MODULE 2: ECONOMIC & FINANCIAL ANALYSIS, Schemes and Mind Maps of Applied Economics

Download MODULE 2: ECONOMIC & FINANCIAL ANALYSIS and more Schemes and Mind Maps Applied Economics in PDF only on Docsity!

BUILDING INVESTABLE

NBS PROGRAMS

MODULE 2:

ECONOMIC

& FINANCIAL

ANALYSIS

Acknowledgements

STEP I. Define Your

Beneficiaries and

Unit of Measurement

STEP V. Monetize the Improvement

in Ecosystem Services

Appendix I. Core Team Profile

and Responsibilities

Glossary

STEP II. Connect

Ecosystem Services

to NBS Interventions

STEP VI. Identify Program Costs

Appendix II. Case Studies and

Additional Resources

Abbreviations

STEP III. Determine Your

Business-as-Usual Scenario

STEP VII. Calculate

Indicators for Economic

and Financial Analysis

Appendix III. Common Modeling

Approaches and Technical Tools

for Predictive Modeling for the

Identification of Measures to Protect

and Maintain the Watershed

Introduction

STEP IV. Target Interventions

Based on Model Outputs

Post-Analysis. Communicating

Results of the Economic

and Financial Analysis

References

GLOSSARY

Beneficiary: The stakeholder who derives a positive impact from the nature-based solutions implemented in the watershed to improve water security.

Business as Usual (BaU) Scenario: A baseline that predicts what the watershed will look like, in the future, without intervention.

Capital Structure: In this document, the term refers to the way the program will finance its NBS through some combination of direct stakeholder investment, debt, equity, or hybrid securities.

Co-benefits: Additional valuable outcomes arising from source water protection or nature-based solutions implemented to improve water security.

Conservation Interventions: Source water protection activities or other nature-based solutions that preserve or enhance the current state of the ecosystem function.

Cost-benefit Analysis: A method for comparing the expenses (costs) and target outcomes (benefits) of a project.

Discount Rate: A rate used to calculate the present value of future costs or benefits. When calculating the ROI, you should discount all costs and benefits of the program through the time horizon to their present value using an appropriate discount rate.

Ecosystem Benefits: While ecosystem services are the outputs or aspects of nature that support human uses, such as clean water flows, the derived ecosystem benefits would be the specific uses people make of ecosystem services, such as water available for municipal drinking water supply, or water available for irrigation or hydropower.

Ecosystem Function: Processes performed by ecosystem structure, such as soil retention or aquifer recharge.

Ecosystem Services: The outputs or aspects of nature that support human uses, such as clean freshwater flows for municipal water supply.

Ecosystem Value: Change in human well-being ecosystem benefits produce, such as avoided cost of municipal water treatment, of development of alternative drinking water sources or of water- related negative health effects.

Empirically-Based Benefit Functions: Quantitative relationships that financially value ecosystem services in a way that is meaningful to the beneficiary’s bottom line. For example, a reduction in TSS concentration could reduce the treatment plant’s application of a specific chemical, or proportionally reduce the amount of water lost in treatment sludge. Implementation Cost: The cost of implementing conservation interventions in the watershed. Land-Use-Land-Cover (LULC): Land cover data documents how much of a region is covered by forests, wetlands, impervious surfaces, agriculture, and other land and water types. Water types include wetlands or open water. Land use shows how people use the landscape — whether for development, conservation, or mixed uses (NOAA, 2018). The combination of land-use-land-cover notes what the landscape is covered by and how the landscape is used, e.g., conserved (use) wetlands (cover). Nature-Based Solutions (NBS): (In the context of water security) actions to protect, sustainably manage and restore natural or modified ecosystems that address water security challenges effectively and adaptively, simultaneously providing human well-being and biodiversity benefits. Net Present Value (NPV): The difference between the present value of inflows and the present value of outflows over a period of time. Often used in investment planning to analyze the profitability of a future project. Opportunity Cost: The difference between the profits landowners realize under business-as-usual land management and under conservation management. Present Value: The current worth of a future value or future stream of values. Sometimes referred to as the present discounted value. Restoration Interventions: Source water protection activities or nature-based solutions that improve ecosystem function. Return on Investment (ROI): A common financial metric of profitability that measures the return — monetary value of the benefits the stakeholder receives — for the money they invested.

