A Complete Guide to the Project Finance Modeling - IIM SKILLS (2024)

Are you interested or currently working in infrastructure, oil, gas, mining, or renewable energy industries such as solar, wind, etc? If yes, one of the most valuable skills you can equip yourself with is project finance modeling. People with this expertise work as analysts, managers, senior managers, associate directors, financial advisers, financiers, and CFOs in project businesses, investment banks, private equity funds, and infrastructure funds. But what is project finance modeling exactly? How can you learn it? Can you learn it on your own? How difficult is it to learn and how do you overcome the obstacles? If the above questions are bugging you, read on to find out.

What is Project Finance Modeling?

First, let us know a little bit about project finance and financial modeling. When we employ a non-recourse or limited recourse financing structure to fund long-term infrastructure, industrial projects, and government services, then it is known as project finance.

Non-recourse financing is a kind of commercial lending in which the lender is only entitled to a repayment from the earnings of the project, not from the borrower’s other assets. The cash flow from the project is utilized to repay the loans and equity that were used to fund it.

Since this is often a complicated procedure, this is usually used for long-term infrastructure or industrial projects. Financial modeling will help to reflect a company’s financial status by producing a summary of costs and earnings in the form of a spreadsheet that can be used to assess the consequences of a future occurrence or action

The most common uses of financial modeling are to create a forecast, value a company, complete mergers, and acquisitions, and raise capital, as well as for budgeting and planning purposes.

To sum it up, project finance modeling is a specialized form of financial modeling, an analytical tool used to assess the risks and rewards of lending to or investing in a project. This is often done on spreadsheets such as MS Excel but can also be done on web-based provided by some companies.

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Why Do Companies Choose Project Finance Modeling?

Companies might hypothetically “corporate finance” have an infrastructure project if they so choose. They still don’t do so because of the benefits of the project finance approach.

Advantage 1: Risk segmentation: There is a contamination of risk when a corporate organization seeks fresh funding for a project that has a riskier profile than its present business activity.

If the project fails, the entire film might be put in jeopardy (i.e. contamination risk). As the cost of debt and stock rises to compensate for the risk, the company’s total worth will likely fall. Project funding eliminates or reduces this risk.

Advantage 2: A larger leverage (gearing) ratio (typically): Higher debt capacity means that project sponsors must commit or raise less equity, resulting in higher equity returns (e.g. IRR).

Advantage 3: Smaller organizations can work on big projects. The capacity to obtain financing is more dependent on the project’s profitability than on the company’s strength.

Here are the Basics of Financial Modeling

The Following Characteristics Are Common in Project Finance Modeling:

1. Scrutiny on Construction and Modeling is Done Monthly.

A solar farm may be built in six months, whereas a hydro dam could take five years (the Three Gorges project in China took 13 years). Because project finance loans have a single purpose — to fund the project’s development and operation – debt drawdowns occur in lockstep with the project’s construction.

During this time, there are significant capital outflows to acquire components and develop the asset. As a result, the building phase is a full phase in the model, which is often modeled weekly (changing to quarterly or semi-annually during operations).

2. There is a Strong Focus on Debt Optimization.

Project financing permits a large level of debt since cash flows are ring-fenced and risks are greatly reduced by contracts, transforming a small return into an excellent return on equity. The maximum amount of project finance debt capital available is generally limited by gearing limits (e.g., debt cannot exceed 70% of total project costs) and a percentage of cash flow (CFADS) to assure loan repayment.

Circularities emerge because the amount of loan interest payable is included in both computations. This is something that the model structure must address (which also necessitates the need for a debt sizing macro). Long-term operations are modeled on a quarterly or semi-annual basis.

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3. Projects Might Last for a Long Time.

The operating life of an asset can range from 5 years (for example, a mine) to 120 years (for example, the Swansea Bay Tidal Project), with median lifetimes of 25 to 35 years. These aren’t the kind of models where you model out five years and then slap a terminal value on the end. Because the cash profile at each stage differs, the project must be modeled across its whole life.

Is the project debt-free? If that’s the case, provide equity investors with additional money for the length of the project. Is a decommissioning reserve required for the project? If this is the case, it may be necessary to begin accumulating cash years before the project is completed.

The project’s cash flow is dependent on payments to stakeholders. Debt dividends govern the distribution periods for equity holders. As a result, modelers frequently prefer to match the model’s periodicity to the loan payback schedule, whether quarterly or semi-annually.

4. Not a Going Concern, Therefore Cash Focused

Since it’s not a going concern, it’s fixated on cash. Corporations are considered “going concerns.” Long-term debt is rolling over, accumulating interest on the balance sheet. The belief is that the principle will be repaid as long as the company is strong and profitable. As a result, lenders look at measures like the Interest Coverage Ratio (EBIT/Interest Expense) to see if the firm can repay its debt.

First, note that EBIT is an accrual number, not a cash one. Lenders are happy with EBIT smoothing out period-to-period cash unpredictability when financing going companies, but not for projects with a defined beginning and conclusion. Second, observe how the coverage formula ignores principal payments and just considers interest.

