Interim and annual statements
may combine financial transactions of a project with those of the EA, where the agency
is established solely for purposes of developing the project.
5.3.2.7. Where an EA is responsible for implementing defined subprojects (with or

without engaging PIUs for subproject implementation) separate financial statements should
be provided for each defined component together with a consolidated financial statement
for the complete project. Where an EA is responsible for developing more than one project,
common or joint project financial transactions of the agency may be apportioned and
allocated to each project on a basis defined in the Notes to the Financial Statements. For
projects where multiple EAs are required to submit separate APA/CFS, compliance details
will be recorded separately in PPRs indicating separate status of compliance and ratings
which will be the basis for calculating the overall APA/CFS rating/compliance of the
project (PAI 5.10 refers).
5.3.2.8. For a revenue-earning project, ADB requires English language presentations

of audited annual financial statements of the project and of the borrower or project EA
for the period of the loan. The reports on the project may be incorporated within EA
financial statements provided that the statements explicitly describe the financial status
and performance of the project for the fiscal year, the previous fiscal year and from start-
up. Interim financial reporting should follow the format of the annual financial statements,
but should cease on completion of ADB disbursements.
5.3.2.9. Borrowers are asked to provide interim and audited annual financial
statements in accordance with a timetable agreed with ADB. Interim financial reports are
normally required at intervals of three, four or six months of each fiscal year. Audited
annual financial statements should be provided normally within six to nine months (or
such other period as ADB may agree) following the end of each fiscal year.
5.3.2.10. Where audited financial statements are to be first submitted to a government

legislature, (with the risk thereby of substantially delaying the transmission of the audited
financial statements to ADB), a draft thereof, certified by the chief financial officer and
the auditor, should be submitted to ADB within the required reporting timetable, with
subsequent confirmation after they have been ratified by the legislature.
5.3.2.11. Interim and annual financial statements should normally be presented in

the local currency, with the basis for translation of any foreign exchange transactions or
commitments explicitly stated.
5.3.3. Accounting Statements and Financial Reports
5.3.3.1. The following table summarizes the financial reporting requirements for
projects and EAs/PIUs. While the reporting requirements for revenue-earning projects
and EAs/PIUs are uniform, those for non-revenue-earning projects and EAs/PIUs are not.
5.3.3.2. The most significant difference among the financial reports of non-revenue-
earning projects and EAs/PIUs depends on whether entities use the accrual or the cash
basis of accounting. Under the cash basis of accounting, nonfinancial assets (for instance,
fixed assets, receivables, inventories) will not be systematically recorded. Consequently,
the information that is necessary to prepare Income Statements and Balance Sheets will
not be available; instead, Statements of Cash Receipts and Payments will be prepared.
Where accrual accounting is used, Statements of Income and Expenses will be prepared
along with Balance Sheets. Accrual statements should always be supplemented with a
Cash Flow Statement. While many ADB DMCs have signaled their intention to adopt the
accrual basis of accounting, this will take many years. However, non-revenue-earning
entities in some countries that have historically used the Soviet Accounting System (e.g.,
Uzbekistan), may prepare accrual-based financial statements.
5.3.3.3. The purpose and format of each accounting statement, which is listed in the
following table, is described in the following subsections.
Accounting Statements and Financial Reports
Non-Revenue- Revenue-Earning
Earning Projects and Projects and Executing
Executing Agencies (PIUs Agencies (PIUs
Interim Annual Interim Annual
Accounting Statements (PMRs) Audited (PMRs) Audited
Statement of Accounting/Financial Policies … ' … '

Statement of Income (Cash Receipts) ' ' … …
Statement of Expenses (Cash Payments) ' ' … …
Cash Flow Statement ' note (i) ' note (i) ' '
Imprest Account Statement ' ' ' '
Statement of Expenditures (SOE) ' ' ' '
Income Statement These statements are ' '

usually not prepared,
Balance Sheet as most non-revenue- ' '
earning projects currently
use the cash basis of
accounting
Notes to the Financial Statements ' note (ii) ' note (ii) ' note (i) ' note (i)
Other Information ' note (iii) ' note (iii) ' note (iii) ' note (iii)
(i) The content and format of Cash Flow Statements for non-revenue-earning projects (and EAs) will not necessarily
conform to international accounting standards or to national accounting standards.
(ii) The notes to the financial statements provide further breakdowns or explanations of the information provided in
the main financial statements.
(iii) The scope and nature of other information provided will be negotiated between ADB and the borrower.
Statement of Accounting or Financial Policies
5.3.3.4. As discussed in section 5.2.3, and irrespective of whether the cash or accrual
basis of accounting is used, a clear statement of the accounting or financial policies that
underlie the accounting statements must be provided.
Statement of Income (or Cash Receipts)
5.3.3.5. Shows the year’s complete financial information, and cumulative data from
project start-up to date. Where the cash basis of accounting is followed, the opening and
closing cash balances should be shown. ADB financing should be subdivided as follows
when ADB disburses via SOE procedures: (i) by expenses category in the loan agreement,
RRP or revisions thereto; (ii) disbursements via SOE; and (iii) other methods.
Statement of Expenses (or Cash Payments)
5.3.3.6. Shows the year’s financial information, and cumulative totals from project
start-up to the current date. Where the accrual basis of accounting is used, this statement
will include non-cash items, such as depreciation.
Cash Flow Statement
5.3.3.7. The Cash Flow (or project funds) Statement should include:
• Sources of project financing (for example, ADB, Government contribution, etc.),

and by methods of disbursement by ADB (for example, direct payment, imprest
account, etc.)
• Uses of funds summarized under project disbursement categories as per the loan
agreement (for example: equipment, civil works, consultant services and training,
and “Other” whi ch may be further subdivided following start of project
implementation)
• The opening and closing cash balances; and
• In accordance with IAS 7, separate disclosure is required of funds that are not available
for use, such as confirmed future commitments.
Imprest Account Statement
5.3.3.8. This statement summarizes ADB’s advances and replenishments, less amounts
withdrawn by the project entity, showing the remaining cash balance in the Imprest
Account.
5.3.3.9. Bank statements should be provided by each local bank that is selected to
operate each imprest account, where these are in use for the project. Each bank statement
should summarize the current year’s advances and replenishments, interest earned on
balances; less withdrawals for project expenditures. The first account is used to receive
money from ADB for the credit of the “Project Imprest Account”, and the second may
be used by the project for local operating purposes (“Second Generation Imprest
Account”). The Project Imprest Account is to be used to replenish the SGIA, when this
is in use. It will be necessary to attach “Reconciliation Statements” to reflect in-transit
items between ADB and the Imprest Account and between Imprest Account and the
SGIA. (Replenishment made by ADB not yet received; and reimbursements to the SGIA
from the Imprest Account not yet received by it). The third financial statement is a detailed
statement of transactions of the Imprest Account’s Operating Account(s). This is to be
generated by the EA, where the Imprest Account is used to make direct payments in local
and foreign currency.
Statement of Expenditures (SOE)
5.3.3.10. The Statement of Expenditures (SOE) procedure is an ADB reimbursement

procedure that does not require submission of supporting documentation. The SOE form
should include certification, confirming existence of registration for mobilization and
secured advances/deposits. The ADB Loan Disbursement Handbook describes the use of
this method and associated reporting and auditing procedures.
Income Statement and Balance Sheet
5.3.3.11. These statements may not be necessary where cash accounting is used. These
statements are described in section 4.3.4 (Preparing Financial Tables).
Notes to Financial Statements
5.3.3.12. The EA should provide Notes to the financial statements. These should be
explanatory notes and/or supplementary financial statements that analyze or qualify
important heads of account, or that present the information in conformity with generally
accepted accounting practices of the country.
5.3.3.13. For example, if Statements are prepared on a “cash basis”, information may
be required from the EA to convert key items to an “obligation” or “accrual” basis and
ADB, therefore, may seek details relating to obligations (unpaid commitments and accounts
receivable) in supplementary statements. Similarly, details may also be required to
distinguish between transactions relating to capital (development) investments and
operating expenditures.
Other Information
5.3.3.14. ADB wishes to receive financial reports on a project that illustrate both
performance in the fiscal year under review and accumulated transactions from project
commencement particularly with regard to sources of funds and expenditures for assets
and inventories.
5.3.3.15. Reporting practices in some government entities require only disclosure of

annual financial transactions against annual budget authorizations. Therefore, in order
to monitor performance from start-up throughout the project’s implementation period,

the reported results of project transactions and financial performance data for previous
fiscal years should be included as memorandum entries in a current fiscal year’s Statement
of Income (or Cash Receipts) and Statement of Expenses (or Cash Payments).
5.3.3.16. Alternatively, the reported results of prior years may be included in the annual
financial statements as of the last day of the reporting fiscal year, that summarizes and classifies
all receipts and expenditures relating to the project from its commencement. In addition, the
accumulated sources or provision of funds for the project in the ratio agreed upon between
the borrower and ADB should be disclosed in the Notes to the financial statements.
5.3.4. Interim Financial Statements and the Project

Management Report (PMR)
5.3.4.1. During the course of each financial year, ADB requires Project Financial
Management Reports (PMRs) as part of the system for monitoring a project’s performance.
The PMR is required on a periodic basis, and is designed to assist the EA/PIU to maintain
regular control of project performance. The PMR financial statement is an interim financial
statement that is a useful tool for reviewing progress and for planning, and is recommended
for all projects.
5.3.4.2. The information in the PMR should be provided in respect of: (i) the most
recent completed financial period (normally a quarter or semester of a year); (ii) the
totals for the year to date; and (iii) cumulative totals to date from the beginning of the
project.
5.3.4.3. The PMR should also show, for each line item, the planned/budgeted amounts
for comparison with the actual reported information, with variances shown between
actual and the plan. Explanations should be attached to the PMR with respect to significant
variances for use in managing and monitoring the project.
5.3.5. Audited Project Financial Statements
5.3.5.1. Audited annual project financial statements should be provided to ADB to

fulfill the fiduciary requirements of the borrower, cofinancier/ donor(s), and ADB. These
financial statements may be classified into two broad categories:
• Annual financial statements in respect of a non-revenue-earning project only that

may also include information on the performance and status of the EA where this
agency has no other financial performance commitments to ADB under a loan
agreement; and
• Annual financial statements in respect of a revenue-earning project and of the project

EA where the latter is an autonomous or semi-autonomous revenue-earning entity
with responsibility for implementing the project, usually to provide an addition to
its revenue-earning capacity.
5.3.6. Annual Financial Statements for a Non-Revenue-

Earning Project
5.3.6.1. Annual financial statements should be prepared by an EA in respect of a

project only particularly where the project is non-revenue-earning and is implemented
by organizations of national, provincial, state or regional and/or local governments.
Financial transactions relating to the EA may be included as line items in project income
and expenses.
5.3.6.2. The statements may take the following forms and may be produced in the
local budgetary and accounting formats for the project and, where applicable, for the EA
concerned:
• Statement of Income (or Cash Receipts)

• Statement of Expenses (or Cash Payments)
• Imprest Fund Account
• Statements of Expenditure; and
• Notes to the Financial Statements
5.3.7. Annual Financial Statements for Revenue-Earning

Projects and EAs
5.3.7.1. Borrowers are asked to provide ADB with annual financial statements in
respect of each autonomous or semi-autonomous EA that plays a substantive role in
implementing and/or operating a project having revenue-earning characteristics. These
financial statements should contain details sufficient to identify the financial performance
and status of the project/EA. Normally these should comprise:
• A Balance Sheet showing the financial position of the entity, including the project,
as at the close of each fiscal year.
• An Income (or Operating, or Income and Expenditure, or Profit and Loss) Statement.
• A Cash Flow Statement that should disclose the cash flows during each Fiscal year.
• An Imprest Account Statement.
• Record of Statements of Expenditures.
• Notes to the Financial Statements.
5.3.7.2. Financial statements should include comparative figures for the preceding
fiscal year; with appropriate supporting schedules and explanatory notes (e.g., methods
of revaluation of assets; unusual conditions that affected performance). Supplementary
financial statements should be provided containing information requested by ADB with
respect to items requiring additional disclosure or explanation.
5.3.7.3. At appraisal, the proposed EA would be expected to provide these statements

with an auditor’s opinion and report for the most recent years of its performance as an
established agency, usually five fiscal years preceding the date of appraisal.
5.3.7.4. During project implementation, an extended form of the PMR is requested

for each autonomous or semi-autonomous EA that plays a substantive role in implementing
and/or operating a project having commercial or revenue-earning characteristics.
Unaudited interim Cash Flow Statements and Balance Sheets, may be required for specified
periods of each fiscal year – for example, each quarter or semester – in addition to audited
annual financial statements.
5.3.7.5. An Income Statement should report the results of operations for the period
covered under major categories of financial information. These may embrace, but are not
limited to the following: (i) operating revenue by categories of sales or service
charges; (ii) operating expenses by category (e.g., labor, supplies, and administration;
cost of sales, or transmission and distribution, etc.); (iii) depreciation; (iv) income from
sources other than operations; (v) taxes on income; (vi) interest and financing costs charged
to operations; and (vii) net income.
5.3.7.6. The Cash Flow Statement should show, during the period covered by the
Income Statement, the origins of all cash flows and their use in financing the project, any
expansion of the entity, debt service, working capital, and, where appropriate, payment
of dividends on equity or other forms of surplus funds distribution. ADB prefers that this
Cash Flow Statement be designed and presented in a manner which illustrates the cash
flow of the entity during the period, with separately identified information on non-cash
and working capital transactions.
5.3.7.7. The Balance Sheet should be drawn up at the close of a reporting period and
should display fixed, current and other assets, with liabilities, particularly long-term and
short-term debt, paid-up equity, and accumulated earnings and surpluses. To best illustrate
the nature and business of the entity, the Balance Sheet should be compiled in a manner
that highlights such important characteristics as the capital structure, the liquidity position,
or the reserves.
5.3.8. Supplementary Financial Statements
5.3.8.1. ADB will normally specify the form and content of supplementary financial
statements to be attached to the standard annual financial statements, but borrowers
should include all information that is considered informative and appropriate to illustrate
the performance of project implementation and operation. The following are examples
of information that may be requested by ADB:
• a detailed summary of the fixed assets of an entity distinguishing between assets in

service and construction work in progress, and accounting for changes during the
year, the basis for their valuation (and revaluation, where applied), and related
accumulated depreciation, including an explanation of the methods and rates of
depreciation (frequently required for public utilities).
• A summary of long-term debts, including lenders, terms, amounts outstanding
showing subborrowers repayment history, amounts still to be disbursed showing
currencies of repayment, and noting the extent to which any of the entity’s assets
have been pledged (frequently required for financial institutions).
• A summary of accounts receivable and accounts payable in terms of their age, showing
differences in accounts outstanding for government and nongovernment parties
(frequently required where agencies of governments do not meet their commitments
to public utilities).
• A summary showing major categories of inventory and the basis of their valuation.
• For financial institutions, a summary of subborrowers’ accounts showing the short-
term and long-term positions, with an explicit statement on provisions for losses
(bad and doubtful debts), their methods of computation, and the adequacy of
securities.
• Information on costs of sales, labor costs, and other important items in the Income
Statement.
• Comparators and performance indictors showing the methods of calculation and
tracking record from start-up of the project or such other date as shall be agreed
with ADB.
• An analysis of any asset and debt revaluation, method used, and the effect on the
entity’s financial position.
• A statement of budget allocations and actual expenses to date.
5.3.9. Designing Financial Reports for Revenue-Earning

Projects
5.3.9.1. The characteristics of the project and of the EA should normally determine
the detail and timing of periodic financial reports. Normally, a revenue-earning EA should
be asked to provide the following financial statements and information:
• balance sheets showing the EA’s financial condition at the opening and close of a
financial reporting period (usually a part or the whole of a fiscal year)
• combined income statements for the project and the EA for the current and previous
reporting period or fiscal year
• statements of cash flows for the EA for the current and previous reporting period
or fiscal year, showing flows specific to the project, and
• Notes to the Financial Statements plus supplementary information and disclosures
necessary to support or explain information presented in the reports.
5.3.9.2. In all cases referred to above, where the financial statements include
information relating to the operation of the EA, the financial and statistical data relating
to a project should be clearly segregated and reported within each statement. In particular,
if the project has been under implementation for more than two years, the Notes to the
Financial Statements should provide a listing of annual expenses against annual budgets.
5.3.9.3. Where subborrowers or secondary EAs are responsible for implementation

of project components, they should be required by the borrower or the principal EA to
provide similar financial statements necessary to document project activities, and where
appropriate, their own financial performance and status.
5.3.9.4. EAs for revenue-earning projects are required to provide updated forecasts after
loan signing and the start of project implementation, for a specified period. These updated
forecasts provide early warnings of project problems so that timely corrective actions can be
taken. The specified period is at the discretion of the financial analyst but will normally be
from three to five years following project completion. Likewise, an EA for a revenue-earning
project will normally be required to submit audited annual financial statements for a
specified period for monitoring purposes. This requirement will be specified in the loan
agreement. The exact period is at the discretion of the financial analyst and will normally
match with the specified period for which updated forecasts are required to be provided.
5.3.9.5. Arrangements should be made by the management of the regional division

concerned to retain the relevant records within the Division, or to have ready access
made available by Records Section, for the requisite period.
5.3.10. Designing Financial Reports for Non-Revenue-

Earning Projects
5.3.10.1. While annual financial statements are likely to be required to demonstrate

the financial position and performance of all revenue-earning EAs, including project
implementation and operational performance, the requirements for non-revenue-earning
EAs are usually determined on a case-by-case basis.
5.3.10.2. Many of these projects are in the public sector, and are implemented and
operated by government departments or agencies. In each case, it should be decided
whether financial reporting is limited to project activities only, or the project-related
activities of the EA that manages the project, or the whole agency. For example, a health
care center project to be implemented by a regional or district health authority is unlikely
to require an audit of the related Ministry of Health or of a complete Regional Health and
Hospitals Division.
5.3.10.3. However, in case of a project that includes the reorganization or improvement

of the financial management of a Ministry or a municipality, ADB may require financial
reporting and auditing of these institutions. This requirement would assist in the monitoring
of performance of project implementation, even though the project’s principal components
may be non-revenue earning. Examples are provided in the box below.
Examples of Financial Reporting and Auditing Requirements

For a Government Ministry
A Hospital Management Division of a Ministry of Health is required to administer an annual

budget of $2.5 million equivalent. It has no effective budget compilation procedure, because it
has no budgetary control records, nor does it maintain any records of individual hospitals’
expenditures and incomes. A health project component is introduced to rectify these budgetary
and accounting failures, and to ensure that mismanagement of funds could not occur in the future.
By requiring the preparation of financial reports on this Hospital Management Division’s activities,
and audits thereof, ADB can monitor the extent to which mismanagement is being replaced by
a sound system.
For a Local Government Municipality
A housing sites and services project may be used as a means of improving the financial management
of municipal housing by providing financial assistance to improve the accounting and rent collection
control systems within the municipality. The municipality also regularly subsidizes its housing
stock. In order to ensure that this stock does not place an unreasonable burden on the remainder
of municipal services, ADB requires that audited financial statements of the municipality, which
will show the overall finances of the municipality, the housing subsidies, and the housing accounting
and income control, are to be provided.
5.3.10.4. Project objectives, particularly financial objectives, will also determine the
scope of financial reporting requirements. Projects developed in some sectors by a
municipality or regional authority may have components that may not be revenue-earning
and may or may not affect the EA’s financial performance or status. For example, a sites
and service housing scheme could be executed by a municipality using grant funds, with
resulting increases in property tax revenues from the higher property values accruing to
the municipality.
5.3.10.5. If, in such a case, a project objective is the improvement of municipal finance
and operations, the reporting requirements should address the municipality as a whole,
or specified key activities or departments. But if the objective is slum upgrading only,
the project could be treated as non-revenue-earning, and the reporting requirements
could be limited accordingly.
5.3.10.6. Broadly, ADB requires financial reporting and auditing of non-revenue-

earning projects: (i) for project transactions only when an EA executes the project, but
does not operate the facilities; (ii) for the relevant activities of the EA, including project
transactions, when an agency executes the project and operates the resultant facilities,
particularly if ADB financing is used to meet incremental current expenditures of ongoing
operations, and (iii) for the relevant activities of the EA, including project transactions,
when it finances improvements in the financial management of that agency.
5.3.10.7. Financial reports for a non-revenue-earning project preferably should contain,

to the extent possible, data constructed and presented in a similar manner and form as
for revenue-earning projects. This latter form of reporting is designed to yield maximum
information for management and ADB. However, as a minimum, these reports may
comprise Statements of Income and Expenses, or Statements of Cash Receipts and Cash
Payments only. Staff should request borrowers to incorporate simple adjustments (e.g.,
to convert the latter financial reports to an accruals basis, in order to disclose the treatment
of past and current obligations), if such adjustments are necessary for good management
and reporting. The income or receipts shown in these minimum form statements should
disclose the sources of funds, including local funds, ADB loan disbursement proceeds
and cofinanciers fund disbursements, where appropriate.
5.3.10.8. In a non-revenue-earning project that includes the financing of incremental

current expenditures, e.g., salaries, wages, the financial reports should include separate
statements of these expenditures and any related recurrent income of the EA. These
statements should include annual budgetary provisions and allotments; supplementary
budget provisions and allotments; and actual expenditures under each budget head and
subhead. The budget heads and subheads of expenditures for which ADB financing is
furnished and the actual expenditures and amounts of ADB disbursements claimed should
be indicated. In this respect, it is important during project preparation to ensure that
adequate budgetary descriptions and line items are, or will be, made available to fulfill
this analysis.
5.3.10.9. Details of the financial position, at the start and end of each fiscal year, of
a non-revenue-earning project or EA should be requested from the borrower. These
details may be best provided in a form of balance sheet, at the opening and closing of
each fiscal year, to show the accumulated totals of transactions over the project period
and to account for assets, inventories, equity (or grants) and loans provided as part of
the project.
5.3.10.10. Balance sheet preparation need not be an elaborate process. Its preparation
can take the form of an accumulation of data from income statements for completed
years, with adjustments to show closing balances of inventories and cash, where
appropriate. However, some government departments may not be experienced in
preparing and maintaining data for balance sheets. In such cases, during project
preparation, the analyst should ask the government to arrange for the training of staff
prior to loan negotiations and project start-up. Otherwise, engagement of competent
personnel, including a fulltime financial management expert and a project accountant
to prepare the financial reports in the required form and on a timely basis, should be
provided.
5.3.11. Examples of Model Financial Statements
5.3.11.1. The Knowledge Management section of these Guidelines provides examples

of model financial statements for revenue-earning and non-revenue-earning projects.
Furthermore, a set of model financial statements, which are cross-referenced to IAS
requirements, together with a disclosure checklist is provided at www.iasplus.com.20
5.4. Auditing Standards and Auditor Engagement
5.4.1. Introduction
5.4.1.1. An audit’s overall objective is for the auditor to express an opinion as to

whether the financial statements present a true and fair view of the project(s) and, where
applicable, of the EA, or are similarly presented fairly in all material respects, in conformity
with IAS or other standards acceptable to ADB, and applied on a basis consistent with
that of the preceding year.21
5.4.1.2. The auditor’s opinion is necessary to establish the credibility, or otherwise,

of the financial statements of an EA. The examination should be of such scope and depth
to allow the auditor to give an opinion and make a report on the veracity, accuracy and
fairness as regards the presentation of the financial statements of an EA or a defined part
thereof (such as a project, a project unit, or a department or division). These financial
statements may be annual, periodic, or ad hoc (i.e., relating to special reports).
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5.4.1.3. The auditor’s examination should include an evaluation of the systems and
operating procedures for accounting, custody of assets, the control environment and
internal financial control, financial reporting and related systems. An analysis of
explanations submitted to the auditor, and all information necessary to support the
auditor’s opinion and to construct the report of the auditor, should be provided.
5.4.1.4. Financial analysts, however, cannot assume that the auditor’s opinion is an
assurance as to the future viability of an entity or as to the efficiency or effectiveness with
which management has conducted the affairs of the entity.
5.4.1.5. During project identification and preparation, analysts should become familiar
with the existing laws, regulations and rules of the country and the EA that govern financial
reporting and auditing requirements. It is essential to identify incompatibilities between
ADB and local legal requirements for auditing and to resolve these before appraisal.
5.4.2. ADB Requirements
5.4.2.1. ADB requires the borrower and the project EA to have the required financial
statements for each year audited by an independent auditor acceptable to ADB, and in
accordance with standards on auditing that also are acceptable to ADB. An audit of such
financial statements includes: (i) an assessment of the adequacy of accounting and internal
control systems with respect to project expenditures and other financial transactions,
and to ensure safe custody of project financed assets; (ii) a determination as to whether
the borrower and project implementing entities have maintained adequate documentation
on all relevant transactions; (iii) confirmation that expenditures submitted to ADB are
eligible for financing and identification of any ineligible expenditures; and (iv) compliance
with loan covenants and ADB’s requirements for project management.
5.4.2.2. ADB recognizes ISAs, promulgated by IFAC and the auditing standards of the
International Organization of Supreme Audit Institutions (INTOSAI. ISAs are widely adopted
by the international accounting profession and many national professions. They form the
benchmark for standards on auditing acceptable to ADB for audits in the public and private
sector. Many Auditors-General and their equivalents use INTOSAI auditing standards.
5.4.2.3. ADB prefers that auditors conform to ISAs, but recognizes that in some
countries auditors are expected to apply generally accepted auditing standards which
may not conform to these Guidelines but that have been prescribed by a country’s law,
or that have been adopted by public accountants or associations of public accountants
in the country concerned.22
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5.4.2.4. Supplementary auditing and reporting procedures may be requested by ADB,

if necessary, to confirm accountability and financial performance in cases where ADB
considers local standards need to be supplemented. In addition, ADB would expect
auditors to indicate in their report the extent of differences, and the impact on the audit,
of use of local auditing standards compared to the application of ISAs.
5.4.3. Auditing Procedures
5.4.3.1. The audit is intended to provide an ex post review of the EA’s financial
statements, financial systems, records, transactions, and operations, performed by
professional accountants. It is intended to provide assurances of accountability, give
creditability to the financial statements and other management reports, identify weaknesses
in internal controls and financial systems, and make recommendations for improvements.
5.4.3.2. The auditor should obtain an understanding of the project and the entity
being audited, including the contents of the RRP, legal agreements, and these Guidelines.
In addition the following guidance is available from the: (i) ADB Loan Disbursements
Handbook; (ii) ADB Sample bidding documents for competitive bidding under
international competitive bidding procedures; and (iii) ADB Procurement Handbook.
5.4.3.3. The extent of an auditor’s review of the accounting records depends on the
systems of accounts and of internal checks and controls used by the entity being examined.
As an example, an auditor will need to examine, and where necessary, test: (i) the
organizational procedures for making financial decisions, budgeting and authorizing
expenditures; (ii) the design, management, and operation of the accounting system; (iii) the
effectiveness of related systems and procedures such as inventory control and data
processing; (iv) the efficiency of the systems of internal control and of internal audit; (v)
all financial transactions, and verify year end balances, including an appropriate degree
of physical verification; (vi) compliance with IASs and any other applicable accounting
standards, including the adequacy of disclosures; (vii) subsequent events and their possible
effect on the financial statements; (viii) overall comparators of actual costs and
achievements against budgets and planned indicators, obtaining and reporting adequate
explanations for significant variations; (ix) test compliance with loan covenants and ADB’s
requirements for project management; and (x) the adequacy and competence of accounting
staff. In the light of their findings, auditors should normally test the financial transactions
of the organization against such documentary or other evidence as maybe necessary to
enable them to be satisfied as to the authenticity and correctness of the transactions,
their complete and proper entry in the books of account, and their effect on financial
performance and status.
5.4.3.4. The timeliness and accuracy of the recording of assets and liabilities and of
the methods of their valuation should be reviewed by the auditors, particularly for projects
executed by government departments, for which asset recording typically is not a routine
requirement. In addition they should be satisfied as to the methods of regularly determining
their existence, ownership and appropriate valuation, including, where necessary, physical
inspection by the auditor. Examples of items to be addressed include: (i) land, buildings,
machinery, and equipment, including methods of provision for depreciation, if such
provision is applicable to the accounting procedures for the project or EA under audit;
(ii) inventories, including appropriate accounting for obsolescence, spoilage, or losses;
(iii) receivables, including provisions for bad and doubtful debts; (iv) cash and bank
balances; (v) investments; (vi) amounts due to third parties (long-term and short-term
loans and suppliers’ accounts payable); and (vii) insurance coverage, particularly of project
components.
5.4.3.5. Where appropriate, an auditor should examine such items as capital

commitments and treatment of contingent liabilities, the effects of currency devaluation
or revaluation on foreign currency transactions, and events occurring after the date of
preparation of the balance sheet.
5.4.3.6. Circumstances beyond the control of an auditor and the EA may sometimes
make it impossible to carry out all preferred auditing procedures, at least in full; in such
cases, auditors should satisfy themselves by alternative procedures that are practicable
and reasonable in the circumstances. However, there are two important auditing
procedures which should be carried out: (i) direct correspondence with debtors and
creditors on a substantial test basis by an auditor, to confirm sums due to, and payable
by, the EA under audit; and (ii) observation by the auditor of physical inventory taken
by the client. Specific disclosure should be made of the reasons for noncompliance in
cases where these procedures are not carried out, and whether satisfactory alternative
procedures were employed.
5.4.3.7. Any country-specific variations in accounting standards and practices that

are adopted by the borrower, and are known by the auditor to differ substantially from
IAS, should be disclosed. Any significant effects on the financial performance or status
of the project, as a result of not conforming to IASs, should be disclosed.23 Examples
of such variations and their effects on reported financial results that should be disclosed
are any overstatements of assets and understatements of liabilities that may be sanctioned
by local laws; accounting on a cash basis or on a basis other than historical costs;
recognition and equalization of income over several accounting periods; omission of
certain gains or losses in determination of net income; the use of “reserve” accounting
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when full details of movements in, and realized profits on, reserves may not be revealed;
and the treatment of foreign exchange profits or losses in a manner that does not disclose
their impact.
5.4.3.8. The auditor should review the periodic PMR for each year and compare
them with the financial statements of the fiscal year. ADB requires the auditor to report
any differences, particularly any ineligible expenditure against which ADB may have
disbursed, recommending actions necessary to avoid recurrences.
5.4.3.9. The audit of SOEs (where required) should be included as a part of the
overall audit of the project. However, ADB requires that particular attention be paid to
the internal control systems and the verification of documents relating to SOE
expenditures, not only to ascertain proper financial accountability, but also that
expenditures are eligible for inclusion in the project. ADB requires a special reference in
the auditor’s opinion with respect to the SOE portion of the audit.
5.4.3.10. ADB also requires an audit of the Imprest Accounts, which may be separate,
or included as a part of the overall audit of the project. This audit is limited to the
transactions of the Imprest Accounts, as the audit of the expenditures reimbursed or
paid directly from the Imprest Accounts are to be audited as a part of the project audit,
with appropriate review of the in-transit items. Where the audits of the Imprest Accounts
are self-standing, a special purpose audit opinion is required. Where the audit forms a
part of that of the project, a separate reference to the Imprest Account audit should be
included in the auditor’s opinion.
5.4.4. Auditor Selection and Appointment
5.4.4.1. Legal and professional requirements will normally determine the scope and
depth of an audit examination, but these may also be supplemented by client instructions
in the form of a Terms of Reference. These instructions would usually extend an audit’s
scope and detail, but they may restrict an auditor’s activities rendering them unacceptable.
Care should be taken when framing a request for additional work from an auditor.
5.4.4.2. Borrowers should be asked to remove unacceptable restrictions, or otherwise

arrange for an acceptable audit to be carried out. A borrower is responsible for the selection,
appointment and performance of an auditor. ADB wishes to be informed by a borrower
of an ongoing or proposed appointment of an auditor, who should meet the required
standards in terms of independence, experience and competence. More specifically, ADB
should indicate the acceptability of an auditor in the form of a “no objection” provided
that actual or proposed auditors satisfy the following criteria:
• They must be impartial and independent of the management of the entity to be

audited, and of the person appointing them. In particular, the auditors should not
otherwise be employed by, serve as directors for, or have any financial or close
business relationship with the entity during the period covered by the audit.
• They must be well-established and reputable using procedures and methods that
conform to ISAs or INTOSAI auditing standards, and employ adequate staff with
the skills and competence required for their responsibilities.
• They must be able to demonstrate experience in auditing the accounts of projects
or entities comparable in nature, size, and complexity to the assignments they are
to undertake (specialized auditing experience, obtainable only from external sources,
may be necessary for some projects).
• The audit work should be assigned to personnel who have the professional and
technical training and proficiency required in the circumstances.
5.4.4.3. ADB requires that the borrower and the project implementing entity select
and appoint an auditor acceptable to ADB within sufficient time to carry out its
responsibilities, including a review of the financial management systems at the beginning
of project implementation, and periodically thereafter.
5.4.4.4. ADB does not normally advise on the selection of auditors, but prefers to
review a list of several auditors submitted from whom an appointment will be made by
the borrower, and indicating any auditor who may not meet ADB’s criteria. ADB will
indicate its agreement to a proposal to engage an auditor when it is satisfied that an
existing auditor, or the auditor under consideration for engagement, would be acceptable
to ADB in terms of independence and competence to carry out the audit.
5.4.4.5. Many prospective borrowers and EAs have ongoing audit arrangements. In
other cases, borrowers initiate audit engagements at the start of a project. Whenever an
auditor is to be appointed by a borrower, or the auditor is a statutory appointee, ADB
may seek information in order to be satisfied regarding independence and experience of
the proposed auditor. To ascertain acceptability, ADB routinely seeks information in order
to be satisfied on the independence and competence of the proposed auditor. The required
information includes: (i) the name of the auditor; (ii) the names, qualifications, and
experience of the principals and managers; (iii) the approximate number of professional
staff employed; (iv) a listing of some of the main audits currently and previously carried
out by the auditor; and (v) a statement of the independence of the firm of auditors vis-
à-vis the entity it is proposed to audit.
5.4.5. Issues in Auditor Selection
5.4.5.1. The scope and detail of an audit may also depend upon laws or regulations
that may constrain a government auditor from providing the depth of examination required
by ADB. For example, the following are unlikely to be acceptable auditors for ADB lending
operations: (i) a government auditor whose staff may be required by laws or regulations
to participate in the processing of financial transactions; (ii) an auditor who acts for an
EA for the preparation of annual financial statements; or (iii) an auditor who designs and
constructs components of the EA’s financial management system. In each case, the financial
analyst must thoroughly review the circumstances and have adequate support, if necessary,
by seeking an independent opinion, for the exclusion of the proposed auditor from doing
the auditing assignment.
5.4.5.2. In certain instances, staff constraints may cause the borrower and PIU to
request an auditor to compile part or all of the annual or supplementary financial
statements. Where this is necessary, to be eligible to carry out the audit, the auditor
should play no part in any aspect of the decision making and/or management of the
entity concerned, including maintaining and finalizing accounting and financial reporting
preparation services for the current year of audit and at least the most recent preceding
fiscal year of the project. The extent of the auditor’s involvement in accounting should
be discussed in the Management Letter.
5.4.5.3. It is essential that auditors are able to commence work at project start-up, and
thereafter sufficiently early in each fiscal year to complete the audit expeditiously after the
year-end; for example, the checking of stocks and balances at critical times in a year may
require the presence of an auditor if a qualified report is to be avoided. Therefore, an auditor
should be appointed by the borrower before the beginning of each fiscal year. The borrower
will be expected to provide ADB with an assurance that the initial auditor has been notified
of ADB’s requirements, including the timing of the audit and issuance of the auditor’s report.
In all cases, this will not be later than the starting date of the project or the date of the ADB’s
Board approval to the loan, whichever is the earlier. Financial analysts are also encouraged
to meet with the auditor at the first opportunity following their appointment.
5.4.5.4. Where a government auditor is to serve during execution and operation of

a revenue-earning project until the loan period expires, the borrower will be expected
to provide ADB with an assurance that the government auditor will begin and complete
the audit operations within the timetable required. This timely appointment allows the
auditor to carry out interim audits, therefore reducing their work at the year-end to
facilitate timely reporting. Also, it allows the earlier identification of possible errors and
frauds and enables quicker corrective actions where required.
5.4.6. Selecting Auditors
5.4.6.1. Auditors for public sector projects and public sector EAs may be drawn
from commercial or state audit practitioners. Government auditors will not be acceptable
for private sector projects and for public sector EAs of revenue-earning entities, unless
confirmed by ADB when a review of capacity, capability, and ongoing performance has
been conducted.
5.4.6.2. The EA, or its controlling authority is normally responsible for this selection
and appointment, except in cases where a government auditor is required by law to
provide the service. Therefore, where no auditor is currently engaged, steps should be
taken during project preparation to ensure that the borrower will engage an auditor
acceptable to ADB by the date of loan signing or start up of the project.
5.4.6.3. Where an auditor is currently engaged, staff should ensure that they carefully
review the past performances of the auditor with respect to the quality of reports and
opinions, and management letters. If the capabilities and capacity of the auditor to perform
to ADB-required standards would be questioned by the appraisal mission, the borrower/
EA should be advised as to the possible deficiencies, and should be asked to convey
these concerns to the auditor.
5.4.6.4. In cases where the auditor fails to respond to the concerns raised or the
auditor is clearly unacceptable to ADB, the borrower/EA should be advised that another
auditor be selected prior to loan signing.
5.4.6.5. When private or commercial auditors are to be used, staff may, if requested,
assist borrowers to review the qualifications and experience of an auditor. For this purpose,
in order to form a judgment on their competence, it may be necessary to visit the local
offices of the auditors and request samples of their previous or ongoing work, including
typical audit reports prepared by them.
5.4.6.6. Examination of data on auditors submitted to ADB prior to their engagement

by a borrower should include the ability and track record of an auditor to meet the
requirements set out in the Handbook for Borrowers on the Financial Management of Investment
Projects Financed by the ADB. Borrowers should be notified on the auditors who do not
meet these criteria.
5.4.6.7. An auditor’s engagement should be kept under review to ensure consistent

quality of performance, including ability to adapt to changes in an entity’s accounting
and general operations, and to adopt improved audit techniques. For example,
development of computerized accounting would require complex and expensive auditing
techniques. Auditors inexperienced in this field may not be able to provide these services,
or may be constrained from appropriate expansion of services by an inadequate audit
fee. In such cases, inclusion of audit costs in the project costs would be appropriate.
5.4.6.8. Borrowers should therefore be encouraged to restrict audit engagements to

relatively short-term assignments.
5.4.6.9. It is common practice in some countries to appoint the auditor each year.
However, engagements should normally be long enough to enable an auditor to become
familiar with the project or EA under audit and to permit efficient operation, but short
enough to facilitate a change of auditor, if necessary. Engagements of three to five years
are in the optimum range.
5.4.7. Terms of Reference for an Auditor
5.4.7.1. ADB requires that the auditor’s opinion be of such scope and detail as ADB
may reasonably request, and requires that a Terms of Reference (TOR) acceptable to ADB
be prepared for each audit. For different types of audits, the scope of the audit will vary
according to the nature of the implementing organization and type of operation being
audited. For example, the TOR for the audit of a Financial Institution will require the
auditor to pay particular attention to the loan portfolio, while the area of greatest emphasis
for auditing of a public utility may be the accounting of its fixed assets and its accounts
receivable.
5.4.7.2. ISAs suggest that the auditor determine the scope of the audit of financial
statements in accordance with the requirements of legislation, regulations, and generally
accepted auditing standards. The TOR must not restrict the auditor’s obligations with
respect to the above. The auditor should not be allowed to claim in the event of poor
performance that the TOR prevented performance with respect to statutory, regulatory
or professional requirements.
5.4.7.3. However, the TOR provides the opportunity for drawing special attention
to areas of concern that may not be covered or emphasized under a normal audit, such
as compliance with loan covenants; for example, a special review of procurement
documents. The TOR should always include in the scope of the audit the requirement
to give an opinion on any specific items. A Management Letter will always be required.
Appointing an Auditor – Using the Model Terms of Reference
5.4.7.4. The Knowledge Management section of these Guidelines provides a Model