Social Discount Rate: The rate at which a society would be willing to trade present for future consumption (Lopez, 2008). Social Opportunity Cost (SOC): The value to society of the next best alternative use of the resources devoted to the project in question (Lopez, 2008). Social Time Preference (STP): Assigns current values to future consumption based on society’s evaluation of the desirability of future consumption (Lopez, 2008). Source Water Protection: Protection of source water areas (e.g., by conserving and restoring forests and reducing agricultural pollution) in order to improve water security. Stakeholder: A person with an interest in or opinion about the proposed project, program or investment portfolio. Time Horizon: How many years the model will project outputs into the future. Choosing an appropriate time horizon will allow you to compare the cost-effectiveness of your interventions with other solutions your beneficiary(ies) may be considering. Time Value of Money: Concept which argues that money available at the present time is worth more than the identical sum in the future, due to its potential earning capacity. Transaction Cost (TAC): The expenses indirectly associated with implementing source water protection or other nature-based solutions; not the cost of the intervention, itself, but rather, the incidental costs of coordinating among stakeholders. For example, costs associated with landowner outreach; with drawing up, monitoring and enforcing agreements with land users or owners; dispute resolution; or with establishment and operation of any compensation schemes. Water Security: Availability of an acceptable quantity and quality of water for health, livelihoods, ecosystems and production, coupled with an acceptable level of water-related risks to people, environments and economies (Grey and Sadoff, 2007).

1 Note, definitions listed are in the context of this guidance; economic analysis of source water protection or nature-based solutions for water security programs.

ABBREVIATIONS

BaU Business as Usual

BEFA Basic Economic and Financial Analysis

CBA Cost-Benefit Analysis

DEFA Detailed Economic and Financial Analysis

DSS Decision Support System

LULC Land-Use-Land-Cover

LCM Land Change Modeling

NBS Nature-based Solutions

NPV Net Present Value

ROI Return on Investment

SOC Social Opportunity Cost

STP Social Time Preference

SWP Source Water Protection

TAC Transaction Costs

TSS Total Suspended Solids

USD United States Dollar

© BRIDGET BESAW

increasingly defined, the business case for investing in nature is still an emerging field:

robust examples of application in the water sector are required so that these solutions can

become a trusted, mainstream alternative or addition to grey infrastructure. A business

case, in the most basic sense, would provide the reasoning for initiating an NBS project.

As such, it is useful to analyze the return on investment (ROI) of a package of NBS

interventions so investors can objectively compare results with grey infrastructure

investments that would provide similar benefits. A return on investment (ROI) analysis

refers to a common financial metric of profitability that measures the return — monetary

value of the benefits the stakeholder receives — for the money they invested.

Other indicators like net present value, benefit-cost analysis, and cost-effectiveness

analysis can also indicate whether a project is a good investment. The types of indicators

used will depend on factors like the stakeholders, the type of proposed investment and the

potential investors. This guidance outlines the methodology for conducting financial and

economic analyses, of which ROI, and the aforementioned indicators, are a component.

Economic and Financial Analysis: One Component

Identifying the magnitude of benefits, who receives them, how much they are worth

and when investors can see a return on their investment is critical and forms the basis of

a “good” business case, but more is needed to attract investments. There are critical

elements of a preparatory package — economic and financial analysis, governance

arrangements, financial structuring, etc. — that practitioners need to generate financeable

and fundable NBS projects.

The economic and financial analysis — outlined in this guidance — Is one component of

investable NBS programs and is meant to complement other modules in the process

(Figure 1).

While this guidance was originally developed to support the establishment of financially

viable water funds (Box 2), the guidance is also useful for others looking to make the case

for investing in NBS for water security. For example, managers of feasibility studies that

include the definition of prioritized packages of NBS interventions, some of which could

lead to the establishment of a water fund if the institutional context is supportive.

As such, language and terminology will be inclusive of a broad range of NBS for water

security projects, as much as is feasibly possible. The reader will, however, note call-out

boxes and sections dedicated to guidance specific to water funds throughout the document.

