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PROPOSAL OF A COMMON SCORING SYSTEM FOR SELECTION OF EU
FUNDED PROJECTS DEVELOPED BY ROMANIAN COMPANIES
Droj Laurentiu
University of Oradea, Faculty of Economics, Oradea, Romania
laurentiu.droj@gmail.com
Abstract: Since the start of the European Union Structural Funding Programs 2007-
2013, especially those focused on financing investments proposed by private
companies, a big change seems to be taken place. Large numbers of companies
have applied for grants within these programs and especially for funding under the
European Regional Development Fund (ERDF). But after the initial enthusiasm and
initial success reported by both the Management Authorities and private
beneficiaries big issues have aroused regarding lack of financial resources for co-
financing to support investments or expenditures in the initial stages funding the
project. Under this context the banking sector was called for support and was
expected to be heavily involved in ensuring external financing. This was not as
initially predicted. A big concern came from the fact that the projects, even if
achieved excellent scores on the technical evaluation from the management
authorities, had huge problems in receiving even basic approval from the banking
system. Since it seems that most of these inconsistencies are derived from the
evaluation phase of projects this study tries to focus on establishing an equilibrium
between banking analysis indicators and the scoring system used by the European
Union management authorities. Identifying common criteria used for selection of
good sustainable projects to be funded within European Structural Funds
constitutes a big challenge for the management authorities and for the banking
institutions as well. The applicants must realize financing application based on a set
of indicated criteria. In order to achieve financing, these entities learned to modulate
their financial indicators and their business plans according to the requirements. But
a large number of already approved projects by the ERDF managing authorities
found themselves in impossibility to comply with banking standards as well.
Correlation of both European Union and banking system criteria, especially the Cost
and Benefit Analysis Indicators with the banking financial indicators could be a great
solution to current challenges: making the projects proposed for financing bankable,
also, and thereby increase the absorption capacity of the beneficiaries. To solve this
problem the current study proposed the creation of a mixed scoring assessment
system containing 15 indicators for which were established various evaluation
values. The main goal of the system was to fulfil both the evaluation criteria of
European Union management authorities and the creditworthiness criteria used by
the banking sector. In the final stage of this paper the assessment system was
tested over a number of 50 Romanian companies, which were selected for
European financing.
Keywords: financial analysis, Cost Benefit Analysis, European funding, selection
system, bankability, European projects
JEL classification: H43, G30, G32, C61, G17, G21
373
1. Introduction
Since the start of the European Union Structural Funding Programs 2007-2013,
especially those focused on financing investments proposed by private companies,
a big change seems to be taken place. Large numbers of companies have applied
for grants within these programs and especially for funding under the European
Regional Development Fund (ERDF).
But after the initial enthusiasm and initial success reported by both the Management
Authorities and private beneficiaries big issues have aroused regarding lack of
financial resources for co-financing to support investments or expenditures in the
initial stages funding the project. In these phases of the projects, European funding
grant recipient must invest their own financial resources to support the projects.
These resources will be repaid later by the Management Authorities of the
Programmes, if they are carried out respecting the national legislation, the rules of
the programme and are considered eligible expenses under the conditions of the
financing contract.
Under this context the banking sector was called for support and was expected to
be heavily involved in ensuring external financing. This was not as initially predicted.
The increase of applicants for special banking products which were required for
sustaining project grants was initially received with surprise and distrust by the
banking sector. But given the effect of the financial crisis and that since this area of
activity is proving to be profitable for the banking sector, most Romanian banks have
created special packages of products which exclusively dedicated for co-financing
and/or pre-financing, to ensure different types of projects European funding.
Soon, big concerns arise from the fact that the projects, even if achieved excellent
scores on the technical evaluation from the management authorities, had huge
problems in receiving even basic approval from the banking system.
Since it seems that most of these inconsistencies are derived from the evaluation
phase of projects this study tries to focus on establishing equilibrium between
banking analysis indicators and the scoring system used by the European Union
management authorities. Identifying common criteria used for selection of good
sustainable projects to be funded within European Structural Funds constitutes a big
challenge for the management authorities and for the banking system as well.
The applicants must realize financing application based on a set of indicated criteria.
In order to achieve financing, these entities learned to modulate their financial
indicators and their business plans according to the requirements. But a large
number of already approved projects by the ERDF managing authorities found
themselves in impossibility to comply with banking standards as well.