TOR for an auditor.
5.4.7.5. Whenever ADB wishes to approve the TOR of an auditor to be engaged by

a borrower or a project entity, it is preferable that staff should remain independent of the
drafting thereof. Staff will hence be free to advise on the documentation prepared by a
borrower or EA. There is no objection, however, to staff giving borrowers advice based
on the model TOR.
5.4.7.6. The model should not be regarded as universally applicable to audits of

ADB projects or project entities. Staff should select those components they consider
appropriate for a particular audit engagement, omit inappropriate items and add relevant
matters that are not in the model to develop a working draft.
5.4.7.7. This model relates only to the appointment of auditors to carry out an audit,
as defined in these Guidelines. The model is not intended for the appointment of
accountants for other forms of investigation, assessment, design or installation of
accounting or internal auditing systems.
5.4.7.8. The drafting of these TOR should not restrict an auditor’s obligations with
respect to legislation, regulations, and generally accepted auditing standards, nor give
reasons for an auditor to claim that adherence to the TOR prevented adequate statutory,
regulatory or professional performance.
5.4.8. Contract or Engagement Letter of Auditor
5.4.8.1. The use of a Contract or Audit Engagement Letter is recommended. Where

a formal contract is used, it is normally prepared by the PIU. A simple engagement letter
is frequently used, often prepared by the auditor. The contract or letter sets out the
responsibilities of the auditor and should include, but not be limited to:
• Confirmation of acceptance of the appointment including reference to the TOR

• The borrowers’ responsibilities, particularly the preparation of financial information
(the financial statements)
• The provision of access to whatever premises, records, documentation (including
Staff RRP, legal agreements, etc.) and any other information the auditor may request
in connection with the audit.
• The form of audit reports
• Arrangements regarding the involvement of internal auditors and of any other external
auditors (such as the government auditor
• The expected date of issuance of the audited financial statements, etc
• The basis on which fees are computed and any billing arrangements
5.4.9. International Standards on Auditing (ISAs)
5.4.9.1. The International Auditing Practices Committee (IAPC) of IFAC promulgates

ISAs and International Auditing Practice Statements (IAPSs). The latter offer advice and
guidance on the practical application of ISAs.
5.4.9.2. ADB expects auditors to conform to the ISAs and related auditing practices
recommended in the IAPS. However, in some countries, the auditing profession may be
required to comply with generally accepted local auditing standards prescribed either by
law or by the national body of accountants.
5.4.9.3. Auditors when compiling their opinions and reports, often use the term
“generally accepted auditing standards”. These standards differ from country to country,
but are intended by the accounting profession to imply the highest standards of auditing
practice. These standards are likely to be those adopted by professional accountants or
associations of accountants, or standards prescribed by law, governments or bodies
responsible for regulating national financial reporting.
5.4.9.4. Although ISAs and IAPSs are widely recognized, it should not be assumed
that these have been adopted by national accounting professions or governments, and
are therefore automatically applicable to audits and auditors of project entities. Local
standards may not conform partially or completely with international guidelines.
5.4.9.5. Therefore at project identification, or during project preparation, analysts

are required to accurately determine the auditing standards that will be applied by an
auditor of annual financial statements of a borrower. If these do not correspond to ISAs
and IAPS, the analyst must determine the extent and impact of variances in application
of the local standards.
5.4.9.6. In the event that the impact of variances is sufficient to give rise to concerns
for the adequacy and veracity of an audit, the analyst must request the EA to have the
auditor adopt ISAs and IAPS for the audit of the ADB-financed project and the project
entity. Where applicable, an auditor who would adopt ISAs and IAPS may be engaged.24
5.4.9.7. Failure by an EA to meet such requests must be reported in the Aide Memoire
and the fact-finding BTOR. If agreement is not obtained by project appraisal, an Issues
Paper should be prepared so that management can give guidance. The BTOR and the
RRP should include confirmations of the acceptable auditing standards that will be used.
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5.4.9.8. Where necessary, the EA should also be requested to ensure that auditors
be required by their terms of reference to indicate in their opinions and report, the extent
of any differences, and the impact on the audit, by their use of local auditing (or other)
standards compared to the use of the ISAs.25 For an example, see box that follows.
Auditing in an EDP Environment
International Standard on Auditing – Auditing in an EDP Environment – requires possession of

certain levels of skills and competence with regard to computing hardware and software by the
auditor, and of those who they are supervising.
The TOR for an auditor should specifically call for a statement of the auditor’s skills and competence
in this field, and the report by the auditor should contain a statement indicating the extent to
which they were able, or could not meet the requirements of this Guideline, and the impact on
the audit of any deficiency on their part.
Such a requirement is relatively simple to check. In EAs which have computing facilities, if the
auditor fails to confirm that they were able to comply with this Guideline, or to make any meaningful
statement as to the capability and quality of their audit of information compiled by computing
facilities in the agency, it must be questionable whether the audit report and opinion offered could
be acceptable to ADB.
5.4.10. Government Auditors
5.4.10.1. In some countries where projects are to be executed by government

controlled/sponsored entities, statutory requirements may specify the use of the
government auditor. Under such circumstances, ADB will continue to require that the
auditor is independent and competent; that the auditor has the capacity and professional
capability to provide audit reports and opinions of the quality required by ADB, and is
generally acceptable to ADB. Normally, the independence of a government auditor would
not be questioned if the auditor’s position is established under constitutional or legal
provisions designed to assure independence (e.g., by reporting directly to a legislature).
5.4.10.2. In circumstances where the government auditor is acceptable, but the auditor’s
report will be placed before a governing national assembly for approval (e.g., a Parliament),
the borrower should provide ADB a draft of the report, certified by the Chief Financial
Officer and the auditor, immediately on completion of the audit. As specified in the loan
agreement, the approved version of the auditor’s report should be submitted to ADB as
soon as this becomes available.
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5.4.10.3. Circumstances exist where government auditors are involved directly or

indirectly in pre-expenditure and revenue collection decision-making – a status that
compromises their independence. ADB then may seek to agree with a borrower either
that auditor, or that ADB, will be provided with opinions and reports prepared by an
independent private or commercial auditor in addition to the report of a government
auditor. A government auditor who does not control, and is not under the control of the
department or agency of government to be audited, and who is not involved in any
aspects of its management, may in some instances be considered as independent.
5.4.10.4. Where ADB has doubts with respect to the auditor’s independence and/or
competence, ADB will seek an agreement with the borrower to have the government
auditor subcontract the audit to an independent and competent private auditor to carry
out the audit on their behalf. In appropriate circumstance, ADB could include this
expenditure in the loan. In general, ADB requires that private auditors, using their
experience in the use of ISAs, carry out the audit of a commercial or revenue-earning
entity.
5.5. Reviewing Financial Reports
5.5.1. Introduction
5.5.1.1. Project Administrative Instruction (PAI 5.09) sets out ADB’s requirements
for the delivery of audited annual financial statements of projects and EAs, including the
monitoring requirements by ADB staff. PAI 5.09 also contains the remedial actions that
ADB will undertake in the event of noncompliance with loan covenants relating to financial
reporting and auditing.
5.5.2. The Review Process: Late or Unacceptable

Financial Reports
5.5.2.1. The Project Officer responsible for a particular project’s implementation

should ensure that all requirements on progress reporting are prepared in a timely manner
acceptable to ADB. The Project Officer is responsible for maintaining records on the
schedule of the date of submission of progress reports (and annual financial reports,
auditor’s reports and completion reports), the actual date of receipt by ADB, and date of
completion of review.
5.5.2.2. The Project Administration Unit may have installed a computerized

monitoring system for recording the receipt of covenanted audited and unaudited project
accounts and financial statements. The Financial Analyst or Financial Management
Specialist should in all cases review the interim or annual financial reports of the project,
with or without auditors’ reports and opinions.
5.5.2.3. The report should cover separately the submission of (i) unaudited and
audited project accounts and, where applicable, (ii) the unaudited and audited financial
statements of EAs. Where loan documents require submission of unaudited and audited
financial statements beyond the closing date of the loan, the monitoring of submission
of financial statements and compliance with financial performance covenants should
continue.
Remedial Actions Under PAI 5.09
When APA/CFS are not received by due dates, regional divisions are to write immediately to EAs
stating they are overdue and if they are not received within six months, imprest accounts will not
be replenished and further reimbursement requests, commitment letters, and contract awards
will not be processed.
When APA/CFS are not received within six months after the due dates, regional divisions initiate
stopping replenishment of imprest accounts, and processing of reimbursement requests,
commitment letters, and contract awards. Regional divisions then advise the EAs of ADB’s actions
and state if the situation does not improve within six months, loans may be suspended.
When APA/CFS are not received within twelve months after the due dates, regional divisions must
determine, by consulting with COPP and CTDO if the loan should be suspended. The regional
division will recommend loan suspension to Management.
Delays in submission of APA/CFS will directly impact the overall Implementation Progress [IP]
rating of the project.
5.5.2.4. Within four weeks of the receipt from the Project Officer of the unaudited
and audited annual financial statements relating to a project and, where applicable, to
an EA, the concerned financial analyst should review the financial statements in
consultation with the relevant project staff. The Financial Analyst or Financial Management
Specialist will provide a memo to the Project Officer, copied to the director and manager
of the regional department/division, on (i) the financial status of the project and, where
applicable, the EA and (ii) the compliance with all of ADB’s financial and audit covenants.
The status of compliance upon receipt of financial statements, and during the review
period, shall be assumed to be COMPLIED and ACCEPTABLE until the final result of
review, which is within four weeks after the receipt of the document (PAI 5.09).
5.5.2.5. On the basis of this review, notice should be sent to the borrower and EA
acknowledging receipt of the financial statements (and, where applicable, the Audit Report)
and to point out any violation of the loan’s financial and audit covenants. Remedial action
to be taken within a reasonable time will be required from the borrower and EA.
5.5.2.6. The Operations Coordination Division, the Manager COPP, and the Assistant
Controller, CTDO are informed of the review results only if: (i) the audited annual financial
statements are unacceptable; (ii) the auditor’s report contains significant findings that
would affect loan proceeds and implementation of the overall project (or other
accountability issues); or (iii) the auditor’s report contains any findings on the imprest
accounts and statements of expenditures.
5.5.2.7. A financial analyst should report downward compliance trends with financial
or audit covenants to the Project Officer, which may ultimately result in noncompliance,
when a time-bound remedial action plan would be needed.
5.5.2.8. Receipt of a response to a request for a time-bound plan of action should

be closely monitored and if the response is not received within the specified time, the
lack of a response must be noted as an issue to be addressed under the loan.
5.5.2.9. A decision by a financial analyst (or a Project Officer) not to recommend a

time-bound remedial action plan should be made in writing, reviewed, and if appropriate,
endorsed by the concerned regional department.
5.5.3. Compliance With Financial Performance Covenants
5.5.3.1. The majority, if not all, financial performance covenants for a project include
the clause “except as ADB shall otherwise agree.” The exercise of the prerogative to
“otherwise agree” rests exclusively with management.
5.5.3.2. In cases where noncompliance exists with a financial performance covenant,

the regional department should analyze the adequacy of the proposed actions to be taken
by the borrower and EA while assessing the probability of their being successfully
implemented within the period specified.
5.5.3.3. The Project Officer should write a memo through the Operations Coordination
Division outlining the review and conclusions. Recommendations on whether management
should agree to a deviation from the covenant (including minor technical deviations), or
such other actions as the regional department may propose, are put forward. The regional
department should communicate its decision to the borrower and EA.
5.5.3.4. The memo should also specify whether the current auditor is acceptable to
ADB or whether ADB should ask for a replacement.
5.5.4. Communication with Government Auditors
5.5.4.1. Communications requesting submission of audited financial statements

should be addressed to the EA and/or the borrower. However, in some cases, compliance
with the submission of audited accounts is delayed by difficulties encountered in the
government audit office. When delays are attributable thereto, it is likely that similar
problems are being experienced by other divisions/departments.
5.5.4.2. PAI 5.09 – Submission of APAs and FSs – sets out the procedures for ensuring
that APAs and CFSs are submitted by the agreed due date. PAI 5.09 also stipulates the
actions to be taken when APAs and CFSs are not provided as agreed. While PAI 5.09
requires that regional divisions are responsible for communicating with EAs, with regards
to government auditors, in the interests of avoiding the duplication of efforts and the
possibility of inconsistencies in ADB’s position, it is desirable to coordinate all
communication with government auditors through the Operations Coordination Division.
Assistance from the Disbursement Operations Division in following up submission of
audited accounts may be sought by the concerned Project Officer/Regional Division.
5.6. Reviewing Auditors’ Reports
5.6.1. Introduction
5.6.1.1. ADB requires the borrower and the project EA to have the required financial
statements for each year audited by an independent auditor acceptable to ADB, and in
accordance with standards on auditing that also are acceptable to ADB. An audit of such
financial statements includes:
• An assessment of the adequacy of accounting and internal control systems with

respect to project expenditures and other financial transactions, and to ensure safe
custody of project financed assets.
• A determination as to whether the borrower and project implementing entities have
maintained adequate documentation on all relevant transactions.
• Confirmation that expenditures submitted to ADB are eligible for financing and
identification of any ineligible expenditures.
• Compliance with loan covenants and ADB’s requirements for project management.
5.6.1.2. The examination of the annual financial statements of EAs is an important

feature of project supervision and should be conducted in the same way as financial
appraisal. Additional attention, however, should be given to actual performance against
appraisal forecasts, compliance with financial covenants and review mission financial
reports. Interim reports and unaudited annual financial statements may be the only up-
to-date monitoring documents available on project progress, and their accuracy should
be tested both during review missions and against audited annual financial statements.
It is reasonable to expect that there should be no change between unaudited and audited
financial statements.
5.6.1.3. It is useful to gain experience with individual EAs to identify those where
ADB staff can reasonably depend on unaudited annual financial statements, and later to
examine audited statements for exceptions. Before beginning this latter examination for
a completed fiscal year, however, a review of the auditor’s opinion on the statements is
essential to ensure that the published results are likely to be valid.
5.6.1.4. The auditor’s reports may not contain enough essential information for ADB
to be able to rely on the data in the statements and thereby evaluate performance. Three
principal features should be addressed when examining an auditor’s report: (i) authenticity,
form and timeliness of the report; (ii) quality, or tenor, of the opinion; and (iii) scope,
significant accounting policies, auditing practices, qualifications, and other matters
addressed by the auditor.
5.6.1.5. The wide sectoral coverage of ADB projects precludes giving advice for
examining the opinions for each type of project. For general guidance, a checklist of
matters that a reviewer of an auditor’s report should consider is provided in the Knowledge
Management section of these Guidelines (its application is discussed further in section
5.6.11). The checklist is not universally appropriate and staff will need to draw their
own conclusions about its applicability to each project and related audit reports. While
extensive, the checklist is not exhaustive and reviewers must exercise their own skills
and common sense in deciding the adequacy of the completed audit. Similarly, reviewers
should decide whether the auditor, in the manner of framing comments, is trying to
convey a message of concern, which may be difficult to express explicitly.
5.6.1.6. If there are any “no” answers on the checklist, especially in areas of key
concern to the project, then clarifications of the auditor’s report should be sought from
the borrower and/or the EA unless the audit itself is under development by use of technical
assistance. If the omissions are serious and/or the quality of the report unacceptable, the
matter should be discussed with the Operations Coordination Division and the Office
of the General Counsel.
5.6.1.7. The borrower and/or the entity should be advised that the audit does not
conform to standards and practices acceptable to ADB. The monitoring records should
be annotated accordingly.
5.6.1.8. If a qualified opinion and report by an auditor is received, the materiality

and extent of the qualification should be determined, particularly as regards accountability
for project funds and the agency’s financial position. In the case of substantial qualifications,
the financial analyst should ascertain as soon as possible what remedial measures the
borrower proposes to take.
5.6.1.9. If the borrower is unable or unwilling to take corrective action, staff should,
after investigating the reasons, follow the course of action recommended in cases of
noncompliance with covenants.
5.6.1.10. Qualifications which appear not to be of a material nature (limited

inadequacies in accounting sub-systems, failure by accounting staff to respond to inquiries,
etc.) should be followed up with the borrower by correspondence or during review
missions, to ensure that appropriate corrective action is taken.
5.6.1.11. In the same way that accounting systems need to be designed and installed
over a period of time, auditing capability often also needs gradual development. In such
cases, loan agreements should refer to the form and timing of this process.
5.6.1.12. The analyst should participate in review work in a manner that fosters
improvement of the auditor’s work. Early audit reports that lack quality and depth of
performance should not readily be rejected. Instead, the EA and the auditor should be
informed in writing of possible deficiencies and encouraged to produce either an improved
audit report, or to improve presentation of next year’s financial statements. Under such
circumstances, it is important that the financial management and accounting functions
of the entities involved be carefully supervised, so as to compensate as far as possible
for inferior auditing ability. The foregoing does not, however, preclude ADB from requesting
the replacement of an auditor, particularly if training or other support is unlikely to
achieve short-run improvements.
5.6.2. Auditors’ Reports and Opinions
5.6.2.1. ISA 700 advises auditors in detail on the form and content of an auditor’s
report, and ADB would expect an auditor to closely follow this advice. In particular,
paragraph 17 of ISA 700 addresses the Opinion Paragraph of an auditor’s report as follows:
“The auditor’s report should clearly state the auditor’s opinion as to whether the
financial statements give a true and fair view (or are presented fairly, in all material
respects,) in accordance with the financial reporting framework and, where
appropriate, whether the financial statements comply with statutory requirements”.
5.6.2.2. An audit report must include: (i) title of the auditor; (ii) date of the report; (iii)
addressee (EA and/or borrower); (iv) identification of the financial information audited; (v) a
reference to auditing standards or practices followed; (vi) an expression of opinion,
including a qualification; disclaimer or declining of an opinion, on the financial information;
(vii) the auditor’s signature; (viii) auditor’s address; and (ix) date of signing of the report.
5.6.2.3. Section 5.6.3 provides examples of the body of typical auditor’s reports and
opinions for (i) an unqualified opinion for a non-revenue-earning project; and (ii) an
unqualified opinion for a revenue-earning project. The auditor should appropriately
restate each example when qualifications or other modifications are necessary.
5.6.2.4. Audited financial statements provided to ADB in accordance with a loan

agreement should be accompanied by the report of the auditor that contains their opinion
on the financial statements.
5.6.2.5. ADB prefers that auditors’ report provide details on ADB’s requirements,
particularly with respect to receiving, among other requirements, an auditor’s view on
compliance with loan covenants and on ADB’s requirements for project management.
5.6.2.6. The auditor should indicate whether any attached supplementary financial
statements and Notes to the Financial Statements have been subjected to the same auditing
procedures as in the case of the basic financial statements.
5.6.2.7. Additional matters may be addressed in a detailed auditor’s report, where

these are not addressed in the Management Letter. As examples: (i) implementation of
the auditor’s recommendations made in prior years; audit reports; (ii) efficacy of, and
improvements required in budgetary control; (iii) reliability of field and financial controls;
and (iv) any payroll, procurement, or inventory problems.
5.6.2.8. The auditor’s opinion for a project should refer to the reporting format agreed
between the borrower and ADB, noting the basis of accounting followed (e.g., cash basis).
5.6.2.9. The auditor’s opinion for a revenue-earning entity, including a commercial

type entity in the private sector, should refer to the accounting standards adopted and
any significant departures from IASs (if any), with a reference to a quantified impact of
such departures on the Balance Sheet and the Income Statement prepared by the EA in
the Notes to the Financial Statements. An example of the above would be where
government regulations legislate the basis for bad debt provision rather than relying on
an actual assessment.26
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5.6.3. Model Audit Opinions
5.6.3.1. Model Audit Opinion for a Non-Revenue-

Earning Project
To: Borrower (or designated agency)
We have audited the accompanying financial statements (pages____ to ____) of the

___________ Project financed under the Asian Development Bank Loan #______ as of
December 31, 20___, and for the year then ended.
These financial statements are the responsibility of the management of the
________ EA.
Our responsibility is to express an opinion on the accompanying statements
based on our audit.
We conducted our examination in accordance with International Standards on Auditing.
Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of misstatement. Our audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. Our audit also includes assessing the accounting principles and significant
estimates made by management, as well as evaluating the overall statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
The ____ (EA’s) policy is to prepare the accompanying statements in the
format agreed between the Asian Development Bank and the Government of ________
as noted in the Minutes of Negotiations for the Loan, [on a cash receipts and disbursements
basis in which cash is recognized when received and expenses are recognized when paid,
rather than when incurred] / [on an accruals basis in which expenses are recognized
when incurred and revenue is reported when income is due.]
In our opinion, (A) the aforementioned financial statements and appended
notes that were also the subject of the audit, fairly present in all material respects the
financial position of the _________ project as at__________20__and the results of its
operations for the year ended _________ 20__, in conformity with ____________
accounting standards, applied on a basis consistent in all material respects with that of
the previous year; (B) the [Borrower] [EA] has utilized all proceeds of the loan withdrawn
from the Asian Development Bank only for purposes of the Project as agreed between
the Asian Development Bank and [the Borrower] in accordance with the Loan Agreement;
and no proceeds of the loan have been utilized for other purposes; and (C) the [Borrower]
[EA] was in compliance as at the date of the balance sheet of the year of audit with all
financial covenants of the Loan Agreement.
In addition:
(a) (1) With respect to Statements of Expenditures, adequate supporting

documentation has been maintained to support claims to the Asian Development
Bank for reimbursements of expenditures incurred; and (2) which expenditures
are eligible for financing under Loan Agreement No. ____.
(b) (1) The Imprest Accounts (page __) give a true and fair view of the receipts
collected and payments made during the year ending ____ ; and (2) these receipts
and payments support Imprest Account liquidations/replenishments during the
year.
[(a) and (b), above, are to be provided where the Loan Agreement requires separate
Imprest Account and Statement of Expenditures audits and audit opinions.]
5.6.3.2. Model Audit Opinion for a Revenue Earning

Project
To: Borrower (or designated agency)
“We have examined the Balance Sheet of __________as of ________ 20__ , and the
Income Statement, Cash Flow Statement and related statements and Notes (see pages____
to ____ of our Report) of the _________________ Project financed under the Asian
Development Bank Loan #________________ as of December 31, 20___, and for the
year then ended.
We conducted our examination in accordance with International Standards
on Auditing [auditing standards of the country of ______].27 Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of misstatement. Our audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. Our
audit also includes assessing the accounting principles and significant estimates made
by management, as well as evaluating the overall statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, (A) the aforementioned financial statements and appended
notes that were also the subject of the audit, fairly present separately (i) the financial
position of the ___________ project and (ii) the overall operations of the ___________
[name of EA] as at__________20__and the separate results of the project operations
and the EA’s operations for the year ended _________ 20__, in conformity with
international accounting standards [accounting standards of the country
of___________],28 applied on a basis consistent in all material respects with that of the
27
discretion ee alter
agree native ar
arrangements
28
discretion ee alter
agree native ar
previous year; (B) the [Borrower] [EA] has utilized all proceeds of the loan withdrawn
from ADB only for purposes of the Project as agreed between the Asian Development
Bank and [the Borrower] in accordance with the Loan Agreement; and no proceeds of
the loan have been utilized for other purposes; and (C) the [Borrower] [EA] was in
compliance as at the date of the balance sheet of the year of audit with all financial
covenants of the Loan Agreement.
In addition:
(a) (1) With respect to Statements of Expenditures, adequate supporting
documentation has been maintained to support claims to the Asian Development
Bank for reimbursements of expenditures incurred; and (2) which expenditures
are eligible for financing under Loan Agreement No. _________________.
(Required where an SOE audit is required under the Loan Agreement.)
(b) The Imprest Accounts (page____) gives a true and fair view of the receipts
collected and payments made during the year ending __________________.
[(a) and (b) above to be provided where a separate Imprest Account audit is required
under the Loan Agreement.]
5.6.4. Compliance with Loan Covenants
5.6.4.1. Borrowers and EAs enter into financial performance covenants with ADB.
The auditor is required to confirm, or otherwise, compliance with each financial covenant
contained in the legal documents for the project. The auditor should also indicate, where
present, the extent of any noncompliance, by reference to the specified (required) and
actual performance measurements for each financial covenant for the fiscal year concerned.
5.6.5. Compliance with ADB’s Requirements
5.6.5.1. Borrowers and EAs enter into agreement with ADB in the loan documents
to provide all appropriate financial management, accounting and financial reporting
requirements necessary to support effective management of the project. The auditor should
also indicate the extent of any noncompliance with the loan agreement, by reference to
the specified (required by the loan documents) and actual performance of the borrower in
respect of these requirements of ADB for the fiscal year concerned.
5.6.6. Types of Auditors’ Opinion
5.6.6.1. An unqualified opinion indicates the auditor’s satisfaction in all material

respects with the following matters:
• The financial information has been prepared in accordance with (a) for a project -
the reporting format agreed; and (b) for a revenue-earning entity - accounting
standards and practices acceptable to ADB have been consistently applied.
• The financial information complies with relevant regulations and statutory
requirements.
• The view presented by the financial information as a whole is consistent with the
auditor’s knowledge of the project/entity.
• There is adequate disclosure of all material matters relevant to the proper presentation
of the financial information.
• Additional requirements that may have been requested in the TOR have been met.
5.6.6.2. When a qualified opinion, adverse opinion, or a disclaimer of opinion is

given, theaudit report should state in a clear and informative manner all of the reasons
for such opinion. ISA provides guidance to auditors on the form and content of the
auditor’s report issued in connection with the independent audit of the financial statements
of any organization.
5.6.6.3. A qualified opinion is issued when the auditor concludes that an unqualified
opinion cannot be issued, but that the effect of any disagreement, uncertainty or limitation
of scope of the audit is not so material as to require an adverse opinion or a disclaimer
of opinion. The subject of the qualification and its financial effect must be clearly stated
in the auditor’s report.
5.6.6.4. An adverse opinion is issued when the possible effect of a disagreement is

so pervasive and material to the financial statements that the auditor concludes that a
qualification of the report is not adequate to disclose the misleading or incomplete nature
of the financial statements.
5.6.6.5. A disclaimer of opinion is issued when the possible effect of a limitation on

the scope of the audit or of an uncertainty is so significant that the auditor is unable to
express an opinion on the financial statements.
5.6.7. Materiality
5.6.7.1. ISA 320 states among other things:
“Information is material if its omission or misstatement could influence the economic

decisions of users taken on the basis of the financial statements. Materiality depends on the
size of the item of error judged in the particular circumstances of its omission or
misstatement. Thus materiality provides a threshold or cut-off point, rather than being
primarily qualitative characteristic which information must have if it is to be useful”
5.6.7.2. Some auditors (particularly government auditors) provide reports listing all
mistakes, irrespective of their materiality. ADB requires a clear opinion. Thus irregularities
and instances of noncompliance with government or institutional rules and regulations
that do not give rise to a qualified or disclaimed opinion should not be subjects of the
report of the auditor. Where an auditor has comments that are not material to the opinion,
these should be set out in the Management Letter.
5.6.8. Use of Technical Experts
5.6.8.1. For certain types of expenditures to be financed from ADB loans/credits, the
auditor may need to rely on an independent technical expert who normally would be engaged
by the EA. An example would be civil works executed by the regular labor force of an entity
(e.g., “force account” carried out by the Ministry of Works); or fixed-price reimbursements
for measured units of work to be supervised by independent experts such as an engineering
or architectural firm. In addition to the normal responsibility of such experts to check that
the work is performed in accordance with the plans and specifications, an appropriate
certification by the expert of the value of the work executed may be acceptable to ADB.
5.6.8.2. The acceptability of the certification would depend on the independence

and competence of the firm and its staff engaged in the verification. Such a certification,
where used, should normally be attached to the related documentation supporting the
expenditure. Any dissatisfaction with the work of the expert that concerns the auditor
should be stated in the auditor’s report.
5.6.8.3. The content of the certificate might cover matters such as whether the goods
and services were procured, received, paid for and used in the project in conformity with
the loan agreement. In the above instances, the auditor should include a note under the
scope paragraph of the opinion, stating the extent and amount involved with respect to
their reliance on the technical expert (who should be identified and expertise noted in
the Notes to the Financial Statements prepared by the EA).
5.6.9. Statements of Expenditure (SOE) and

Imprest Accounts
5.6.9.1. Where the legal agreement of a project requires the separate audit of the
SOE and the Imprest Accounts, respectively, additional paragraphs should be included
in the audit opinion of the project:
• referring to the SOE financial statement, certifying to the eligibility of those

expenditures against which SOE disbursements were made; and
• referring to the Imprest Account financial statements attached.
5.6.10. Reviewing Audit Management Letters
5.6.10.1. The scope of the engagement as set out in the TOR should require the auditor
to provide a Management Letter with reference to the EA. This is a report on the internal
controls and operating procedures of the entity, covering all aspects included during the
normal course of the audit. Because an auditor is unlikely to cover all activities of a client
during an annual audit, the Management Letter may address only those specific matters
that came to the attention of the auditor during the review.
5.6.10.2. The borrower and the auditor may agree at the commencement of the audit
on particular subjects (including those at the request of ADB) to be included in the TOR
and addressed in the Management Letter. These may include the review of compliance
with financial covenants, and actual versus planned performance indicators. However,
it should be the prerogative of the auditor to address any matter not agreed upon, but
which, in the auditor’s opinion, should be drawn to the borrower’s attention. In addition,
the auditor should comment on all significant variations between the PMR and the annual
audited financial statements.
5.6.10.3. An auditor may use the Management Letter as a means of obtaining financial
management and accounting systems and internal control improvements that would likely
make the audit work easier and less time consuming to complete. An effective Management
Letter, properly responded to by a client can reward the latter with a less expensive audit
operation.
5.6.10.4. ADB wishes to review all Management Letters, and the project officer, financial
analyst or Financial Management Specialist should ensure that copies are forwarded to
ADB by the EA concerned at the same time as the audited annual financial statements
are issued.
5.6.10.5. The Project Officer should ensure that a financial analyst or Financial
Management Specialist reviews each Management Letter. The financial analyst should
advise the Project Officer of any matters to which the auditor has drawn attention that
may adversely affect the operation of the EA and project implementation.
5.6.11. Audit Report Questionnaire
5.6.11.1. The Audit Report Questionnaire that is provided in the Knowledge

Management section of these Guidelines is provided only as an example of the nature
and type of questions that should be considered when reviewing the report of an auditor.
Financial analysts should have regard to the nature of the organization under audit and
frame their questions accordingly.
5.6.11.2. Agencies operate in a wide range of sectors and activities, and therefore the
form and nature of their financial statements will vary equally widely. Furthermore,
approaches to, and the quality of auditing is variable. Therefore, the questions set out
in the questionnaire should be regarded with some caution, because these may not have
sufficient breadth or depth for some institutional statements and audits. Conversely, these
may also be considered too extensive for some EAs, their activities and the audit services
available.
5.6.11.3. Nevertheless, by using this questionnaire, or a suitably modified version

thereof to reflect the nature and form of the EA concerned, a financial analyst should be
able to obtain a reasonable view of the acceptability of the financial statements concerned
and the audit thereof.
6. Financial Institutions (FIs)
6.1. FI Introduction and Overview
6.1.1. DMCs use financial institutions (FIs) to manage funds received from
government, multilateral development banks (including ADB), other donors, and the
financial markets. The FIs act as financial intermediaries in providing loans and equity
contributions to public or private sector organizations in sectors, or subsectors, such as
agriculture, industry, and small- or medium-scale enterprises.
6.1.2. FIs include commercial banks and other financial institutions. ADB loans to
FIs may be referred to as FILs. ADB previously referred to FIs as Development Finance
Institutions (DFIs). The World Bank and the African Development Bank refer to FIs as
Financial Intermediaries. They are also known by sectoral titles, such as agricultural
banks (AgDBs), industrial banks (IDBs) and housing development banks (HDBs), or as
development financial intermediaries, microfinance institutions (MFIs) and microfinance
intermediaries.
6.1.3. FIs are expected to generate an interest rate spread (the difference between
lending and borrowing rates) that covers all operating costs, including provisions for bad
and doubtful debts, and in appropriate circumstances provides a profit. ADB can support
FI operations in both the public and the private sectors. In addition to this introduction,
this part has five sections:
6.2 Reviewing FI This section describes specific issues to be