Prior to executing an economic and financial analysis, it is important to have completed key

preassessment steps outlined in Module 1 and summarized in Box 1.

INVESTABLE NBS PROGRAM COMPONENTS

MODULE

01

Identify Technical

Options

What is your water

security challenge and

which NBS could

improve outcomes?

MODULE

02

Conduct an Economic

& Financial Analysis

What is the optimal

NBS portfolio and how

much does it cost?

What are the outcomes

and who benefits?

MODULE

03

Determine Funding

& Financing Strategy

What funding is

available? How secure

is it? What’s the gap

and how do you fill it?

Who might invest?

MODULE

04

Define Governance

& Institutional

Arrangement

Who makes decisions

and who implements?

How does funding flow

toward NBS?

FIGURE 1. The components of an NBS investment program for a preparatory package. This Guidance is focused on Module 2, Economic and Financial Analysis.

© SCOTT WARREN

BOX 1

Analysis Preparation Steps

Prior to executing an economic and financial analysis, it is important to have completed key preassessment steps from Module 1, or from a Feasibility assessment. It is germane to understand the water security challenge and the potential ‘scope’ of the intervention program, including objectives, potential NBS options and geographic scope. Your situation analysis should also collect water sector information, including supply and demand, who is responsible for water resource management, who the largest water users in the basin are, who determines water pricing and what the process is for doing so, and characteristics of the legislative and regulatory environment. This information is important for determining how your economic and financial analysis can be leveraged, and it will help determine the governance and institutional arrangement for your NBS program down the line (Module 4).

As your team collects water sector information, you should also undergo a stakeholder mapping exercise. Box 3 has more information about the mapping process, and it’s advised to read Step I of the guidance to understand what the stakeholder mapping is in service to in the context of an economic and financial analysis. You’ll need to understand the main actors and their level of influence in order to choose a beneficiary or beneficiaries for your analysis. Not all stakeholders identified may be ‘beneficiaries’ (e.g., derive a monetary benefit from the NBS program) but engaging these other stakeholders will still be important for the success of your NBS program. See Table 4 for stakeholder engagement guidance.

Before beginning an economic and financial analysis, it’s also critical the team undertake a survey of the existing data available, and any current modeling and valuation efforts. Your analysis should be additive and avoid duplicating ongoing or past work as economic and financial analyses can carry a substantial price tag. It’s possible this research was done during a feasibility or pre-feasibility assessment, but if it was not part of a prior information gathering effort, do so now.

If you have not completed the analysis preparation steps, please refer to Module 1 of this series, the Water Funds Toolbox feasibility section and Table 3 which outlines common pitfalls of economic and financial analyses.

© NICK HALL

Economic and Financial Analyses: Degrees of Detail

Before undertaking an economic and/or financial analysis, it is important to determine if

they will meet the needs of — or are even the right tools to advance — your NBS project.

Whether an economic or financial analysis (or both), the same underlying methodology is

used to value the benefits of NBS projects, but the difference lies in who benefits. In

economic analyses, the beneficiary is generally society writ large. Public policy actors, for

example, tend to use economic analyses to represent the total benefit of a project to the

population in their jurisdiction. Financial analyses, on the other hand, typically quantify

the financial benefits that accrue to one or more specific stakeholders, like utilities or

corporations, rather than society writ large. These stakeholders are typically investors in

the NBS program. While the underlying methodology — outlined in this document — is the

same, the type of analysis you choose will undoubtedly affect some aspects like scope

(analysis preparation), the type of valuation indicator chosen (Step VII), the discount rate

(Step VII) and the value of benefits (Step VII), among others.

For simplification, this guidance jointly refers to the methodology of an economic and

financial analysis since the underlying steps are the same. The guidance, however, will

explicitly note differences when they arise.

Tables 1 and 2 outline the different degrees of detail — or scale — of economic and financial

analyses that can be considered and how they can be leveraged to reach a project’s goals.

In the water fund project cycle (Figure 2), the Detailed Economic and Financial Analysis

(DEFA) and the Decision Support System (DSS) are prepared during the Design Phase.

