All About Project Finance

What is Project Finance?

Project finance is the financing of long-term infrastructure, industrial projects, and other public services based on a non-recourse or limited recourse financial structure. It is when the project pays back the debt and equity incurred by the project, by making use of the project’s generated cash flow. Basically, Project Financing is a loan structure that is dependent on using the project’s cash flow while using the project’s assets, rights and interests as collateral.

According to its definition, it is clear to see that project finance is only possible when the project itself have the ability to generate cash to cover all the expenses incurred for the project and at the same time have enough cash to pay off the debt. Hence, project finance is more popular and attractive to private sectors because companies are guaranteed to fund certain major projects off balance sheet. Thus, this will not affect the credit of the stockholders or government regulators and shift some of the project risks to the debtors, resulting in a gain of a higher rate compared to normal corporate lending.


Key Concepts of Project Finance

Now, you might be wondering what is the typical project finance structure? What is non-recourse or limited recourse financial structure? What is off balance sheet? Let’s discuss it one by one.

(1) Typical Project Finance Structure

As an example, we’ll use the B.O.T. or build, operate, and transfer project as basis of showing a typical project finance structur

BOT projects usually include a special purpose vehicle (SPV). The company’s sole activity is generally carrying out the project, which involves subcontracting such as the construction contract and operations contract. When building new projects, it is clear that there won’t be any revenue stream generated. So, the debt service won’t be effective until the project is capable once it starts its operations phase. This shows that the trust between parties involve, taking great risks during the construction phase. Which is why the sole revenue stream is likely under a power purchase agreement. And since there is limited and no recourse to the shareholders of the project, the project remains off-balance sheet.


(2) Non-Recourse/ Limited Recourse Financing

The difference between non-recourse financing and recourse financing is, in recourse financing, the lenders are given a full recourse to the assets or cash flow of the shareholders to repay the loan in the case of failure by the SPV. Once the project or the SPV fails to provide the lenders the agreed repayments, this will give the lenders the right to posses the assets and revenue of the shareholders with no limitation.

On the other hand, in project financing, it follows the non-recourse or limited financing. The project is basically given a limited liability SPV. Therefore, giving the lenders a limited recourse primarily and entirely to the project’s assets, including the guarantees, bonds, and completion, in the case of project defaults.


It is critical to take note that in non-recourse financing, there might be circumstances that will arrive in which the lenders will have opportunities to gain recourse to some or all of the shareholders’ assets. This is obviously a breach of contract on part of the agreement in between the parties. Hence, applicable laws may restrict the extent where shareholder liability can be limited.


(3) Off Balance Sheet Items

In project financing, it is allowed for the shareholders to keep the financing and liabilities of the project off balance sheet. Generally, the project debt held is not consolidated onto the balance sheet of the respective shareholders. Thus, reducing the impact of the project on the cost of the existing debts of the shareholders and their debt capacity, allowing them to be capable of issuing other investments. Obviously, any project structure that conducts off balance sheet needs to be considered carefully under applicable law and accountancy rules.

The government can also use project finance to keep the debt and liabilities incurred by the project off balance sheet, but of course only to a certain extent to take up less fiscal space. Keeping debt off balance sheet does not reduce the actual liabilities of the government, but merely disguising its condition, reducing the effectiveness of the government debt monitoring mechanisms.

As a reminder for policy issue, using off balance sheet debt needs to be scrutinized properly and prepare for protective mechanisms to be implemented together with it.


Preparing a Project Finance Model – XLS

How do companies assess the economic feasibility and ability of the project to pay back? It is none other than preparing a financial model to help assess the economic feasibility of the project. This will be used in creating a proper framework of a project finance deal. Most importantly, it is used to determine the maximum amount of debt the project can incur and a proper repayment plan.

Generally, the framework of any financial model is very simple: input – calculation algorithm – output. While in project finance model, it is more or less uniform and the calculation algorithm is predetermined by the accounting rules, where the input is highly project-specific. It is subdivided in categories such as:

  • Variables for forecasting revenues
  • Variables for forecasting expenses
  • Capital expenditures
  • Financing

Did you notice that most financial models end with an xls file extension? XLS file extension stands for an excel file. To have a better outlook or view on a structured model, using Excel is preferable. Since building a project finance model xls typically consist of the usual accounting spreadsheets like balance sheet, income statement, cash flow, retained earnings, taxes, present values, etc.

You might have heard of the term Debt Sculpting as it is common in project finance modeling. Basically, it calculated the principal repayment liability to make sure that the principal and interest liabilities are matched properly to the expected pattern of the cashflows in each period. The calculation algorithm will be easily understood and done by making use of the excel tool features.

A project finance model xls is usually build to serve as a base and conducting a sensitivity analysis is critical, to determine the effects and changes in input variables on key outputs such as internal rate of return, net present value and payback period.

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