Inflation and escalation

Note: The following procedure is used only for user-entered project variables and Contract Terms variables. Calculated variable values are passed directly into Regime modules.

1. When a project is calculated, FINANCIALS makes a copy of all user-entered variable values.
2. If a variable is marked as currency in the Variable Definitions, FINANCIALS checks if its value is nominal. If it is not, it is converted to nominal by applying inflation rates specified in the Global Options (see Currency).
3. All nominal values are converted into the currency specified in the Regime document (see The General tab).
4. For each variable marked as currency in the Variable Definitions, FINANCIALS checks the value in the Escalation Category field. If a variable has a category, its value is escalated by the corresponding escalation rates specified in the Calculation Parameters document linked to the node which contains the calculated project.
5. Variable values are passed into Regime modules for further calculations.

Note: Values from Price Files liked to hierarchies are not escalated; they are passed directly into Regimes. Thus, to obtain automatically escalated prices, you need to enter prices manually into projects by using the Local Price option, or link Price Files directly to projects. If you want to use prices linked to hierarchies, you need to account for escalation when you create Price Files.

Note: You can choose whether historical values are "deflated" or "de-escalated" in the application settings on the Others tab (see Database Setup).

Both inflation and escalation use a standard compounding interest calculation:

Inflation Factor = (1 + r) ^ N

where r = rate per period

N = number of periods

When entering the data in the inflation or escalation arrays, be aware that the values are always converted to monthly rates using the formula:

Monthly Rate = (1 + r) ^ (1/m) – 1

where r = rate per period (i.e. quarterly, semi-annually or annually)

m = number of months in that given period (i.e. 3 for quarterly, 6 for semi-annually and 12 for annually)

If the Apply Yearly Inflation and the Yearly Escalation boxes are checked (see Currency), the monthly rates are then compounded again into an annualized rate which is applied to the calculation.

It is important to understand how the inflation/escalation date is used and how it determines the value of N in the formulas above. This is often the greatest source of confusion when users try to match numbers.

In the following examples, historical values are not deflated and the annual inflation rates for 2012, 2013 and 2014 are 2%, 3% and 4% respectively. The inflation rate is the rate specified on the Currency screen (see Currency) and the inflation factor is the actual rate applied to values.

Example 1 – Inflation date of January 2013 inflated monthly

Example 2 – Inflation date of January 2013 inflated yearly

Example 3 – Inflation date of May 2012 inflated monthly

Example 4 – Inflation date of May 2012 inflated annually