These analyses are an essential building block to developing a compelling, actionable

Strategic Plan that not only articulates how the Fund will contribute to improved water

security in the region, but how it will be managed, funded, and monitored and evaluated for

impact. We suggest conducting the Basic Economic and Financial Analysis (BEFA) during

the Feasibility (or even pre-feasibility) phase of the Fund to help narrow the focus for your

complete economic and financial analysis. A BEFA can also demonstrate whether there’s

even a preliminary ROI for your proposed project.

For non-Water Fund projects, the Detailed Economic and Financial Analysis and Decision

Support System are typically prepared during Feasibility, while the Basic Economic and

Financial Analysis would only be useful as an initial assessment during Eligibility.

All three scales of the economic and financial analyses in Tables 1 and 2 have the same

underlying methodology as outlined in this guidance. However, the detail of the analyses

— and therefore the accuracy, applicability and flexibility of the results — improves from

left to right across the table. The primary difference between the Detailed Economic and

Financial Analysis (DEFA) and the Decision Support System (DSS) is the ability to update

the DSS over time to adaptively manage decisions as a program changes, e.g., to update

biophysical models as in-field monitoring instruments begin generating data, or to reflect

new beneficiaries that are investing in the program. The DEFA, by contrast, provides a

snapshot in time for an investment, and therefore cannot be altered after completion to

reflect these new realities. The analysis would need to be performed anew.

The BEFA provides a general estimate of the return on investment for a set of nature-based

solutions. However, unlike the DEFA and DSS, the models used in the Basic Economic and

Financial Analysis to calculate the ROI are usually built using readily available global or local

data sets. As such, the BEFA will produce less accurate results than if a DEFA or DSS is

employed. BEFAs are more useful for a quick assessment of whether NBS could produce the

desired benefits in a cost-effective manner. However, building an NBS program and recruiting

funders/investors will require more detailed analyses and should not be based on a BEFA.

This scale of analysis is better used as a communications tool to socialize the potential

NBS program with stakeholders and to secure their interest in performing a more rigorous

assessment. It’s important to caveat the results of the BEFA with your stakeholders so they

understand what can and cannot be gleaned from the preliminary analysis.

It’s worth noting upfront that all scales of economic and financial analyses will have a degree

of uncertainty that needs to be addressed with your NBS project’s beneficiaries and

stakeholders. The degree of uncertainty improves with more accurate, site-specific data,

which may not be possible in all cases. Sites that may be great candidates for NBS interven-

tions may not have invested in monitoring and evaluation and are, therefore, lacking a

repository of data. If governments, utilities and/or regulators are interested in exploring the

potential of NBS, it’s recommended they begin a monitoring and evaluation program to

improve the quality of their analysis and to verify the impact of their investments. Step VII

has more information on how to better manage uncertainty and initiate monitoring and

evaluation programs.

If, after reviewing Table 1, an economic and/or financial analysis seems to be the right

tool to advance your NBS project, continue onto Table 2 to find the right economic and

financial analysis for your purposes. The following section describes the format and content

of this Guidance.

TABLE 1. Degrees of detail (scale) of economic and financial analyses that can articulate the economic and financial benefits of a water fund or NBS project.

BASIC ECONOMIC AND FINANCIAL ANALYSIS

DETAILED ECONOMIC AND FINANCIAL

ANALYSIS DECISIONS SUPPORT SYSTEM 2

Description High-level ROI evaluation of a set of NBS catchment management interventions to generate water security. A BEFA can indicate whether NBS interventions might be a viable option for solving local water security challenges. However, a project developer would need a DEFA or DSS to prepare an NBS project for investment.

In-depth analysis that uses locational and stakeholder-specific data to ascribe the financial and economic benefits that accrue to specific downstream user beneficiaries or stakeholders. A DEFA is a ‘static’ document, meaning it can show the potential benefits for an investor if they invested imminently. However, if they chose to implement the NBS program in 5 years, the analysis would need to be redone.

In-depth scenario analysis tool that uses locational and stakeholder-specific data to ascribe the ROI benefits that accrue to downstream user beneficiaries or stakeholders; can be updated over time to assist decisions. A DSS is a ‘living’ document + data management and visualization platform. It can be used for adaptive management of NBS programs to reflect increased implementation and investment.

