Let me see if I can make the difference between economic appraisals and financial appraisals interesting….
They are both covered in the UK Government’s Better Business Cases document. Here’s my take on what they both mean and why you’d want to use them.
The document says that economic appraisals are all about value and benefits from the perspective of the stakeholders, users, and wider societal impact. They consider “all social, economic, environmental costs and all effects on public welfare.” Remember, this is a government publication, so the assumption is that projects will be for the public good. Your project might not have an effect on public welfare, but you can imagine that it will have an effect on the project’s customers or end users.
This is the core of a business case.
It includes an element of financial information as well, such as relative prices, direct and indirect costs, opportunity costs where there are any, environmental costs, and benefits however these play out. You’d also include staff time.
It would exclude inflation, tax, sunk costs (let’s hope there aren’t any of those), depreciation of assets, and other accounting treatments.
Financial appraisals are purely the monetary calculations: can we afford it? Where is the money coming from?
They consider cash flow, budgets, and accounting practices.
This would feed into a business case because there is no point in progressing a project that you can’t afford to complete or that would not provide adequate financial returns where these are measured.
A financial analysis would look at current pricing, cash-releasing benefits (like delivering a portion of the project early so it could start to ‘earn’ for you), capex and opex costs, tax payment, and inflation.
The do nothing option
A business case should also include the minimum possible approach, which is normally the ‘do nothing’ case against which to compare your alternative(s).
Complete an economic appraisal for that option, too, taking into account what stays the same and the benefit cost ratio of doing nothing.
In my experience, it’s always worth including a ‘do nothing’ option as it really makes it clear to execs what they are giving up if they choose to reject a project.
Is an economic appraisal a new thing?
I don’t think an economic appraisal is a new thing, but I think project managers are more used to seeing it be called a business case or an options analysis.
Once you have created an economic appraisal for a variety of options (including the ‘do nothing’), there is likely to be a clear option that stands out as the best course of action. If not, there might be a few to choose from with subtle differences – leave the choice up to the execs to debate in that case!
I think the thing about an economic appraisal is that it forces you to think wider than the numbers. You’re looking for social and environmental benefit, community impact, and return instead of just a simple ‘if we do this, we’ll get paid that in a year’. It’s a way of reframing the business case conversation into something that is wider and more rounded, helping teams become aware of the full impact and benefit of their initiative instead of simply the bottom line.
And I think that’s a good thing. We should be making rounded, fully informed decisions instead of simply relying on the top level numbers. We need to be aware of the full impact from idea to decommissioning and what impact that is going to have on the world around us, not just the bank account.
By adopting the language of economic appraisal instead of business case, we might be shifting the thought process into a richer dialogue with ultimately better decisions being made. What do you think? Let me know in the comments!