Lenders are happy with this when lending to continuing businesses that can refinance at the end of the loan’s term, but not when the loan has a set end date. As a result, these ratios are rarely used in project finance models. Instead, you’ll see the Debt Service Coverage Ratio (DSCR), which takes both interest and principal into account.

The DSCR assists lenders in determining cash coverage over time. If lenders want to look at the big picture, they may calculate the cash flows over the life of the loan, discount them to a single point, and determine how many times the nominal cash pile pays the loan total. The Loan Life Coverage Ratio is what it’s called (LLCR).

Read here How to Become a Professional Financial Modeler

5. The Cashflow Statement becomes the Cashflow Waterfall as a result of the hierarchy

Of course, debt takes precedence over equity in terms of repayment, and this is reflected in a variety of ways, the most obvious of which is that they are higher in the cash flow hierarchy – i.e. Principal and Interest payments come before distributions – ensuring that debt is paid back for that period.

A Cash Flow Waterfall results from this. It has the same line items as a Cash Flow Statement (actually, one arranged using the Direct Method rather than the Indirect Method, which includes non-cash elements such as net profit), but rearranges them according to the cash payment hierarchy.

Trade creditors are paid ahead of taxes. Then there’s senior debt, followed by senior debt reserve accounts, which get priority over subordinated debt, and ultimately equity holders. Debt repayments are computed based on expected cash flows and locked in with a principle repayment plan since funding is secured on the strength of cash flows.

If the loan is for 15 years, for example, the principal repayments required in 15 years will be computed immediately. And will be compensated based on the cash flow available at the time. The loan repayment is made out of each quarter’s cash flow.

Individua loan repayments are put at risk as a result of this; for example, if oil prices have a bad quarter, an oil production project with pricing risk may not be able to satisfy their debt obligation in that quarter, putting the project in default.

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6. Reserve Accounts

These reserve accounts have priority over cash flows to equity, meaning that financing for these accounts occurs earlier in the cash flow. These reserve accounts assist to protect the project against short-term disruptions. As a result, there may be a Debt Service Reserve Account (DSRA) on the balance sheet to offer the project some breathing room in the event of a shock like this.

The DSRA will have funds on hand in the event of an emergency, enough to cover 6 to 9 months of debt service which will need to be achieved by negotiation. This is usually paid for at the conclusion of the project (or less typically, built up from cashflows in the first few years of operation).

Other reserve accounts address the possibility of cash flow interruption such as through periods of capital expenditure on MMRA (major maintenance reserve account), or a CILRA (Change In Law Reserve Account).

A Project Finance Model’s Key Structural Components

Project finance models are created in Excel and must adhere to industry best practices, which include the following elements:

Inputs

1. Technical research, financial market concerns, and current understanding of the project.
2. The model should be configured to perform many scenarios with various inputs and assumptions.

Calculations:

1. Revenue
2. Construction, operating, and maintenance costs
3. Accounting and Tax
4. Debt financing
5. Distributions to equity
6. Project IRR

Outputs

1. Include a summary of essential project metrics for management to make educated decisions.
2. Financial statements are included (Income statement, balance sheet, cash flow statement)

Here is the Guide to the Best Financial Modeling Tools

How to Learn Project Finance Modeling?

Start with getting some general idea of project finance modeling. Learn about what it entails, the topics it covers, skills that it requires. This will help you know whether you develop a liking for it or not and if it is a good fit for you. You can start by taking a professional course to establish a solid understanding of the basics.

Then you should get additional practice by actually doing the modeling. For this, you should read equity research reports to give you something to compare your results to. Take a mature company’s historical financials, build a flat-line model for the future, and calculate the net present value per share. This should be comparable to the current share price or equities research report target pricing.

You can also use online templates & case studies to practice building models. After you’ve established a foundation, look for “project finance modeling” practice case studies online. Many case studies feature pre-built models that you may use as templates or compare to your own

The Most Important Skills for Project Finance Modeling Are:

1. Have an understanding of project management
2. A solid understanding of accounting and tax
3. Excel proficiency
4. Understanding how the three financial statements are linked
5. Knowing how to create a forecast
6. A rational framework for solving problems
7. Attention to detail
8. Ability to condense enormous volumes of information into a simple format
9. A sense of aesthetics and design
10. Clear communication abilities
11. The capacity to zoom in on minutiae and out to high-level strategies with ease.

How to Choose a Course

Here are a few things to think about in order to make an informed selection:

1. How Real-world Modelers Value Businesses

The goal of Financial Modeling is to provide you with practical skills that will help you get through even the toughest situations. As a result, the training should concentrate on dealing with real-world scenarios in the Investment Banking or equity Research domains.

2. A Good Balance of Theory and Practice

While it is true that financial model training should focus on real-world examples, the theory also plays a significant role in solidifying understanding. Basic ideas like time value of money, macroeconomics, corporate finance, and financial management are just as vital as excel skills since you need a firm foundation of key concepts to develop models in numerous circ*mstances.