What is required data inputs, cost, time

Cost: US$20–40K Time: 2–4 mos. Data: portfolio of priority interventions and estimation of associated costs; global or readily available local data sets to use as inputs for ecosystem benefit model(s)

Cost: US$50–100K Time: 6–9 mos. Data: historical land-use-land-cover, hydrologi- cal data, regional or state-level driving policies, detailed costing of NBS interventions and operating platform, cost of competing grey solutions (i.e., filtration, pipes, etc.)

Cost: US$100K+ Plus, additional ongoing maintenance requirements Time: 9–12+ mos. Data: same as the Detailed Economic and Financial Analysis; impact reporting requires addition of implementation actuals

Typical modeling configuration 3 See Appendix III

Tier 1 model 4 (e.g., InVEST) and combined portfolio identification/prioritization tool (e.g., RIOS)

Calibrated and validated Tier 2 model 5 (e.g., SWAT), maps of vetted intervention options (GIS), portfolio ROI optimization protocol (e.g., prioritize R library)

Same as business case, but includes visualization platform to facilitate scenario selection, adaptive management and impact reporting

Comparison to WF project lifecycle

Pre-feasibility, Feasibility Feasibility + Design, static Feasibility + Design, adaptive

Comparison to DFI project lifecycle

Project Concept Development (Eligibility) Project Preparation (Feasibility) Project Preparation and Implementation (Feasibility and Design)

2 While the underlying methodology needed to produce a DSS will be introduced in this guidance, more detail can be found in Module 3: Determining a Funding & Financing Strategy. 3 There are other types of model configurations that can be used (Table 5). An example of a “typical” configuration is provided here to orient the reader. 4 Tier 1 model: long-term static analysis model based on average values across the time period, with basic representation of ecosystem processes intended for quick general results. Examples: InVEST, WaterWorld 5 Tier 2 model: model with calculation time steps allowing for dynamic simulation, based on time series, with detailed results representing ecosystem processes. Examples: SWAT, HEC-HMS, HydroBID

The Guidance

This guidance is developed for non-expert practitioners, and therefore serves as an

introduction to economic and financial analysis best practice to identify the most

cost-effective package of nature-based interventions. It provides an overview of,

(1) the economic and financial analysis methodology;

(2) the capacities required to complete the analysis;

(3) the types of economic and financial tools and indicators (return on investment,

net present value, benefit-cost analysis, etc.) you can calculate;

(4) how to communicate results to your stakeholders, and

(5) how you can use the results to leverage funding

Each step of the methodology starts with a short introduction describing the purpose and

expected outcomes of the step, and information the team should have in hand before

advancing to the next phase. A series of key questions are also provided to help project

teams navigate each stage.

Throughout, the guidance references key capacities that are important for specific phases

of the methodology:

• Project Manager
• Ecologist
• Hydrologist/Modeling Specialist
• Stakeholder Engagement Specialist
• Economist
• Water Supply Systems Specialist ( if conducting an economic and financial analysis for a

large water user )

• Communications Specialist

A team member can represent more than one capacity listed above, but for the sake of

the reader, we have separated the skills. While the team should be well-integrated and

collaborative throughout the process, certain steps will require increased participation from

specific team members. At the beginning of each step, alongside the introduction and key

questions, these capacity profiles will be listed under Team Members, indicating their

increased participation. Defined roles and responsibilities for each of these profiles can be

found in Appendix I. While the guidance is developed with the non-expert practitioner in

mind, you will need experts to complete this analysis.

The document is designed to follow the preparation of a theoretical economic and financial

analysis as it progresses through the steps outlined in the methodology, Figure 3. The

theoretical analysis focuses on reducing sedimentation for an invented utility who is

interested in reducing its treatment costs by employing nature-based solutions in the

watershed. Actual examples from past economic and financial analyses are scattered

throughout the guidance so readers can get a broad sense of how the methodology can be

applied to a range of scenarios.