Financial Management considered when reviewing the financial
management practices of FIs. These issues
include the treatment of interest rate
distortions, directed credit and subsidies.
6.3 FI Investments This section describes ADB’s approach to

FI investments. It discusses selection of
participating institutions and appraisal
approaches.
6.4 Assessing FI Performance This section describes considerations

regarding, and approaches to, measuring the
performance of FIs. In particular, it advises
on applying the CAMEL framework and
assessing FI risks. The section stresses that
2 of 22 Financial Institutions (FIs)
the performance measures recommended

throughout other parts of these Guidelines
are not necessarily applicable to FIs.
6.5 FI Appraisal Checklist A generic checklist is provided for

appraising FIs.
6.6 FI Reporting and This section provides specific guidance on

Auditing Issues the reporting and auditing requirements
for FIs.
6.2. Reviewing FI Financial Management
6.2.1. General Operational Issues
6.2.1.1. State-owned FIs resemble their commercial cousins in that frequently they
have been formed to address the needs of a particular community, or category of commerce
or industry, or branch of human activities, such as lending very small sums to urban and
rural poor through microfinance. Some state-owned FIs are very large, such as the
Industrial Development Bank of India (IDBI) or the Agricultural Bank of China (ABC).
Other state-owned FIs can be very small and are sometimes operated by volunteers under
a manager seconded from a commercial bank. So, as there is no generic model, each FI
must be identified and prepared for a project, and appraised as to its capabilities and
capacities to deliver a proposed project.
6.2.1.2. The objective of reviewing FI operational performance is to assess its ability

to: (i) deliver subloans to achieve defined country/sector economic objectives; (ii) efficiently
recover subloans; and (iii) cover all operating costs and make a reasonable profit on the
invested capital. FIs have numerous forms of performance indicators that can provide
analysts with an understanding of past and ongoing performance.
6.2.1.3. Where an existing FI is the subject of a proposed project, or of a continuing

ADB lending operation, the financial analyst (or investment officer) should begin by
closely studying the FI’s most recent annual financial statements and associated auditors’
reports and opinions.
6.2.1.4. For an ongoing project, this review should be conducted against the objectives
and recommended operational performance set out in the most recent RRP. After drawing
conclusions as to past and current performance, the financial analyst (or investment
officer) should discuss their findings in detail with the project officer and the FI
Financial Institutions (FIs) 3 of 22
management and, if appropriate with the proposed or actual borrower, and an apex
institution, (where participating). Every effort should be made to reach agreement on
these initial findings; particularly on management deficiencies, system defects, and
performance shortcomings or failures.
6.2.1.5. This first step is essential to ensure that the FI management understands
and is likely to fully support the likely objectives of a proposed project, or revision of
objectives (where necessary) for an ongoing project, as the ADB mission continues its
work of preparing or supervising a project.
6.2.1.6. Full collaboration by FI management and their complete endorsement of a

mission’s proposals is critical for the investment’s success. Any reservations by FI management
or the borrower should be confirmed in the Aide Memoire and reported to the MRM.
6.2.1.7. It is particularly important to monitor the implementation and fulfillment

of the stakeholders responsibilities, and the impact of their obligations on: (i) their
respective national economies; (ii) performance of the institution as a borrower;
(iii) national influences on regional operations (where present), and (iv) selected
enterprises in representative regions of countries as subborrowers.
6.2.2. Policy Framework for FIs and FI Loans
6.2.2.1. The design and timing of FILs should take account of the prevailing and
expected macroeconomic environment, including the exchange rate regime and
international capital mobility, as well as conditions in real sectors. Given the critical
importance of the macroeconomic and sectoral framework for financial sector sustainability
and efficiency, ADB considers FILs only in the context of a satisfactory macroeconomic
framework. Within this framework, ADB uses its lending and non-lending services to
focus on improving the incentive environment for FIs.
6.2.2.2. ADB involvement in the financial sector of countries through FILs: (i) supports
improvements in the incentives structure for market participants, including elimination
of impediments to efficient resource mobilization and allocation; (ii) supports development
of infrastructure, including creation and strengthening of sound and competitive financial
institutions and markets, and improvements in financial and prudential regulations,
banking supervision, and accounting and auditing standards; and (iii) aims to remove
or substantially reduce subsidies, whether provided through interest rates, directed credit,
institution-building grants, or otherwise. (Institution-building TA grants and other non-
interest rate subsidies may be provided in a variety of ways, for example, as preferential
income-corporate tax treatment, free use of facilities, consultancies, guarantees, training,
and subsidized staff costs and overheads).
6.2.3. Treatment of Interest Rate Distortions
6.2.3.1. The level and structure of interest rates are critical determinants of: (i) the
economic efficiency with which resources are allocated in an economy, and (ii) financial
sector viability.
6.2.3.2. By definition, interest rates reflect the opportunity cost of capital in

undistorted markets. Interest rate distortions may lead to a misallocation of resources,
resulting in forgone national income. Therefore, the removal of interest rate distortions
in a country is an important objective of financial sector reform programs supported by
ADB-funded FILs.
6.2.3.3. When there are major interest rate distortions in a country (e.g., large interest
rate subsidies, pervasive interest rate controls, or policies that cause extremely high interest
rates), ADB does not support a program until the country establishes agreed programs
to remove or substantially reduce the distortions during implementation of the FIL.
6.2.3.4. Interest rate reforms should be appropriately phased to minimize adverse

impacts on the solvency and liquidity of FIs and enterprises.
6.2.3.5. In determining whether there are major interest rate distortions, the following
factors should be considered: (i) whether domestic interest rates are administered, are
determined non-competitively, or are affected by the government’s fiscal tax/subsidy and
regulatory policies; and (ii) when capital markets are open, whether there are significant
differences between domestic interest rates and interest rates payable on borrowings of
foreign capital (that cannot be explained by prevailing economic conditions).
6.2.3.6. However, under certain circumstances, ADB may support programs that
include directed credit or subsidies.
6.2.4. Treatment of Directed-Credit Programs
6.2.4.1. ADB-supported FILs also aim to remove or substantially reduce the use of
directed credits, that are similar to interest rate subsidies, as these lead to resource
allocation outside market mechanisms.
6.2.4.2. Directed credit programs supported by ADB may be channeled through

specialized FIs, particularly those that concentrate their lending in certain subsector market
niches for business strategy reasons.
6.2.4.3. In many countries, increasing access to credit by specific sectors (e.g., micro-
finance institutions or the rural sector) is a major government policy objective, and some
use directed credit to pursue this objective.
6.2.4.4. An ADB FIL may support directed-credit programs to promote sustainable

financing for such sectors, provided that the programs are accompanied by reforms to
address the underlying institutional infrastructure problems and any market imperfections
that inhibit the market-based flow of funds to those sectors.
6.2.4.5. Such reforms include measures to: (i) address obstacles that impede the
flow of funds to the credit recipients, or (ii) enhance the creditworthiness of the intended
beneficiaries through appropriate approaches such as mutual group guarantees. When
such targeted lending is commercially oriented, it is not considered to be directed credit.
6.2.4.6. It is good practice to routinely monitor the contribution of directed credits

and their associated concessional terms to the growth of the targeted sector(s) and poverty
reduction, taking into account any adverse impact on other parts of the economy.
6.2.5. ADB Policy on Subsidies
6.2.5.1. In some cases, subsidies may be an appropriate use of public funds (e.g.,
poverty-reduction programs). ADB supports programs involving subsidies only if they:
• are transparent, targeted, and capped

• are funded explicitly through the government budget or other sources subject to
effective control and regular review
• are fiscally sustainable
• do not give an unfair advantage to some FIs over other qualified and directly
competing institutions; and
• are economically justified, or can be shown to be the least-cost way of achieving
poverty reduction objectives
6.2.5.2. Subsidies that do not meet these tests should be phased out, or are
substantially reduced, during the course of a FIL.
6.2.6. Eligibility Criteria for FIs
6.2.6.1. ADB requires assurances that FIs, acting as onlenders using FILs and other
investment operations, are financially efficient and viable institutions. In particular, they
must:
• Be financially sustainable – as represented by adequate profitability, capital, and

portfolio quality, as confirmed by financial statements prepared and audited in
accordance with accounting and auditing principles acceptable to ADB
• Have acceptable levels of loan collections
• Have appropriate capacity, including staffing, for carrying out subproject appraisal
(including environmental assessment) and for supervising subproject implementation
• Have the capacity to mobilize domestic resources
• Have adequate managerial autonomy and commercially oriented governance
(particularly relevant when state-owned or state-controlled FIs are involved); and
• Have appropriate prudential policies, administrative structure, and business
procedures.
6.2.6.2. Using these criteria, ADB determines the eligibility of a proposed FI, or it
may require an apex institution or other appropriate entity to do so.
6.2.6.3. New and existing FIs that do not meet all the eligibility criteria for being
intermediaries may participate in an ADB-funded FIL if they agree to an institutional
development plan that includes a set of time-bound monitorable performance indicators
and provides for a midterm review of progress.
6.2.6.4. When an FIL includes such FIs, the size and complexity of the FIL should
be commensurate with the FIs’ implementation capacity; and the FIL may include an
institution-building component that the borrower may pass on in the form of grants.
Such FIs’ continued participation in the FIL is subject to their satisfactory implementation
of their institutional development plans; when progress is not satisfactory, ADB considers
appropriate remedial action, including suspension.
6.2.6.5. FIs whose performance in relation to eligibility criteria has been unsatisfactory
for an extended period of time are required to take substantial corrective measures and
to demonstrate improvement before they are permitted to participate in a FIL under an
institutional development plan as described above.
6.3. FI Investments
6.3.1. Introduction
6.3.1.1. This section describes ADB’s approach to FI investments. It discusses selection

of participating institutions and appraisal approaches.
6.3.2. Investing in FIs
6.3.2.1. ADB’s involvement in a country’s financial sector is set out in the Country
Strategy Paper (CSP) and driven by ADB’s overarching poverty-reduction objective. As
relevant, the CSP: (i) shows how the financial sector affects country development prospects;
(ii) highlights reforms to be supported by ADB financial sector operations, including
their sequencing; and (iii) states why the proposed operation is the appropriate vehicle
for ADB support for reforms.
6.3.2.2. As appropriate, ADB consults with the IMF, the World Bank, and selected
donors on proposed FI lending, and it coordinates its financial sector strategies and
operations with theirs.
6.3.2.3. One of the forms of ADB’s intervention in the financial sector is a Financial
Institution loan (FIL). Under an FIL or an FIL component of an investment loan, ADB
provides funds to eligible participating FIs for on-lending, at the FI’s risk, to final borrowers.
6.3.2.4. The appraisal should ensure that the following objectives of FI lending
include: (i) supporting reform programs in the financial sector or related real sectors; (ii)
financing real sector investment needs; (iii) promoting private sector development; (iv)
helping to stabilize, broaden, and increase the efficiency of financial markets and their
allocation of resources and services; (v) promoting the development of the participating
FIs; and (vi) supporting the country’s poverty reduction objectives.
6.3.2.5. FILs are provided in the context of sound analytical work on sector issues,
appropriate technical assistance, and, as relevant, adjustment operations to address policy
issues.
6.3.2.6. ADB’s intervention in the financial sector may also be in the form of other
lending instruments (e.g., structural and sector adjustment loans and technical assistance
loans), guarantees, and non-lending activities (e.g., country economic and sector work,
training, and financial advisory services).
6.3.3. Selecting Participating Institutions
6.3.3.1. ADB’s Economics and Development Resource Center (EDRC) developed a

paper in 1999 that explored in detail approaches to selecting participating financial
institutions in credit projects. This paper, Towards Good Practice, can be accessed in the
Knowledge Management section of the web-based Guidelines.
6.3.4. Appraising an FI Investment
6.3.4.1.1. ADB’s appraisal of an FIL should:
• Confirm, with justifications, if it is the appropriate intervention to achieve the desired

objectives with due regard to the sustainability of the financial sector
• Establish the financial and economic justifications for the operation
• Confirm, for an FIL justified by its poverty-reduction goals, that it is a practicable,
cost-effective way of achieving such goals
• Confirm the eligibility of FIs proposed for inclusion
• Confirm that implementing the FIL is not likely to undermine the financial condition
of participating FIs.
6.3.4.1.2. The economic analysis of an FIL should take into account the prevailing and
expected macroeconomic environment and substantiate that the proposed operation will
lead to net economic benefits arising from policy and institutional changes and increased
availability of investment funds.
6.3.4.1.3. If the justification for an FIL depends critically on addressing perceived

market failures (i.e., non-market effects or externalities), the analysis should explain the
assumptions and their empirical basis. If there is evidence of a subsidy involved in an
FIL such that resources, through interest rates or other forms, are provided below their
economic opportunity cost, the extent of subsidy dependence must be calculated and
assessed.
6.3.4.1.4. Risk analysis should be used to demonstrate how robust the projected
economic benefits of the project are to possible changes in assumptions about the macro
economy, borrower commitment to the reforms supported by the FIL, and institutional
performance. Note that this reference to risk analysis should not be confused with market
risk and associated indicators.
6.3.4.2. Sub-Projects
6.3.4.2.1. Increased production of goods and services should be established at the

subproject level. It must be derived from expanding existing productive capacity, increasing
the efficiency of capacity utilization, or creating new types of productive capacity. Working
capital financing to maintain existing levels of production is not eligible for ADB financing.
6.3.4.2.2. FILs are used to finance investments in subprojects for increased production
of goods and services. The subprojects must meet eligibility and development criteria
agreed with ADB. ADB agrees with the borrower on appropriate arrangements to monitor
subproject compliance with these criteria. In addition to the above criteria, the appraisal
should ensure that subprojects are financially viable and technically, commercially,
managerially, and environmentally sound.
6.3.4.3. Use of ADB Funds
6.3.4.3.1. The borrower may pass on ADB funds to a FI either as a loan or as borrower’s
equity; similarly, FIs may pass on ADB funds to subborrowers as subloans or equity
investments. In all cases, ADB funds are disbursed against eligible expenditures for goods,
works, and services.
6.3.4.3.2. FILs are normally amortized by ADB’s borrowers on country terms as

established by ADB and not on a back-to-back basis (by earmarking subborrowers’
repayments for amortizing the ADB loan). The borrower may pass the funds on to FIs
either on a back-to-back basis or on the basis of another amortization schedule acceptable
to ADB.
6.3.4.3.3. When FI loan repayments to the borrower are not on a back-to-back basis,
FIs may, within their overall loan amortization schedules, use repayments for purposes
that are consistent with their business strategies, or for prepayments to the borrower.
Under an apex or two-tier lending arrangement, ADB funds are passed initially to an
apex (first-tier) institution, which on lends them to the participating retail financial
institutions.
6.3.4.3.4. An FI with actual or potential conflict-of-interest cannot serve as an apex

institution.
6.3.4.3.5. Two-tier lending arrangements are common, but a three-tier arrangement

may be feasible, particularly to address micro-credit operations.
6.3.4.4. On-lending Terms
6.3.4.4.1. FIL on-lending terms are set in the context of a borrowing country’s interest
rate structure and any agreed program for interest rate reforms.
6.3.4.4.2. ADB funds are priced to be competitive with what the participating FIs and
their subborrowers would pay in the market for similar money, taking into account, as
relevant, maturities, risks, and scarcity of capital.
6.3.4.4.3. When interest rates are not market-determined and there is an agreed program
of interest rate reforms, FIL funds are on-lent to participating FIs at interest rates agreed
with ADB that: (i) are not negative in real terms; (ii) provide adequate margins to FIs to
cover all costs, including credit and other risks, and an adequate profit margin; and (iii)
do not discourage resource mobilization from the market by providing a price advantage
in using FIL funds.
6.3.4.4.4. ADB funds may be on lent to participating FIs and their subborrowers in
either foreign exchange or domestic currency on the basis of prudent credit decisions,
including prospective subborrowers’ ability to bear the foreign exchange risk to avoid
later credit risk. Where interest rates are market-determined and there is relatively easy
capital movement, local currency interest rates include an implicit premium that reflects
market expectations in regard to exchange rate changes. In such situations: (i) ADB FIL
funds are on-lent to FIs in either local or foreign currency, provided the on lending interest
rates are consistent with prevailing interest rates in the borrowing country for comparable
credit; and (ii) FIs normally on lend to subborrowers in the same currency or currencies
that the FIs borrowed.
6.3.4.4.5. If interest rates are not market-determined but are set administratively, it is
not possible to determine market expectations of exchange rate changes, as foreign
exchange risks may be under priced in local currency interest rates. Therefore, the foreign
exchange risk of FIL funds is borne either by: (i) Subborrowers through borrowing and
repayment in foreign currency, or (ii) the government if on-lending and repayment are
in domestic currency at prevailing administered interest rates. In the latter case, the
government charges a fee that is passed on to FIs and subborrowers to offset the anticipated
foreign exchange risk.
6.3.4.5. Monitoring FI Investments
6.3.4.5.1. During project appraisal and negotiations, provision is made for effective
monitoring and evaluation of the FIL’s progress toward its objectives and development
impact throughout the life of the project.
6.3.4.5.2. The performance indicators agreed on at loan negotiations cover sectoral,

financial, and institutional variables.
6.3.4.5.3. The variables for the FIs include among other things, adequacy of capital,
quantity and quality of earnings, quality of assets, sufficiency of liquidity, extent of subsidy
dependence, effectiveness of FI loan administration (appraisal, supervision, and collection
performance), and adequacy and timeliness of preparation of audited financial statements.
During implementation, ADB, the borrower, and the FIs in each tier must use the agreed
performance indicators, implementation progress reports, and a review of a sample of

subprojects to monitor the FIL’s progress.
6.3.4.5.4. At least once each year during implementation, ADB conducts a formal review
of the condition and performance of participating FIs, including a review of their audited
financial statements, to determine their continued compliance with eligibility criteria.
The findings of this review are to be recorded in supervision reports.
6.4. Assessing FI Performance
6.4.1. Introduction
6.4.1.1. A wide range of indicators is available for reporting by FIs. The most
important are described in this section. The ratios and indicators that are described in
other parts of these Guidelines are generally not appropriate for assessing FI performance.
6.4.1.2. It is important that the financial analyst (investment officer) only recommends
indicators that the FI fully understands and is willing to use in their day-to-day
management processes. However, where a FI is reluctant to prepare and use indicators
effectively, or does not have a financial management system capable of preparing the
indicators that ADB staff have recommended, these issues should be recorded in an Aide
Memoire and reported to an MRM.
6.4.1.3. The most important criteria for determining the appropriateness of an

FI to act as a financial intermediary are its solvency, profitability, and liquidity. In this
respect, since 1988, the Basle Committee on Banking Supervision (BCBS) of the
Bank of International Settlements (BIS) has recommended using C apital adequacy,
A ssets quality, M anagement quality, E arnings and L iquidity (CAMEL) as criteria for
assessing an FI.
6.4.1.4. The following sections describe the application of the CAMEL framework
and provide a selection of appropriate indicators. They also discuss risk management in
relation to FIs. A special section examines the application of these Guidelines to
Microfinance Institutions (MFIs).
6.4.2. Assessing Microfinance Institutions (MFIs)
6.4.2.1. The World Council of Credit Unions (WOCCU) recommends a set of financial
ratios covering Protection, Effective financial structure, Asset quality, Rates of return and
costs, and Liquidity and Signs of growth (PEARLS) to monitor the financial stability of
Credit Unions, including MFIs. The PEARLS methodology is specifically designed for
evaluating credit unions and addresses shortcomings of the CAMEL system in this respect.
6.4.2.2. Further information on the PEARLS methodology can be found in the

Knowledge Management section of the web-based Guidelines and at www.woccu.org.
6.4.3. Applying the CAMEL Framework
6.4.3.1. The five following subsections describe the components of the CAMEL
framework and recommend appropriate performance measures.
6.4.3.1. Capital Adequacy Ratio (CAR)
6.4.3.1.1. Capital Adequacy is a measure of an FI’s financial strength, in particular its

ability to cushion operational and abnormal losses. An FI should have adequate capital
to support its risk assets in accordance with the risk-weighted capital ratio framework.
It has become recognized that capital adequacy more appropriately relates to asset structure
than to the volume of liabilities. This is exemplified by central banks’ efforts internationally
to unify the capital requirements of commercial banks and to generate worldwide
classification formulae such as the one proposed here. This indicator requires that assets
be classified by reference to their demands on the equity (or capital) structure of the FI.
6.4.3.1.2. The CAR indicator is derived by comparing the ratio of an entity’s equity to
its assets-at-risk. The covenant specifies that the borrower/EA/FI should not make an
advance to a subborrower if after making the advance, the ratio (the performance indicator)
of its equity to its assets-at-risk would be greater than that specified in the covenant.
[Paid in Capital + Reserve Funds + Risk-free assets should include:

Net Profits ] x 100 (i) Cash on hand; (ii) Due from Banks;
Capital Adequacy Ratio (%) = (iii) Interbank loans; (iv) Government-
Total Assets – Loan loss Provision – guaranteed loans; and (v) Investments
Risk-free Assets in government securities, etc.
6.4.3.1.3. Equity is defined as the total of: (i) unimpaired paid-up capital; (ii) retained
earnings; (iii) reserves available to meet any losses that may be incurred through the
non-recovery of assets; and (iv) all other capital and revenue reserves including provisions
for bad and doubtful debts; provisions for loan and lease losses.
6.4.3.1.4. Assets-at-risk are defined as the total of the impaired values of assets at the
date of making the advance to the subborrower. Assets are typically classified as: (i) risk-
free; (ii) minimum risk; (iii) general risk; (iv) substandard; (v) “workout” (or minimal
chance of recovery); and (vi) fixed assets, furniture and office equipment, computers,
etc. To each of these classifications is awarded a percentage of their values for which an
FI’s capital is needed to cover risk of losses.
6.4.3.1.5. The BCBS of the BIS recommends a mandatory minimum CAR of 8 percent
for banks in OECD countries. However, the emerging banking regulatory and supervision
system in most ADB DMCs, combined with an emphasis on directed lending, results in
poor portfolio quality. As such, these Guidelines recommend a minimum Capital Adequacy
Ratio (CAR) of 12 percent.
6.4.3.2. Assessing Asset Quality
6.4.3.2.1. Asset Quality has direct impact on the financial performance of an FI. The
quality of assets particularly, loan assets and investments, would depend largely on the
risk management system of the institution. The value of loan assets would depend on
the realizable value of the collateral while investment assets would depend on the market
value.
Ratios or Other Measures

Measures Computation Method Significance and Notes
1. Loan Concentration Tables Concentration of Loans by: Indicates concentration of exposure.

• Industry The analyst should review whether
• Region the FI has a policy regarding the
• Borrower ceiling or maximum exposure to
• Portfolio Quality any company or group.
2. Related Party Policies and • Loans outstanding to related

Exposure parties.
• Current approval process for
these loans.
• Checks and balances for such
loans.
Loan Loss Provision

3. Loan Loss Provision Ratio (%) Indicates provisioning requirements
Average Performing Assets on loan portfolio for the current
period.
• The Loan Loss Provision is the
current period allocation to the
loan loss reserve.
• Performing assets currently pay
interest or are not more than 60
days past due.

• Average performing assets:

beginning balance and ending
balance are averaged for the
period (including loans,
investment and advances).
Balance of Loans in Arrears x 100

4. Portfolio in Arrears (%) Measures amount of default in the
Value of Loans Outstanding portfolio.
Amounts Written Off x 100

5. Loan Loss Ratio (%) Indicates extent of uncollectible
Average Loans Outstanding loans over the last period. Any loan
more than one year past due should
automatically be considered
uncollectible.
• The Amount Written Off is the
loss recognized on a loan
during the period.
Loan Loss Reserve x 100

6. Reserve Ratio (%) Indicates the adequacy of reserves
Value of Loans Outstanding in relation to the portfolio.
• The Loan loss reserve is a
reserve maintained to cover
potential loan losses.
6.4.3.3. Assessing Management Quality
6.4.3.3.1. The performance of the other four CAMEL components will depend on the
vision, capability, agility, professionalism, integrity and competence of the FI’s management.
As sound management is crucial for the success of any institution, management quality
is generally accorded greater weighting in the assessment of the overall CAMEL composite
rating.

Operating Costs
1. Cost per Unit of Money Lent Indicates efficiency in distributing
Total Amount Disbursed loans (in monetary terms).
6.4.3.4. Assessing Earning Performance
6.4.3.4.1. The quality and trend of earnings of an institution depend largely on how
well the management manages the assets and liabilities of the institution. An FI must
earn reasonable profit to support asset growth, build up adequate reserves and enhance
shareholders’ value. Good earnings performance would inspire the confidence of
depositors, investors, creditors, and the public at large.

Net Income After Tax x 100
1. Return on Assets (%)
Average Total Assets
Net Income After Tax x 100

2. Return on Equity (%)
Average Total Equity Funds
3. Interest-Spread Ratio (%) Interest Expenses (a) Sum of interest on the loan
Income from and Other portfolio plus interest received
Loan Portfolio Financial Charges from other FIs. It also includes
x 100 (a) x 100 (c) discount and commission
earned and other charges (front-
Average Loan Average end fees) levied on customers.
Portfolio (b) Borrowings (d)
(b) Average of customer loans,
interbank loans and due from
banks.
(c) Includes commission and

discount paid, brokerage,
charges levied by correspondent
banks, etc.
(d) Comprises deposits and other

borrowings.
4. Earnings-Spread Ratio (%) Total Income – Interest Expenses (e) Loan portfolio, cash, Due from
Non-Operating and Other Banks, Interbank loans,
Income x 100 Financial Charges Investments in Government
x 100 securities and other
Average Total Average Total investments.
Portfolio (e) Resources (f)
(f) Equity + Deposits + Borrowings.
5. Intermediation Cost Ratio (%) [Total Expenses – (Interest expenses

+ fees and commissions and
commitment charges)] x 100
Average Total Assets
6.4.3.5. Assessing Liquidity
6.4.3.5.1. An FI must always be liquid to meet depositors’ and creditors’ demand in

order to maintain public confidence. There needs to be an effective asset and liability
management system to minimize maturity mismatches between assets and liabilities and
to optimize returns. As liquidity has inverse relationship with profitability, an FI must
strike a balance between liquidity and profitability.
6.4.3.5.2. Current and quick ratios are inappropriate for measuring FI liquidity. A loan-
to-deposit ratio is more relevant. However, an FI’s liquidity and solvency are directly
affected by portfolio quality. Consequently, Financial analysts (investment officers) should
carefully analyze the FI’s portfolio quality on the basis of collectability and loan-loss
provisioning. Section 6.4.3.2 suggests appropriate measures in this respect.

Measures Computation Method
1. Loan to Deposit Ratio (%) Loans (excluding short-term loans and

marketable securities) x 100
Customer Deposits
2. Loan to Deposit Ratio (Medium and Long-term) (%) Long and Medium-term Loans x 100
Long and Medium-term Deposits
6.4.4. Assessing FI Risks
6.4.4.1. Introduction to FI Risk Management
6.4.4.1.1. The main concern for FIs is risk management. World capital markets are
dynamic – their activities can generate rapid and dangerous movements that need to be
anticipated and managed. The ability of traditional performance measurement criteria to
indicate declining or poor FI performance is limited.
6.4.4.1.2. Therefore the capital markets and their regulators and advisers [e.g., the
Basle Committee on Banking Supervision (BCBS) and the International Organization of
Securities Commissions (IOSCO)] have developed additional means of measuring
performance and, more importantly, to identify problems in a timely manner.
6.4.4.1.3. In many cases, the FIs that ADB deals with are attached to the public sector
and have multiple objectives (e.g., sectoral development objectives in addition to
profitability objectives). The risk factors associated with these FIs are likely to be more
significant than for single-objective commercial banks. Consequently, it is essential that

the financial analyst (investment officer) should seek to: (i) identify the principal potential
risks that an FI is exposed to; and (ii) develop an appropriate set of indicators that will
provide FI management and ADB with an early warning of problems.
6.4.4.1.4. The major risks to be examined include: (i) market risk; (ii) exchange risk;
(iii) maturity risk; and (iv) contagion risk.
6.4.4.2. Market Risk and Value-at-Risk (VaR)
6.4.4.2.1. Market risk arises from the potential that a borrower or counter-party will
fail to perform on an obligation. The assessment of market risk involves evaluating both
the probability of default by counter-party, obligor or issuer and the exposure or financial
impact in the event of default. The BCBS of the BIS (www.bis.org) makes recommendations
on means to sustain the credit-worthiness of FIs.
6.4.4.2.2. The concept of Value-at-Risk (VaR) is very important in risk management.

VaR is a measure of the maximum potential change in an FI’s portfolio’s value with a
given probability over a pre-specified horizon. In simple terms, the Value-at-Risk is meant
to answer the question: “Over a 10-day period, what is the dollar amount of V such that
there is only a 1% chance our portfolio will lose more than V?”
6.4.4.2.3. The main advantages of VaR-based management are that: (i) it incorporates
the mark-to-market approach uniformly; and (ii) it relies on a short forecast horizon of
market variables. In some ADB DMCs, particularly in transitional economies, some bank
lending is government guaranteed. Financial analysts should treat government-guaranteed
bank lending as risk free when estimating VaR.
6.4.4.3. Foreign Exchange Risk
6.4.4.3.1. The Bank of International Settlements (BIS) document on Managing

Settlement Risk is included in the Knowledge Management part of the web-based
Guidelines. The document provides advice and guidance on managing foreign exchange
settlement risks. It also defines foreign exchange settlement risk, advises on management
practices, and includes guidance on internal auditing.
6.4.4.4. Maturity Risk
6.4.4.4.1. Maturity risk relates to mismatching of investments and borrowing

operations. To the extent possible, to avoid losses, an FI should seek to match the maturities
of subloans and borrowing operations to minimize the risk of having to meet large outgoing
interest payments on borrowings and deposits with lower levels of interest receipts from
subloans.
6.4.4.4.2. Mismatching can be expensive during times of increasing market rates,

particularly when the FI may have subloans extended over four to six years with no
break or adjustment clauses to address rising interest costs.
6.4.4.4.3. An FI should maintain a running risk analysis of forecast forward transactions

with alternative scenarios of market (borrowing rates) to identify the date(s) when it is
most at risk, based on its current portfolio. Forecasts of future portfolios can be similarly
risk assessed.
6.4.4.5. Contagion Risk
6.4.4.5.1. Contagion can arise in regions (such as Southeast Asia), in countries, in

regions within countries, or within a class or category of financial institutions (such as
agricultural FIs).
6.4.4.5.2. Contagion risk can arise where declining economic conditions of depositors
and subborrowers simultaneously cause a shortage of funds and a rapid increase in defaults
on subloans. This condition can automatically trigger a substantial rise in the risk premium
of major lenders that prevents an FI from covering shortfalls.
6.4.4.5.3. Anticipating and avoiding contagion risk is best addressed by financial sector
supervisors and regulators because they should maintain a consistent, regular overarching
view of the financial sectors and of the local/national/international economies with the
objective of providing early warnings, not only to the financial institutions, but to the
appropriate ministries that are charged with economic management.
6.4.4.6. The Role of Regulators in

Risk Management
6.4.4.6.1. The financial analyst (investment officer) should interview regulators and
receive assurances that the following matters are addressed:
• Market surveillance for large positions

• Cross-market supervision
• Setting of capital reserves
• Disclosure of data on market value of financial instruments and risk policies to
achieve least-cost uniformity in the sector
• Examination of FIs’ records and internal controls
• Optimum collaboration with FIs’ auditors

• International, regional, and national linkages and exchanges of information
• There is a set of rules and requirements that, at the lowest possible cost, effectively
contributes to prevent an isolated failure or crisis of small proportions threatening
the market as a whole
• To the extent possible obtaining voluntary convergence and agreement on the role
of the regulator
• A complete set of emergency plans
• That the emergency plans are constantly updated
• That the emergency plans are agreed between the central bank and FIs)
6.4.4.7. Other Key Risk Management Steps
6.4.4.7.1. The following steps should be considered as means of supporting the

generation of useful and accurate performance indicators in a FI:
• The use of a consistent set of accounting standards (IOSCO supports the use of
IASs).29
• Efficient netting agreements.
• Segregation of customers’ accounts and protection of customers’ funds in event of
bankruptcy.
• Ensuring regulators are kept fully informed, and are efficient in their reporting.
6.4.5. Determining FI Credit Ratings
6.4.5.1. The BCBS of the BIS is in the process of replacing the CAMEL framework.
The new policy will become effective in 2003 and will mandate the minimum CAR for
banks, based upon their overall credit rating.
6.4.5.2. Financial analysts (investment officers) are required to determine the credit
rating of the FI being appraised. In some cases, these credit ratings will be readily available
from published sources (for instance, the Standard & Poor’s Global Ratings Handbook).
In other cases, the financial analyst (investment officer) can determine the FI’s credit
rating by questioning other FI’s in the country or region.
29
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6.4.6. Specialized FI Internal Controls
6.4.6.1. Internal controls for FIs:
• Should comprise a set of rules and procedures designed to provide qualitative

standards that are complimentary to the quantitative analysis of risk
• Are becoming increasingly employed by banks and securities institutions
• Should be used to internally manage operational risk, agency risk, and legal risk
• Should be exercised by independent control unit reporting to the Board, and having
no operating linkage with trading activities that create risk
6.4.6.2. The objective is to enhance risk management culture in organization,

including by:
• Requiring transparency of reports and documentation of the risk control process

• Monitoring the content and the efficiency of the vertical and horizontal information
flows
• Monitoring and reporting on accountability
• Ensuring remuneration policy rewards efficient risk management through high
returns and minimum risk
• Monitoring observance of trading limits and market procedures
• Establishing rules for dealing with changes in volatilities
• Testing the soundness of models
• Examining the quality and uniformity of data input
• Validating and back-testing procedures
6.5. Appraisal Checklist
6.5.1. A checklist for appraising an FI project is provided in the Knowledge

Management section, along with other appraisal checklists (see section 7.10).
6.5.2. FIs comprise a wide range of institutions, including Apex institutions that
service one or more FIs in a country. FIs may provide services to one or more sectors
in a country (agriculture, various categories of industry, etc.), including support to
microfinance organizations. Therefore the generic appraisal checklist should be used
with caution and appropriately modified to address the nature and form of the FI being
appraised.
6.6. FI Reporting and Auditing Issues
6.6.1. Introduction
6.6.1.1. Financial reporting by, and audits of, FIs require individual specifications
for each institution so that financial reporting and auditing requirements will be
appropriate to the type, nature, and form of the institution.
6.6.1.2. For example, an industrial FI and a microfinance FI have few common

characteristics and the reporting requirements and the auditing specifications will differ
sharply.
6.6.1.3. Unless the financial analyst concerned is well-experienced in the financial

management of FIs, it is recommended that a consultant be employed, who is experienced
with the type of FI that is to be the subject of financial reporting, and later, auditing.
Specific guidance on MFI reporting and auditing issues is given below.
6.6.2. FI Financial Reporting
6.6.2.1. FIs should be required to report in accordance with IAS No. 30 (Disclosures
in the Financial Statements of Banks and Similar Financial Institutions) or SFAS 17 of
US GAAP. 30
6.6.2.2. In addition to the standard statements (Balance Sheet, Income Statement

and Cash Flow Statement), an FI should be required to provide the additional statements
listed below. This listing is not all-inclusive and should be amended to address the
objectives and operations of the FI to be audited:
• The income statement and balance sheet adjusted for subsidies