2. Are the European projects Bankable?
As mentioned by Droj(2012) creditworthiness or “bankability” analysis are performed
quite often in the last years especially concerning investment projects. The term
bankability, comes from the term bankable and was defined in the Business
Dictionary(2012) to be a “Project or proposal that has sufficient collateral, future
cash-flow, and high probability of success, to be acceptable to institutional lenders
for financing” or more simple defined a project “Acceptable to or at a bank”, as
mentioned by Eze(2010). The European Investment Bank(2012) based on
Vinter(2006) considers that a “project is considered bankable if lenders are willing to
finance it”.
374
As reflected in recent studies(Hampl et all, 2011) the realization of infrastructure
investments, especially on European structural funding are conditioned by making
these investments bankable, even if bankability is perceived differently by the
different stakeholders: banks, project management companies, beneficiaries,
European/national management authorities.
But from this point on the bankability of a project and its compliance to European
funding can take different paths. While the banks seem to concentrate and
emphasize more on the capacity of the beneficiary to generate stable cash flows and
on the fact if the project is capable to cover the long-term debt service(Hampl et all,
2011). It stressed the importance of ensuring „the project’s soundness, diligence in
legal, technical and economic matters (Hampl et all, 2011) for all factors involved.
This is presented in the picture below:
Figure 1: Drivers for legal, technical and economical dimensions of project
bankability assessed by banks
Source: Lüdeke-Freund, F.; Hampl, N. & Flink, C. Bankability von Photovoltaik-
Projekten, 2012
Under this concern the European funding programs concentrate on rather different
indicators which are evaluated in the European projects. These indicators are based
especially on Cost Benefit Analysis Methodology. In order to take the decisions, the
EU decision makers need appropriate tools for comparing costs and benefits of
various types: economic, social or ecological investment projects that are ongoing
over several years. These social-economic types of analysis are reviewed also by
some banking experts (Iorga, 2011).
Cost-benefit analysis methodology (European Union, 2008) is not an exact science,
is seen as having many limitations which are generally based on approximations,
working hypotheses and estimates due to missing data or due to inability for
providing all possible situations. The goal of the financial analysis is to use the
predictions such as cash-flows to calculate relevant indicators especially the
Financial Net Present Value (FNPV) and the Financial Internal Rate of Return (FRR),
respectively in terms of return on the investment cost, FNPV(K) and FRR(K).
Correlation of both European Union and banking system criteria, especially the Cost
and Benefit Analysis Indicators with the banking financial indicators could be a great
375
solution to current challenges: making the projects proposed for financing bankable,
also, and thereby increase the absorption capacity of the beneficiaries (Droj, 2012).
The consent with these ideas are also present in a study which is called "Co-
responsibility - The key to success" (Iorga, 2011) where in a slide points out to the
fact that "bankability of a project is the sole responsibility of the bank" so it is
recommended that the entire process absorption of European funds to become
"bankable" so in terms of its development is important to select "bankable
beneficiaries".
3. Romanian companies - between EU funding and banking standards –
proposal of a common system of assessment
In order to solve this issue the steps overtaken in this paper were concentrated
towards validation through different methods of the most efficient selection criteria in
order to obtain a common system which should ensure that a project is both
bankable and also eligible for financing under EU funding. In this chapter we
analyzed and tested a large number of criteria which should allow funding an
investment project by the banking system and the managing authorities as well.
In general the financing institutions: Management Authorities and banking
institutions, as well are using different models in order to realize the scoring of the
beneficiary of a loan or a grant. These models were presented by Oracle Financial
Services(2008):
· Rules based scoring/rating – represents a scoring model which is
established based on the experience of the model’s designers. The main
advantage of this system consists in automatization of the traditional risk
assessment process and “allows the user to assign weighted values to key
elements deemed essential to sound credit decisions” as mentioned in a report
of Oracle Financial Services(2008).
· Statistical methods – are consisting in analyzing “all variables relevant to
default or business failure using regression techniques”. To develop credit
scoring systems, different statistical methods such as linear probability models,
logit models, probit models, and discriminate analysis models are used. The first
three are statistical techniques for estimating the probability of default (PD) based
on factors like loan performance and borrower characteristics. The linear
probability model assumes that the PD varies linearly with the factors; the logit
model assumes that the PD is logistically distributed; and the probit model
assumes that the PD has a (cumulative) normal distribution. Discriminate analysis
differs: instead of estimating the PD, it divides borrowers into high and low default
- risk classes.
· Casual models consisting in simulation models, option pricing or cash-flow
analysis.
Finally the above mentioned research highlights the fact that only a Hybrid approach,
obtained by combining these models can bring successful results as observed in
Figure 2 Approaches to Credit Scoring/Rating Models.
