What is Project Finance?

Project finance is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors.

• Usually, a project financing structure involves a number of equity investors, known as sponsors or promoters, as well as a syndicate of banks or other lending institutions that provide loans to the operation.
• The loans are most commonly non-recourse loans, which are secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modeling.
•  The financing is typically secured by all of the project assets, including the revenue-producing contracts.
• Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.
• Generally, a special purpose entity is created for each project, thereby shielding other assets owned by a project sponsor from the detrimental effects of a project failure.
• As a special purpose entity, the project company has no assets other than the project.
• Capital contribution commitments by the owners of the project company are sometimes necessary to ensure that the project is financially sound, or to assure the lenders of the sponsors’ commitment.
• Project finance is often more complicated than alternative financing methods.
• Traditionally, project financing has been most commonly used in the extractive (mining), transportation, telecommunications and energy industries.
• More recently project financing principles have been applied to other types of public infrastructure under public–private partnerships (PPP)

Project Finance Modeling

• Project finance is only possible when the project is capable of producing enough cash to cover all operating and debt-servicing expenses over the whole tenor of the debt.
• A financial model is needed to assess economic feasibility of the project.
• Model’s output is also used in structuring of project finance deal. Most importantly, it is used to determine the maximum amount of debt the project company can have, the debt repayment profile, what will be the return on equity for the project, what is the IRR and other parameters necessary to assess the project viability.

General Structure of Project Finance Modeling

A basic project finance model has the following broad categories

1. Capital Expenditure
2. Revenue forecast
3. Expense forecast
4. Debt Schedule
5. Books of Accounts
6. Equity return and Valuation
7. Scenario Analysis

Project finance models are usually built as Excel spreadsheets and typically consist of the following interlinked sheets:

• Data input and assumptions
• Capital Expenditure
• Debt Schedule
• Revenue Sheet
• Cost Sheet
• Accounting Statements
• Analysis for Debt repayment and return on Equity

Interlinking Between the Excel Sheets

Data input and assumptions

This sheet has all the assumptions used in the model. Assumptions used in a model depend on the business, the sector and the company.

Capital Expenditure (CAPEX):

Capital expenditure or CAPEX is the amount of money spent on a project before it gets operational. All expenses incurred for the project like design, engineering, procurement, construction, installation, commissioning, duties and taxes etc. contributes to capital expenditure.

This sheet has the capital expenditure forecast for the complete implementation/construction period of the project. It also calculates the quantum of Debt and Equity requirement at each phase of the project as per the CAPEX forecast.

Debt Schedule:

This sheet will show how the debt for the project is drawn, and how it is repaid. It will have yearly opening and closing balance of debt, the amount of debt that is drawn during the year and the amount that is repaid. It also calculates what will be the yearly interest that has to be paid.

Revenue Sheet:

This sheet forecast the revenue that the project will generate during the useful life of the project. For example

In a power project the revenue sheet will have yearly forecasts of the amount of power that the plant will produce, amount of power that will be sold and the price at which it will be sold. Form this yearly projected revenue for the power project is obtained.

Similarly for a road project it has yearly forecasts of traffic in the particular project road stretch, the no of vehicles that are tollable and the toll that is collected for this vehicle. From this the yearly projected revenue for the project road stretch is obtained.

Cost Sheet:

This sheet forecasts the cost and expenses incurred for operating and maintaining the project asset.

For example

In a power plant the cost sheet will have yearly forecasts of primary and secondary fuel expense, operating expense, general and administrative expense, marketing expense, and all other expense that a power plant will incur.

Similarly for a road project the cost sheet will have yearly forecast of maintaining and operating the toll plaza, the cost for regular repair and maintenance of the road stretch, general and administrative expense and all other expense that a Toll Road company will incur.

Accounting Statements:

This sheet forecasts the Profit and Loss statement, cash flow statement and Balance Sheet. To make these statements we need to have depreciation schedule, working capital schedule and the tax schedule.

• Depreciation is standard across all sectors unless there are some special sectors where the Govt allows accelerated depreciation.
• Working Capital Schedule forecast the yearly working capital requirement which will be used in the balance sheet. The components of working capital and their assumption are sector dependent.
• Tax Schedule forecasts the Tax Liability for the project as per Companies Act and as per IT act. The Tax liability is calculated after incorporating Minimum Alternate Tax, Carry forward losses and sector specific Tax norms.
• Debt Service Reserve Account (DSRA): The lenders of the project stipulate that once the project becomes operational, a special account called Debt Service Reserve Account is created in which the project SPV has to maintain the next one or two quarter’s debt and interest payment due. The purpose of a DSRA is to provide a cash buffer during periods where Cash Available for Debt Service is less than the scheduled payments. The existence of this buffer allows some breathing room for Operational issues to be resolved. The DSRA schedule forecast the DSRA requirement for the project.
• Major Maintenance Reserve Account (MMRA): The project company has to undertake major maintenance of all project assets after a particular period to ensure that the project is able to continue operations as planned. The maintenance costs could be high compared to the cash flows of the year during which the maintenance is carried. Therefore a MMRA is created and every year a portion of the cash is kept in that account which will be used during the major maintenance of the project assets. The MMRA schedule forecasts the MMRA requirement of the project.

Analysis for Debt repayment and return on Equity:

After forecasting the Statement of Accounts then analysis is carried out to check whether the cash flow will be sufficient to meet the service the debt. The sponsors or promoters can also check how much return that they can expect from the project. Various ratios are used for the analysis For example to check whether the debt will be serviced regularly we can use DSCR (Debt service coverage ratio) and cash DSCR. For equity IRR and NPV and be used.