• Portfolio Report for current and two past years
• Portfolio Report showing aging of receivables (arrears)
• Portfolio Report showing aging of portfolio at risk
• Capital Adequacy Analysis
• Assets Structure by Income
• Table of Contingencies, Guarantees, Commitments showing corresponding securities
and collateral
30
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arrangements
6.6.3. FI Auditing
6.6.3.1. Selection of an auditor for a FI should include the provision of a TOR that
is specifically geared to the FI concerned.
6.6.3.2. In addition to the standard requirements (See section 5.4) for auditor selection
and appointment, including providing a report and an opinion on the annual financial
statements, the auditor should be required to include in the report confirmation, or
otherwise, that the additional financial statements and the performance indicators listed
above can be relied upon.
6.6.3.3. The Terms of Reference should also address the following:
• The auditor’s impression of the efficiency and effectiveness of the overall operations
and condition of the institution
• The adequacy of the intermediary’s risk management systems and internal control
procedures, including whether or not the bank uses VaR, and if so, whether its use is
professionally managed under a separate non-lending manager; results achieved during
the fiscal year; and the operation of VaR as at the date of completion of the audit
• The quality of the loan portfolio and adequacy of loan loss provisions, illustrated
as necessary by use of performance indicators above
• The competence and effectiveness of management, including development of strategic
plans and their implementation
• The adequacy of accounting, financial reporting and management information
systems
• The adequacy of public information systems
• The resolution, or otherwise, of issues identified off-site or during previous on-site
supervisory processes
• Adherence to laws and regulations and terms of licenses and agreements, including
loan covenants with ADB
• A commentary on central bank or other forms of regulatory supervision during the
fiscal year
• Quality of human resources employed by the FI and their potential to efficiently
sustain all areas of the FI’s operations
6.6.4. MFI Financial Reporting and Auditing
6.6.4.1. The Consultative Group to Assist the Poorest (CGAP) publishes specific
guidance on MFI reporting and auditing issues. This guidance includes Handbooks for
MFI auditors, Guidelines for MFI financial statements, and a handbook on appraising
an MFI. These materials can be accessed online at www.cgap.org.
7. Knowledge Management
7.1. Useful Websites
7.1.1.1. Regulatory and Standard-Setting Bodies
Bank for International Settlements (BIS) www.bis.org

Financial Accounting Standards Board (FASB – United States) www.fasb.org
International Accounting Standards Board (IASB) www.iasc.org.uk
International Federation of Accountants (IFAC) www.ifac.org
7.1.1.2. Professional Bodies
ASEAN Federation of Accountants (AFA) www.afa-central.com

Confederation of Asian and Pacific Accountants (CAPA) www.capa.com.my
South Asian Federation of Accountants (SAFA) www.citechco.net/safa/
The Regional Federation of Accountants and Auditors–Eurasia See www.oecd.org/daf/
corporate-affairs/
disclosure/eurasia/
7.1.1.3. International Organizations
Asia Pacific Economic Council (APEC) www.apecsec.org.sg

Association of Southeast Asian Nations (ASEAN) www.asean.or.id
International Organization of Securities Commissions (IOSCO) www.iosco.org
World Trade Organization (WTO) www.wto.org
7.1.1.4. Donor Organizations
Multilateral Organizations
Asian Development Bank (ADB) www.adb.org
European Bank for Reconstruction and Development (EBRD) www.ebrd.org
European Union – Technical Assistance to http://europa.eu.int/
the Commonwealth of Independent States (EU-TACIS) comm/dg1a/tacis/
index.htm
International Monetary Fund (IMF) www.imf.org
Islamic Development Bank (ISDB) www.isdb.org
United Nations Development Program (UNDP) www.undp.org
World Bank www.worldbank.org
2 of 94 Knowledge Management
Selected Bilateral Organizations

Australian Agency for International Development (AusAID) www.ausaid.gov.au
Canadian International Development Agency (CIDA) www.acdi-cida.gc.ca
Danish International Development Agency (DANIDA) www.um.dk/danida/
Department for International Development (DFID)
(United Kingdom) http://www.dfid.gov.uk/
Gesellschaft für Technische Zusammenarbeit (GTZ) http://www.gtz.de/
(German Technical Cooperation) home/english/
Japan Bank for International Cooperation (JBIC) www.jbic.go.jp
Japan International Cooperation Agency (JICA) www.jica.go.jp
Swedish International Development Agency (SIDA) www.sida.se
United States Agency for International Development (USAID) www.usaid.gov
7.1.1.5. Sectoral References
Microfinance
Consultative Group to Assist the Poorest (CGAP) www.cgap.org
World Council of Credit Unions (WCCU) www.woccu.org
7.2. Operations Manual (OM)

7.2.1. The following OMs were effective as of 1 June 2001:
OM No. Subject Date of Issue
1 Classification of Developing Member Countries 12 December 1995

in Bank Operations
2 Bank Operations in Pacific Developing 12 September 1996
Member Countries
3 Lending and Relending Policies 12 December 1995
(Ordinary Capital Resources)
4 Lending and Relending Policies 12 December 1995
(Asian Development Fund)
5 Sector Lending 12 December 1995
6 Program Lending 16 April 1997
7 Assistance to Private Enterprise 10 October 1996
9 Financing of Interest and Other Charges 12 December 1995
During Construction
10 Financing Indirect Foreign Exchange Cost of Projects 12 December 1995
11 Lending Foreign Exchange for Local Expenditures 12 December 1995
on Projects
12 Retroactive Financing 12 December 1995
13 Supplementary Financing of Cost Overruns on 12 December 1995
Bank-Financed Projects
Knowledge Management 3 of 94
14 Use of Surplus Loan Funds 12 December 1995

15 Foreign Exchange Risk in Bank Operations 12 December 1995
17 Sector Development Programs 16 April 1997
18 Technical Assistance 12 December 1995
19 Guarantee and Security Arrangements for Bank Loans 12 December 1995
20 Environmental Considerations in Bank Operations 07 January 1997
21 Gender and Development in Bank Operations 07 January 1997
22 Benefit Monitoring and Evaluation 07 January 1997
23 The Bank’s Cooperation with NGOs [under preparation]
24 Emergency Rehabilitation Assistance Loan 08 June 1998
for Small DMCs
25 Rehabilitation Assistance After Disasters 12 December 1995
26 Cooperation Arrangements with International [under preparation]
Organizations and Bilateral Sources
27 Coordination with Aid Agencies 20 February 1998
28 Regional Cooperation 12 December 1995
29 Cofinancing 12 December 1995
30 Japan Special Fund 12 December 1995
31 Guarantee Operations 12 December 1995
32 Bank’s Operational Missions 13 January 1997
33 Communication with Members of 12 December 1995
the Board of Directors
34 Processing of Loan Proposals 13 January 1997
35 Project Financial Management Systems, Financial 12 December 1995
Analysis and Financial Performance Indicators
36 Economic Analysis of Projects 12 November 1997
38 Procurement of Goods and Works 12 December 1995
39 Use of Consulting Services 12 December 1995
40 Formulation and Implementation of Loan Covenants 12 December 1995
41 Effectiveness of the Loan Agreement 12 December 1995
42 Loan Disbursement and Loan Closing 12 December 1995
43 Project Accounting, Financial Reporting, 12 December 1995
and Auditing
44 Post Evaluation 12 December 1995
45 Country Planning and Programming 19 November 1996
47 Incorporation of Social Dimensions in Bank 07 January 1997
Operations
48 Poverty Reduction [under preparation]
49 Inspection 31 August 1998
50 Involuntary Resettlement 07 January 1997
51 Internal Audit 16 October 1996
52 Public Disclosure [under preparation]
53 Indigenous Peoples 21 December 2000

54 Governance 13 January 1997
55 Anticorruption 20 July 2000
7.3. Project Administration Instructions (PAIs)

7.3.1. The following PAIs were effective as of 31 December 2001:
PAI No. Subject Date of Issue
1. Preparatory Supervision Actions

1.01 Initial Project Administration Activities December 2001
1.02 Organization Framework for Project Administration December 2001
1.03 Signing of Loan and Technical Assistance
Letter/Agreements December 2001
1.04 Conditions and Declaration of Loan Effectiveness December 2001
2. Consultants
2.01 General Guidelines on Recruiting Consultants December 2001
2.02 Recruiting Consulting Firms for Technical Assistance December 2001
2.03 Types of Technical Proposals December 2001
2.04 Recruiting Consulting Firms for Loan Projects December 2001
2.05 Recruiting Individual Consultants for
Technical Assistance December 2001
2.06 Recruiting Individual Consultants for Loan Projects December 2001
2.07 Recruiting Staff Consultants December 2001
2.08 Recruiting Training Consultants December 2001
2.09 Responsibilities of Appraisal Missions to Help
Borrowers Recruit Consultants December 2001
2.10 Using Domestic Consultants from Borrowing Countries December 2001
2.11 Evaluating the Performance of Consulting Firms December 2001
2.12 Evaluating the Performance of Individual Consultants December 2001
3. Procurement
3.01 Preparatory Work and Procurement Supervision December 2001
3.02 Eligibility December 2001
3.03 International Competitive Bidding December 2001
3.04 Local Competitive Bidding December 2001
3.05 Other Forms of Procurement December 2001
3.06 Domestic Preference Scheme December 2001
3.07 Advertising Procurement of Goods and Works December 2001

3.08 Bid Security December 2001
3.09 Pricing and Freight Charges in Bids and Contracts December 2001
3.10 Procuring Commodities under ADB Loans December 2001
3.11 Functions and Rules of the Procurement Committee December 2001
3.12 Procurement Contract Summary Sheet (PCSS) December 2001
Procurement Contract Update Sheet (PCUS)
4. Disbursement
4.01 Withdrawal Applications December 2001
4.02 Disbursement under Force Account Works December 2001
4.03 Disbursement under Civil Works Contracts December 2001
4.04 Suspension and Cancellation of Loans December 2001
4.05 Loan Closing Dates December 2001
4.06 Controlling Adverse Effect of Foreign Exchange
Flunctuations on Externally Financed or
Cofinanced Grants December 2001
5. Project Administration Actions

5.01 EA Progress Report December 2001
5.02 Contract Awards, Commitments, and Disbursement
Projections December 2001
5.03 Reviewing Compliance with Loan Covenants December 2001
5.04 Change in Project Scope or Implementation
Arrangements December 2001
5.05 Reallocation of Loan Proceeds December 2001
5.06 Utilization of Surplus Loan Funds December 2001
5.07 Project Cost Overruns December 2001
5.08 Local Cost Financing By Borrowers December 2001
5.09 Submission of Audited Project Accounts December 2001
and Financial Statements
5.10 Project Performance Ratings December 2001
5.11 Administration of Grant-Financed Technical December 2001
Assistance Projects
6. Internal Procedures and Reports

6.01 Project Administration Reviews December 2001
6.02 Project Administration Missions December 2001
6.03 Reports by Project Administration Missions December 2001
6.04 Loan Milestone Event Dates December 2001

6.05 Project Performance Reports December 2001
6.06 Reports to Management and the Board Of Directors
on Loan and TA Performance December 2001
6.07 Project Completion Report December 2001
6.08 TA Completion Report December 2001
7.4. International Accounting Standards (IASs)

7.4.1. Thirty-four IASs were effective at 31 March 2001:
IAS 1 Presentation of Financial Statements

IAS 2 Inventories
IAS 7 Cash Flow Statements
IAS 8 Profit or Loss for the Period, Fundamental Errors and Changes
in Accounting Policies
IAS 10 Events After the Balance Sheet Date
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 14 Segment Reporting
IAS 15 Information Reflecting the Effects of Changing Prices
IAS 16 Property, Plant, and Equipment
IAS 17 Leases
IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 22 Business Combinations
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Consolidated Financial Statements and Accounting for Investments
in Subsidiaries
IAS 28 Accounting for Investments in Associates
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 30 Disclosures in the Financial Statements of Banks and Similar
Financial Institutions
IAS 31 Financial Reporting of Interests In Joint Ventures
IAS 32 Financial Instruments: Disclosures and Presentation
IAS 33 Earnings Per Share

IAS 34 Interim Financial Reporting
IAS 35 Discontinuing Operations
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities, and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture
7.5. International Standards on Auditing (ISAs)

7.5.1. The following International Standards on Auditing (ISAs) and International
Auditing Practice Statements (IAPSs) were in effect at 30 September 2000.
International Standards on Auditing (ISAs)

100 Assurance Engagements
120 Framework of ISAs
200 Objective and General Principles Governing an Audit of Financial Statements
210 Terms of Audit Engagements
220 Quality Control for Audit Work
230 Documentation
240 Fraud and Error
250 Consideration of Laws and Regulations in an Audit of Financial Statements
300 Planning
310 Knowledge of the Business
320 Audit Materiality
400 Risk Assessments and Internal Control
401 Auditing in a Computer Information Systems Environment
402 Audit Considerations Relating to Entities Using Service Organizations
500 Audit Evidence
501 Audit Evidence-Additional Considerations for Specific Items
505 External Confirmations
510 Initial Engagements – Opening Balances
520 Analytical Procedures
530 Audit Sampling and other Selective Testing Procedures
540 Audit of Accounting Estimates
550 Related Parties
560 Subsequent Events
570 Going Concerns
580 Management Representations
600 Using the Work of Another Auditor
610 Considering the Work of Internal Auditing

620 Using the Work of an Expert
700 The Auditor’s Report on Financial Statements
710 Comparatives
720 Other information in documents containing Audited Financial Statements
800 The Auditor’s Report on Special Purpose Audit Engagement
810 The Examination of Prospective Financial Information
910 Engagements to Review Financial Statements
920 Engagements to Perform Agreed-Upon Procedures Regarding Financial
Informational
930 Engagements to Compile Financial Information
Glossary of Terms
Preface to ISAs and RSs
International Auditing Practice Statements (IAPSs)

1000 Inter-Bank Confirmation Procedures
1001 CIS Environments-Stand-Alone Microcomputer Systems
1002 CIS Environments-On-Line Computer Systems
1003 CIS Environments-Database Systems
1004 The Relationship Between Bank Supervisors and External Auditors
1005 The Special Consideration in the Audit of Small Entities
1006 The Audit of International Commercial Banks
1007 Communications with Management
1009 Computer-Assisted Audit Techniques
1010 The Consideration of Environmental Matters in the Audit
of Financial Statements
1011 Implications For Management And Auditors Of The Year 2000 Issue
7.6. Financial Review Checklist for RRPs

7.6.1. EDRC has developed the following checklist for reviewing RRPs. Items resulting
in ‘NO’ answers should be resolved to the financial analyst’s satisfaction. When reviewing
projects, it is important to review the lessons learned from the past. In this respect, the
first section of the checklist (lessons from past projects) provides guidance on the issues
that should be examined. The remaining sections apply to the project under appraisal.
7.6.1. Lessons from Past Projects Yes No
(a) Were finance-related covenants met (for instance, revenue- q q

generating targets, following up on agreed financial restructuring,
adhering to expected financial ratios etc)?
(b) Were counterpart funds made available on a timely basis? q q
(c) Were adequate funds made available for operations q q

and maintenance (O&M)?
(d) Were Financial Statements and Auditor reports submitted q q
in a timely manner?
(e) Were auditors’ reports unqualified? q q
(f) Was there an absence of weaknesses in handling finances q q
or in procurement?
(g) Were onlending and relending activities free of problems? q q
(h) Were capacity-building programs effective in relation to financial q q
management?
7.6.2. Project Cost Estimates Yes No
(a) Has the Project Cost Estimate summary table been prepared q q
in accordance with these Guidelines?
(b) Are detailed project cost estimates available and have they been q q
prepared in accordance with these Guidelines?
(c) Are the assumptions that support the estimates available q q
and do they appear reasonable?
(d) Have Local and Foreign costs been properly identified? q q
(e) Are the physical and price contingency provisions adequate? q q
7.6.3 Financing Plan (FP) Yes No
(a) Has the FP summary table been prepared in accordance with q q

these Guidelines?
(b) Do relending and onlending arrangements appear to be reasonable? q q
(c) Does the FP indicate that adequate counterpart funds will be q q
available in a timely manner?
(d) Are local cost financing arrangements in line with ADB policy q q
(OM11)?
7.6.4 Executing Agencies and Implementing Agencies Yes No
(a) Has the past financial performance of the EA/IA been analyzed? q q
(b) Has a ratio analysis of the EA/IA financial statements q q
been conducted?
(c) Are the financial management capabilities of EA and IA adequate? q q
(d) Are properly trained and qualified staff in place to q q
manage finances?
(e) If there are other ongoing operations, have financial details been q q
provided and are these reasonable?
(f) Have EA/IA budgets and forecasts (excluding the project) q q
been provided?
(g) Does the EA/IA have processes in place to prepare or update q q

budgets and forecasts on a regular basis?
(h) Where the EA/IA is not a government department, state q q
government body or local government body; is its capital
adequate to support operations and to execute or implement
the project?
7.6.5 Financial Projections Yes No
(a) Have the assumptions and bases that underlie the financial q q
projections (e.g., cash flows, income, expenses and other
financial projections) been provided?
(b) Are the assumptions that underlie the financial projects reasonable? q q
(c) Are provisions adequate (for instance, bad debts, nonrevenue q q
water and power supplies, and technical losses)?
(d) If the projections were prepared by the financial analyst or by q q
consultants, does the borrower “own” the projections?
7.6.6 Financial Analysis Yes No
(a) Have the detailed FIRR calculations been undertaken in q q

accordance with these Guidelines?
(b) Are the detailed FIRR calculations reasonable? q q
(c) Have the detailed WACC calculations been undertaken in q q
(d) Are the detailed WACC calculations and assumptions reasonable? q q
(e) Does FIRR exceed WACC and, if not, are there reasonable q q
justifications for proceeding with the project?
(f) Have sensitivity analyses been conducted in accordance with q q
these Guidelines?
7.6.7 Project Justifications Yes No
(a) Is the project financially sustainable? q q

(b) Have cost-recovery mechanisms and pricing issues been q q
adequately considered?
(c) Has an affordability study been conducted on proposed prices q q
(tariffs)?
7.6.8 Accounting and Auditing Yes No
(a) Have arrangements been made to ensure the timely submission q q

of quarterly reports?
(b) Have actions been taken to select and engage auditors in q q
(c) Have arrangements been made to support the timely submission q q

of audited annual reports (within six to nine months)
including audit reports on special agreements such as SOEs?
(d) If in the past government audits were either not satisfactory or q q
not available, has the appointment of private auditors and funding
to cover cost of such appointments been considered?
7.6.9 Procurements and Disbursement Arrangements Yes No
(a) Has adequate attention been given to anticorruption measures? q q

(b) Are adequate fund reimbursement procedures in place q q
(in accordance with ADB requirements)?
7.6.10 Finance-Related Risks Yes No
(a) Have risks regarding the timely availability of adequate q q

counterpart funds been minimized?
(b) Have risks regarding the timely availability of adequate funds q q
for operations and maintenance been minimized?
(c) Have risks regarding the availability of staff to manage q q
financial management activities been minimized?
7.6.11 Assurances Yes No
(a) Have adequate assurances been obtained in relation to measures q q

to counter finance-related risks (see above)?
(b) Have adequate assurances been obtained that proposed pricing q q
formulas will be implemented?
(c) Have adequate assurances been obtained that efficiency q q
improvements and capacity building in relation to financial
management will be undertaken?
(d) Have adequate assurances been obtained that financial covenants q q
will be implemented and monitored as agreed?
7.7. Appraisal Checklist: Non-Revenue-Earning Project
7.7.1.1. Preparation at Headquarters
7.7.1.1.1. Meet with Division Manager and Project Officer to receive briefing on ADB’s
approach to defining a non-revenue-earning project with respect to the country, borrower,
cofinanciers, project and appraisal mission.
7.7.1.1.2. Study and note all positive and negative attributes ascribed to country, sector
and similar projects in: (i) the Country Strategy Paper to understand the role that the
project is to be designed to fulfill; (ii) relevant reports on the country profile, institutions
to be involved in, and responsible for the project, and where available, the proposed EA;
(iii) all reports on project identification and preparation, including forecasts of local and
foreign inflation for the country concerned; (iv) relevant reports on country project
performance; and (v) all recent reports on ongoing projects in the sector in the country.
7.7.1.2. Initial Steps
7.7.1.2.1. Participate in, or where necessary, arrange initial meetings with counterparts
in organizations in the government concerned with the project, including the EA.
7.7.1.2.2.. Ensure that all managers and staff to be involved in project planning and
implementation have copies of ADB’s Handbook for Borrowers on Financial Management
and Financial Analysis of Investment Projects, ADB’s Loan Disbursement Handbook and
ADB’s Procurement Handbook.
7.7.1.2.3. Advise on the availability of the web-based Financial Management Guidelines.
7.7.1.3. The Institutional Environment
7.7.1.3.1. Confirm/modify information obtained through readings (see paragraph

7.7.1.1.2 above).
7.7.1.3.2. Determine current organizational and management linkages of central

government, state government (where applicable) and sector institutions to be involved
in financial aspects of project design, development, implementation, and operation.
7.7.1.3.3. Determine current and/or proposed organizational and financial aspects of

the management structure of the existing or proposed EA to be involved in project design,
development, implementation and operation.
7.7.1.3.4. Understand the country’s financial sector, the role of the central bank and
the banking system, and their potential application to/impact on the project.
7.7.1.3.5. Determine the capability, capacity, and current performance of the accounting
and auditing profession in the country, particularly as they will impact on the project.
7.7.1.3.6. Determine the capability, capacity, and current performance of the government
audit service, particularly as they will impact on the project.
7.7.1.3.7. Determine the quality of accounting and bookkeeping capability, and training
in the existing or proposed EA.
7.7.1.3.8. Determine the capability of the financial manager(s) designated to be

responsible for the project.
7.7.1.3.9. Make recommendations for modifications to organizational structures,

managements, staffs and training necessary to support the project – share with Project
Officer – and, where necessary, prepare an institutional appraisal of the EA to support
upgrading of institutional performance.
7.7.1.4. Financial Management Systems
7.7.1.4.1. Taking into account, sections 7.7.1.3.3–7.7.1.3.9, where there exists an

ongoing financial management system, accounting and book-keeping systems, computer/
data processing systems, and an internal control environment and internal control systems
to support the project, form a judgment on the acceptability, or otherwise, of these systems.
Examine the following systems to the extent that they are likely to be necessary to support
the project:
Planning and budgeting records Ledgers & journal systems Cash management
Payroll including HR records Bank accounts & reconciliations Asset records
Accounts payable Equity records Internal controls
Accounts receivable Subsidies received and internal audit
Taxes & duties Grants/Donations records Periodic and annual
Inventories Loans received & repayments financial statements
Project accounting records Loans advanced External auditors’ reports
and opinions
7.7.1.4.2 On the basis of examination in 7.7.1.4.1, determine the nature and form of
the accounting standards in use and their likely acceptability to ADB. In the event that
they would not be acceptable, define ADB’s requirements to counterparts of the EA and
the borrower.
7.7.1.4.3 On the basis of examination in 7.7.1.4.1, determine the nature and form of the
auditing standards in use and their likely acceptability to ADB. In the event that they would
not be acceptable, define ADB’s requirements to counterparts of the EA and the borrower.
7.7.1.4.4 In the absence of any of the system elements set out in 7.7.1.4.1, define new
or additional system requirements necessary to support the project and advise a timetable
to counterparts for their introduction and full operation, including necessary staff additions
and training.
7.7.1.5. Definition of Project Cost Requirements
7.7.1.5.1. Review with counterparts and consultants responsible for project design/
preparation, the project description and specifications documents in order to understand
the likely project components and their related cost elements.
7.7.1.5.2. Although this project is proposed as non-revenue-earning, review with the

Project Officer the possibility of introducing a tariff and charges as part of project design,
for meeting all or any critical part of the costs of producing products/outputs/sales, etc.,
ensuring that such a tariff and charges would encourage cost savings that could be proposed
as part of the project and meet forecast inflationary factors.
7.7.1.5.3. Where available, use COSTAB software to compile all project costs and
procurement documentation.
preparation the project cost table for comprehensiveness, adequacy of structure/
descriptions of base cost line items, including annual foreign and local costs, and annual/
periodic expenditures including financial charges during development, where applicable.
Ensure that taxes and duties are clearly defined and capable of being measured for
exclusion from ADB financing.
7.7.1.5.5. Prepare or obtain a country/sector disbursement profile to judge the likely

accuracy of the forecasts of proposed expenditures and ADB disbursements.
7.7.1.5.6. Examine the price contingencies for accuracy with respect to local and foreign
costs, including application of appropriate rates of local and foreign inflation.
7.7.1.5.7. Examine the physical contingencies for accuracy with respect to appropriate
allowances as prescribed.
7.7.1.5.8. Discuss with Project Officer and, where appropriate, with counterparts, the
Financing Plan and disbursement profile to determine the total financing requirements,
the amount and timing of receipt of each input of funds requirements, the proposed
amount of ADB’s proposed total loan/credit proceeds, of receipts from cofinanciers, and
from counterpart funds.
7.7.1.6. Preparation of Financial Projections

and Draft RRP
7.7.1.6.1. Determine forecast annual operating costs of the EA that is to implement the
project only, and incorporate forecast inflation.
7.7.1.6.2. Using the information from 7.7.1.5.3–7.7.1.5.8, prepare projected combined

annual income statementfor the project period.
7.7.1.6.3. Using the information from 7.7.1.5.3–7.7.1.5.8, compile the Financial

Internal Rate of Return (FIRR), with appropriate financial performance indicators for the
project and, where appropriate, the EA. Discuss proposed indicators with Project Officer
and counterparts, explaining logic of selection and methods of calculation.
7.7.1.6.4. With Project Officer, explain in detail to counterparts the method of

compilation and the forecast results of all financial statements at all appropriate levels
of concerned institutions and managements with the objective of reaching agreement on
the Project Cost Table, the financing plan, the financial projections and any tariffs and
charges proposed.
7.7.1.6.5. With the Project Officer, meet with cofinanciers at mutually agreed locations
(whenever possible, in the presence of counterparts) to explain the method of compilation
and the forecast results of all financial statements at all appropriate levels of concerned
institutions and managements with the objective of reaching agreement on the, Project
Cost Table, the financing plan, the financial projections, performance indicators and any
tariffs and charges proposed.
7.7.1.6.6. Draft the section of the Aide Memoire relating to all financial aspects of the
project and discuss with Project Officer. Make any agreed amendments for presentation
of complete Aide Memoire to counterparts at appropriate levels.
7.7.1.6.7. Draft paragraphs for inclusion in the financial section of the RRP, and prepare
financial appendixes to attach to the RRP. Review with the Project Officer.
7.8. Appraisal Checklist: Revenue-Earning Project
approach to defining a revenue-earning project with respect to the country, the sector,
the project and objectives of the appraisal mission.
and similar projects in: (i) the Country Strategy Paper; (ii) relevant reports on the country
profile, institutions to be involved in design, authorization, implementation, and operation
of the project, particularly where available, the proposed EA, including the Country DSAA
(see section 4.2.5), where available; (iii) reports on project identification and preparation.
Obtain forecasts of inflation for the country concerned from the Operations Coordination
Division; (iv) reports on country and sector project performance; (v) reports issued within
the past five years on similar projects in the sector in the country.
7.8.1.2.1. Participate in, or where necessary, arrange meetings with key managers and
any counterparts representing managers in the EA to confirm appraisal arrangements/
requirements. Make a judgment on the likely efficiency of the managers and the
counterpart(s).
in all organizations in the government likely to be concerned with project development,
to confirm appraisal arrangements/ requirements.
7.8.1.2.3. Ensure all managers and staff to be involved in project planning and
implementation have copies of ADB’s Handbook for Borrowers on the Financial
Management and Financial Analysis of Investment Projects, ADB’s Loan Disbursement
Handbook and ADB’s Procurement Handbook.
7.8.1.3.1. Confirm evidence provided through readings in paragraph 7.8.1.1.2.
7.8.1.3.2. Determine current organizational structure and responsibilities with respect

to the project of central government, statement government(s) and sector agencies that
will be involved in project design, development, implementation and operation, for
example, Ministries of Finance and Economy, Industrial Production, Planning and
Development, Agriculture, Export Guarantee Agency, etc.
7.8.1.3.3. Determine the likely acceptability to ADB of current and/or proposed

organizational and management structure of the EA and/or consultants involved in
preparing the project’s planning, programming, design, development, implementation
and operation.
the banking system, and their probable application to/impact on the project.
7.8.1.3.5. Explore current status of positive and negative attributes in paragraph

7.8.1.1.2 above.
7.8.1.3.6. Determine the capability, capacity, and current performance of the country’s
accounting and auditing profession as it impacts, or will impact, on the EA and on the
project (review the Country DSAA, see section 4.2.5, where available).
7.8.1.3.7. Determine the capability, capacity, and current performance of the government
auditing profession, particularly the Auditor-General’s Office, as it impacts, or will impact,
on the EA and on the project.
7.8.1.3.8. Determine the actual, or forecast anticipated, quality of accounting and

bookkeeping capability and training in the EA to service the project and EA.
7.8.1.3.9. Determine the capability of the financial managers designated to be

responsible for the project, against the background of 7.8.1.3.6 – 7.8.1.3.8.
7.8.1.3.10. Make recommendations for modifications to organizational structures,

financial management, accounting /bookkeeping/ inventory management staffs and training
necessary to support the project – share with Project Officer – and where necessary, prepare
an institutional appraisal of the EA to support upgrading of institutional performance.
7.8.1.4.1. Taking into account 7.8.1.3.7 – 7.8.1.3.10 above, where there exists an
ongoing financial management system, accounting and bookkeeping systems, computer/
data processing systems, and an internal controlenvironment and internal control systems
to support the project, form a judgment on the acceptability, or otherwise, of these systems
and documentation. Examine the following systems and documentation to the extent
that they are likely to be necessary to support the project:
Planning & budgeting records Bank accounts & reconciliations Cash management
Payroll including HR records Records of stock issues & Dividends records
Accounts payable re-purchase Asset & depreciation
Accounts receivable Investors/Shareholders records records
Taxes & duties Equity records Internal controls and
Inventories Subsidies received internal audit
Cost of manufactured goods Grants/Donations records Periodic and annual
Project accounting records Loans received & repayments financial statements
Management and overhead Loans advanced External auditors’ reports
Ledgers & journal systems and opinions
7.8.1.4.2. In cases where the EA is a public company owned wholly or in part, by

the government, the following two additional matters should be reviewed: (i) Financial
clauses of the Articles of Incorporation (or Association) of the Company; and (ii) Minutes
of company meetings for the most recent three years (or such other period as may be
reasonable) in which financial policy, strategy, decisions, and issues were recorded.
7.8.1.4.3. On the basis of examination in 7.8.1.3.6, 7.8.1.3.8 and7.8.1.4.1, determine

the nature and form of the accounting standards in use and their likely acceptability to
ADB. In the event that they would not be acceptable, define ADB’s requirements to
counterparts of the EA and the borrower (where applicable).
7.8.1.4.4. On the basis of examination in paragraphs 7.8.1.3.6, 7.8.1.3.7 and7.8.1.4.1,

determine the nature and form of the auditing standards in use and their likely acceptability
to ADB. In the event that they would not be acceptable, define ADB’s requirements to
counterparts of the EA, the existing auditing firm (if it is to be retained for the project)
and the borrower (where applicable).
7.8.1.4.5. In the absence of any, or all, of the system elements set out in 7.8.1.4.1
above, define new or additional system requirements and documentation necessary to
support the project and advise a timetable to counterparts for their introduction and full
operation, including necessary staff additions and training.
preparation, the project description and specifications documents in order to understand
the cost of each project component (new assets) and their likely foreign and local costs
for each year of implementation, the total cost of each asset for depreciation purposes
(including financial charges during development) and the forecast date(s) of their
commissioning.
7.8.1.5.2. Review with the Project Officer the likely adequacy and suitability of the
existing tariff and charges, or any new tariff and charges developed as part of project
design, for products/ outputs/ sales, etc. ensuring, where necessary, that the tariffs and
charges reflect cost savings proposed as part of the project and take account of forecast
inflationary factors.
descriptions of base cost line items, and annual/ periodic expenditures including financial
charges during development, where applicable. Ensure that taxes and duties are clearly
defined and capable of being easily defined for exclusion from ADB financing.
7.8.1.5.5. Use a country/sector disbursement profile to judge the likely accuracy of the
forecasts of proposed expenditures and ADB disbursements.
7.8.1.5.6. Examine the physical contingencies and their legitimacy.
Financing Plan and disbursement profiles to determine the total financing requirements,
the amount and timing of receipt of each input of funds requirements, the proposed
amount of ADB’s proposed total loan proceeds, of receipts from cofinanciers, from internal
funds, and from government counterpart funds (where applicable).
7.8.1.6. Financial Projections for an Ongoing

Production Operation
7.8.1.6.1. Determine actual and forecast physical output statistics and losses (industrial/
agricultural products/ electricity/ water/ telecommunications, etc.) for at least two
completed fiscal years prior to the start of project implementation, for the period of
project implementation, and for at least three years of operation.
7.8.1.6.2. In consultation with the Project Officer and counterparts, as appropriate,

apply the tariff and charges in section 7.8.1.5 to provide a revenue stream during
implementation and thereafter.

determine a commissioning schedule for the components of the project with related
costs, and prepare a depreciation schedule for the assets to be provided by the project.
7.8.1.6.4. In consultation with the Project Officer and counterparts, as appropriate, if

it will be necessary to revalue assets periodically through the implementation period and
thereafter to reflect the impact of severe inflation, prepare a forecast depreciation schedule
with and without the assets in 7.8.1.5.1.

prepare the EA’s operating costs with and without the project for at least two completed
fiscal years prior to the start of project implementation, for the period of project
implementation, and for at least three years of operation and incorporate inflation as
forecast in 7.8.1.5.7.
7.8.1.6.6. Prepare schedules of interest payments due to lenders
7.8.1.6.7. Prepare schedules of loan repayments to lenders
7.8.1.6.8. Using the results of 7.8.1.6.1–7.8.1.6.7, compile an income statement for

at least two completed fiscal years prior to the start of project implementation, for the
period of project implementation, and for at least three years of operation.
7.8.1.6.9. For an ongoing operation – using the projected annual investments from
7.8.1.5.1, disbursements from 7.8.1.5.8, the schedules in 7.8.1.6.6–7.8.1.6.7, and the
results from the Income statements in 7.8.1.6.8 – prepare a cash flow statement for at
least two completed fiscal years prior to the start of project implementation, for the
7.8.1.6.10. For an ongoing operation – on the basis of audited annual financial statements
for two fiscal years prior to implementation and the results of the Income statement in
7.8.1.6.8 and the Cash Flow Statements in 7.8.1.6.9, prepare balance sheet for the period
of implementation and three years of operation.
7.8.1.7. Financial Projections for a New Production

Operation
7.8.1.7.1. Determine forecast physical output statistics and losses (industrial/

agricultural products/ electricity/ water/ telecommunications, etc.) for the period of project
implementation (if any), and for at least five years of operation.