There is a growing body of knowledge on the subject and this guidance is not all encom-

passing. Other partners and leaders in the field have produced valuable guidance on this

topic (Pearce et al., 2016, Browder et al., 2019, Eastern Research Group, Inc., 2015). World

© ERIKA NORTEMANN/TNC

Resources Institute’s working paper Green-Gray Assessment: How to assess the costs and

benefits of green infrastructure for water supply systems (Gray et al., 2019) presents a six-

step methodology with three pre-assessment steps to assess the costs and benefits of

integrating green infrastructure into existing water supply systems. We recommend

readers also review this guidance once they gain an understanding of the basic process.

The approach outlined in this document is based on past field experience and analyses

performed by The Nature Conservancy, in particular, Kroeger et al., 2017, Assessing the

Return on Investment in Watershed Conservation: Best Practices Approach and Case Study for

the Rio Camboriú PWS Program which presents a series of principles and a framework for

performing economic and financial analyses. Appendix II contains references to additional

resources and case studies — including Kroeger et al., 2017 — that can help the reader

go further.

Common Pitfalls of Economic and Financial Analyses

The success of your economic and financial analysis is largely dependent on your team’s

level of preparation and stakeholder consultation, as well as your team’s knowledge of the

project development cycle. It’s important the project manager understands how to use

the economic and financial analysis to help inform a project’s funding and financing

strategy (Module 3) and future governance and institutional framework (Module 4). Clear

objectives for your NBS project or program will also clarify the scope of the analysis and

drive more effective collaboration.

There have been cases where economic and financial analyses have not furthered a

program’s objectives due to poor execution and lack of preparation. Table 3 outlines

common pitfalls to avoid during the process and how to do so. Revisiting this table through-

out the project will help your team produce a practical return on investment study that

can be leveraged to meet your program’s objectives.

© ALAN W. ECKERT

PHASE PITFALL DESCRIPTION WHEN TO ADDRESS

Execution Method When choosing your modeling process, it’s important to match the models and datasets your team is using to address the scope defined in Analysis Preparation and refined in Step I. In addition to consulting with your beneficiary to determine if they have any preferences, your team should consult other expertise whose endorsement of the methodology may be important to the success of your project. Get stakeholder endorsement early to ensure they will agree with the results of the analysis and how it was undertaken, once complete.

Models, Datasets, Proposed Methodology Step III

Engagement with beneficiaries

Before building and running your models, the team should consult with its defined beneficiaries to ensure that they are valuing the ecosystem services that their beneficiary cares about. This will ensure you’re using the right unit of measurement and empirically-based benefit functions to assess the benefit of the NBS program. Defining the valuation methodology will usually require looking into the stakeholders’ own facility arrangements and overall investment program, e.g., agreeing upon the specific intake arrangement of the water treatment plant; the sediment management program of the hydropower dam; the alternative water supply options during a low-flow period, etc. Once your team is ready to calculate the economic and financial value of the NBS program, ask your beneficiaries which discount rate and economic and/or financial indicator they prefer. It’s particularly important for the team to get these right so the results of the analysis speak your beneficiaries’ “language” and are therefore useful to them.

Ecosystem Services and Metric Step I Empirically-based Benefit Function Step V Discount Rate and Indicator Step VII

Engagement with stakeholders

In addition to bringing in expertise and stakeholders to consult on the models and datasets used in the analysis, they should be involved in reviewing interim and final results. Review periods where their feedback can be solicited are built into the template Terms of Reference, and Table 4 has detailed information on how to engage stakeholders during each step of the process. Before modeling your intervention scenario (Step V), the team should validate the practicality of the proposed NBS interventions by consulting with the stakeholders who will be responsible for implementation on the ground. For example, if your team is going to propose cover crops on agricultural lands in the basin, you should confirm that farmers are willing to implement these practices on their lands. If they are not, even with financial incentives, your team should remove this as a potential NBS under consideration. Alternatively, if farmers are willing to implement cover crops but the incentive payments for doing so are not feasible, you should consider whether it’s truly a viable NBS. While this may not be necessary for a BEFA, it is definitely a necessary touchpoint for a DEFA and a DSS.

