SMART TASK 2

OF
PROJECT FINANCE
By
(VARDHAN CONSULTING ENGINEERS)

SUBMITTED BY-
DEVESH BHATT
EMAIL ID- [email protected]
(SCHOOL OF MANAGEMENT STUDIES)
PUNJABI UNIVERSITY, PATIALA
(2019-21)
1. While preparing a financial model what are the various assumptions we need to take. Please list
down the various assumptions with the value, assuming the project will be set up in India.

Project finance allows shareholders to raise finance for a project without the lenders having a claim on
their other assets (known as ‘non-recourse’ financing). As the financing is standalone, project finance is
only suitable for investments which generate predictable cash flows, and where a lot of the risks are
distributed away from the operational company – typically known as a ‘special purpose vehicle’. Typical
projects would be large infrastructure programs sponsored by governments.

The special purpose vehicle is the beating heart of the transaction – it holds all the relevant contracts
and owns the operational assets. The contracts are key to understanding the structure and how risk is
distributed. They include:

• Concession agreement (usually signed with the host government) which allows the construction
to commence

• Construction contract – signed with the contractor who is building the project

• Engineering contract – signed with the engineers in a complex construction project e.g. a power
plant

• Operation contract – where the project SVP is going to operate the facility on an ongoing basis

• Take or pay contract – where agreed customers must take the product e.g. gas or pay for it even
if they don’t take delivery (the payment can be offset against future deliveries)

• Put or pay contract – where agreed suppliers must deliver their supplies e.g. oil for a refinery or
pay for the supply to be sourced elsewhere

• Credit agreement / syndicated loan agreement – an agreement between the lender and the
Special Purpose Vehicle

Most project finance models have to start with some assumptions – how much you estimate to spend
constructing the project, what percentage of financing will come from equity financing versus debt, and
also the cost of different debt items.

Sometimes the project will need to build up a level of inventory in the last year of construction in
preparation for the operational period. Usually, the assumptions are split between the financing and
operational assumptions. Here’s a good example of an assumption set: :

• First make financial and operational assumptions

• Make source and users of funds

• Calculate the depreciation of capital expenses

• Make a balance sheet or cash flow statement

• Make a income statement

• Make a reserve sheet

Next, you build the sources and uses of funds:

Next, model out the depreciation of the capital expenditure in both the construction period and the
maintenance capex in the operational period. Be careful not to over depreciate or amortize the capex
and soft costs.

2. Explain the function of revenue, cost and debt sheet in a financial model?

Revenue is the value of all sales of goods and services recognized by a company in a period. Revenue
(also referred to as Sales or Income) forms the beginning of a company’s Income Statement and is often
considered the “Top Line” of a business. Expenses are deducted from a company’s revenue to arrive at
its Profit or Net Income.

According to the revenue recognition principle in accounting, revenue is recorded when the benefits and
risks of ownership have transferred from seller to buyer, or when the delivery of services has been
completed.

Notice that this definition doesn’t include anything about payment for goods/services actually being
received. This is because companies often sell their products on credit to customers, meaning that they
won’t receive payment until later.

When goods or services are sold on credit, they are recorded as revenue, but since cash payment is not
received yet, the value is also recorded on the balance sheet as accounts receivable.

When cash payment is finally received later, there is no additional income recorded, but the cash
balance goes up, and accounts receivable goes down.
Below is an example of Amazon’s 2017 income statement. Let’s take a closer look to understand how
revenue works for a very large public company.

Amazon refers to its revenue as “sales,” which is equally as common as a term. It reports sales in two
categories, products and services, which then combine to form total net sales.

In 2017, Amazon recorded $118.6 billion of product sales and $59.3 billion of service sales, for a grand
total of $178.9 billion. The figure forms the top line of the income statement.

Beneath that are all operating expenses, which are deducted to arrive at Operating Income, also
sometimes referred to as Earnings Before Interest and Taxes (EBIT).

Finally, interest and taxes are deducted to reach the bottom line of the income statement, $3.0 billion of
net income.

Revenue in Different Sectors

Below, we will explore what the concept of revenue means in different sectors. As you will see, it can be
composed of many different things and varies widely in terms of what the most common examples are,
by sector.

Personal finance:

• Salaries

• Bonuses

• Hourly wages

• Dividends

• Interest

• Rental income

Public finance:

• Income tax

• Corporate tax

• Sales tax

• Duties and tariffs

Corporate finance:

• Sale of goods

• Sales of services

• Dividends

• Interest
Non-profits:

• Membership Dues

• Fundraising

• Sponsorships

• Product/service sales

Cost sheet

A cost sheet play the following function

Planning

Planning is an important function of management accounting which is most effectively performed by the
preparation of budgets and forecasts.

Forecasting is the process of estimation of the expected financial performance and position of a business
in the future. Common types of forecasts include cash flow forecast, projected profit and loss and
balance sheet forecast. Forecasts assist in determining the likely change in the financial performance
and position of a business when considered in the context of the various assumptions used in forming
the projections. Forecasting is the starting point in determining the resource requirements of a business
which are quantified into budgets.