apply the tariffs and charges in 7.8.1.5.2 to provide a revenue stream during
implementation and thereafter.

determine a commissioning schedule for the components of the project with related
costs, and prepare a depreciation schedule for the assets to be provided by the project.

if it will be necessary to revalue assets periodically through the implementation period
and thereafter to reflect the impact of severe inflation, prepare a forecast depreciation
schedule.

prepare the EA’s operating costs for the period of project implementation, and for at least
five years of operation and incorporate inflation as forecast in 7.8.1.5.7.
7.8.1.7.6. Prepare schedules of interest payments due to lenders.
7.8.1.7.7. Prepare schedules of loan repayments to lenders.
7.8.1.7.8. Using the results of 7.8.1.7.1–7.8.1.7.7 above compile an Income statement

for the period of project implementation, and for at least five years of operation.
7.8.1.7.9. Using the projected annual investments from 7.8.1.5.1, disbursements from
7.8.1.5.8, the schedules in 7.8.1.7.6–7.8.1.7.7, and the results from the income statement
in 7.8.1.7.8 – prepare a cash flow statement for the period of project implementation,
and for at least five years of operation.
7.8.1.7.10. On the basis of the results of the income statements in 7.8.1.7.8 and the
Cash Flow Statements in 7.8.1.7.9, prepare balance sheets for the period of implementation
and five years of operation.
7.8.1.8. For All Projects
7.8.1.8.1. Using the data from sections 7.8.1.6 and 7.8.1.7, compile appropriate
financial performance indicators including the Financial Internal Rate of Return (FIRR)
for the project and, where appropriate, the EA. Discuss proposed indicators with Project
Officer and counterparts, explaining logic of selection and methods of calculation.

the Project Cost Table, the financing plan, the financial projections and tariffs and charges
proposed.
(if possible in the presence of counterparts) to explain the method of compilation and
the forecast results of all financial statements at all appropriate levels of concerned
institutions and managements with the objective of reaching agreement on the Project
Cost Table, the financing plan, the financial projections and tariffs and charges proposed.
7.9. Appraisal Checklist: Private Sector Project
approach to funding private sector projects in the country, the borrower, use of
cofinanciers, the project objectives and those of the appraisal mission.
to be involved in, and responsible for the project, and where available, the proposed
private sector company; (iii) reports on project identification and preparation, including
forecasts of local and foreign inflation for the country concerned; (iv) relevant reports
on country and sector project performance; and (v) relevant reports on current projects
in the sector in the country.
in all concerned organizations in the government concerned with the project, including
the existing or a proposed company.
7.9.1.3.1. Confirm/modify information obtained through readings and reviews in

7.9.1.1.2.
7.9.1.3.2. Determine current central and state government and sector agencies that
will need to be involved in project design, implementation and operation, for example,
Ministries of Finance and Economy, Industrial Production, Planning and Development,
Agriculture, Export Guarantee Agency, etc.
7.9.1.3.3. Determine the likely capability and capacity to deliver the project by the
current organizational and management structure of the company’s central management
units/ departments and operating units/ departments that are/ will be involved in project
design, implementation and operation.
7.9.1.3.4. Study and understand the country’s financial sector, the role of the central
bank and the banking system, and their probable contribution to/application to/impact
on, the project, with particular regard to provision of funds and foreign exchange
requirements.
7.9.1.3.5. Determine the capability, capacity and current performance of the country’s
accounting and auditing profession to meet ADB’s requirements for use of International
Accounting Standards (IASs) for financial reporting by the EA, and auditing using
International Standards on Auditing (ISAs).31
7.9.1.3.6. Determine the quality of accounting and bookkeeping training in the EA

and their ability to apply IAS when reporting to ADB.32
7.9.1.3.7. Determine the capability and integrity of the financial managers designated
to be responsible for the financial management of the project, through due diligence.
7.9.1.3.8. Make judgments on required modifications to organizational structures,

financial management positions, accounting, bookkeeping and inventory maintenance
staffs and their training necessary to support the project – share with Project Officer –
Recommend any necessary upgrading, if necessary, recommending an appraisal element
to support funding for this purpose.
31
Financial Analysts have discretion to agree alternative arrangements (see paragraph 2.4.3)
32
7.9.1.4.1. Taking into account section 7.9.1.3, where there exists an ongoing financial
management system, accounting and bookkeeping systems, computer/data processing
systems, and an internal control environment and internal control systems to support the
project, form a judgment on the acceptability, or otherwise, of these systems. Examine the
following systems to the extent that they are likely to be necessary to support the project:
Financial clauses of the Articles of Ledgers & journal systems

Incorporation (or Association) of Bank accounts & reconciliations
the company Records of stock issues & repurchase
Minutes of company meetings for Investors/Shareholders records
the most recent three years (or such Equity records
other period as may be reasonable) Subsidies received
in which financial policy, strategy, Grants/Donations records
decisions and issues were recorded Loans received & repayments
Planning & budgeting records Loans advanced with repayments
Payroll including HR records Cash management
Accounts payable Dividends records
Accounts receivable Asset & depreciation records
Taxes & duties Internal controls and internal audit
Inventories Periodic and annual financial statements
Cost of manufactured goods & services External auditors’ reports and opinions for past
Project accounting records three years
Management and overhead
7.9.1.4.2. On the basis of examination in 7.9.1.4.1, determine the nature and form of
the accounting standards in use and their likely acceptability to ADB. In the event that
they would not be acceptable, define ADB’s requirements with respect to IASs and the
national GAAP to counterparts of the company and the borrower.33
7.9.1.4.3. On the basis of examination in 7.9.1.4.1, determine the nature and form of
the auditing standards in use and their likely acceptability to ADB. In the event that they
would not be acceptable, define ADB’s requirements form use of ISAs to counterparts of
the company and the borrower.34
7.9.1.4.4. In the absence of any of the system and documentation elements set out in
7.9.1.4.1, define new or additional system and documentation requirements necessary
to support the project and advise a timetable to counterparts for their introduction and
full operation, including necessary staff additions and training.
33
34
preparation the project description and specification documents in order to understand
the cost of each project component (new assets) and their likely foreign and local costs
for each year of implementation, the total cost of each asset for depreciation purposes
(including financial charges during development), and the forecast date(s) of their
commissioning.
existing tariff and charges or the new (proposed) tariff and charges developed as part of
project design, for products/outputs/sales, etc. ensuring where necessary that the tariffs
and charges reflect both cost savings proposed as part of the project and impact of forecast
inflationary factors.
descriptions of base cost line items, and annual/ periodic foreign and local expenditures
including financial charges during development, where applicable. Ensure that taxes
and duties are clearly defined and capable of being easily defined for exclusion from ADB
financing.
7.9.1.5.5. Use a country/sector disbursement profile to judge the likely accuracy of the
forecasts of proposed expenditures and ADB disbursements.
7.9.1.5.6. Examine the physical contingencies and their legitimacy.
7.9.1.5.8. Subject to any recommendations arising from section 7.9.1.8, with respect
to the determination of private sector funding, discuss with Project Officer and, where
appropriate, with counterparts, the financing plan and disbursement profiles to determine
the total financing requirements, the amount and timing of receipt of each input of funds
requirements, the proposed amount of ADB’s proposed total loan/credit proceeds, of
receipts from cofinanciers, from internal sources, and government counterpart funds.
7.9.1.6. Preparing Projections for Ongoing Production

Lending Operation
7.9.1.6.1. Determine actual and forecast physical output statistics and losses (industrial/
agricultural products/ electricity/ water/ telecommunications, etc.) for at least two
project implementation, and for at least three years of operation.

apply the tariff and charges and all relevant financial information from 7.9.1.5.2 to
7.9.1.6.1 to provide a revenue stream during implementation and for at least three years
following commissioning.

thereafter to reflect the impact of severe inflation, prepare a forecast depreciation schedule
for all assets, and those from 7.9.1.5.1, and (ii) without the assets in 7.9.1.5.1.

forecast the company’s operating costs with and without the project for at least two
project implementation, and for at least three years of operation and incorporate the
impact of inflation as forecast in 7.9.1.5.7.
7.9.1.6.5. Prepare schedules of interest payments due to existing and proposed lenders
for the new project (including appropriate treatment of financial charges during
development).
7.9.1.6.6. Prepare schedules of loan repayments to existing and proposed lenders for
the new project.
7.9.1.5.8, and the results of 7.9.1.6.1–7.9.1.6.5, compile an income statement for at
least two completed fiscal years prior to the start of project implementation, for the
7.9.1.6.8. On the basis of audited annual financial statements for two fiscal years prior
to implementation, the schedules in 7.9.1.6.5–7.9.1.6.6, and the results of the income
statement in 7.9.1.6.7, prepare a cash flow statement for the period of implementation
and three years of operation.
7.9.1.6.9. On the basis of the Income Statement in 7.9.1.6.7 and the Cash Flow
Statement in 7.9.1.6.8, prepare balance sheets for the period of implementation and
three years of operation.
7.9.1.7. Preparing Projections for a New Production

Lending Operation
7.9.1.7.1. Obtain from counterparts and consultants the forecast physical output
statistics and losses (industrial/ agricultural products/ electricity/ water/
telecommunications, etc.) from the start of commissioning of assets to the conclusion of
the period of project implementation, and for at least five years of full operation.

apply the tariff and charges in 7.9.1.5.2 to provide a revenue stream (if any) during
implementation and thereafter in operation using 7.9.1.6.7.

thereafter to reflect the impact of severe inflation, prepare a forecast asset revaluation and
depreciation schedule.

forecast the company’s operating costs for the period of project implementation, and for
at least five years of operation and incorporate inflation as forecast in 7.9.1.5.7.
7.9.1.7.5. Prepare schedules of interest payments due to lenders, (including appropriate

treatment of financial charges during development).
7.9.1.7.6. Prepare schedules of loan repayments to lenders.
7.9.1.5.8, and the financial results of 7.9.1.7.1–7.9.1.7.5, prepare an Income statement
for at least two completed fiscal years prior to the start of project implementation, for
the period of project implementation, and for at least five years of operation.
7.9.1.5.8, the schedules in 7.9.1.7.5–7.9.1.7.6, and the results from the Income statements
in 7.9.1.7.7 – prepare a cash flow statement for the period of project implementation,
and for at least five years of operation.
7.9.1.7.9. On the basis of the results of the Income statements in 7.9.1.7.7 and the
Cash Flow Statements in 7.9.1.7.8, prepare balance sheets for the period of implementation
and five years of operation.
7.9.1.8. Financing Plan Involving Private Sector

Funding
7.9.1.8.1. Determine all sources of funds forecast to be required external to the

company’s own resources, from the private sector, governmental institutions (where
appropriate) and ADB.
7.9.1.8.2. Where loans are proposed from private sources, including banks and finance
houses, check the terms and conditions proposed by the potential lenders and confirm
the capacity of the company to meet the future obligations against the background of its
forecast costs, sales and revenue streams and capital funding commitments. In particular
check the security offered by the company, particularly any specific assets, which if lost
due to default to a lender, would seriously impair earnings.
7.9.1.8.3. Where the company is proposing to attract equity contributions as a private

company, check to validity of its proposals and of the offers made by potential stakeholders.
7.9.1.8.4. Where a company is, or intends to be, a public company and is proposing
to seek an initial public offering on a stock market/exchange, review all documentation
and correspondence relating to the proposed flotation. In particular, review the auditor’s
report and ensure the report was made in accordance with ISAs. Any concerns should
be expressed in a meeting with the auditors and the company counterparts to obtain full
assurances as to the reliability of the proposed flotation documentation. Discuss with
the concerned financial advisers to the company who are managing the flotation, (and
if necessary, with the stock exchange managers) the prospects for the flotation, and in
particular, the realism of the timing of entry into the market and the nature/class of the
stock/shares to be issued.
7.9.1.8.5. Where a company is seeking to issue additional capital, if necessary up to

its limit of authorized capital, examine the records of stock/shares management and related
auditor’s reports for due performance. Review the effective use of the existing capital
issue, particularly the return on capital issued and dividends paid to stakeholders. Review
the proposed terms of the proposed issue including the class of share(s), and particularly
the issue price(s) for realism and potential to meet the financial needs of the company
for the period of the project.
7.9.1.9. Defining Financial Performance Indicators

and Reviewing Projections
7.9.1.9.1. On the basis of generated data as a result of 7.9.1.6 (for an ongoing operation),
7.9.1.7 (for a new production operation) and 7.9.1.8, compile the FIRR and appropriate
financial performance indicators for the project and the company. Discuss proposed
indicators with Project Officer and counterparts, explaining logic of selection and methods
of calculation.

of concerned institutions and management with the objective of reaching agreement on
the project cost table, the financing plan, the financial statements containing the financial
projections, and any tariffs and charges proposed.
(whenever possible in the presence of counterparts) to explain the method of compilation
and the forecast results of all financial statements at all appropriate levels of concerned
institutions and managements with the objective of reaching agreement on the project
cost table, the financing plan, the financial projections, financial performance indicators,
and tariffs and charges proposed.
7.9.1.9.5. Draft paragraphs for inclusion in the financial section of the RRP and prepare
7.10. Appraisal Checklist: Financial Institution
7.10.1. Financial institutions (FIs) comprise a wide range of institutions, including

Apex institutions that service one or more FIs in a country. FIs may provide services to
one or more sectors in a country (agriculture, various categories of industry, etc.), including
support to microfinance organizations. The latter may also receive support from the
banking sector in a country, with or without FI support. Therefore the generic checklist
that follows should be used with caution and appropriately modified to address the nature
and form of the FI that is under appraisal.
approach to funding FIsin the country, the sector (e.g., agriculture, industry, etc), the
objectives of the project and of the appraisal mission.
to be involved in design, authorization, implementation, and operation of the project,
particularly where available, the proposed FI; (iii) all reports on project identification
and preparation; (iv) all relevant reports on country and sector project performance; (v)
all reports issued within the past five years on similar FI projects in the country. Review
credit-rating agency publications to determine if the FI being appraised has been assigned
a credit rating.
7.10.1.2.1. Participate in, or where necessary, arrange meetings with key managers and
any counterparts representing managers in the FI to confirm appraisal arrangements/
requirements. Make a judgment on the likely efficiency of the managers and the
counterparts.
in all organizations in the government likely to be concerned with project development,
to confirm appraisal arrangements/ requirements. The range of the organizations will
depend on whether or not the FI is state-owned or private sector. Organizations may
include the Central Bank, Ministry of Economy, Ministry of Finance, sector ministries
(Agriculture, Industry), Ministry of Trade and Industries, etc. The likely credit rating for
the concerned FI should be determined through these discussions (where the concerned
FI does not have a published credit rating).
7.10.1.3.1. Confirm evidence provided through readings in 7.10.1.2 above.
7.10.1.3.2. Determine current organizational structure and management position

responsibilities, with respect to the FIand the project, of any central government, state
government, and sector agencies that will be involved in project design, development,
implementation and operation (for example, Central Bank, Ministries of Finance and
Economy, Industrial Production, Planning and Development, Agriculture, Export
Guarantee Agency, etc).
7.10.1.3.3. Determine the likely acceptability to ADB of current and/or proposed

organizational and management structure of the FI and/or consultants involved in
preparing the project’s planning, programming, design, development, implementation
and operation.
the banking system, and their probable application to/impact on the FI and the project.
7.10.1.3.5. Understand the role that the FI plays within the financial sector; for example,
is it an apex institution serving one or more FIs? Is it a microfinance institution serving
a specific small sectoral or regional/ local group of clients? Is it a narrowly focused
operation for a subsector such as textiles?
7.10.1.3.6. Determine the capability, capacity and current performance of the country’s
accounting and auditing profession as it impacts, or will impact, on the FI and on the
project.
7.10.1.3.7. In countries where the government audit service is required to audit FI

activities and financial statements, determine the capability, capacity and current
performance of the government auditing profession, particularly the Auditor-General’s
Office or equivalent, as it impacts, or will impact, on the FI and on the project.
7.10.1.3.8. Determine the actual, or forecast anticipated, quality of accounting and

bookkeeping capability and training in the FI to service the FI and the project.
7.10.1.3.9. Determine the capability of the financial manager(s) designated to be

responsible for the project.
7.10.1.3.10.Make judgments as to required modifications to the FI’s organizational

structures, lending operations, cash management, risk management, financial accounting/
bookkeeping/ management and staffs, and training necessary to support the project –
share with Project Officer – and where appropriate recommend for inclusion as a
component in the project for appraisal.
7.10.1.4. Management Policies and Systems
7.10.1.4.1. Form a judgment on the acceptability, or otherwise of the lending operations

systems, cash management systems, risk management systems, financial accounting
system, general accounting and book-keeping systems, computer/data processing systems,
and the internal control environment and internal control systems to support the FI and
the project, including examining examples of all relevant documentation.
7.10.1.4.2. Examine the following policies, systems and documentation to the extent
that they are likely to be necessary to support the FI and the project:
1. Soundness and Clarity of Management Policy
Check points Specific sample questions
a. Soundness, rationality, and integrity • When drawing up management policy, does the
of management policy management take into consideration soundness,
Has management established a sound rationality, and feasibility?
and rational policy (short- and long-term • Is the management policy integrated?
strategies) with full consideration
given to current and future management
conditions?
b. Clarity and permeability of • Is the management policy clear with respect to
management policy criteria for action by each department?
Is management policy clear and well • Is the policy well understood throughout the entire
understood, and does it function well? organization, and does it function well?
• Does the FI compile a medium- and long-term
business plan (e.g., every 3-5 years)?
• Does the FI compile a business plan (annually or
semi-annually)?
• Does the department in charge of management
planning regularly monitor the level of
accomplishment and make necessary adjustments?
2. Permeability of Risk Management Policy
a. Understanding of risk •Does the management have high professional moral

management standards and make efforts to establish awareness
Does the management accurately of the importance of internal controls among
recognize the types of risk and risk employees?
exposure inherent in the bank’s portfolio•Does the management recognize internal and external
and understand the method of risk factors constituting potential risks to the FI, and is the
management, and has it encouraged management aware of the different types and degrees of
the FI to establish full awareness of risk and risk exposure inherent in these factors?
the importance of risk control •Does the management recognize different risk
throughout the FI? management methods according to the types of risk and
risk exposure?
• Does the management set limits to the acceptable amount
or degree of risks inherent in the FI and adequately
instruct relevant sections?
b. Basic strategy for risk • Is the management clearly aware of its responsibility
management for drawing up appropriate and adequate risk
Is the management actively involved management policy?
indrawing up strategies and • Does the board of directors decide basic policy
establishingthe framework for risk vis-à-vis risk-taking and risk control giving due
management givingdue consideration consideration to the balance between various risks to the
to the balance betweenvarious risks to FI’s capital as well as each business operation?
the FI’s capital and alsothe strategic • Does the management regularly check the effectiveness
importance of its risk-taking? of its risk management system?
• Does the management possess the necessary framework,
system, and procedures for identifying, monitoring,
and controlling various risks?
• Does the management aim to build a comprehensive risk
management system on an institution-wide basis?
c. Diversification of risks • Is the FI aware of the necessity of diversifying fund-
Does the FI diversify risks in the raising sources and investment vehicles?
operation of its various businesses? • Does the FI have in place an organization and
operational framework that further emphasizes the
importance of risk management rules and regulations
such as limit on exposure to a single borrower?
• Does the FI avoid excessive dependency on a specific
counter-party in its business operation?
• Is it possible to monitor risks so as to detect
any mal-distribution?
d. Countermeasures against • Does the FI have in place countermeasures against

payment failure of other FIs payment failure by other FIs or resulting financial
Does the management understand the system instability?
effects of payment failure by other FIs
and resulting instability of the financial
system, and have in place appropriate
countermeasures?
3. Internal Controls: Organization, Delegation of Authority, and Reporting System
a. Organization • Is the FI adapting its organization and staff allocation

Is the FI adapting its organization so so as to strengthen the risk management system?
as to strengthen the risk management • Is the burden of responsibility regarding business
system and to implement flexible operations and risk management clearly defined?
countermeasures to meet • Does the FI have in place a system that can control
changes in the financial environment? risk exposure while responding to economic change by
utilizing research department data?
• Does the FI have in place an internal control system
capable of swiftly and adequately dealing with newly
recognized risks arising from changes in the environment,
etc.?
• Is the FI aware of the necessity for organizational reform
in line with changes in the environment, etc., and is there
a department responsible for planning and implemen-
ting measures in response to such changes?
• Does the institution-wide risk management section
regularly assess the effectiveness of the FI’s overall risk
control system?
b. Separation of responsibilities • Are internal rules for the delegation of authority
Are the framework and procedures for rational from the standpoint of securing double-
decision-making clarified? Are delegation checking of operations and risk control in line with
of authority and allocation of business expansion?
responsibilities conducted appropriately • Has the FI confirmed that there is no excessive
from the standpoint of securing a concentration of authority nor extreme delegation of
double-checkingsystem and avoiding authority to subordinates?
conflict of interest? Are these • Does the FI have in place a framework where
procedures clearly stipulated in the monitoring and evaluation of major risks are
internal rules for delegation of conducted by a specializing section independent
authority? from the business promotion department?
• Are risk management responsibilities clearly defined

among the board of directors, ALM committee, directors
in charge, and department heads?
• Does the department head keep to the unavoidable
minimum the range of duties where a sufficient double-
checking system cannot be applied, and does the FI have
in place a system for close monitoring?
c. Reporting of business information • Does the FI have in place an appropriate reporting
Does the FI have in place an system by which directors in charge and the board of
appropriate reporting system by which directors receive information on business operations
the management can receive valuable and risk management without undue delay?
information on business operations • Does the FI have a consistent reporting format, giving
and risk management? Are decisions due consideration to easy comprehension and coherency
made by the management clearly of contents?
understood by the entire organization? • Are decisions made by directors in charge and the board
of directors adequately communicated to, and understood
by, concerned sections (including domestic and overseas
branches)?
• Does the FI have in place a regular reporting system to
senior officers and management regarding risk
management?
4. Staff Recruitment and Training
a. Staff recruitment • Does the FI recruit staff with appropriate experience,

Does the FI recruit staff with skill levels, and degree of expertise to undertake
appropriate experience, skill levels, specialized business operations, in particular, those
and degree of expertise to undertake relating to risk management?
specialized business operations? • Do staff members actively take part in business
operations in line with their position and
responsibilities?
• Does the FI recruit staff based on an employment plan?
b. Training • Does the on-the-job training (OJT) program function
Does management have a clear adequately?
staff-training policy? • Does the FI have training programs according to
qualifications and job description?
• Does the FI revise training programs in accordance with
changes in business operation and sophistication of risk
management?
5. Internal Audit
a. Audit system • Are the frequency, checkpoints, and scope of

Does the FI conduct effective internal internal audits adequate?
audits (headquarters audit and • Does the internal audit section/department have
in-house audit) to enhance its risk auditors with expertise in each business area, and are
management system and check the they able to effectively audit the FI’s overall operation?
thoroughness of internal rules? • Does the internal audit section/department have access
to all relevant documents and vouchers?
• Does the FI conduct regular internal audits of all
departments including headquarters and of all operations
excluding those that are considered customarily
exempted from auditing?
• Is the internal audit section/department completely
independent from other sections/departments, and does
it directly report to the management?
b. Follow-up of audit
Does the management give prompt and • Are internal audit results reported to the management
adequate attention to audit results, promptly and accurately?
and take appropriate measures if • Is information useful for improvement of operations
problems are detected? regularly passed on to concerned departments such as
the operations planning department?
• Does the internal audit section/department take the
initiative in directing improvement measures such as the
revision of internal rules in order to prevent the
reoccurrence of problems?
• Does the management appropriately monitor whether
improvement measures directed to sections/departments
are carried out?
6. Profit and Loss Management
a. Monitoring of profit/loss • Does a specialized department (e.g., the financial

Do the management and individual department) monitor profit/loss from various viewpoints
departments within the organization such as profit by customer and branch, and on a
monitor profit/loss while considering consolidated basis?
the balance between risk and return? • Does each department manage profit/loss bearing in mind
the allocation of indirect costs?
• Is due consideration given to risk profiles when
assessing and determining profit/loss conditions?
• Is there a computerized support system for
profit/loss management (e.g., cost accounting of
deposits and lending)?
b. Distribution of management • Does the FI thoroughly assess capital and other

resources taking into account risk resources before embarking on a new business?
and return • Does the management appropriately decide the
Is due consideration given to the resources distribution policy based on regular profit/
balance between risk and return, loss reports?
and between risk and the FI’scapital • Are limits on risk exposure set for each department
when distributing management taking into consideration the FI’s capital?
resources to each department?
c. Rational pricing • Is the differential between actual market rates and

Is pricing of deposit and lending rates pricing of deposit, lending, and derivatives rates
rational in view of operational/profit within a rational range?
planning, market conditions, and risks? • Is delegation of authority relating to pricing
clearly defined?
• In pricing, is consideration given not only to operations,
profit, and market conditions, but also operating cost,
credit spread, and embedded option premium for
premature cancellation?
7. Risk Management of Affiliated Companies
a. Monitoring of profit/loss on a • Is financial performance monitored on a consolidated

consolidated basis including basis with full understanding of the business performance
affiliated companies of companies subject to consolidated accounting?
Is financial performance monitored • Is financial performance monitored appropriately on
appropriately on a consolidated basis the basis of including affiliated companies not subject to
or on the basis of including affiliated consolidated accounting taking into consideration
companies (but not consolidating)? degree of business affiliation?
b. Risk management of affiliated • Is there a section responsible for monitoring the
companies business operations of affiliated companies
Does the head office fully recognize (including nonbank financial institutions)?
the risks inherent in domestic and • Is the FI capable of checking unusual activities such
overseas affiliated companies, and as large fund transfers among affiliated companies?
monitor them appropriately? • Does the head office fully recognize the risk profiles
inherent in overseas affiliated companies?
• Does the FI regularly monitor risks to which
domestic and overseas affiliated companies are exposed
to ensure that they are within a rational range in relation
to their financial strength such as capital?
8. Establishment of Compliance Framework
a. Management understanding of • Does the management fully understand that

legal compliance and action to insufficient compliance can impair the management base?
achieve it • Is the top management making efforts to ensure that
Does the management fully recognize recognition of the importance of compliance penetrates
the importance of complying with laws throughout the FI?
and regulations, market rules, and • Is the management fully aware which FI operations
internal rules? Are they taking the are most likely to cause problems in terms of
initiative in raising compliance compliance?
awareness? • When starting a new operation, does the management
take into consideration of newly arising risks in the area
of compliance?
b. Establishment and • Are responsibilities with respect to compliance clarified
implementation of a framework by appointing an executive director and setting up a
for compliance responsible coordination department?
Has the FI established a framework Are matters regarding compliance such as planning and
andconcrete procedures (a compliance monitoring under centralized control?
program)to ensure consistent • Does the FI have in place concrete procedures
compliance? Are theyappropriately (i.e., planning of education and training programs,
implemented? compiling codes of conduct and compliance manuals,
drawing up internal rules, etc.) that effectively initiate
compliance?
• Do FIs with overseas branches have a compliance officer
for each country who regularly monitors local legal
changes?
• Has the FI appropriately placed a person in charge of
compliance in relevant departments and clearly
stipulated their job descriptions in the allocation of
duties? Have thesepositions been effectively put into
practice (i.e., implementation of training programs
and educational activities, consultation, and inspection
in the event of any doubtful contradictions to rules, swift
reporting to the coordinating department)?
• In the development and sales of new
products, does the coordinating department
confirm the legal compliance of its content
and policy of customer explanation in
advance?
• Does the FI maintain close contact with its
lawyers with a view to forestalling trouble
and dealing with any incident appropriately
and swiftly?
c. Monitoring and reporting to • Is the compliance consistency in each type of FI

management business monitored by compliance officers and
In addition to monitoring, does a in-house audits on a daily basis?
department independent of operations • Does the compliance officer promptly and appropriately
sections conduct checks on compliance? report the compliance consistency and problems
Are lawsuits and problems that could in each operation section to the coordinating department?
harm the FI’s reputation appropriately • Does a department (i.e., internal audit department)
reported to the management? independent from operation sections and a coordinating
department regularly examine the compliance
consistency?
• Does the coordinating or internal audit department
promptly and appropriately report the compliance
consistency and problems to the management and
auditors (or auditors committee)?
• Are incidents and accidents swiftly reported to the
supervisory authorities? Is the credibility of the content
of reports sent to other authorities assured?
• Are summaries of customer complaints or lawsuits sent
to branches in order to forestall problems?
9. Disclosure and Accounting Process
a. Active disclosure of financial • Are the FI’s management policy and strategies made
information and restraints on widely known through disclosure magazines and other
management means?
From the standpoint of fulfilling • Are major indicators of the FI’s performance accurately
accountability to customers and disclosed?
shareholders, does the management • Do the board of directors and auditors (or auditors
actively and fairly disclose financial committee) function appropriately to secure proper
information? Is the management execution of business by the management? When
sufficiently monitored internally and required, does the FI appoint external board
externally in order to secure business members and set up a compliance committee?
operations? • Does the management take due notice of the
opinions of external auditors (letters of advice on
improvement of internal control, i.e., management
letters)? Does the management examine and implement
appropriate improvement measures?
• Does the FI actively initiate relations with investors,
by for example, conducting briefings about its business
performance for investors?
b. Appropriate accounting • Is the processing of daily accounts carried out properly?

procedures • Are annual financial statements produced in
Is the FI’s processing of daily accounts accordance with accounting principles?
andannual financial statements sound? • Is there any unsound accounting manipulation of
statements (i.e., figures subject to financial statements
and disclosure) such as carrying over of losses that
should be realized?
• Are the required amounts of write-offs and provisioning
determined by self-assessment appropriated in the
financial statements?
• Are soundness of accounting principles and reliability of
financial statements secured through adequate auditing?
10. Compilation and Understanding of Contingency Plan
a. Compilation of a contingency • Has the FI drawn up a comprehensive plan for the head
plan office and all branches, and is there a manual for it?
Has the FI drawn up a counter- • Is there a section responsible for drawing up and
measure (contingency plan) against coordinating the plan?
disasters and accidents?
b. Understanding of the plan • Is the management aware of the plan, and do they
Are the management and the staff fully understand it?
aware of the contingency plan, and do • Are staff aware of the plan, and do they fully
they fully understand it? understand it?
• Is the plan approved by the board of directors?
c. Content of the plan Managerial factors:
Does the contingency plan enable the • Does the plan give due consideration to the safety
FI to continue its operations in of customers and employees in case of an emergency?
case of emergency? • Does the plan clearly designate an emergency
headquarters to be in charge of dealing with a crisis?
• Does the plan assess the degree of impact an
emergency will have on operations?
• Does the plan clearly designate the priority level of each
operation, delegation of authority, and arrangements for
obtaining the necessary staff in case of an emergency?
• Does the plan clearly state the order and method of
contacting management and staff in case of an emergency?
• Does the FI have a means of communication with
entities operating payment systems and supervisory
authorities, etc., in case of an emergency?
• Does the FI have in place a public relations network
(including the use of mass communications) directed at
customers in case of an emergency?
Material factors:
• Does the plan take into consideration electricity, water,

and food supply?
• Does the plan clearly designate the necessary action to
protect assets such as securing a warehouse to store things
and deciding the evaluation procedure for damaged
property?
• Has the FI secured backup data in a vault and/or distant
location?
• Does the FI have in place a backup center or a backup
contract with trustworthy subcontractors or other FIs?
• Has the FI secured multiple communications methods
using private lines between the head office and branches,
and between the computer center and branches?
• Has the FI secured countermeasures (i.e., alternative
office space, etc.) in the event of an emergency
(in particular, for overseas branches)?
d. Review and on-site drilling of • Does the FI have a system to review the plan
the plan when necessary?
Does the FI have a system for • Are on-site drills conducted regularly at the
reviewing the contingency plan when head office against possible shutdown of the system?
appropriate, and are on-site drills • Are on-site drills conducted regularly at both the head
conducted regularly? office and branches?
• Are results of on-site drills reported to management
after appropriate assessment, and utilized in reviewing
the plan?
7.10.1.4.3. Determine the nature and form of the accounting standards and policies in
use and their likely acceptability to ADB. In the event that they would not be acceptable,
define ADB’s requirements to counterparts of the FI and the borrower (where applicable).
7.10.1.4..4. Determine the nature and form of the auditing standards in use and their
likely acceptability to ADB. In the event that they would not be acceptable, define ADB’s
requirements to counterparts of the FI, the existing auditing firm (if it is to be retained
for the project) and the borrower (where applicable).
7.10.1.4.5. In the absence of any, or all, of the system elements set out in above, define
new or additional system requirements necessary to support the FI and the project and
advise a timetable to counterparts for their introduction and full operation, including
necessary staff additions and training.
preparation the project description and specifications documents in order to understand
the cost of proposed subprojects and similar components (new subloans) and the likely
foreign and local costs for each year of new advances.
existing interest rate spread, or any new spread that needs to be instituted as part of
project design, for onlending of ADB loan proceeds, etc. ensuring, where necessary, that
the charges reflect any operating cost savings proposed as part of the project and take
account of forecast inflationary factors.
descriptions of base cost line items, and annual/ periodic funds flows. Ensure that any
taxes and duties to be funded by subloans are clearly defined and capable of being easily
defined for exclusion from ADB financing.
7.10.1.5.4. Examine any proposed physical contingencies and their legitimacy.
financing plan to determine the total financing requirements, the amount and timing of
receipt of each input of funds requirements, the proposed amount of ADB’s proposed
total loan proceeds, of receipts from cofinanciers, from internal funds, and from
government’s counterpart funds (where applicable).
7.10.1.6. Prepare Financial Projections for Ongoing FI

Operation
7.10.1.6.1. Determine the FI’s operating objectives for at least two completed fiscal years
prior to the start of project implementation and the extent of their fulfillment, and reasons
for any shortcomings.
7.10.1.6.2. Examine and determine the feasibility of, and acceptability to ADB of, the
FI’s operating objectives for the period of project implementation and its forecast for the
next two following years.
7.10.1.6.3. Review the portfolio of performing and nonperforming loans, paying specific
attention to adverse commentaries (if any) by the external auditors.
7.10.1.6.4. Review the actual ongoing performance and past statistics relating to
recoveries, bad debts, and provisions, particularly the adequacy of the latter.
7.10.1.6.5. Review the status and performance of equity participations and the realism
(realisability, earning capacity) of the related entries in the FI’s financial statements.
7.10.1.6.6. Review the adequacy of the FI’s interest rate spreads to meet all obligations.
7.10.1.6.7. Examine for reasonableness and profitability the FI’s proposed term lending
program using ADB loan proceeds and other resources.
7.10.1.6.8. Examine the FI’s proposed equity participation program using ADB loan
proceeds and other resources.
7.10.1.6.9. Measure the resilience, earning capacity, and security of the FI’s past, ongoing
and proposed short-term lending program and its actual and proposed sources of funding.
7.10.1.6.10. Examine the continuing feasibility/profitability of the FI’s current and

proposed leasing program and its actual and proposed sources of funds.

determine if it will be necessary to revalue assets periodically through ADB loan period
and thereafter to reflect the impact of severe inflation, prepare a forecast of the impact
on lending operations.