Review Interim and Final Results Step III, Step IV, Step VII Validate NBS Practicality Step II and Step IV

Leveraging analysis for funding and governance

As the analysis progresses, teams should keep in mind the subsequent steps that the economic and financial analysis will help inform: developing a funding and financing strategy (Module 3) and establishing a governance and institutional arrangement (Module 4). Having clear costs and benefits in financial and economic terms will help projects identify potential sources of funding and recruit their support. A clear portfolio of NBS interventions and the stakeholders who will be critical to their implementation — whether on the ground, directing funding, or creating favorable regulation — will help choose a suitable governance and institutional framework.

Preparing for Modules 3 and 4 Step I–VII

Post-Analysis Communication Once your analysis is complete and you have the results in hand, it’s time to present the outcomes to your beneficiaries and stakeholders using language and a format that resonates with them. As a result, the team will probably produce a few communications pieces, each with a different level of detail and focus. For example, a government agency responsible for watershed health may prefer a presentation with an in-depth analysis of the methodology, while a member of the public may prefer an infographic summarizing the high-level ecosystem services or co-benefits they may receive, e.g.,clean water, organic foods, increased green space or a nature preserve.

Communicating Results to Stakeholders Post-Analysis

FIGURE 3. The methodology, analytical processes and inputs/outputs for an economic and financial analysis outlined in this Guidance.

Technical Analysis

Preparation

Water Security

Objectives

Geographic Scope

Survey of Existing Data

and Literature

Target Beneficiary(ies)

and Unit of

Measurement

A.

Portfolio of Potential

NBS Interventions

B.

Unit Cost of Each

NBS Intervention

IV.

Portfolio

Prioritization/Optimization

F.

Empirically-Based

Benefit Functions

E.

Intervention Map

D.

BaU Scenario

V.

Financial Model

G

Intervention

Scenarios

H.

Identify Program Costs

III.

Hydro-sedimentological

and/or Hydrodynamic

Simulation Model

C.

Future Land Use

Change Map

II.

Land-Use-Land-Cover

Model

STEP I. Define Your Beneficiaries

and Unit of Measurement

STEP III. Determine Your

Business-as-Usual Scenario

STEP VI. Identify Program Costs

STEP V.

Monetize the

Improvement

in Ecosystem

Services

STEP VII. Calculate Indicators for

Economic and Financial Analysis

STEP IV. Target Interventions Based on Model Outputs

STEP II. Connect Ecosystem

Services to NBS Interventions

I.

Analytical Process Final Program ROI

Input/Output Step in Methodology

Team Members:

Project Manager, Stakeholder Engagement

Specialist, Ecologist, Hydrologist.

Key Questions:

 Who are your target beneficiaries? What are

their views about nature-based solutions?

Do they understand the potential benefits?

 Who are your stakeholders?

 Does your team have a strong relationship

with the stakeholders and beneficiaries you

have outlined?

 What benefits do your beneficiaries and

stakeholders care about?

 Are your beneficiaries willing to provide you

with details about their operations and

associated costs. This will be very important in

subsequent steps in order to calculate the

beneficiary’s return on investment (ROI).

 What ecosystem services provide the benefits

your beneficiaries and stakeholders care about?

 What metrics can you use to measure

ecosystem services that represent their value

to your beneficiaries and stakeholders?

Defining the Beneficiary

In order to define the focus of your economic and financial

analysis, you must first define the beneficiary(ies). Your

beneficiaries will be the stakeholders who derive a financial

or economic benefit from the nature-based solutions

implemented in the watershed because they have — or

intend to — invest in the NBS program. Some examples of

common beneficiaries are utilities, beverage companies,

municipal governments, energy producers, etc. As noted

in the introduction, your beneficiaries will be different

depending on whether you are undertaking an economic

or a financial analysis, and, therefore, not all stakeholders

may be “beneficiaries”.

It is important, however, that the project team chooses a

beneficiary (or group of beneficiaries) with which they have

a strong relationship. A stakeholder analysis can facilitate

the process (Box 3). If the project team does not yet have

a beneficiary with strong interest in the project, the

Stakeholder Engagement Specialist can help cultivate the

relationship. Before moving forward with the analysis,

however, the team should have identified their beneficiaries

and received confirmation that they will advise and engage

in the process.