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Figure 2: Approaches to Credit Scoring/Rating Models
Source: Oracle Financial Services, Credit Risk Analytics: A Cornerstone for Effective
Risk Management, 2008
4. Proposal of common evaluation system - Case study
The steps taken in this paper focused on validation by various methods of the most
effective selection criteria for funding of a project to be eligible for both the banks
and EU funding. These criteria were tested both qualitatively and quantitatively and
were based on the use of spread modelling methods possible to be used in a system
of evaluation. In this context was proposed a common economic and financial
evaluation system appropriate to select beneficiaries which comply both to EU
sectorial grants and bank rating system, as well(Bente, 2011). Ideally the submission
and acceptance of a project by European funding authorities should make it directly
eligible for financing within the banking sector.
The evaluation system proposed in this paper was tested over 50 companies which
benefited on EU funding. The criteria which constitute the main elements of the study
are divided in four chapters:
- Applicant's ability to implement the project
- Financial analysis of the project (based on CBA criteria)
- Financial analysis of the company (based on diagnostic analysis)
- Analysis of the non-financial elements of the investment
In the following lines we motivate the score given to each criterion and sub-criteria,
the importance of each chapter as a whole but also in terms of evaluation criteria.
The maximum score obtainable is 100 points and was intended both to achieve the
related eligibility criteria for funding European projects and for having bankable
projects as well.
377
Table 1: Criteria for evaluating an investment project to determine both the
eligibility for EU funding as well as its bankability
No.
Criteria / Sub
-criteria
Maximum
points
1.
Applicant's ability to implement the project
30
1.1.
Applicant's ability to carry out the proposed investment
10
1.2.
The ratio between the value of investment and annual turnover
10
1.3.
Project budget
5
1.4
Level of warranties of the beneficiary
5
2.
Financial analysis of the project
25
2.1.
Financial indicators(NPV, FRR)
10
2.2.
Projected cash flow
8
2.3.
Economic analysis and risk assessment
7
3
Financial analysis of the company
35
3.1
Analysis of financial statements
10
3.2.
Solvency analysis
5
3.3.
Analysis of global financial autonomy
5
3.4
Self
-financing reimbursement rate
5
3.5.
Return on Equity
5
3.6
Banking history of the beneficiary
5
4.
Analysis of non-financial elements of the investment
10
4.1.
Analysis of target market / competition
5
4.2.
Business Idea
5
Source: Proposed by author
Below we intend to present the results of testing the evaluation model over other 30
companies that have not been taken into account to develop the model and that were
funded in 2007-2009 were completed successfully investments are operating period
of the investment. Assessment of the post implementation stage over 30 companies
was based on the criteria they had to accomplish in the initial evaluation stage of the
investment project.
For the first chapter of evaluation - Applicant's ability to implement the project were
awarded a total of 30 points since is considered an important chapter of evaluation
present both in evaluations characteristic of the banking sector and in the
implementation of grant programs. Regarding the sub-criteria were proposed to be
granted 10 points to each of the first two sub-criteria:
1.1 Applicant's ability to carry out the proposed investment and 1.2 The ratio
between the value of investment and annual turnover because was desired to be
quantified the important historical elements in the analysis of both eligibility and
bankability. From the point of view of the applicant's ability to carry out the proposed
investment the analysis focuses on both quantitative and qualitative criteria
considering the crucial elements required.
378
Criterion 1.3 Project budget (maximum 5 points) is followed strictly at the level of
management authorities and also within the banking system both in terms of clarity,
realism and its time-schedule.
Criterion 1.4 Level of warranties of the beneficiary (maximum 5 points) is an essential
criterion for the determination of the proposed credit / letter of guarantee from a bank
account. This item can be correlated according to Government Decision 606/2010
on the security / mortgage of movable or immovable obtained funding. This criterion
was used by organizations such AIPPIMM in evaluating projects submitted under
the START Programme. The results, as it can be seen in the picture below, obtained
pointed out that most of the most beneficiaries of funding (about 80%) achieved good
scores highly on this criterion, which can be explained by the fact that both the initial
assessment criteria proposed by Financing Authorities and especially the evaluation
criteria have high relevance to the success of project funding.