prepare the FI’s operating costs with and without the project for at least two completed
fiscal years prior to the start of project implementation, for the period of ADB loan
disbursement, and for at least two years of operation and incorporate impacts of inflation
forecasts.
7.10.1.6.13. Review the FI’s status and performance of schedules of interest payments
due to lenders.
7.10.1.6.14. Review the FI’s status and performance of loan repayments to lenders.
7.10.1.6.15. Examine the reliability of the system of liquidity (cash) management and
determine the number of occasions when cash reserves were depleted to dangerous levels
in the most recent two years without available recourse.
7.10.1.6.16. Compile the following financial statements for at least two completed fiscal
years prior to the start of loan signing, forecasts for the period of loan disbursement, and
forecasts for at least three years thereafter.
• Balance Sheet
• Income Statement
• Cash Flow Statement (In cases where the FI has not prepared cash flow statements
in the past, it may be difficult to prepare these retrospectively. In these cases, while
the financial analyst has discretion to waive the requirement for historical cash flow
statements, forecast cash flow statements are still required)
• Capital adequacy analysis
• Portfolio of Investments at year-end
• Schedule of nonperforming assets showing:
— Nonperforming not rescheduled
— Nonperforming rescheduled but not performing
— Nonperforming Equity investments, and
— Nonperforming leases
• Analysis of Income and Earnings showing percentage of average assets by categories
• Losses experience by sector/activities
• Credit risk management
• Liquidity and Interest Rate Sensitivity Management
• Provisions for Losses, Write-offs and Recoveries
• Schedule of Collateral and Securities
7.10.1.6.17. Review VaR records and prepare a chart showing significant at-risk dates
and amounts at risk in the two years prior to appraisal.
7.10.1.6.18. On the basis of generated data above, compile appropriate financial

performance indicators. Discuss proposed indicators with Project Officer and
counterparts, explaining logic of selection and methods of calculation.

the Project Cost Table, the Financing Plan, the financial projections, interest spreads,
and lending conditions proposed.
(if possible in the presence of counterparts) to explain the method of compilation and the
forecast results of all financial statements at all appropriate levels of concerned institutions
and managements with the objective of reaching agreement on the Project Cost Table,
Financing Plan, the financial projections and interest spreads, and lending conditions proposed.
of complete Aide Memoire to counterparts at appropriate levels of authority.
7.11. Undertaking Sensitivity and Risk Analyses
7.11.1. Step 1: Identify the Key Variables
7.11.1.1. The selection of variables which should be tested and the detail in which
they are specified apply primarily to (i) critical cost and benefit items, (ii) critical items
likely to cause nonperformance of financial covenants, (iii) the effect of delays; and (iv)
aggregate costs and benefits, which are the four principal areas of a project for which
sensitivity analysis normally is considered.
7.11.1.2. Critical Cost and Benefit Items: The most effective tests are achieved by detailed
disaggregation of costs and benefits and therefore these items should be subjected to
specific analysis for each project. Analysis is more beneficial if individual items that are
most critical to the project are subjected to individual review. These include on the costs
side, prices of major inputs, productivity coefficients, currency risks and inflation rates,
and on the benefits side, output prices (with the substitution of possible tariff structure
variations), rate of growth in demand for output, and unit cost savings. While “revenues”
can be regarded as a critical benefit, it is likely to be more useful to identify the element
or elements of revenues that are most at risk, such as “revenues from installing new sewer
connections”, along with the extent/scope of their contribution to benefits and the timing
thereof.
7.11.1.3. Nonperformance of Financial Covenants: The sensitivity of the principal

elements of operations (critical operating costs e.g., wages, power and fuel, etc.,), operating
revenues, working capital requirements, etc., that will impact on the EA’s ability to achieve
(i) rate of return ratio – a rate of return on net fixed assets in operation; (ii) self-financing
ratio; (iii) debt service coverage, etc., should be measured.
7.11.1.4. Effect of Delays: Start-up delays, implementation delays, capacity utilization

and full development delays, and parallel investment delays should be subjected to
analysis. Delays come in different shapes and sizes and on different occasions (at start-
up; at critical commissioning stages, e.g., river crossings; weather delays, e.g., regular
“wet season”; resource shortages – shipping delays, personnel strikes and slow-downs;
in commissioning; in completion; and in commencement of operation. It is important
to identify the delay(s) most likely to be considered in terms of the maximum permissible
delay(s) for inclusion as a Switching Value (SV). Delays may also be analyzed in terms
of the periodic effects on NPV (annual, forecast percentage of completion).
7.11.1.5. Aggregate Costs and Benefits: Sensitivity analysis of the effects of variations in
total costs and benefits of a project is useful to indicate the collective influence of
underlying variables, and should be applied in all cases.
7.11.1.6. In addition to the foregoing, other critical areas which merit subjection to
sensitivity analysis are potential cost overruns in project implementation and non-
achievement of capacity utilization. In simple cases the variability in the project’s rate
of return on net fixed assets in operation will largely reflect the influence of two or three
variables. In such cases probability assessments regarding those variables might provide
an adequate basis for judging the risk of the project’s failure, thus avoiding the need for
more detailed quantitative risk analysis. Even in more complex cases sensitivity analysis
may some times facilitate risk analysis by identifying the variables for which probability
distributions should be specified.
7.11.2. Steps 2 and 3: Calculate Effects of Changing

Variables
7.11.2.1. The values of the basic indicators of project viability (FIRR and FNPV should
be recalculated for different values of key variables. This is preferably done by calculating
sensitivity indicators (SIs) and switching values (SVs).
7.11.2.2. Switching Values (SVs) are sometimes used for conducting sensitivity analysis,
but their application is not mandatory . It is the financial analyst’s responsibility to

determine whether a demonstration of the impacts of switching values would support
any decisions used in their selections. The SV of a variable is that value at which a
project’s FNPV becomes zero (or the FIRR equals the discount rate). The SVs are normally
given in terms of the percentage change in the value of the variable needed to turn a
project’s FNPV equal to zero. SVs are useful to determine those variables that are most
likely to affect project outcomes. SVs of the more important (or potent) variables should
be presented in order of declining sensitivity.
7.11.2.3. The meaning of these concepts is presented in the following Box and a sample
calculation immediately follows. Sensitivity indicators and switching values can be
calculated for the FIRR and FNPV as shown below
Using Sensitivity Indicators and Switching Values
Sensitivity Indicator Switching Value
Definition 1. Towards the Net Present Value 1. Towards the Net Present Value
Compares percentage change in The percentage change in a variable or combination

FNPV with percentage change in a of variables to reduce the FNPV to zero (0).
variable or combination of
variables.
2. Towards the Internal Rate of Return 2. Towards the Internal Rate of Return
Compares percentage change in FIRR above The percentage change in a variable or combination
the cut-off rate with percentage change of variables to reduce the FIRR to the cut-off rate
in a variable or combination of variables. (=discount rate).
Expression 1. Towards the Net Present Value 1. Towards the Net Present Value
( FNPVb – FNPV1 ) / FNPVb ( 100 x FNPVb ) ( X b – X 1)

SI = SV = x
(Xb – X1 ) / Xb ( FNPVb - NPV1 ) Xb
where: where:
Xb – value of variable in the base case X b – value of variable in the base case
X1 – value of the variable in the X 1 – value of the variable in the
sensitivity test sensitivity test
FNPVb – value of FNPV in the base case FNPVb – value of FNPV in the base case
FNPV1 – value of the variable in the FNPV 1 – value of the variable in the
( FIRRb – FIRR1 ) / ( FIRRb – d ) (100 x ( FIRRb – d )) ( Xb – X1 )

SI = SV = x
( Xb – X 1 ) / Xb ( FIRRb FIRR1) Xb
where: where:
Xb – value of variable in the base case Xb – value of variable in the base case
X1 – value of the variable in the X1 – value of the variable in the
FIRRb – value of IRR in the base case FIRRb – value of FIRR in the base case
FIRR1 – value of the variable in the FIRR1 – value of the variable in the
d – discount rate d – discount rate
Calculation 1. Towards the Net Present Value 1. Towards the Net Present Value
example
Base Case: Base Case:
Price = Pb = 300 Price = Pb = 300
FNPVb = 20,912 FNPVb = 20,912
Scenario 1: Scenario 1
P1 = 270 (10% change) P1 = 270 (10% change)
FNPV1 = 6,895 FNPV1 = 6,895
(20,912 – 6,895) / 20,912 (100 x 20,912) (300 – 270)

SI = 6.70 SV = x = 14.9%
(300 – 270) / 300 (20,912 – 6,895) 300
Sensitivity Indicator Switching Value
Base Case: Base Case:

Price = Pb = 300 Price = Pb = 300
FIRRb = 15.87% FIRRb = 15.87%
Scenario 1: Scenario 1:
P1 = 270 ( 10% change ) P1 = 270 (10% change)
FIRR1 = 13.31% FIRR1 = 13.31%
d = 12% d = 12%
(0.1587 – 0.1331 ) / ( 0.1587 – 0.12) ( 100 x ( 0.1587 – 0.12 )) ( 300 – 270 )

SI = SV =
( 300 – 270 ) / 300 ( 0.1587 – 0.1331 ) x 300
= 6.61 = 15.1%
Interpretation (i) percentage change in FNPV respectively A change of approximately 15 % in the price
(ii) percentage change in FIRR above the variable is necessary before the FNPV becomes
cut-off rate (12%)is larger than percentage zero or before the FIRR equals the cut-off rate.
change in variable: price is a key variable
for the project.
Characteristic Indicates to which variables the project Measures extent of change for a variable that
result is or is not sensitive. Suggests will leave the project decision unchanged.
further examination of change in variable.
7.11.2.4 The switching value is, by definition, the reciprocal of the sensitivity indicator.
Sensitivity indicators and switching values calculated towards the FIRR yield slightly
different results if compared to SIs and SVs calculated towards the FNPV. This is because
the FIRR approach discounts all future net benefits at the FIRR value and the FNPV
approach at the discount rate d.
Example of the Base Case for a Project
PV @12% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Benefits 2,104 0 283 339 396 453 509 566 566 566 566
Costs:
Investment 1,687 1,889 0 0 0 0 0 0 0 0 0
Operations &
maintenance 291 0 61 61 61 61 61 61 61 61 61
Total Costs 1,978 1,889 61 61 61 61 61 61 61 61 61
Net Cash Flow 126 -1,889 222 278 335 391 448 505 505 505 505
7.11.2.5. In the base case, the FNPV is 126 and the FIRR is 13.7 percent. The sensitivity
of the base case FNPV has been analyzed for (adverse) changes in several key variables, as
follows:
• An increase in investment cost by 10 percent
• A decrease in economic benefits by 10 percent
• An increase in costs of operation and maintenance by 10 percent;
• An adverse foreign-exchange movement of 20 percent, and

• A delay in the period of construction, causing a delay in revenue generation by one
year.
7.11.2.6. Proposed changes in key variables should be well explained. The sensitivity
analysis should be based on the most likely changes. The effects of the above changes
are summarized in the following table.
Sensitivity Analysis: A Numerical Example
Item Change FNPV FIRR % SI (FNPV) SV (FNPV)
Base Case 126 13.7

Investment + 10% – 211 9.6 13.3 7.5%
Benefits – 10% – 294 7.8 16.6 6.0%
Operating and Maintenance Costs + 10% 68 12.9 2.3 43.4%
Foreign Exchange Movements – 20% – 294 7.8 16.6 6.0%
Construction delays One year 99 10.8 NPV 178% lower
SI = Sensitivity Indicator, SV = Switching Value
7.11.2.7. Combinations of variables can also be considered. For example, the effect
on the FNPV or FIRR of a simultaneous decline in economic benefits and an increase in
investment cost can be computed. In specifying the combinations to be included, the
project analyst should state the rationale for any particular combination to ensure it is
plausible.
7.11.3. Step 4: Analyze Key Variable Changes
7.11.3.1. In the case of an increase in investment costs of 20 percent, the sensitivity

indicator is 13.34. This means that the change of 20 percent in the variable (investment cost)
results in a change of (13.3 x 20 percent) = 266 percent in the FNPV. It follows that the
higher the SI, the more sensitive the FNPV is to the change in the concerned variable.
7.11.3.2. In the same example, the switching value is 7.5 percent, which is the
reciprocal value of the SI x 100. This means that a change (increase) of 7.5 percent in
the key variable (investment cost) will cause the FNPV to become zero. The lower the
SV, the more sensitive the NPV is to the change in the variable concerned and the higher
the risk with the project.
7.11.3.3. At this point the results of the sensitivity analysis should be reviewed. It
should be asked: (i) which are the variables with high sensitivity indicators; and (ii) how
likely are the (adverse) changes (as indicated by the switching value) in the values of the
variables that would alter the project decision?
7.11.4. Undertaking Risk Analysis
7.11.4.1. In cases where project results are expected to be particularly sensitive to

certain variables, it has to be assessed how likely it is that such changes would occur.
This likelihood can be assessed by studying experiences in earlier, comparable projects
and by investigating the situation in the sector as a whole.
7.11.4.2. Steps should be taken to reduce the extent of uncertainty surrounding those
variables where possible. The following remedial actions might be taken at the project
level:
• The development of specific agreements to ensure that contractor performance and
project quality during construction works reduces the likelihood of delays
• The development of agreements for long-term supply contracts at specified quality
and prices to reduce the uncertainty of operating costs
• The formulation of capacity-building activities to ensure appropriate technical and
financial management
• The implementation of pilot phases to test technical assumptions and to observe user’s
reactions, in case there is considerable uncertainty in a large project or program, and
• The setting of certain criteria that have to be met by subprojects before approval.
This is especially important in sector loans where most (small) subprojects will be
prepared after loan approval.
7.11.4.3. The results of the sensitivity analysis should be stated along with the
associated mitigating actions being recommended, and the remaining areas of uncertainty
that they do not address. Sensitivity analysis is useful at all stages of project processing:
at the design stage to incorporate appropriate changes; at the appraisal stage to establish
a basis for monitoring; and, during project implementation to take corrective measures.
The uncertainty surrounding the results of the economic and financial analysis is expected
to decrease as the project moves into the operational phase.
7.11.4.4. For the key variables and combinations of such variables, a statement can
be presented including: the source of variation for the key variables; the likelihood that
variation will occur; the measures that could be taken to mitigate or reduce the likelihood
of an adverse change; and the switching values and/or sensitivity indicators.
7.11.4.5. The purpose of quantitative risk analysis is to estimate the probability that
the project FIRR will fall below the opportunity cost of capital; or that the FNPV, using
the FIRR as the discount rate, will fall below zero. A statement of such an estimate means
that decisions can be based not just on the single base-case FIRR but also on the probability
that the project will prove unacceptable. Projects with smaller base-case FIRRs may
involve less uncertainty and have a higher probability of being acceptable in
implementation. Projects with higher base-case FIRRs may be less certain and involve
greater risk. Risk analysis can be applied also to projects without measurable benefits,
for example to assess the probability that unit costs will be greater than a standard figure.
7.11.4.6. Undertaking a risk analysis requires more information than for sensitivity
analysis. It should be applied to selected projects that are large or marginal, or where
a key variable is subject to a considerable range of uncertainty. A large project is one that
takes a high proportion of government or the country’s investment resources, for example
a project using more than 5 percent of the government’s investment budget in the peak
project investment years. A marginal project is one where the base-case FIRR is only
marginally higher than the opportunity cost of capital. A decision should be taken at
an early stage of analysis whether to include a risk analysis in the appraisal or not.
7.12. Model Operating Covenants
7.12.1. Rate of Return (see 3.6.2.2)
7.12.1.1. The following is an outline for a Rate of Return covenant for use in a loan
agreement. It is intended as a guide only. It is the responsibility of the OGC to determine,
in consultation with the mission leader and financial analyst, the precise wording for
inclusion in the legal agreements. In cases of borrowers conducting multiple operations,
the text of the covenant should define which operations are to be subject to performance
measurement. As an example, in an electric power project to be carried out by a borrower
that operated electric power, water supply and telecommunications services, the covenant
normally would be drafted to apply only to the electric power operations.
Section _____.
(a) For the purposes of this Loan Agreement, all financial calculations, ratios and financial
covenants shall be applied in respect of the Borrower’s Operations only.
(b) Except as ADB shall otherwise agree, the Borrower shall earn, for each of its fiscal
years after its fiscal year ending on [day/month/year], an annual return of not less
than _____ percent of the average current net value of the Borrower’s fixed assets
in operation.
(c) Before (date/month) in each of its fiscal years, the Borrower shall, on the basis of
forecasts prepared by the Borrower and satisfactory to ADB, review whether it would
meet the requirements set forth in paragraph (a) in respect of such year and the next
following fiscal year and shall furnish to ADB the results of such review upon its
completion.
Paragraph (d): Option 1: Where the borrower or government has discretion to adjust
tariffs/rates:
(d) If any such review shows that the Borrower would not meet the requirements set
forth in paragraph (b) for the Borrower’s fiscal years covered by such review, the
Borrower shall promptly take all necessary measures (including without limitation,
adjustments of the structure or levels of its rates (prices)) in order to meet such
requirements.
Paragraph (d): Option 2: Where there is an independent regulator in place (or where it
is anticipated that an independent regulator may be established during the project
implementation period):
filing applications with the [name of regulator] seeking a tariff/rate increase) in order
to meet such requirements.
(e) For the purposes of this Section:
(i) The annual return shall be calculated by dividing the Borrower’s net operating
income for the fiscal year in question by one half of the sum of the current
net value of the Borrower’s fixed assets in operation at the beginning and at
the end of that fiscal year.
(ii) The term “net operating income” means total operating revenues less total
operating expenses.
(iii) The term “total operating revenues” means revenues from all sources related
to operations, after making adequate provisions for uncollectible debts, but
excludes government grants, subsidies and transfers.
(iv) The term “total operating expenses” means all expenses related to operations,
including administration, adequate maintenance, taxes and payments in lieu
of taxes, and provision for depreciation on a straight-line basis at a rate of not
less than ____ percent per annum of the average current gross value of the
Borrower’s fixed assets in operation, or other basis acceptable to ADB, but
excluding interest and other charges on debt.
(v) The average current gross value of the Borrower’s fixed assets in operation
shall be calculated as one half of the sum of the gross value of the Borrower’s
fixed assets in operation at the beginning and at the end of the fiscal year
[Where revalued: as valued from time to time in accordance with sound and
consistently maintained methods of valuation satisfactory to ADB].
(vi) The term “current net value of the Borrower’s fixed assets in operation” means
the gross value of the Borrower’s fixed assets in operation less the amount of
accumulated depreciation [Where revalued:, as valued from time to time in
accordance with sound and consistently maintained methods of valuation
satisfactory to ADB].
(vii) The terms “operations” or operating” refer to the [identify relevant part of the
operations] operations of the Borrower.
7.12.2. Self-Financing Ratio (see 3.6.2.3)
7.12.2.1. The following is an outline for a Self-Financing Ratio covenant for use in a
loan agreement. It is intended as a guide only. It is the responsibility of the OGC to
determine, in consultation with the mission leader and financial analyst, the precise
wording for inclusion in the legal agreements. In cases of borrowers conducting multiple
operations, the text of the covenant should define which operations are to be subject to
performance measurement. As an example, in an electric power project to be carried out
by a borrower that operated electric power, water supply and telecommunications services,
the covenant normally would be drafted to apply only to the electric power operations.
Section _____
(b) Except as ADB shall otherwise agree, the Borrower shall produce, for each of its
fiscal years after its fiscal year ending on _________, cash from internal sources
equivalent to not less than ___ percent of the annual average of the Borrower’s
capital expenditures incurred, or expected to be incurred, for
Remainder of Paragraph (b): Option 1:
that year, the previous fiscal year and the next ______ following fiscal years.
Remainder of Paragraph (b): Option 2:

that year and the next ______ following fiscal years.
following fiscal year and shall furnish to ADB a copy of such review, upon its
completion.
tariffs/rates:
requirements.
(i) The term “cash from internal sources” means the difference between:
(A) the sum of cash flows from all sources related to operations, plus cash
generated from consumer deposits and consumer advances of any kind,
sale of assets, cash yield of interest on investments, and net non-operating
income.; and
(B) the sum of all expenses related to operations, including administration,

adequate maintenance and taxes and payments in lieu of taxes (excluding
provision for depreciation and other non-cash operating charges), debt
service requirements, all cash dividends paid and other cash distributions
of surplus, increase in working capital other than cash and other cash
outflows other than capital expenditures.
(ii) The term “net non-operating income” means the difference between:
(A) revenues from all sources other than those related to operations, after
making adequate provisions for uncollectible debts; and
(B) expenses, including taxes and payments in lieu of taxes, incurred in the
generation of revenues in (a) above.
(iii) The term “working capital other than cash” means the difference between
current assets excluding cash and current liabilities at the end of each fiscal
year.
(iv) The term “current assets excluding cash” means all assets other than cash which
could in the ordinary course of business be converted into cash within twelve
months, including accounts receivable, marketable securities, inventories and
prepaid expenses properly chargeable to operating expenses within the next
fiscal year.
(v) The term “current liabilities” means all liabilities which will become due and
payable or could under circumstances then existing be called for payment
within twelve months, including accounts payable, customer advances, debt
service requirements taxes and payments in lieu of taxes, and dividends.
(vi) The term “debt service requirements” means the aggregate amount of
repayments (including sinking fund payments if any) of, and interest and other
charges on, debt, excluding interest charged to construction and financed from
loans.
(vii) The term “capital expenditures” means all expenditures incurred on account
of fixed assets, including interest charged to construction, related to operations.
(viii) The terms “operations” or operating” refer to the [identify relevant part of the
(ix) Whenever for the purposes of this Section it shall be necessary to value, in
terms, of the currency of the (Borrower/Guarantor), debt payable in another
currency, such valuation shall be made on the basis of the prevailing lawful
rate of exchange at which such other currency is, at the time of such valuation,
obtainable for the purposes of servicing such debt, or, in the absence of such
rate, on the basis of a rate of exchange acceptable to ADB.
7.12.3. General Price Level (see 3.6.2.4)
7.12.3.1. The following is an outline for a General Price Level covenant for use in a
loan or guarantee agreement. It is intended as a guide only. It is the responsibility of the
OGC to determine, in consultation with the mission leader and financial analyst, the
precise wording for inclusion in the legal agreements.
Section _______.
(a) The (Borrower/Guarantor) and ADB shall, from time to time, at the request of either
party, exchange views with regard to the (Borrower’s/Guarantor’s) _________pricing
policies and its plans in respect of the overall development of the ___________sector.
(b) The (Borrower/Guarantor) agrees, as long as it exercises control over the setting of
prices of the _________companies, to establish prices for _______sold by such
companies which would: (i) allow the _________companies, under conditions of
efficient operation at reasonable levels of capacity utilization, to cover their operating
costs including taxes, earn an adequate return on funds invested in them, meet
their financial obligations and make a reasonable contribution to future investment
for expansion of capacity; (ii) be reasonably competitive with prices for
_____________in other major producing countries; and (iii) subject to the
achievement of objectives (i) and (ii) above, pass on the benefit of declines in the
real cost of production to _____________through reduction in prices in real terms.
7.12.4. Operating Ratio (see 3.6.2.5)
7.12.4.1. The following is an outline for an Operating Ratio covenant for use in a loan
7.12.4.2. This covenant may be converted to a working ratio covenant by substituting

a definition of working expenses for operating expenses. This will normally require that
depreciation be omitted from the definition of operating expenses recommended herein.
Section______
(b) Except as ADB shall otherwise agree, the Borrower shall maintain, for each of its
fiscal years after its fiscal year ending on _________, a ratio of total operating expenses
to total operating revenue not higher than _______ (percent).
meet the requirements set forth in Paragraph (a) in respect of such year and the next
following fiscal year, and shall furnish to ADB the results of such review upon its
completion.
tariffs/rates:
requirements.
(e) For the purposes of this Section
(i) The term “total operating expenses” means all expenses related to operations,
less that ______ percent per annum of the average current gross value of the
(ii) The term “total operating revenues” means revenues from all sources related
to operations, after making adequate provisions for uncollectible debts.
(iii) The average current gross value of the Borrower’s fixed assets in operation
fixed assets in operation at the beginning and at the end of the fiscal year, as
valued from time to time in accordance with sound and consistently maintained
methods of valuation satisfactory to ADB.
(iv) The terms “operations” or operating” refer to the [identify relevant part of the
7.12.5. Breakeven Covenant (see 3.6.2.6)
7.12.5.1. The following is an outline for a Breakeven Ratio covenant for use in a loan
measurement. As an example, in a sewerage project to be carried out by a borrower that
also operated water supply services, the covenant normally would be drafted to apply
only to the sewerage operations.
Section _______.
(b) Except as ADB shall otherwise agree, the Borrower shall produce for each of its
fiscal years after its fiscal year ending on____________, total revenues equivalent
to /or not less that the sum of (i) its total operating expenses; and (ii) the amount
by which debt service requirements exceed the provision for depreciation.35
forecast prepared by the Borrower and satisfactory to ADB, review whether it would
following fiscal year and shall furnish to ADB the results of such review upon its
completion.
35 For some borrowers, which enter into this type of covenant, depreciation may not be applicable.
tariffs/rates:
requirements.
(e) If any such review shows that the Borrower would not meet the requirements set
(f) For purposes of this Section:
(i) The term “total revenues” means the sum of total operating revenues and net
non-operating income, but excludes all government grants, subsidies and
transfers income.
(ii) The term “total operating revenues” means revenues from all sources related
to operations, after making adequate provisions for uncollectible debts.
(iii) The term “net non-operating income” means the difference between:
(A) revenues from all sources other than those related to operations; and
generation of revenues in (iii)(a) above.
(iv) The term “total operating expenses” means all expenses related to operations,
less than ______ percent per annum of the average current gross value of the
(v) The average current gross value of the Borrower’s fixed assets in operation
fixed assets in operation at the beginning and at the end of the fiscal year, as
valued from time to time in accordance with sound and consistently maintained
(vi) The term “debt service requirements” means the aggregate amount of
repayments (including sinking fund payments, if any) of, and interest and
other charges on, debt.
(vii) The term “debt” means any indebtedness of the Borrower maturing by its terms
more than one year after the date on which it is originally incurred.
(viii) Debt shall be deemed to be incurred: (a) under a loan contract or agreement
or other instrument providing for such debt or for the modification of its
terms of payment on the date of such contract, agreement or instrument; and
(b) under a guarantee agreement, on the date the agreement providing for
such guarantee has been entered into. Financial liabilities incurred by a
borrower who is a lessee under finance leasing agreements may also be included
as debt.
(ix) Whenever for the purposes of the Section it shall be necessary to value, in
terms of the currency of the Guarantor, debt payable in another currency, such
valuation shall be made on the basis of the prevailing lawful rate of exchange
at which such other currency is, at the time of such valuation, obtainable for
the purposes of servicing such debt, or, in the absence of such rate, on the
basis of a rate of exchange acceptable to ADB.
(x) The terms “operations” or operating” refer to the [identify relevant part of the
7.13. Model Capital Structure Covenants

(Version A: Historical orientation)
(see 3.6.3.3)
7.13.1.1. The following is an outline for a Debt Service Coverage covenant for use in
a loan agreement. It is intended as a guide only. It is the responsibility of the OGC to
wording for inclusion in the legal agreements. In cases of borrowers conducting multiple
operations, the text of the covenant should define which operations are to be subject to
performance measurement. As an example, in an electric power project to be carried out
by a borrower that operates electric power, water supply and telecommunications services,
the covenant normally would be drafter to apply only to the electric power operations.
Section ________.
(b) Except as ADB shall otherwise agree, the Borrower shall not incur any debt, unless
the net revenues of the Borrower for the twelve months prior to the date of such
incurrence shall be at least ____times the estimated maximum debt service
requirements of the Borrower for any succeeding fiscal year on all debt of the
Borrower, including the debt to be incurred.
(c) For the purposes of this Section:
(i) The term “debt” means any indebtedness of the Borrower maturing by its terms
(ii) Debt shall be deemed to be incurred: (a) under a loan contract or agreement
such guarantee has been entered into. Financial liabilities incurred by a
borrower who is a lessee under finance leasing agreements may also be included
as debt. The alternative definition of incurrence of debt, as illustrated in the
Debt-Equity Ratio Covenant should not be used for this form of debt limitation
covenant.
(iii) The term “net revenues” means the difference between:
(A) the sum of revenues from all sources related to operations, after making
adequate provisions for uncollectible debts, adjusted to take account of
the Borrower’s (rates) (prices) in effect at the time of the incurrence of
debt even though they were not in effect during the twelve-month period
to which such revenues relate and net non-operating income; and
(B) the sum of all expenses related to operations including administration,

adequate maintenance, taxes and payments in lieu of taxes, but excluding
provision for depreciation, other non-cash operating charges and interest
and other charges on debt.
(iv) The term “net non-operating income” means the difference between:
(A) revenues from all sources other than those related to operations; and
(B) expenses including taxes and payments in lieu of taxes, incurred in the
generation of revenues in (iv)(A) above.
(v) The term “debt service requirements” means the aggregate amount of
other charges on debt. Interest charges which are incurred in financing capital
expenditures during development should be excluded, if such charges are
capitalized. However, if the borrower’s policy is to meet the cost from operating
income, such interest charges should be included in “debt service
requirements”. Lease payments under finance leases should also be included
(vi) Whenever for the purposes of this Section it shall be necessary to value, in

(Version B: Forecast orientation) (see 3.6.3.3)
7.13.2.1. In cases of borrowers conducting multiple operations, the text of the covenant
should define which operations are to be subject to performance measurement. As an
example, in an electric power project to be carried out by a borrower that operated
electric power, water supply and telecommunications services, the covenant normally
would be drafted to apply only to the electric power operations.
Section_____.
(b) Except as ADB shall otherwise agree, the Borrower shall not incur any debt unless
a reasonable forecast of the revenues and expenditures of the Borrower shows that
the estimated net revenues of the Borrower for each fiscal year during the term of
the debt to be incurred shall be at least _____times the estimated debt service
requirements of the Borrower in such year on all debt of the Borrower including the
debt to be incurred and no event has occurred since the date of the forecast which
has, or may reasonably be expected in the future to have, a material adverse effect
on the financial condition of future operating results of the Borrower.
such guarantee has been entered into.36
(iii) The term “net revenues” means the difference between:
(A) the sum of revenues from all sources related to operations and net non-
operating income, after making adequate provisions for uncollectible
debts; and
36 The alternative definition of incurrence of debt, as illustrated in the Debt-Equity Ratio Covenant should
not be used for this form of debt limitation covenant.
(B) the sum of all expenses related to operations including administration,

adequate maintenance, taxes and payments in lieu of taxes, but excluding
provision for depreciation, other non-cash operating charges and interest
and other charges on debt. Lease payments under finance leases must
also be included.37
(iv) The term “net non-operating income” means the difference between:
(A) revenues from all sources other than those related to operations, and
generation of revenues in (iv)(a) above.
(v) The term “debt service requirements” means the aggregate amount of
other charges on debt.
(vi) The term “reasonable forecast” means a forecast prepared by the Borrower not
earlier than nine months prior to the incurrence of the debt in question, which
both ADB and the Borrower accept as reasonable and as to which ADB has
notified the Borrower of its acceptability.
(viii) Whenever for the purposes of this Section it shall be necessary to value, in
at which such other currency is at the time of such valuation obtainable for
7.13.3. Debt-Equity Ratio (see 3.6.3.4)
7.13.3.1. The following is an outline for a Debt-Equity Ratio covenant for use in a
37 Interest charges that are incurred in financing capital expenditures during development should be ex-
cluded, if such charges are capitalized. However, if the Borrower’s policy is to meet the cost from
operating income, such interest charges should be included in “debt service requirements.”
wording for inclusion in the legal agreements.
Section _______.
(b) Except as ADB shall otherwise agree, the Borrower shall not incur any debt, if after
the incurrence of such debt the ratio of debt to equity shall be greater than
_______to______.
(c) For purposes of this Section:
Subparagraph (ii): Option 1: General usage:
(ii) Debt shall be deemed to be incurred: (a) under a loan contract or agreement,
or conditional sale or transfer or financing lease agreement or other instrument
providing for such debt or for the modification of its terms of payment on the
date of such contract, agreement or instrument; and (b) under a guarantee
agreement, on the date the agreement providing for such guarantee has been
entered into. Financial liabilities incurred by a borrower who is a lessee under
finance leasing agreements may also be included as debt.
Subparagraph (ii): Option 2: Primarily intended for use with financial institutions:
terms of payment, on the date, and to the extent, the amount of such debt has
become outstanding pursuant to such contract, agreement or instrument; and
such guarantee has been entered into but only to the extent that the guaranteed
debt is outstanding. Lease payments under finance leases should also be
included.
(iii) The term “equity” means the sum of the total unimpaired paid-up capital,
retained earnings and reserves of the Borrower not allocated to cover specific
liabilities.
(iv) Whenever for purposes of this Section it shall be necessary to value, in terms
of the currency of the Guarantor, debt payable in another currency, such
at which such currency is, at the time of valuation, obtainable for the purposes
of servicing such debt, or, in the absence of such rate, on the basis of a rate
of exchange acceptable to ADB.
7.13.4. Capital Adequacy Ratio (see 3.6.3.6)
7.13.4.1. The following is an outline for a Capital Adequacy Ratio covenant for use
in a loan agreement. It is intended as a guide only. It is the responsibility of the OGC
to determine, in consultation with the mission leader and financial analyst, the precise
Section _____
(b) Except as ADB shall otherwise agree, the Borrower shall not make an advance to
a subborrower [including leasing of an asset], if after the making of any such advance
[or lease], the ratio of its equity to its assets-at-risk shall be greater than ____to____.
(c) For purposes of this Section,
(i) The term “equity” means the sum of the total of unimpaired paid-up capital,
retained earnings, and reserves of the borrower available to meet any losses
which may be incurred by non-recovery of assets, including provisions for
bad and doubtful debts and loan [and lease] losses at the date of making such
advance [lease] in (a) above;
(ii) The term “assets-at-risk” means the sum of the total impaired value of assets
at the date of making such advance [lease] in (b) above;
(iii) The term “impaired value of assets” in (ii) above means the value of each asset
of the borrower valued in accordance with sound and consistently maintained
7.14. Model Liquidity Covenants
7.14.1. Current Ratio (see 3.6.4.2)
7.14.1.1. The following is an outline for a Current Ratio covenant for use in a loan
Section _____.
(b) Except as ADB shall otherwise agree, the Borrower shall maintain a ratio of current
assets to current liabilities of not less than______.
meet the requirements set forth in paragraph (b) in respect of such year and the
next following fiscal year and shall furnish to ADB the results of such review upon
its completion
Paragraph (c): Option 1: Where the borrower or government has discretion to adjust
tariffs/rates:
requirements.
Paragraph (c): Option 2: Where there is an independent regulator in place (or where it
(i) The term “current assets” means cash, all assets, which could in the ordinary
course of business be converted into cash within twelve months, including
accounts receivable, marketable securities, inventories and prepaid expenses
properly chargeable to operating expenses within the next fiscal year.
(ii) The term “current liabilities” means all liabilities, which will become due and
service requirements, taxes and payments in lieu of taxes, and dividends.
(iii) The term “debt service requirements” means the aggregate amount of
(iv) Whenever for the purposes of this Section it shall be necessary to value, in
the purposes of servicing such debt, or, in the absence of such rate on the
(v) The terms “operations” or operating” refer to the [identify relevant part of the
7.14.2. Quick Ratio Covenant (see 3.6.4.3)
7.14.2.1. The following is an outline for a Quick Ratio covenant for use in a loan
Section _____.
(b) Except as ADB shall otherwise agree, the Borrower shall maintain a ratio of liquid
current assets to current liabilities of not less than______.
meet the requirements set forth in paragraph (b) in respect of such year and the
next following fiscal year and shall furnish to ADB the results of such review upon
its completion.
tariffs/rates:
forth in paragraph (b) for the Borrower’s fiscal years covered by such review, the Borrower
shall promptly take all necessary measures (including without limitation, adjustments
of the structure or levels of its rates (prices)) in order to meet such requirements.
(i) The term “liquid current assets” means cash, all assets, which could in the
ordinary course of business be converted into cash within twelve months,
including accounts receivable, marketable securities, and prepaid expenses
properly chargeable to operating expenses within the next fiscal year, but
excluding inventories.