For a financial analysis to be compelling, it must accurately

calculate the beneficiaries’ return on investment (ROI), so

the project team will need input from them during this step

of the financial analysis (Step VII). The ROI is a common

financial metric of profitability that measures the return

— monetary value of the benefits the stakeholder receives

— for the money they invested. To assign monetary value

to benefits, the project team will need a window into a

beneficiary’s operations, and the costs associated with

these operations.

A stakeholder analysis is a systematic process for gathering and analyzing information to determine who should be engaged in the design and operation of a Water Fund by accounting for and incorporating the needs of those who have a ‘stake’ in the project.

To give an oversimplified example, if we are calculating the

ROI for a utility that is interested in decreasing the amount

of sediment in the water it filters, it would be helpful for the

project team to know their filtering process and the costs

associated with that process. If the interventions in the

watershed improve soil retention, thereby reducing the

concentration of sediment that reaches the filtration plant,

will the utility need to use less chemicals to purify the

water? How much less will they need to use and what is

the cost of that savings compared to what they invested in

the watershed interventions?

As you can see, if a project team is unable to assign monetary

value to these benefits, they will be unable to calculate the

ROI for their stakeholder. We focus on how to identify the

benefits a stakeholder cares about — referred to, from here

on, as ecosystem services — in the section below.

Identifying the Right Ecosystem Services

Once you have chosen and defined the beneficiaries of

your project, you can now focus on identifying the

ecosystem services for your economic and financial

analysis. But what, specifically, are ecosystem services?

It’s important to distinguish among ecosystem services,

function, benefits and values, as they each have different

definitions that can be confused in an analysis. Figure 4 defines each term and their

relationships.

In your economic and financial analysis, you will specifically focus on the final ecosystem

services, those components of nature that are directly enjoyed, consumed or used to

produce human well-being, and you’ll define these services with metrics that reflect the

characteristics crucial to generating the benefits your stakeholders care about.

Let’s continue with the example posed earlier in this section. You’ll recall we chose a utility

as our beneficiary. Figure 4 gives the example of clean freshwater flows for municipal water

supply as the ecosystem service. However, this can be further defined for a utility as a

reduction in concentration of total suspended solids (TSS) at the filtration plant’s intake

point. Focusing on the final, specific ecosystem service — TSS concentration at the intake

point — will help avoid double counting the value of intermediate services.

This is important because the value of a service, in this case reduced TSS concentration,

can often vary widely depending on how that service is used. One cubic meter of water

with reduced TSS concentration will produce different magnitudes of benefits whether that

cubic meter of water is used for municipal water supply, crop irrigation, hydropower or

swimming. Likewise, the value of that cubic meter of water can vary depending on location

or the time that it is used; the value of TSS concentration will vary depending if it’s high or

low flows.

Before moving on to Step 2, it’s important the project team ensures they can quantitatively

relate the ecosystem service(s) they defined to benefits the beneficiary will experience.

In essence, ensure that the ecosystem service(s) defined can be translated into economic

or financial value for the beneficiary.

Engaging Your Stakeholders

Similar to Step I, throughout the analysis, your team will need to engage your beneficiaries

and stakeholders during key steps to solicit their feedback and approval. Adequate

consultation will ensure the results of your analysis are applicable to their needs and meet

their expectations. Additionally, stakeholders who are consulted throughout the process

are more likely to endorse or support the NBS program and invest.

Table 4 outlines key steps of the analysis where your stakeholders should be engaged

and consulted.

PRODUCE

FUNCTIONS

Processes performed

by ecosystem

structure

EXAMPLE

soil retention or aquifer

recharge

SERVICES

The outpts or aspects

of nature that support

human uses

EXAMPLE

clean freshwater flows

BENEFITS

Specific uses people

make of ecosystems

services

EXAMPLE

municipal drinking

water supply

VALUES

The change in human

well-being ecosystem

benefits produce

EXAMPLE

avoided cost of

municipal water

treatment

PRODUCE

PRODUCE

FIGURE 4. Definition of ecosystem functions, services, benefits and values. Adapted from Kroeger et al., 2017. © DALE TURNER/TNC