Figure 3: Applicant's ability to implement the project
Source: Data processed by author
2. Financial analysis of the project (according to requirements of the European
Commission - CBA) – it is an important criterion awarded with 25 points and is
composed from three other sub-criteria: 2.1 Financial Indicators – which are
important to be determined by the banking system and the management authorities
as well since contains the calculation of NPV, FRR and their correlation with the
sustainability elements. 2.2 Projected cash flow – it is necessary to be positive in
both analysis and receives a maximum of 8 points, being considered an essential
condition for the financial sustainability of the investment. 2.3 Economic and risk
analysis – receives a maximum score of 7 points. This analysis is particularly
important especially regarding major infrastructure projects. In case of simple
investment projects is recommended to be realized only the realization of a brief
analysis and risk control strategy.
As observed in figure 4, below level scores were obtained in chapter: "The financial
analysis of the project" and this can be explained by the fact that funding bodies
require, as basic conditions, IRR values well below those considered acceptable by
banks. Also in this aspect of the analysis, were realized corrections due to the
different methodologies used in practice. Increased attention should be paid towards
bankability of projects.
379
Figure 4: Financial analysis of the project
Source: Data processed by author
3. The financial analysis of the company benefits from a maximum of 35 points
distributed on a number of 6 criteria. To the first criteria were allocated a maxim
number of 10 points: 3.1 Analysis of financial statements. The following four criteria
were allocated a maximum of 5 points for obtaining average values of the indicators
proposed: 3.2. Solvency analysis 3.3 Analysis of global financial autonomy 3.4. Self-
financing reimbursement rate, 3.5 Self-financing reimbursement rate. The last
criterion 3.6 Banking history of the beneficiary is considered to be a key element in
the analysis of a company both when contracting new loans but also when
monitoring the level of financial discipline at the level of beneficiaries.
Financial analysis of a company provides very clear results about the financial
potential that companies which contract EU funding must benefit to implement their
projects. Thus any of the analyzed companies did not score the three lower
thresholds. In this context we can assume the Iorga's observation (2011) is accurate:
"European funds are not designed for beneficiaries 'with no money'".
Figure 5: Financial analysis of the company
Source: Data processed by author
4. For analysis of non-financial elements of the investment are allocated only 10
points divided equally on two simple criteria to evaluate: 4.1 Analysis of target market
380
/ competition and 4.2 Evaluation of business ideas. These elements may indicate
some qualitative aspect of business proposals. As shown in the above lines were
not proposed criteria and allocation of scores to the socio-economic elements of
project: number of jobs created, equal opportunities, sustainable development,
utilization of local resources. In the analysis of non-financial items we can observe
that the winning projects received higher scores on the scale proposed by the author.
Thus 77% of the projects reviewed have achieved scores above 7 points which
shows that better construction of non-financial elements at the level of applicant
companies is imperative to be achieved and later measured during the selection
process.
Figure 6: Analysis of non-financial elements of an investment
Source: Data processed by author
5. Conclusions
Identifying common criteria used for selection of good sustainable projects to be
funded within European Structural Funds constitutes a big challenge for the
management authorities and for the banking institutions as well. The applicants must
realize financing application based on a set of indicated criteria. In order to achieve
financing, these entities learned to modulate their financial indicators and their
business plans according to the requirements.
Correlation of both European Union and banking system criteria, especially the Cost
and Benefit Analysis Indicators with the banking financial indicators could be a great
solution to current challenges: making the projects proposed for financing bankable,
also, and thereby increase the absorption capacity of the beneficiaries.
To solve this problem the current study proposed the creation of a mixed scoring
assessment system containing 15 indicators for which were established various
evaluation values. The main goal of the system was to select those
indicators/variables which fulfil both the evaluation criteria of European Union
management authorities and the creditworthiness criteria used by the banking
sector. Upon completion of the analysis of the four criteria for selection, as observed
in the lines above, the projects were approved for funding and recorded superior
results on the proposed selection grid, so it can be validates for a larger usage. Of
course this proposed model should be based on the specifics and extension of each
proposed programme: major infrastructure projects business / tourism / industrial
cannot be assessed in the same way as those involving minor investments or those
381
developed by micro-enterprises. It should also be separated the investments which
require bank financing from those who do not need it.
A better attention should be given to the input data which are used for calculation,
especially when assessing the financial analysis of the project, because the banking
system and the management authorities use the same type of analysis but with
different data and sometimes different simulation methods.
Applications for Analysis and Assessment linking the financial analysis with the
bankability of projects should be expanded and developed properly, perhaps through
the technical assistance programs of the European Commission. A partnership
between management authorities, banks and / or consulting companies could
generate, in 2014 – 2020, higher acceptable rate by the European Union and the
banks. This will really take to a significant influence of the banking and financial
measures in order to encourage the absorption capacity.
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