service requirements, taxes and payments in lieu of taxes, and dividends.
other charges on debt.
the purposes of servicing such debt, or, in the absence of such rate on the
(v) The terms “operations” or operating” refer to the [identify relevant part of the
7.14.3. Dividend Limitation (see 3.6.4.4)
7.14.3.1. The following is an outline for a Dividend Limitation covenant for use in a
Section_______.
(b) Except as ADB shall otherwise agree, the Borrower shall not declare any dividend
or make any other distribution with respect to its share capital, unless after such
dividend has been paid or other distribution has been made, the current assets of
the Borrower would equal or exceed ___ times the current liabilities of the Borrower.
(i) The term “current assets” means cash, all assets, which could in the ordinary
course of business be converted into cash within twelve months, including
accounts receivable, marketable securities, inventories and prepaid expenses
properly chargeable to operating expenses within the next fiscal year.
service requirements, taxes and payments in lieu of taxes and dividends.
7.15. Commonly Used Ratios
7.15.1. Few of these ratios are appropriate for financial institutions (FIs). Appropriate
indicators for assessing FI performance are described in section 6.4.
7.15.1. Operating Indicators
Ratios or Other Measures Computation Method Significance and Notes
1. Rate of Return on Net Operating Income (a) x 100 Measures the productivity (yield) of
Net Fixed Assets Average of Net Fixed Assets in Service (b) Net (Depreciated) Fixed Assets in use.
in Service (a) Excluding government grants
(%) and subsidies
(b) These fixed assets may, or may not,
be subject to revaluations.
See section 3.6.2.2 for a legal
description and section 4.4.6.2 for a
discussion of applicability.
2. Self-Financing Cash from internal sources Also called Cash Generation Capability
Ratio (%) and Contribution to Expansion.
Average Annual Capital Expenditure* Measures the percentage of annual
capital investments financed from
available cash resources.
* Average Annual capital expenditures
may be derived from an average of
multiple years (e.g. one past, the present
year and one future year).
description and section 4.4.6.3 for
a discussion of applicability.
3. Operating Ratio Total Operating Expenses (including Measures the coverage of operating
(%) Depreciation and Taxes x 100 expenses by operating revenues.
Total Operating Revenues See section 3.6.2.5 for a legal
description and section 4.4.6.4 for a
discussion of applicability.
4. Number of times Operating Income (before interest on Measures the coverage of interest
interest earned long-term debt) charges particularly on long-term
(before income Annual Interest Expense on Long-term Debt debt before taxes.
taxes
5. Total Fixed Operating income, Interest, Lease Similar to interest coverage ratio
Charge Payments (before taxes and charges) except that it is expanded to cover
Coverage Annual Interest, Lease Charges and Other leases and other fixed charges.
Fixed Charges
6. Return on Net Income + Interest Expense Measures the productivity of assets

Total Assets Average Investment in Assets
7. Return on Net Income - Preference Dividends Indicates the earning power on

Common Average Common Stockholders’ Equity common stockholders equity.
Stockholder
Equity
8. Return on Net Income after Taxes + Tax-adjusted Interest A measure of the efficient
Capital Equity + Long-term Debt deployment of capital by the
Employed company.
9. Percentage Current Period Revenues – Previous Measures the increase in revenues

Growth in Period Revenues x 100 between two periods.
Revenues Previous Period Revenues
10. Percentage of Cost of Goods Sold x 100 Measures the gross margin for any
Revenues used Revenues period.
to meet Operating
(manufacturing)
Expenses
11. Gross Profit Revenues – Cost of Goods Sold Measures gross profit before inclusion
Margin Revenues of selling, warehousing, management
and administration costs.
12. Non-operating Selling, Warehousing, Management and Overhead expense element of Revenues.
(manufacturing) Administration costs x 100
Cost compared Revenues
to Sales
13. Profit element Net Profit Measures the profit element of sales.
of Revenues Total Revenues
14. Fixed Assets Revenues Measures the number of times fixed

Turnover Ratio Net Fixed Assets assets are turned over.
15. Inventory Cost of Goods Sold in period Measures the rate of movement in total
Turnover Average Inventory for Period inventory, that is, the number of times
the inventory is turned over.
16. Revenues to Revenues Measures efficiency of use of assets in

Total Assets generating sales.
17. Return on Net Profit Measures the rate of return on the

Equity Equity investment in the business.
7.15.2. Capital Adequacy Indicators
7.15.2.1. The indicators in the table below are suitable for assessing capital adequacy.
18. Debt Service Net Revenue [revenues – expenses Measures the number of times that debt
Coverage Ratio (excluding non-cash and service requirements are covered by
(Version A) interest charges)] available revenues.
(a) Revenues may be adjusted to take
Annual Debt Service (b) into account any change in tariffs/
charges in the year of measurement.
(b) Aggregate debt repayments
including principal and interest.
19. Debt Service Estimated Net Revenues [estimated Measures the extent to which forecast
Coverage Ratio revenues – estimated expenses cash flows are able to cover forecast debt
(Version B: (excluding non-cash and interest charges] service requirements.
Forecast Cash Estimated Debt Service Requirements See section 3.6.3.3 for a legal
Flows) (Principal + Interest payments) description and section 4.4.7.6 for
20. Debt: Equity Total Debt Measures the relationship between all
Ratio Equity borrowed funds and shareholders’
invested capital.
21. Long-Term Total Long-term Debt A capital adequacy measure.
Debt to Total Equity Measures the relationship of long-term
Equity Ratio debt to equity.
22. Long-Term Long-term Debt A capital structure measure.
Debt to Total Long-term Debt + Equity Measures the relationship of long-term
Capitalization debt to total capitalization.
23. Equity Ratio Total Stockholders’ Equity Shows the protection to creditors and
Total Shareholders’ Equity + Total Liabilities the extent of trading on the equity
(leverage).
7.15.3.1. The indicators in the table below are suitable for assessing liquidity
24. Current Ratio Current Assets Measures the short-run debt paying
Current Liabilities ability. Is highly dependant on the
quality and content of Current Assets.
25. Quick Ratio Cash + Marketable Securities + Accounts Measures short-term liquidity but does
(Acid Test) Receivable+ other Liquid Assets not depend on the realizing of
(excluding inventories) inventories.
Current Liabilities See section 3.6.4.3 for a legal
26. Days in Average Accounts Receivable x 360 days Measures the average number of days
Receivables Revenues required to recover accounts
receivable.
27. Accounts Receivable Net Revenues Measures the number of times that
Turnover Average Accounts Receivable receivables turn over in a year.
The higher the turnover, the shorter the
time between sales and collecting cash.
28. Days in Inventory Average Inventory Measures the average number of days
Cost of Goods Sold / 360 it will take to sell an inventory.
29. Inventory Turnover Cost of Goods Sold Number of times the inventory is turned
Average Inventory over in a period.
30. Days in Accounts Payable Average Accounts Payable Measures the average time span of
Cost of Goods Sold / 360 days unpaid payables.
31. Accounts Payable Cost of Goods Sold Measures the number of times Accounts
Turnover Average Accounts Payable Payable turnover during a period.
7.16. Model Financial Statements: Service Organization
7.16.1. The following model set of summary financial statements is appropriate for
use by a service-type organization. When using these financial statements, it is essential that:
• An appropriate Statement of Accounting Policies be developed and agreed between ADB
and the borrower (see section 5.2).
• Appropriate Notes to the Financial Statements supplement the financial statements.
• Where appropriate, the Financial Statements should be tailored so that they adequately
reflect the performance and position of the organization.
7.16.2. The format used for this particular model set of summary financial statements
is appropriate for forecasting (projecting) financial statements (for instance, during project
preparation) – the forecast period will be determined by the financial analyst (see section
3.4.1).
Example Service Organization

Forecast Income Statements
[Format for PPTA financial projections]
For the years ended 31 December
20X1 20X2 20X3 20X4 20X5 20X6 20X7
($000s) Notes Actual Actual Actual Actual Actual Forecast Forecast
Operating Revenues
Revenues from services 1 35,052 36,748 39,288 41,202 41,202 41,202 41,202
Investment income 1,157 1,073 1,126 1,243 1,243 1,243 1,243
Other operating revenue 317 332 279 269 269 269 269
36,526 38,153 40,693 42,714 42,714 42,714 42,714
Operating Expenses
Wages, salaries and employee benefits 12,960 13,363 13,975 14,504 14,504 14,504 14,504
Supplies and consumables used 4,022 4,285 4,582 4,687 4,687 4,687 4,687
Repairs and maintenance 1,000 1,000 1,000 1,000 1,000 1,000 1,000
Depreciation and amortization expenses 791 872 918 926 926 926 926
Other operating expenses 18,677 20,395 20,601 21,280 21,280 21,280 21,280
37,450 39,915 41,076 42,397 42,397 42,397 42,397
Surplus/(Deficit) from Operating Activities -924 -1,762 -383 317 317 317 317
Project-related interest income / (costs) 2,373 2,527 2,588 2,512 2,512 2,512 2,512
Other interest costs .. .. .. .. .. .. ..
Gains on sale of fixed assets .. .. .. .. .. .. ..
Total non-operating revenue / (expenses) 2,373 2,527 2,588 2,512 2,512 2,512 2,512
Surplus/(Deficit) from Ordinary Activities 1,449 765 2,205 2,829 2,829 2,829 2,829
Minority interest share of surplus/(deficit) .. .. .. .. .. .. ..

Net surplus/(deficit) before extraordinary items 1,449 765 2,205 2,829 2,829 2,829 2,829
Extraordinary items .. .. .. .. .. .. ..
Income tax expense .. .. .. .. .. .. ..
Net Surplus/(Deficit) for the Year after Tax 1,449 765 2,205 2,829 2,829 2,829 2,829

Forecast Balance Sheets
As at 31 December
20X1 20X2 20X3 20X4 20X5 20X6 20X7
Current Assets
Cash and cash equivalents 210 93 97 100 100 100 100

Marketable securities 10,440 11,279 9,929 9,473 9,473 9,473 9,473
Receivables 5,520 5,490 5,559 5,593 5,593 5,593 5,593
Inventories 274 329 348 379 379 379 379
Work in progress 3,995 4,768 5,519 6,032 6,032 6,032 6,032
Investments 338 341 954 2,210 2,210 2,210 2,210
20,777 22,300 22,406 23,787 23,787 23,787 23,787
Less: Current Liabilities
Payables and provisions 4,716 4,588 4,428 4,401 4,401 4,401 4,401
Short-term borrowings 2,236 2,413 2,413 2,413 2,413 2,413 2,413
Current portion of borrowings 7,208 7,648 7,533 7,528 7,528 7,528 7,528
Employee benefits 832 857 857 856 856 856 856
14,992 15,506 15,231 15,198 15,198 15,198 15,198
WORKING CAPITAL 5,785 6,794 7,175 8,589 8,589 8,589 8,589
Plus: Non-current Assets

Investments 14,392 15,204 16,102 16,930 16,930 16,930 16,930
Property, plan and equipment 25,252 25,861 25,787 25,851 25,851 25,851 25,851
Intangible assets 2 302 830 1,322 1,322 1,322 1,322
39,646 41,367 42,719 44,103 44,103 44,103 44,103
Less: Non-current Liabilities
Payables 524 510 492 489 489 489 489
Borrowings 28,833 30,591 30,131 30,113 30,113 30,113 30,113
Employee benefits 7,491 7,710 7,716 7,706 7,706 7,706 7,706
36,848 38,811 38,339 38,308 38,308 38,308 38,308
Net Assets 8,583 9,350 11,555 14,384 14,384 14,384 14,384
EQUITY
Issued and paid-up capital 1,000 1,000 1,000 1,000 1,000 1,000 1,000
Reserves 7,201 7,190 7,190 7,190 7,190 7,190 7,190
Accumulated surpluses/(deficits) 382 1,160 3,365 6,194 6,194 6,194 6,194
Total Equity 8,583 9,350 11,555 14,384 14,384 14,384 14,384

Forecast Cash Flow Statements
20X1 20X2 20X3 20X4 20X5 20X6 20X7
Receipts
Cash receipts from customers 34,793 36,603 39,177 41,118 41,118 41,118 41,118
Other receipts 341 265 289 279 279 279 279
Payments
Employees -12,615 -13,043 -13,428-13,917 -13,917 -13,917 -13,917

Suppliers -19,750 -20,920 -20,848-21,167 -21,167 -21,167 -21,167
Other payments -369 -490 -1,088 -1,684 -1,684 -1,684 -1,684
Net Cash Flows from Operating Activities 2 2,400 2,415 4,102 4,629 4,629 4,629 4,629
Receipts
Interest received 1,070 835 834 901 901 901 901

Sales of fixed assets 250 125 68 59 59 59 59
Sales of investments 1,983 57 1,071 244 244 244 244
Payments
Interest paid -2,507 -2,516 -2,561 -2,502 -2,502 -2,502 -2,502

Purchases of fixed assets -1,469 -2,459 -2,808 -3,181 -355 -355 -355
Purchases of investments -130 -55 -102 -98 -98 -98 -98
Net Cash Flows from Investing Activities -803 -4,013 -3,498 -4,577 -1,751 -1,751 -1,751
Receipts
Capital contributions from owners .. .. .. .. .. .. ..

Proceeds from new borrowings 275 1,477 353 56 56 56 56
Payments
Capital withdrawals .. .. .. .. .. .. ..
Repayment of borrowings -1,900 .. -953 -105 -105 -105 -105
Dividends paid .. .. .. .. -2,829 -2,829 -2,829
Net Cash Flows from Financing Activities -1,625 1,477 -600 -49 -2,878 -2,878 -2,878
Balances as at 1 January 230 210 93 97 100 100 100

Currency changes on opening balances 8 4 .. .. .. .. ..
Net increases/(decreases) for period -28 -121 4 3 .. .. ..
Balances as at 31 December 210 93 97 100 100 100 100

Notes to the Financial Statements
20X1 20X2 20X3 20X4 20X5 20X6 20X7
Note 1: Revenues by Service Type
Service Type A 376 353 379 387 387 387 387

Service Type B 34,035 35,748 38,274 40,195 40,195 40,195 40,195
Service Type C 641 647 635 620 620 620 620
35,052 36,748 39,288 41,202 41,202 41,202 41,202
Note 2: Reconciliation of Income Statement to Operating Cash Flows
Net Surplus/(Deficit) per Income Statement 1,449 765 2,205 2,829 .. .. ..

Unrealized net foreign exchange gains -66 -87 .. .. .. .. ..
Interest received -1,070 -835 -834 -901 .. .. ..
Interest paid 2,507 2,516 2,561 2,502 .. .. ..
Asset movements
Depreciation 791 872 918 926 .. .. ..
Gains/(losses) on sales of assets -7 3 .. .. .. .. ..

Movements in employee benefit liabilities -936 110 864 1,134 .. .. ..
Movements in working capital -286 -929 -1,612 -1,861
Net Cash Flows from Operations 2,400 2,415 4,102 4,629 .. .. ..
7.17. Model Financial Statements: Manufacturing Organization
7.17.1. The following model set of summary financial statements is appropriate for
use by a manufacturing organization. When using these financial statements, it is essential
that:
• An appropriate Statement of Accounting Policies be developed and agreed between ADB
and the borrower (see section 5.2)
• Appropriate Notes to the Financial Statements supplement the financial statements.
• Where appropriate, the Financial Statements should be tailored so that they adequately
reflect the performance and position of the organization.
7.17.2. The format used for this particular model set of summary financial statements
is appropriate for year-end reporting.
Example Manufacturing Organization

Income Statement
[Format for year-end reporting]
For the year ended 31 December 20X2
For the Year Ended 31 December 20X2 Cumulative Since Project Start-Date
Actual Forecast Variance Actual Forecast Variance
Notes $000s $000s $000s % $000s $000s $000s %
SALES 1 893,121 1,431,093 -537,972 -37.6% 1,976,522 2,173,098 -196,576 -9.0%
Less Cost of Goods Sold 2 813,673 1,296,081 482,408 37.2% 1,760,823 1,932,016 171,193 8.9%
GROSS PROFIT 79,448 135,012 -55,564 -41.2% 215,699 241,082 -25,383 -10.5%
Operating Costs
Administrative Salaries 27,326 37,742 10,416 27.6% 39,950 41,506 1,556 3.7%
Depreciation 3,917 7,335 3,418 46.6% 8,554 7,953 -601 -7.6%
Amortization 12,357 12,357 .. 0.0% 12,357 12,357 .. 0.0%
Administration Costs 56,037 88,259 32,222 36.5% 92,672 97,306 4,634 4.8%
Marketing Expenses 3,109 4,985 1,876 37.6% 6,904 7,596 692 9.1%
102,746 150,678 47,932 31.8% 160,437 166,718 6,281 3.8%
OPERATING PROFIT -23,298 -15,666 -7,632 48.7% 55,262 74,364 -19,102 -25.7%
Other income 1,000 1,080 -80 -7.4% 1,166 1,260 -94 -7.5%
Foreign exchange
gains/(losses) .. -1,570 1,570 -100.0% -1,564 -1,845 281 -15.2%
Net Income before Interest and Taxes -22,298 -16,156 -6,142 38.0% 54,864 73,779 -18,915 -25.6%
Project-related interest expenses -42,672 -63,657 20,985 -33.0% -52,343 -39,604 -12,739 32.2%
Other interest expenses .. .. .. 0.0% .. .. .. 0.0%
Income tax expense .. .. .. 0.0% .. -8,189 8,189 -100.0%
Net Income after Interest and Taxes -64,970 -79,813 14,843 -18.6% 2,521 25,986 -23,465 -90.3%
Gross Margin (% of Sales) 8.9% 9.4% -0.5% … 10.9% 11.1% -0.2% …

Operating Margin (% of Sales) -2.6% -1.1% -1.5% … 2.8% 3.4% -0.6% …

Balance Sheet
As at 31 December 20X2
Notes $000s $000s $000s % $000s $000s $000s %
Current Assets
Cash and bank 25,308 10,373 34,085 -62,165

Bills receivable 56,114 59,943 82,791 91,025
Accounts receivable 3 18,705 19,981 27,597 30,342
Inventories 4 365,150 402,058 427,488 455,796
Prepayments and other
current assets 120,193 120,193 120,193 120,193
585,470 612,548 692,154 635,191
Less: Current Liabilities
Accounts payable 93,174 103,203 140,826 156,768
Short-term debt 207,610 207,610 207,610 207,610
Notes and bills payable 5,000 5,000 5,000 5,000
Advances from customers 13,084 13,084 13,084 13,084
Accrued wages and salaries 184,427 184,427 184,427 184,427
Taxes payable 72,607 72,648 72,890 81,167
Accruals and other current
Liabilities 47,749 47,749 47,749 47,749
Current portion of term debt 3,000 13,578 28,824 71,070
626,651 647,299 700,410 766,875
WORKING CAPITAL -41,181 -34,751 -8,256 -131,684
Plus: Non-current Assets

Fixed assets 800,263 1,222,024 1,136,4821,056,928
Capital work in progress
(Assets under construction) 445,108 169,390 520,880 913,740
Intangibles and deferrals 49,426 37,069 24,712 12,355
Other non-current assets 30,572 15,572 .. ..
1,325,369 1,444,055 1,682,0741,983,023
Less: Non-current Liabilities
Term loans 443,700 621,349 554,132 670,517
Payables 7,646 7,646 7,646 7,646
Other non-current liabilities 49,250 49,250 49,250 49,250
500,596 678,245 611,028 727,413
NET ASSETS 783,592 731,059 1,062,790 1,123,926
EQUITY
Issued and paid-up capital 315,147 342,427 671,637 706,787

Accumulated surpluses/(deficits) 468,445 388,632 391,153 417,139
783,592 731,059 1,062,790 1,123,926
Current Ratio 0.93 0.95 0.99 0.83

Quick Ratio 0.16 0.14 0.21 0.08
Long-term Debt: Equity 0.64 0.93 0.57 0.65

Statement of Cash Flows
Notes $000s $000s $000s % $000s $000s $000s %
Receipts
Cash receipts from customers 915,146 1,448,537 -533,391 -36.8%1,972,0842,173,621 -201,537 -9.3%
Tax rebates 23,260 27,280 -4,020 -14.7% 30,990 35,150 -4,160 -11.8%
Other receipts 1,000 1,080 -80 -7.4% 1,166 1,260 -94 -7.5%
Payments
Employees and suppliers -896,292-1,387,934 491,642 -35.4%-1,811,168-2,019,189208,021 -10.3%

Taxes paid -5,942 -7,508 1,566 -20.9% -10,212 -11,414 1,202 -10.5%
Other payments .. 0.0% .. 0.0%
Net Cash Flows
from Operations 5 37,172 81,455 -44,283 -54.4% 182,860 179,428 3,432 1.9%
Receipts
Interest received .. .. .. 0.0% .. .. .. 0.0%

Sales of fixed assets .. .. .. 0.0% .. .. .. 0.0%
Sales of investments .. .. .. 0.0% .. .. .. 0.0%
Payments
Interest paid -28,482 -42,370 13,888 -32.8% -41,700 -39,604 -2,096 5.3%
Capital expenditures .. -219,390 219,390 -100.0% -351,490 -392,860 41,370 -10.5%
Purchases of investments .. 0.0% .. 0.0%
Net Cash Flows from
Investing Activities -28,482 -261,760 233,278 -89.1% -393,190 -432,464 39,274 -9.1%
Receipts
Capital contributions
from owners .. .. .. 0.0% .. .. .. 0.0%
Proceeds from new
borrowings .. 168,370 -168,370 -100.0% 247,620 185,610 62,010 33.4%
Payments
Repayment of borrowings -3,000 -3,000 .. 0.0% -13,578 -28,824 15,246 -52.9%

Dividends paid .. .. .. 0.0% .. .. .. 0.0%
Net Cash Flows from
Financing Activities -3,000 165,370 -168,370-101.8% 234,042 156,786 77,256 49.3%
Balances as at 1 January 19,618 25,308 10,373 34,085

Currency changes on opening
balances .. .. .. ..
Net increases/(decreases)
for period 5,690 -14,935 -20,625 -138.1% 23,712 -96,250 -119,962-124.6%
Balances as at 31 December 25,308 10,373 34,085 -62,165

$000s $000s $000s % $000s $000s $000s %
Note 1: Gross Margin by Product
Sales by Product:
Product A 240,318 284,659 -44,341 -15.6% 394,096 433,618 -39,522 -9.1%
Product B 230,868 258,132 -27,264 -10.6% 357,413 393,240 -35,827 -9.1%
Product C 262,416 586,880 -324,464 -55.3% 812,700 894,080 -81,380 -9.1%
Product D 149,919 287,022 -137,103 -47.8% 397,913 437,760 -39,847 -9.1%
Product E 9,600 14,400 -4,800 -33.3% 14,400 14,400 .. 0.0%
Total 893,121 1,431,093 -537,972 -37.6% 1,976,522 2,173,098 -196,576 -9.0%
Cost of Sales by Product:
Product A 203,418 311,059 107,641 34.6% 352,165 405,723 53,558 13.2%
Product B 203,418 336,981 133,563 39.6% 316,948 367,083 50,135 13.7%
Product C 260,375 414,746 154,371 37.2% 739,546 734,166 -5,380 -0.7%
Product D 138,324 220,334 82,010 37.2% 334,556 405,723 71,167 17.5%
Product E 8,138 12,961 4,823 37.2% 17,608 19,321 1,713 8.9%
Total 813,673 1,296,081 482,408 37.2% 1,760,823 1,932,016 171,193 8.9%
Gross Profit by Product ($’000):
Product A 36,900 -26,400 63,300 -239.8% 41,931 27,895 14,036 50.3%
Product B 27,450 -78,849 106,299 -134.8% 40,465 26,157 14,308 54.7%
Product C 2,041 172,134 -170,093 -98.8% 73,154 159,914 -86,760 -54.3%
Product D 11,595 66,688 -55,093 -82.6% 63,357 32,037 31,320 97.8%
Product E 1,462 1,439 23 1.6% -3,208 -4,921 1,713 -34.8%
Total 79,448 135,012 -55,564 -41.2% 215,699 241,082 -25,383 -10.5%
Gross Margin by Product ( % ):
Product A 15.4% -9.3% 24.6% … 10.6% 6.4% 4.2% …
Product B 11.9% -30.5% 42.4% … 11.3% 6.7% 4.7% …
Product C 0.8% 29.3% -28.6% … 9.0% 17.9% -8.9% …
Product D 7.7% 23.2% -15.5% … 15.9% 7.3% 8.6% …
Product E 15.2% 10.0% 5.2% … -22.3% -34.2% 11.9% …
Total 8.9% 9.4% 28.2% … 10.9% 11.1% 20.5% …
Note 2: Cost of Goods Sold
Raw Materials 424,751 690,624 265,873 38.5% 945,534 1,039,383 93,849 9.0%
Utilities 238,734 416,461 177,727 42.7% 592,612 679,561 86,949 12.8%
Direct Labor 79,639 121,775 42,136 34.6% 118,937 112,413 -6,524 -5.8%
Direct Depreciation 35,257 66,012 30,755 46.6% 76,988 71,601 -5,387 -7.5%
Other Variable Costs 22,750 38,117 15,367 40.3% 52,182 57,366 5,184 9.0%
801,131 1,332,989 531,858 39.9% 1,786,253 1,960,324 174,071 8.9%
Plus opening finished

goods 93,437 80,895 -12,542 -15.5% 117,803 143,233 25,430 17.8%
Less closing finished
goods -80,895 -117,803 -36,908 31.3% -143,233 -171,541 -28,308 16.5%
Cost of Goods Sold 813,673 1,296,081 482,408 37.2% 1,760,823 1,932,016 171,193 8.9%

For the Year Ended Cumulative Since Project

31 December 20X2 Start-Date
$000s $000s $000s % $000s $000s $000s %
Note 3: Receivables
By Organization Type:
Related parties 576 700 750 750
State-owned organizations 10,256 12,500 17,200 19,000
Other organizations 9,744 9,000 12,500 14,000
Gross Receivables 20,576 22,200 30,450 33,750
By Age
Less than 30 days old 10,000 11,000 15,000 19,000
30 to 60 days old 5,000 5,500 7,000 9,000
60 to 90 days old 2,500 2,500 5,000 4,000
90 to 180 days old 2,000 2,000 2,000 1,000
More than 180 days old 1,076 1,200 1,450 750
Gross Receivables 20,576 22,200 30,450 33,750
Less: Provision for Doubtful Debts -1,871 -2,219 -2,853 -3,408
Net Receivables per balance 18,705 19,981 27,597 30,342
Note 4: Inventories
By Age
Less than 2 months old 100,000 120,000 125,000 160,000
2 to 4 months old 80,000 90,000 95,000 150,000
4 to 6 months old 100,000 95,000 95,000 90,000
6 to 9 months old 60,000 60,000 70,000 40,000
9 to 12 months old 20,000 30,000 35,000 20,000
More than 12 months old 15,150 17,058 17,488 5,796
Gross Inventories 375,150 412,058 437,488 465,796
Less: Provision for Obsolete Inventories -10,000 -10,000 -10,000 -10,000
Net Inventories per balance sheet 365,150 402,058 427,488 455,796
Note 5: Reconciliation of Income Statement to Operating Cash Flows

Net Surplus/(Deficit) per Income Statement .. .. .. ..
Unrealized net foreign exchange gains .. .. .. ..
Interest revenues .. .. .. ..
Interest expenses .. .. .. ..
Asset movements
Depreciation .. .. .. ..
Gains/(losses) on sales of assets .. .. .. ..
Movements in employee benefit liabilities .. .. .. ..
Movements in working capital
Decrease/(increase) in receivables .. .. .. ..
Decrease/(increase) in inventories .. .. .. ..
Decrease/(increase) in work in progress .. .. .. ..
Increase/(decrease) in payables .. .. .. ..
Net Cash Flows from Operations .. .. .. ..
7.18. Model Terms of Reference for an Auditor
Summary of Contents
• Name of employing authority or entity
• Delivery of opinion and report
• Clear description of the entity for which the service is to be provided
• Clear description of the material and data to be provided for the audit and timing
of provision
• Scope and detail of the audit required
• Management Letter
• Statement of access available to the auditor
• Independence requirements
• Auditor and audit staff competence (Curriculum Vitae)
• Submission of Proposal and Work Plan by auditor
Detailed Contents of Terms of Reference
7.18.1. The name and address of the proposed contractors of the auditor’s services,
Email address, facsimile and telephone number(s) should be given. If the employer is
acting on behalf of, or is a constituent part of, a larger authority or entity, this should
be disclosed, to assist prospective auditors in determining their independence.
7.18.2. The auditor should be invited to submit a proposal for the delivery of an
opinion and report based on the scope and detail of the audit as set out in 7.18.5. The
proposal should be in respect of the annual financial statements specified in 7.18.4 of
the entity described in 7.18.3. A management letter containing an opinion of the auditor
on the financial management accounting and internal control systems of the entity, with
recommendations for any changes needed to improve performance within (specify) ___
(days) (weeks) (months) after the provision of the annual financial statements to the
auditor will also be provided. This section should specify whether the engagement is
for one or more fiscal years (or for a specific period). It is preferable that the period be
fixed to give the auditor an opportunity for a medium-term contract. This will enable
them to become familiar with the entity (e.g., three to four years), while the contract can
still be terminated at a fixed date to enable the employer to consider alternative auditors.
Also, the contract should allow for termination on grounds of inadequate performance,
but not on grounds of a qualified report or disclaimer.
7.18.3. A detailed description – both legal and generally informative – should be

provided to enable the auditor to understand fully the nature, location and objective of
the entity under audit. Any widespread geographic characteristics should be revealed,
together with: (i) Organization charts; (ii) Names of senior managers; (iii) Name and
qualification of the person(s) responsible for financial management, accounting and

internal audit; (iv) Name and address of any existing external auditor; (v) Computing
or other data processing facilities in use; (vi) A copy of the latest published financial
statements; and (vii) Internal facilities (if any) available to an external auditor (e.g., office
accommodation, calculators, computing).
7.18.4. The exact form of the annual financial statements and supporting
documentation that will be supplied to the auditor on which they are to give an opinion
and a report will be specified. The estimated time of the provision of these documents
to the auditor should be given (e.g., three months after the close of the fiscal year). The
annual financial statements must consist of a balance sheet, income statement and cash
flow statement for a revenue-earning entity accompanied by supplementary statements
or schedules supporting the basic statement (e.g., inventories, schedule of assets,
outstanding loans, aging of receivables, etc.). In a non-revenue earning entity, or for the
audit of project accounts, the annual financial statement may consist of the Statement
of Receipts and Payments only on project transactions. Other schedules of value or
cumulative work-in-progress, assets and inventories and a summarized reconciled bank
statement are to be attached.
7.18.5. The scope and detail of the audit should be given in sufficient detail to enable
an auditor to understand particularly if there are any requirements beyond those of a
“normal” or routine audit. Typical requirements could be:38
• The audit should be carried out in accordance with generally accepted auditing
standards, which include professional or general standards, standards of fieldwork
and reporting. The auditor should indicate the extent (if any) that an auditor would
not conform to those standards and indicate any alternative standards to which they
may (be required to) conform.
• The auditor should comment on the accounting principles adopted by the entity
under audit, particularly to confirm the extent that generally accepted accounting
principles have been and are being consistently applied. The adoption of other
principles and their effect on the annual financial statements should be indicated.
In particular, the auditor should show the impact on the financial statements arising
from deviations from international accounting standards issued by the International
Accounting Standards Committee. They should be required to comment on the
basis of accounting changes, either during a fiscal year, or from one year to another.
• The auditor should provide a confirmation, or otherwise, of the borrower’s compliance
with covenants in the loan agreement and with ADB’s specific requirements with
respect to the financial management of the EA.
38
• The auditors should be required to plan and conduct their work on the basis of
a sufficient audit program that will cover the entity’s activities and enable them to
express an opinion and furnish the reports they are tasked to provide.
• In devising the audit program, the auditor should be required to take into
consideration not only the nature and scale of the expenditure and income operations,
but also the scale, effectiveness and reliability of the accounting and administrative
procedures. Also, the financial and administrative internal controls and checks
should be considered. Systems of internal controls and checks, including internal
audit, should be reviewed and evaluated. This process will determine the degree
of reliance that can be placed upon the existing arrangements, and the extent of
testing that needs to be performed by the auditor.
• The auditor’s activities should include dialogue with independent board members.
Among other things, the dialogue should cover the adequacy of bad-debt provisions,
contingent liabilities, related-party transactions, internal control systems,
management and board reporting, and management systems, integrity and capability.
• The auditor should be required to appraise the procedures for:
o Safeguarding assets between operating, custodial, accounting and internal audit
duties, and assurance that such duties and responsibilities are clearly defined
and that sufficient staff are available to perform the function accurately and
efficiently.
o Ensuring that assets and resources are used in accordance with instructions
or regulations in the most effective and economical manner.
o Ensuring that all transactions are accounted for accurately and properly.
o Compilation and certification of Statements of Expenditures (where used for
loan disbursements).
o Any other matter required by ADB to assure satisfactory financial management
of the project (and EA).
• The auditors should satisfy themselves as to the fairness and accuracy of the financial
statements and the supplementary statements provided by obtaining sufficient
supporting evidence through the examination of accounting records and supporting
corroborative material, direct physical inspection, general observation, inquiry and
confirmations, including:
o A verification to ascertain that all assets and liabilities are properly recorded,
and that holdings, in particular, inventory and stock accounts, have been
verified by physical inspections and counts, when feasible.
o Ensuring that expenditures are in accord with budgetary provision, and that
the appropriate regulations and directives have been observed.
o Tests of calculations, e.g. payrolls; check of disbursement percentages in claims
for withdrawals of ADB loans.
o Verification of systems of commitments and payments to confirm entitlements
and actual discharges by creditors, and/or receipts to ascertain that all dues
have been received, or amounts receivable properly brought to account; these

verifications should include obtaining certificates or other forms of confirmation
from debtors and creditors.
o A verification of securities and moneys recorded in the books as being on
deposit through certificates issued by the depositories, including appropriate
reconciliations.
o Verification of efficacy of data processing.
o The verification of the financial statements against the entries in the main
books of account, supplemented by tests of the latter with subsidiary books,
records and vouchers, contracts, purchase orders and other original documents.
o The auditor should be required to verify Statements of Expenditure (SOE) or
copies thereof, where these are used, against the records of prime entry (e.g.,
operating expenses accounts, inventories records and job cards), supplemented
by tests against both initial documentation (e.g., invoices, salary sheets with
receipts) and physical inspection of work done, or goods and services acquired;
• To the extent not addressed in a Management Letter, the auditor should be required
to conduct a review and provide a report on the following:
o Efficiency and economy in the use of resources.
o Determination of whether planned results of a project are being achieved.
o Compliance, or otherwise, with financial and other performance covenants
and other obligations of the borrower and the EA as specified by ADB and the
extent of actual compliance or noncompliance of each covenant and obligation
by reference to performance criteria agreed with ADB.
o Defined areas of systems (e.g., improvements in accounting and data processing
operations which may be under development) on which the auditor’s comments
are necessary to ensure accuracy, efficiency and provision of adequate audit
trails.
o Any other activities on which an auditor may usefully report.
• The foregoing list is not exhaustive, nor should all matters be addressed in every
project. The scope and detail of an audit are likely to be unique for each project
or project entity.
7.18.6. A Management Letter.
7.18.7. The auditor should be informed in a clearly worded statement that they
have full and complete access at any time to all records and documents, including books
of account, legal agreements, bank records and invoices. Also the auditor will be provided
with full cooperation by all employees of the entity whose activities involve, or may be
reflected in, the annual financial statements. The auditor should be advised on their
rights of access to banks and depositories, consultants, contractors and other persons or
firms hired by the employer. In the event that an auditor may not have unrestricted
access to any person or location during the course of an audit, this restriction should
be defined in the terms of reference.
7.18.8. The auditors should be informed of the need for their impartiality and
independence from any aspects of management or financial interest in the entity under
audit. In particular, the auditor should be independent of the control of entity. The
auditor should not, during the period covered by the audit, be employed by, or serve as
director for, or have any financial or close business relationship with the entity, except
as an independent professional adviser. The auditor should not have any close personal
relationship with any senior participant in the management of the entity. It may be
appropriate to remind an auditor of any existing statutory requirements relating to
independence and to require auditors to disclose any relationship likely to compromise
their independence.
7.18.9. The auditor should be authorized to practice in the country and be capable
of using procedures and methods that conform to generally accepted auditing practices
of the country. The auditor should have adequate staff, with appropriate professional
qualifications and suitable experience, including experience in auditing the accounts of
entities comparable in nature, size and complexity to the entity whose audit they are to
undertake.
• Curriculum vitae (CVs) should be provided to the client by the principals of the
firm of auditors who would be responsible for providing the opinions and reports,
together with the CVs of managers, supervisors and key personnel likely to be
involved in the audit work.
• It may be appropriate to indicate desirable minimum professional qualifications
considered necessary for the higher levels of auditors to be responsible for the work
(e.g. certified public accountant).
• CVs should include details on audits carried out by these staff, including ongoing
assignments. The principal objective of the foregoing is to satisfy the employer that
an auditor has the capability and capacity to execute the audit.
• The auditor may have not only a contractual obligation but also a statutory obligation
to conduct a satisfactory audit, and it may not be necessary to insist on the employer
being notified every time the auditor substitutes a staff member. Nevertheless, this
precaution may be invoked.
7.18.10. The auditor should be asked to provide a proposal and a work plan that
among other things, should address:
• Whether the audit would be conducted as a completed audit (i.e., will the auditors
carry out their audit after the close of the fiscal year, when the books of account are,
or are being, closed).
• Whether an audit carried out after the close of a fiscal year would be supplemented
by one or more interim audits during a fiscal year. The principal purpose is to test
ongoing systems and internal controls, and to relieve pressure on the staff of the
entity and on the auditor at year-end.
• The manner in which the auditor proposes to address any statutory requirements
relating to audit (e.g., certifications relating to shareholders’ equity required under
the companies’ act) or to which they may be implicitly bound by contractual
obligations of the employer (e.g., ADB auditing requirements, Statements of
Expenditure, Imprest Accounts).
• Procedural requirements for certain verification procedures (e.g., checking of stocks,
inventories, assets, etc.).
• Specific actions required on the part of the employer (e.g., access to EDP, disclosures).
• Discussions before signing the opinion and report on any matters arising from the
audit, and with whom these discussions would be held.
• Special audits (e.g., review of portfolio and securities).
• Timetable for provision of opinions and reports.
7.19. Audit Report Questionnaire
7.19.1. Using the Audit Report Questionnaire
7.19.1.1. This questionnaire is provided only as an example of the nature and type
of questions that should be considered when reviewing the report of an auditor. Financial
analysts should have regard to the nature of the organization under audit and frame their
questions accordingly.
7.19.1.2. Agencies operate in a wide range of sectors and activities, and therefore the
form and nature of their financial statements will vary equally widely.
7.19.1.3. Further, approaches to, and the quality of auditing is variable. Therefore,
the questions set out below should be regarded with some caution, because these may
not have sufficient breath or depth for some institutional statements and audits. Conversely,
these may also be considered too extensive for some EAs, their activities and the audit
services available.
7.19.1.4. Nevertheless, by using this checklist, or a suitably modified version thereof

to reflect the nature and form of the EA concerned, a financial analyst should be able
to obtain a reasonable view of the acceptability of the financial statements concerned and
the audit thereof. To the extent possible each question should be answered by either
“YES”, or “NO”, or N/A (Not applicable).
7.19.2 Authenticity, Form, and Timeliness
Yes No N/A Ref Remarks
(1) Are the audited annual project financial statements and, where q q q
applicable, the EA’s audited annual financial statements signed by
the entity’s management?
(2) Is the audit report signed by the auditor? q q q
(3) Is the opinion on the auditor’s letterhead? q q q
(4) Is the report bound and pages consecutively numbered? q q q
(5) Was the report received within a reasonable time after signing? q q q
(6) Was the report received within period covenanted q q q
(refer to the loan agreement)?
(7) Is there a copy of a Management Letter? q q q
(8) Where appropriate, do the annual financial statements q q q
include reported data for the previous accounting period
to enable comparisons to be made, particularly closing balances
which should represent opening balances for the fiscal year
under audit, and illustrate increases and decreases,
where applicable?
7.19.3. Audit Opinion