3. Complete Excel Advanced Training

Building solid financial models requires strong Excel abilities. Given this, enrolling in a course that teaches advanced Excel capabilities is your best choice.

4. All Valuation Methodologies Are Covered.

Instead of receiving a one-dimensional understanding, a quick introduction to various valuation approaches and explanations of their application will provide you with a comprehensive picture of things.

5. Sector-specific Training Is Available.

It is critical to first comprehend a company’s business model before constructing a suitable financial model. This necessitates a thorough understanding of the dynamics of a given industry.

6. Learning About Both Domestic and International Firms and Financial Statements

Learning the financial models of huge MNCs like Infosys, Accenture, and Apple is fascinating since each of these firms has divisions/sub-divisions that teach the complexities of divisional financial reporting, revenue mix analysis, and understanding the influence of global issues on corporate operations. As a financial modeler, you must, nevertheless, have a deep understanding of domestic organizations and their activities.

7. Flexibility in Learning

This is the era of flexibility, so if you’re a full-time student or a working adult, you’ll want a course that allows you to keep up with your present activities.

8. Possibility for Practice

Self-involvement in the process through capstone projects, case studies, and other industry practice models will assist to develop the learned abilities.

9. Faculty Members Should Be Well Qualified and Have Sufficient Industrial Experience.

It doesn’t matter how effective the financial modeling program is if the professors can’t pass on the information in the most practical way.

10. Leading Industrial Organizations Grant Certification.

A financial modeling course alone is insufficient. There must be sufficient market credibility for that course, and accreditation by a reputable industry organization helps to ensure this.

11. Assistance With Job Placement Is Available.

In the real world, you have to work hard to build a name for yourself. However, placement assistance in the appropriate direction is essential.

Also Read: Financial Modeling Courses in India

Books Recommendations to Help You With Your Learning

Corporate and Project Finance Modeling: Theory and Practice (Wiley Finance) by the Author Edward Bodmer

Corporate and Project Finance Modeling gives a logical, well-organized approach to complicated and technical subjects. This book, written by a well-known financial and economic consultant, gives a complete description of project finance modeling and analysis as well as the practical use of newly developed approaches.

Theoretical discussion, case studies, and step-by-step tutorials help readers understand a variety of challenging modeling challenges while also demonstrating how to design highly organized models from the bottom up. The accompanying website contains downloadable examples, templates, and hundreds of exercises that allow users to put the complicated concepts addressed into practice right away.

Principles of Project Finance by Author E.R. Yescombe

This practical introduction to project finance integrates legal, contractual, scheduling, and other areas that are involved in big multiparty projects, single-asset acquisitions, and broad-based financing programs for fleets of assets. It incorporates both theories and case studies while avoiding being overly focused on a single sector.

It concentrates on the principles and practices needed by project finance professionals without being excessively academic or overburdened with case studies. Although the author, who comes from a legal background, realizes the need for some legal material, he does not aim to publish a law book.

The Law and Business of International Project Finance by Author Scott L. Hoffman

Project financing is used to fund large-scale energy, infrastructure, toll highways, ethanol, and recycling projects, among other things. A wide range of risks must be carefully analyzed and structured in project finance. The third version, which has been entirely revised, discusses these dangers and how to mitigate them, as well as the components of successful project finance. This all-in-one manual explores each phase of the process, mirroring the structure of a real project financing contract.

Also Read: Financial Modeling Courses in Delhi

Financial Modeling for Business Owners and Entrepreneurs by Author Tom Y. Sawyer

One of the most critical books for every small or medium-sized business owner or manager to read. It combines rational business ideas and strategies with a step-by-step process for planning and modeling a firm, as well as solving specific business challenges. You’ll learn how to use Excel to develop operational and financial models that quantitatively characterize your company’s operations and help you avoid the pitfalls and dead ends that many organizations encounter.

Financial Modeling Using Excel and VBA by Author Chandan Sengupta

Any entrepreneur or manager of a small or medium-sized business should read this book. It combines rational business ideas and tactics with a step-by-step process for planning and modeling a firm as well as resolving specific business issues. You’ll learn how to use Excel to develop operational and financial models that quantitatively characterize your company’s operations and help you avoid the pitfalls and dead ends that so many firms encounter.

FAQ

1. Can you learn project finance modeling on your own?

Yes, if you put in the effort behind it. But it would take you a lot more time and zero certifications will make finding clients more difficult.

2. Can you use project finance modeling for smaller projects?

You can if you want to but it would likely not be worth the high costs for extra due diligence applied.

3. What are the prerequisites for this?

There are no formal requirements for this subject; any graduate can pursue it. However, participants will find it easier to be able to appreciate the intricacies and finer concepts if they have a background in finance, statistics, mathematics, or economics.

Conclusion

If traditional education has not been satisfactory to you so far, then you can not just sit and sulk rather you must take action to improve yourself. And With fast-paced changes happening in the business landscape it is a necessity to be always learning and upgrading your skillset. It is an emergent lucrative field and investing your time, effort, money, and energy in developing this expertise will give you huge returns in the long term.