(1) Was the examination asserted to be made in accordance q q q

with generally accepted auditing standards?
(2) Were generally accepted accounting principles applied on q q q
a basis consistent with that of the preceding year?
(3) Is a precise and “clear” opinion provided on: (i) Financial q q q
position, (ii) Results of operation, and (iii) Cash flows?
(4) Does the paragraph on the scope of the audit cover q q q
examination of the: (i) Balance Sheet (ii) Income Statement,
and (iii) Cash Flow Statement?
(5) Are supplementary data stated fairly in all material respects, q q q
when considered in conjunction with the financial
statements taken as a whole?
(6) Does the report address the auditor’s objectives under the q q q
loan agreement (i.e., utilization of loan funds, compliance
with specific covenants, use of imprest funds, statement
of expenditure procedures, conformity with ADB’s
Procurement Guidelines)?
(7) Does it appear that the supplementary statements form q q q
part of the accounts? Are they covered by the
auditor’s certificate?
(8) Is the auditor’s opinion unqualified? q q q
7.19.4. Matters Addressed

(1) Balance Sheet Fixed Assets
(a) Is the categorization and analysis of assets representative q q q

of the entity’s interests and activities (e.g., land,
buildings, equipment, machinery, vehicles)?
(b) Are fixed assets under construction shown separately q q q
(Does the line item include the project)?
(c) Is there a schedule attached of gross fixed assets, q q q
accumulated depreciation provision and net fixed
assets: (i) in operation; (ii) not in operation;
(iii) with data on changes in asset holdings in year,
including (a) sales, (b) revaluations, and basis for it,
and (c) changes in depreciation provision?
(d) Is accumulated depreciation shown with depreciation q q q
rates and bases of calculation in supporting schedules?
(e) Are disclosures made of assets: (i) leased out, q q q
and (ii) pledged?
(f) In cases of revaluation of fixed assets and/or q q q
restatements of foreign long-term debt, is sufficient
information provided to reconstruct both sides of
the revaluation entries?
(2) Balance Sheet Current Assets
(a) Is the total of current assets revealed? q q q

(b) Is there an adequate analysis of current assets (e.g., prepaid q q q
expenses, deposits on contracts, receivables, inventories,
marketable securities, short-term bank deposits, cash at bank,
and cash on hand)?
(c) Are receivables adequately analyzed, aged and classified q q q
between key classes of debtors?
(d) Do marketable securities exclude medium-/long-term investments? q q q
(e) Is a bad and doubtful debt allowance indicated (Have actual q q q
bad debts been written off)? For financial institutions, is the
provisioning policy in compliance with prudential guidelines)?
(f) Is there a suitable inventory analysis including: (i) manufacturers’ q q q
products for sale, (ii) materials and goods for incorporation,
(iii) materials in manufacturing progress, (iii) materials and
goods for maintenance, and (iv) work-in-process? Are the
valuation bases described for each? Are the inventory policies
and practices consistent from year to year?
(3) Balance Sheet Investments and other Assets
(a) Are investments detailed in supporting schedules, q q q

with bases of valuation, revaluation, losses and yields?
(b) Are deferred charges and pre-operating expenses shown q q q
with amortization rates and accumulated amortization,
where appropriate?
(c) For Other Assets, are goodwill or intangibles shown, q q q
with valuation bases? (Are “Other assets” substantial,
and if so, is there an analysis in the Notes to the
Financial Statements)
(4) Balance Sheet Investments and other Assets
(a) Is there an adequate analysis of equity (e.g., authorized capital; q q q

paid-in capital; share premiums; shares outstanding;
government or other public authority contributions;
surpluses from appropriated earnings, unappropriated
earnings, and revaluations)?
(b) Is there a statement of shareholders equity? q q q
(5) Balance Sheet Long-term Debt
(a) Are current maturities excluded and shown under q q q

current liabilities?
(b) Are all amounts due and payable but not repaid to q q q
lenders disclosed?
(c) Is there a comprehensive schedule of long-term debt, q q q
showing, among other things, for each outstanding loan:
(i) original amount borrowed; (ii) interest rate, grace
and repayment period and other relevant terms,
(e.g., secured debt); (iii) currency in which debt is
repayable and conversion rates, if applicable, at date
of borrowing and current; (iv) gross amount outstanding
and effective currency conversion, if applicable; (v) long-term
debt transactions during year; (vi) current maturities; and
(vii) maturities due and payable, but not paid?
(6) Balance Sheet Current Liabilities
(a) Is total of current liabilities shown and suitably analyzed q q q

(e.g., current maturities of long-term debt, short-term
borrowings, consumer deposits, taxes due, dividends due,
accounts payable, accrued and other liabilities)?
(7) Balance Sheet Other Liabilities
(a) Are relevant other liabilities adequately described and q q q

analyzed, including such matters as: pensions
and other employee benefits, and deferred Taxation?
(b) Are the analysis of the foregoing and the format of the q q q
balance sheet items in accordance with sound accounting
practices?
(c) Are contingent liabilities and pledges disclosed? q q q
(d) Are reserve funds (e.g., pension funds) adequately classified, q q q
explained and legally utilized and provided for?
(e) Are suspense accounts fully explained? q q q
(f) Is there an adequate description of verification procedures q q q
for fixed and movable assets and inventories?
(g) Is a statement of adequacy of insurance required? q q q
(h) Is there an analysis in Notes to the Financial Statements q q q
of “Other Liabilities” where the amount is substantial?
(8) Income Statement
(a) Does the construction of the revenue, expenditure and q q q

other key items of this statement and supporting data
provide satisfactory financial evidence of the results of
activities conducted by the entity?
(b) Does the statement provide statistical data on (i) sales q q q

or other performance; (ii) manufacturing costs; (iii) sales
costs; (iv) operating costs; (v) maintenance costs;
(vi) administration costs; (vii) depreciation;
(viii) non-operating income (analyzed);
(ix) amortization of deferred charges?
(c) Are unusual items clearly shown (e.g., exchange gains or q q q
losses; profit or losses on sale of assets; and profits
or losses from adjustments made to reflect changing
prices and/or inflation)?
(d) Does the statement include any items relating to other q q q
fiscal years (e.g., prior-year adjustments), and are these
separated from the current year?
(e) Is the net income relating to the fiscal year’s operations q q q
clearly demonstrated before inclusion of other items,
as in (c) and (d) above?
(f) Is the allocation of Net Income clearly demonstrated? q q q
(g) Does the opinion cover this statement? q q q
(9) Cash Flow Statement
(a) Does the statement provide a clear description of q q q

operating, investing and financing cash flows?
(b) Do the transactions shown tie back to the q q q
Balance Sheet and Income Statement with
the appropriate reconciliations?
(c) Does the opinion cover this statement? q q q
7.19.5. Auditors Opinion and Report
(1) Where the audit opinion is qualified, is there sufficient q q q

information to quantify the effects of qualification on the:
Balance Sheet Income Statement and Cash Flow Statement?
(2) Does the audit report contain an opinion on whether the q q q
entity/ borrower is complying with/ breaching any ADB
covenants or other legal agreements? For instance:
• Utilization of loan proceeds (e.g., diversion of ADB funds,
utilization for aspects where counterpart funds should
have been used, etc).
• Project implementation (delays, bottlenecks, procedural
procurement lapses).
• Statement of Expenditures (splitting of payments
to avoid SOE ceiling, amount inadmissible).
• Imprest Fund (used for aspects meant for
counterpart funds).
• Agreed upon matters between ADB and Borrower
that require special attention.
• For revenue-earning EAs/Borrower (significant
changes in financial statement balances between
financial years, significant bad debts, unrecorded
liabilities, etc).
(3) Did the audit examine the efficiency of systems of q q q

internal control? If so, does the audit report disclose
any material deficiencies or weaknesses in the
accounting system or overall system of internal control?
(4) Does the audit report confirm, or otherwise, that q q q
financial management systems employed by the EA
conformity with ADB requirements in the
loan agreement?
7.19.6. Conclusion and Further Action (if any)

Remarks
(1) Have the audit findings/recommendations of previous years

been resolved satisfactorily by the EA (Please list separately
all outstanding audit findings and recommendations as of
the end of the previous year, and indicate on each finding
whether or not it has been resolved by the EA during the
current review period).
(2) Have you reviewed the questions marked as “No” in the
checklist filled out by the external auditors? If so, are there
any material aspects that need to be pursued further?
(3) Indicate conclusion reached by reviewer
(4) Indicate any follow-up action needed immediately
or during the next mission.
Prepared by: Endorsed by: Approved by:
Notes: In the case of revenue-earning EAs, the Project Officer will continue to make use of the financial
statement in the manner currently used, which may include computations of ratios.
The above questionnaire is meant to serve as a guide for regional divisions. It may be modified to
suit specific needs.
A
Accounting Basis
• Accrual 5.2.3.5.2, 5.3.3.2, 5.3.3.4
• Cash 5.3.3.2, 5.3.3.5, 5.3.3.11, 5.4.3.7, 5.6.2.8
Accounting Policies 2.4.3, 2.7.1, 4.2.8.4, 5.2.1.3, 5.2.3.2, 5.2.3.5,
5.3.2.3, 5.6.1.4, 7.4.1
Accounting Systems 3.7.3.5.1, 4.2.6.1.8, 4.2.6.2.4, 4.2.8.1.7, 4.2.8.6,
4.2.9.2, 4.2.9.3, 4.2.9.6.6, 5.3.1.2
Action Plans 3.7.3.6.5, 5.2.3.2.6
ADB
• Asian Development Fund (ADF) 2.2, 3.4.3.1.1, 4.2.4.4.4, 4.3.4.10.4
• Disbursement Handbook 4.2.9.8.4, 5.4.3.2
• Guidelines on Operational 2.7.1, 2.8.1, 5.3.1.1
Procedures GP 43
• Japan Special Fund (JSF) 2.2.1
• Operations Manual
• Ordinary Capital Resources (OCR) 2.2.1
• Procurement Handbook 5.4.3.2, 7.7.1.2.2, 7.8.1.2.3, 7.9.1.2.2, 7.10.1.2.3
ADB Reports
• Back to Office Report (BTOR) 3.4.4.2.6, 3.4.4.3.4, 4.4.5.3.3, 5.4.9.7
• Project Completion Report (PCR) 2.11.1, 3.7.4.2
• Project Preparation 2.6.3, 3.7.2
• RRP 2.7.1, 3.4.3.3.1, 3.4.4.1.3, 3.4.4.3.4, 3.5.2.2.2,
3.7.2.4, 3.7.3, 4.2.9.5.4, 4.3.4.10.3, 5.3.1.4,
7.9.1.9.5
• Supervision 2.10.1, 4.3.3.5.1, 6.3.4.5.3
Annual Net Cash Flows 2.7.1, 3.4.7
Anti-corruption 4.2.3.6
Appraisal Checklist 1.4.3, 3.1.2, 3.3, 6.5.1, 7.10
Asset Revaluation 4.4.5.8, 7.9.1.7.3
Assumptions 1.5.2, 3.4.3.6, 3.4.4.3.4, 4.3.4.7.2, 4.3.7
Auditing Standards 5.4
2 of 8 Index
Auditors
• Auditing Procedures 5.4.3,
• Government Auditors 4.2.9.7.2, 5.4.10, 5.5.4
• Management Letters 5.4.5.2, 5.4.6.3 , 5.4.7.3, 5.6.10
• Opinion on Compliance with 5.6.5
ADB Requirements
• Opinions 5.6.2
• Model Opinions 5.6.3
• Selection and Appointment 5.4.4, 5.4.5, 5.4.6, 5.4.8
• Terms of Reference 5.4.7, 7.18
• Using Technical Experts 5.6.8
C
Capital Adequacy 3.6.3.6, 4.4.5.1.6, 4.4.5.5.1, 4.4.5.10, 4.4.7.9,
6.4.3.1, 6.6.2.2, 7.13.4, 7.15.2
Cofinancing 2.2.5, 3.4.6.3, 4.2.6.3.12
Contingencies 3.4.4, 6.6.2.2
• Physical Contingencies 3.4.4.2
• Price Contingencies 3.4.4.3
• Risk Contingencies 3.4.4.4
Cost Estimates 3.4.3, 3.4.6.3, 3.4.7.3, 4.3.4.10.1, 4.3.6.1.6, 7.6.2
• Base Cost Estimate 3.4.3.8, 3.4.3.3, 3.4.4.1.2, 3.4.4.3.8, 3.4.5.5
• Foreign Costs 3.4.3.2, 7.7.1.5.6, 7.8.1.5.7, 7.9.1.5.7
• Local Costs 3.4.3.1, 3.4.3.3, 7.7.1.5.4, 7.8.1.5.1, 7.9.1.5.1,
7.10.1.5.1
Cost Recovery Systems 3.7.3.4, 3.7.3.6.7, 4.3.3.1, 4.3.3.2, 4.3.3.3, 4.3.3.4
COSTAB Model 3.4.2, 7.7.1.5.3
Country Diagnostic Study of 2.6.3, 4.2.5, 5.2.3.1.1, 7.8.1.1.2
Accounting and Auditing (DSAA)
D
Disbursement Profiles 3.4.5, 7.8.1.5.8, 7.9.1.5.8
Discount Rate 3.5.2, 7.11.2.2, 7.11.4.5
Index 3 of 8
E
Executing Agency (EA) 3.7.3.1.1, 4.2.6.3, 4.2.9.1.1, 4.2.9.4
• Appraising an Executing Agency 4.2.6.3
• Determining the Status and Roles 4.2.6.2
of EAs
F
Financial Analysis 1.3.1, 3.4.7.3, 3.5.4.7, 3.7.3.4.2, 3.7.3.6.2,
3.7.4.1.4, 4.3, 4.4.5.2.1, 7.6.6, 7.7.1.2.2
Financial Analyst 1.3.4, 2.4.3, 2.6.3, 3.1.2, 3.4.1.3, 3.4.3.6,
3.4.4.3.5, 3.6.1.7, 3.7.1.1, 3.7.2.2, 4.1.2, 4.1.4,
4.2.1.4, 4.2.4.2, 4.2.7.6, 4.4.5.1.4, 4.4.5.11.1,
5.2.3.1.1, 5.2.3.3.1, 6.4.4.6.1, 7.6.1, 7.11.2.2,
7.19.1.1
Financial Charges During 3.4.2.1, 3.4.3.4, 3.4.7.3
Development (FCDD)
Financial Institutions (FIs) 1.3.3, 1.4.6, 2.4.1, 2.4.4, 2.6, 3.3.4, 3.6.3.1.2,
3.6.3.6, 4.1.4, 4.4.7.6.2, 4.4.7.9.1, 6.1, 6.2, 6.3,
6.6.2.1, 7.10
• ADB Policy
• Directed-Credit Programs 6.2.4
• Interest Rate Distortions 6.2.3
• Subsidies 6.2.5
• Appraisal 6.3.4
• Appraisal Checklist 6.5, 7.10
• Assessing FI Performance 6.4
• CAMEL Framework 6.4.3, 6.4.5
• Capital Adequacy Ratio (CAR) 3.6.3.6, 4.4.5.10, 4.4.7.9, 6.4.3.1, 6.6.2.2, 7.13.4,
7.15.2
• Credit Ratings 6.4.5
• Financial Reporting Issues 6.6.2
• General Operational Issues 6.2.1
• Internal Controls 6.4.6
• Policy Framework for FIs and 6.2.2
FI Loans
• Reviewing Financial Management 6.2
• Role of Regulators 6.4.4.6
• Value at Risk (VaR) 6.4.4.2, 6.6.3.3, 7.10.1.6.17
4 of 8 Index
Financial Internal Rate of Return 3.5.2.1.1, 3.5.3, 4.3.5.2.6, 7.8.1.8.1, 7.9.1.9.1,

(FIRR) 7.11.2, 7.11.2.3, 7.11.4.5
Financial Management 1.3.6, 4.1, 4.2.8.7, 4.2.9.2, 5.3.4.1, 5.4.6.6,
5.6.10.3, 7.7.1.4, 7.8.1.4, 7.9.1.4,
Financial Management Guidelines
• Handbook for Borrowers 1.1.3, 5.4.6.6, 7.7.1.2.2, 7.8.1.2.3, 7.9.1.2.2,
7.10.1.2.3
• Objectives 1.3
• Rationale 1.2
• Updating Process 1.6
Financial Net Present Value (FNPV) 3.5.3, 3.5.4, 7.11
Financial Opportunity Cost of 3.5.2.1, 3.5.4.2
Capital (FOCC)
Financial Policies 1.2.1, 2.4.2, 2.6.3, 4.2.1.1, 4.2.4, 4.2.7.4,
4.2.8.1.7, 4.4.5.10.6, 5.2.1.3, 5.2.3.1.2, 5.3.3.3
Financial Regulations 4.2.8.5, 4.2.8.9, 4.2.9.3.1
Financial Reports
• Balance Sheets 3.6.3.2.1, 3.7.3.2.1, 3.7.3.6.3, 4.3.4.1.2, 4.3.4.7,
4.3.6.5.1, 5.3.3, 5.3.7.1, 5.3.7.7, 7.17.2, 7.19
• Cash Flow Statements 3.4.3.4.2, 3.4.6.3, 3.7.3.6.2, 4.3.4.6, 4.3.4.9.1,
4.3.4.10.1, 6.6.2.2, 7.8.1.6.9, 7.10.1.6.16, 7.16.2,
7.18.4, 7.19
• Designing Financial Reports 5.3.9, 5.3.10
• Fiscal Period Coverage 4.3.5.2, 4.3.5.3
• Imprest Account Statements 4.2.9.8.4, 5.3.2.5, 5.3.3, 5.4.3.10, 5.6.9
• Income Statements 4.3.4.5, 4.3.6.5.1, 5.3.3.3, 5.3.3.11, 5.3.7.5, 5.3.8,
7.16.2, 7.17.2, 7.19.4
• Notes to the Financial Statements 5.2.3.1.2, 5.2.3.5.2, 5.3.2.7, 5.3.3, 5.3.9.1,
5.6.2.6, 5.6.2.9, 5.6.8.3, 7.16.1
• Reviewing Financial Reports 5.5
• Statement of Accounting Policies 5.2.3.3, 7.16.1, 7.17.1
• Statements of Expenditures (SOE) 3.4.3.1.7, 3.4.3.6.5, 4.2.8.6.4, 5.3.3.3, 5.3.3.10,
5.4.3.9, 5.6.9
• Statements of Expenses 5.3.3.3, 5.3.3.6, 5.3.3.15, 5.3.6.2
(or Cash Payments)
• Statements of Income 5.3.3.3, 5.3.3.5, 5.3.3.15, 5.3.6.2
(or Cash Receipts)
Index 5 of 8
Financial Viability and Sustainability 3.5, 3.6.1.2, 3.6.2.1.4, 3.6.2.6.1, 3.6.3.1.5,4.2.1.5,

4.2.4.1.2, 4.2.7.2, 4.3.1.2, 4.3.2.2.2, 4.3.3.1.5,
4.4.5.1.1, 4.4.5.3.1, 4.4.5.4
Financing Plans 3.4.2.1, 3.4.6, 3.4.7.5, 3.5.2.2.2, 3.6.2.3.3,
3.7.3.1.1, 3.7.3.6.1, 3.7.3.6.2, 4.3.4.3.1, 4.3.4.6.3,
4.3.6.2.1, 4.3.4.10, 7.6.3, 7.9.1.8
Forecasting 3.1.2, 3.4, 3.5.1.4, 3.7.4.1.4, 4.1.1, 4.3.4.4,
4.3.5.1.1, 4.3.6, 4.3.7, 7.16.2
• Assumptions 3.4.3.6, 3.4.4.3.4, 3.5.1.4, 3.7.3.6.5, 4.3.4.7.2,
4.3.6.1.6, 4.3.7
• Constant Prices 4.3.6.3
• Current Prices 3.4.4.4.1, 4.3.6.1.1, 4.3.6.1.5, 4.3.6.2.1
• Real Prices 4.3.6.2
G
Governance 1.2.1, 4.2.1.5, 4.2.3
Government Accounting 4.2.9.3, 4.2.9.6.5
I
Implementing Agency (IA) 1.4.8, 2.4.4, 4.1.6, 4.2.6, 4.2.8.8.4, 5.2.3.1.2,
5.2.3.4.1, 5.3.1.5, 5.3.3.1, 5.3.3.3,
Institutions and Systems 4.2
Internal Auditing 4.2.8.7.1, 4.2.8.9.1, 4.2.8.10.2, 5.4.7.7, 6.4.4.3.1,
7.10.1.4.2
Internal Control Systems 2.4.2, 4.2.8.6.3, 5.4.2.1, 5.4.3.9, 7.7.1.4.1, 7.18.2
International Accounting Standards 2.4.3, 2.4.4, 4.3.4.4.5, 4.4.5.8.1, 5.2.1.2, 5.2.2,
(IASs) 5.2.3.5.2, 7.4, 7.9.1.3.5, 7.18.5
International Accounting 1.2.1, 1.1.6, 5.2.1.2, 5.2.3.5.2, 7.1.1.1
Standards Board (IASB)
International Accounting Standards 5.2.2.2
Committee (IASC)
International Federation of 1.2.1, 5.4.2.2, 5.4.9.1, 7.1.1.1
Accountants (IFAC)
International Standards on Auditing 1.2.1, 5.4.9, 7.5, 5.4.2.2, 5.4.7.2
(ISAs)
6 of 8 Index
Investment Projects 1.1.2, 1.3.8, 1.4.3, 2.3.1, 3.1, 3.2, 4.4.6.2.1, 5.1.2,
7.7.1.2.2, 7.8.1.2.3, 7.9.1.2.2, 7.10.1.2.3
L
Loan Covenants 3.1.2, 3.6, 4.3.1.2, 4.4.5.3.3, 4.4.6.3.3, 5.3.2.2,
5.4.3.3, 5.5.1.1, 5.6.1.1, 5.6.4
• Capital Structure 3.6.3, 7.13
• Debt Equity Ratio Covenant 3.6.3.4
• Debt Limitation Covenant 3.6.3.5
• Debt Service Coverage 3.6.3.3
• Financing Leases 3.6.3.2, 3.6.3.2.3
• Restricting the Use of Loan
Funds 3.6.3.2.5
• Short Term Debt 3.6.3.2.1
• Liquidity 3.6.4, 7.14
• Current Ratio Covenant 3.6.4.2
• Dividend Limitation Covenant 3.6.4.4
• Quick Ratio Covenant 3.6.4.3, 7.14.2
• Operating
• Breakeven Covenant 3.6.2.6, 7.12.5
• Operating Ratio Covenant 3.6.2.5
• Rate of Return Covenant 3.6.2.2
• Self-financing Ratio Covenant 3.6.2.3
Loan Negotiations 2.9, 3.6.3.6.3, 4.2.1.3, 4.2.6.1.3, 4.2.8.4.3,
4.2.8.5.2, 4.2.8.9.3, 4.3.4.4.8, 4.3.6.1.1, 4.4.2.2,
4.4.5.3.1, 4.4.5.4.1, 5.2.3.1.2, 5.2.3.1.3, 5.3.1.1
Loan Preparation 2.7
M
Management and Cost Accounting 4.2.8.1.8, 4.2.8.10, 4.2.8.10.5, 7.18.2, 4.2.8.10.2,
4.4.5.8.1
Measuring Performance 4.1.4, 4.4, 4.4.2, 6.4.4.1.2
• Indicators 3.6.1.3, 4.3.2.3.2, 4.3.2.4, 4.3.4.2.1, 4.4.2.1,
4.4.3, 4.4.4, 4.4.5, 4.4.6, 6.4.4.7.1, 6.6.3,
7.7.1.6.3, 7.8.1.8.1, 7.9.1.9, 7.10.1.6.18
• Selecting Indicators 4.4.5
Microfinance Institutions 6.4.2, 6.6.4
Index 7 of 8
• Financial Reporting and 6.6.4

Auditing Issues
• PEARLS methodology 6.4.2.1, 6.4.2.2
Multilateral Investment Guarantee 3.4.4.4.5
Agency (MIGA)
N
Non-Revenue-Earning Projects 3.2.2, 3.4.6.3, 4.2.6.1.6, 4.2.9, 4.3.1.1, 4.3.2.2.8,
and EAs 4.3.5.3, 5.3.2.1, 5.3.3.1, 5.3.6, 5.3.10, 5.6.3.1, 7.7
O
• List of OMs 7.2.1
• OM 35 2.6.3, 2.8.1, 4.2.1.1
• OM 43 2.7.1, 2.8.1, 5.3.1.1
• OM 54 1.2.1, 2.7.1, 4.2.3
P
• Project Administration Instructions
• List 7.3.1
• PAI 1.02 2.7.1, 2.10.1, 3.7.4.1.3
• PAI 1.05 3.7.4.1.3
• PAI 3.02 3.7.4.1.3
• PAI 5.07 3.7.4.1.3
• PAI 5.08 2.10.1, 3.7.4.1.3
• PAI 5.09 2.10.1, 3.7.4.1.3, 5.5.1, 5.5.2.3, 5.5.4.2
• PAI 5.10 2.10.1, 5.3.2.4, 5.3.2.7
• PAI 6.02 2.7.1, 2.10.1, 3.7.4.1.3
• PAI 6.03 2.10.1, 3.7.4.1.3
• PAI 6.06 2.10.1, 3.7.4.1.3
• PAI 6.07 2.11.1, 3.7.4.1.3
PPTA Resources 2.3.3, 2.6.3, 3.7.2
Private Sector 1.1.5, 2.2.3, 2.4.4, 2.6, 3.3.3, 4.2.6.1.1, 4.2.7.5,
4.2.8.1.1, 4.3.2.1.1, 4.3.2.3, 4.3.3.2.1, 4.4.3.1,
5.2.3.1.3, 5.3.3.3, 7.9, 7.9.1.8
Private Sector Loans 2.3
Program Loans 2.2.3, 2.3
Project Completion Report (PCR) 2.11, 3.7.4.2
Project Cost Estimate Table 3.4.3
8 of 8 Index
Project File 1.5, 3.7.4.1.2, 4.3.4.4.7, 4.3.7.2, 4.4.3.5, 4.4.6.1.6

Project Identification 2.5.1, 2.6.3, 3.2.1.1, 3.4.1.1, 3.4.3.5.2, 4.2.8.1.8,
4.2.9.3.6, 5.2.3.4.1, 5.3.1.3, 5.4.1.5, 5.4.9.5,
7.7.1.1.2, 7.9.1.1.2, 7.10.1.1.2
Project Investments
• Possible non-revenue-earning 3.2.2
projects
• Possible revenue-earning projects 3.2.1
Project Loans 2.2.3
R
Retroactive Financing 3.4.3.5, 4.2.8.6.4, 5.3.2.4, 7.2.1,
Revenue-Earning Projects and EAs 2.4.3, 3.1.2, 3.2.1, 4.1.4, 4.2.8, 4.3.1.3, 4.3.2.2,
4.3.8.5.2, 5.3.3.3, 5.3.7, 5.3.9, 5.6.3.2, 7.8
Risk Analysis 2.7, 3.5.4, 6.3.4.1.4, 6.4.4, 7.11
S
Sector Loans 2.2.3, 2.3.1, 3.4.3.3.4, 7.11.4.2
Sensitivity Analysis 3.4.4.1.8, 3.4.4.4.4, 3.4.6.3, 3.5.1.4, 3.5.4,
3.7.3.3.1, 4.3.4.10.3, 4.3.6.2.3, 7.11
Subsidies 3.4.6.5, 3.4.6.6, 3.6.1.3, 3.6.2.6.2, 3.7.3.6.7,
4.3.3.1.9, 4.3.4.10.4, 4.4.6.5.2, 5.3.10.2, 6.2.2.2,
6.2.5, 7.12.1
T
Tariffs 3.6.1.9, 3.7.3.6.7, 4.3.2.2.6, 4.3.3, 7.9.1.5.2
Taxes and Duties 3.4.3.4, 3.4.3.6, 3.4.7.3, 4.3.4.5.3, 5.2.3.5.2,
5.3.7.5, 7.10.1.5
W
Weighted Average Cost of Capital 3.5.1.4, 3.5.2
(WACC)

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Guidelines

Effective January 2002

Key Information on these Guidelines

What araree these Guidelines?

When araree the Guidelines Updated?

What Recent Changes have been made to the Guidelines?

Who can I ask for help on the Guidelines?

ADB Asian Development Bank

IEG International Education Guideline (issued by IFAC)

3.7. ADB Reports

5.3. Financial Reporting 5.6.10. Reviewing Audit Management

7.6.9. Procurements and 7.13.3. Debt-Equity Ratio (see 3.6.3.4)

1.1.5. These Guidelines address the financial management of investment projects

1.1.6. The Knowledge Management section of Guidelines (most of which is only

1.1.7. These Guidelines have been developed as a web-based document, with a

• a summarized quick reference guide and detailed checklist on project financial

1.3.8. The Guidelines aim, in this regard, to provide fundamental parameters,

1.3.9. The advice, directions, and recommendations in these Guidelines should

1.4.3. Part 3 – Pr eparing and Appraising Investment Pr

1.4.4. Part 4 – Financial Management of Executing Agencies – advises on

1.4.5. Part 5 – Repor

1.4.6. Part 6 – Financial Institutions (FIs) – describes the particular applicability

1.4.7. Part 7 – Knowledge Management – The 1989 Guidelines provided limited

1.5. Project File

1.6. Guideline Updates

2.2. ADB Lending and Technical Assistance

2.2.3. ADB has four primary types of lending:

– Sector lending is particularly appropriate when a large number of subprojects

2.2.5. ADB encourages cofinancing. The cofinancing strategy comprises:

2.3. Applying these Guidelines

2.4. Project Types and General Treatments

2.4.1. These Guidelines effectively classify projects, executing agencies, and

Financial Analyst Discretion to Agree Accounting Standards

2.4.3. ADB requires revenue-earning EAs to follow national accounting standards

In exercising this discretion, financial analysts are responsible for ensuring

Sector: State-Owned (Public Sector) Private Sector

2.5. An Overview of Project Processing Steps

2.5.1. Once a project is identified by agreement between a government and ADB,

2.5.3. In appraising a project, its technical, financial, economic, social,

existing agencies; government departments; semi-government and public enterprises;

2.6. Step 1: Identification and Early Preparation

Responsibility1 Project Type2

• If project is not identified

2.7. Step 2: Loan Preparation

2.7.1. Loan preparation involves justifying the technical feasibility, economic

Responsibility3 Project Type4

• Obtain copies of annual

Responsibility3 Project Type4

• Consider governance aspects

• Supervisory Actions (PAI 1.02) ' … 3.7.4.1 … … … …

2.8. Step 3: Project Examination

2.8.1. Project feasibility, as presented in the consultants’ report, is then examined

Responsibility5 Project Type6

(i) Fact-finding Mission

• Review EA/IA financial

(iii) Appraisal Mission

• Review EA/IA financial

(v) Board Consideration

2.9. Step 4: Loan Negotiations

2.10. Step 5: Project Implementation

Consultants General Non-

• Update Project Cost Estimates ' ' 3.4.3 … … … …