Budgets quantify the financial targets to be achieved by the management of an organization. Budgeting
process often begins with the preparation of a master budget which is then used as a basis for the
preparation of departmental and operational budgets. Budgeting helps in the effective allocation of
resources of an organization between competing needs (e.g. departments, products, etc) in order to
achieve the financial goals of a business. Budgets and forecasts help businesses to deal with potential
problems proactively and avoid foreseeable bottlenecks in business resources.

Decision Making

Management accounting facilitates the provision of financial information to management for decision
making. Management accounting also involves the evaluation of alternative strategies and actions by
the application of techniques and concepts such as relevant costing, cost-volume-profit analysis, limiting
factor analysis, investment appraisal techniques and client / product profitability analysis.

Debt

Debt play the following function

A debt schedule lays out all of the debt a business has in a schedule based on its maturity. It is typically
used by businesses to construct a cash flow analysis. As shown in the graphic below, interest expense in
the debt schedule flows into the income statement, the closing debt balance flows onto the balance
sheet, and principal repayments flow through the cash flow statement (financing activities).

The debt schedule is one of the supporting schedules that ties together the three financial statements.

Components of a Debt Schedule in a Financial Model

Components of this schedule include:

• Opening balance (beginning of the period)

• Repayments (decreases)

• Draws (increases)

• Interest expense

• Closing balance (end of the period)

The above items allow the debt to be tracked until maturity. The closing balance from the schedule
flows back to the balance sheet, and the interest expense flows to the income statement.

Types of Debt Listed in a Debt Schedule

To construct a debt schedule, analysts need to list all debt currently outstanding by the business. The
types of debt include:

• Loans

• Leases

• Bonds

• Debentures

Factors to Consider in the Construction of a Debt Schedule

Before committing to borrow money, a company needs to carefully consider its ability to repay debt and
the real cost of the debt. Here is a list of the factors a company needs to consider:

Debt maturity – Most debt is amortized and paid monthly. The longer the maturity of the debt, the
lower the amount due monthly, yet the higher the total sum of the debt and interest accrued.

Interest rate – The lower the interest rate, the better, but not always. A low interest rate for a long-term
debt usually results in higher total interest due than short-term debt with a high interest rate.

Floating or fixed interest – A floating interest rate will change the overall debt amount each year, while a
fixed interest rate provides reliability in the calculation. Depending on the future assumptions, a floating
interest rate is the better choice in a low or declining interest rate environment.

Ability to generate gain – There is no reason to take on new debt if the debtor cannot use the funds to
generate a steady stream of income to pay the debt off. Failure to pay a debt might result in a drop in
their credit rating or even forced liquidation.
3. Explain in detail the various steps involved (with the importance) in the fin flows sheet. Why and
what the bank needs to check before financing the project?

The 3 financial statements are all linked and dependent on each other. In financial modeling, your first
job is to link all three statements together in Excel, so it’s critical to understand how they’re connected.

Accounting Principles

The income statement is not prepared on a cash basis – that means accounting principles such as
revenue recognition, matching, and accruals can make the income statement very different from the
cash flow statement of the business. If a company prepared its income statement entirely on a cash
basis (i.e., no accounts receivable, nothing capitalized, etc.) it would have no balance sheet other than
shareholders’ equity and cash.

It’s the creation of the balance sheet through accounting principles that leads to the rise of the cash flow
statement.

Net Income & Retained Earnings

Net income from the bottom of the income statement links to the balance sheet and cash flow
statement. On the balance sheet, it feeds into retained earnings and on the cash flow statement, it is
the starting point for the cash from operations section.

PP&E, Depreciation, and Capex

Depreciation and other capitalized expenses on the income statement need to be added back to net
income to calculate the cash flow from operations. Depreciation flows out of the balance sheet from
Property Plant and Equipment (PP&E) onto the income statement as an expense, and then gets added
back in the cash flow statement.

For this section of linking the 3 financial statements, it’s important to build a separate depreciation
schedule.

Capital expenditures add to the PP&E account on the balance sheet and flow through cash from
investing on the cash flow statement.

Working Capital
Modeling net working capital can sometimes be confusing. Changes in current assets and current
liabilities on the balance sheet are related to revenues and expenses on the income statement but need
to be adjusted on the cash flow statement to reflect the actual amount of cash received or spent by the
business. In order to do this, we create a separate section that calculates the changes in net working
capital.

balance sheet, and the change in the principal amount owed is reflected on the cash from financing
section of the cash flow statement.

In this section, it’s often necessary to model a debt schedule to build in the necessary detail that’s
required.

Cash Balance

This is the final step in linking the 3 financial statements. Once all of the above items are linked up
properly, the sum of cash from operations, cash from investing, and cash from financing are added to
the prior period closing cash balance, and the result becomes the current period closing cash balance on
the balance sheet.

This is the moment of truth when you discover whether or not your balance sheet balances!

How to Link the Financial Statements for Financial Modeling

If you’re building a financial model in Excel it’s critical to be able to quickly link the three statements. In
order to do this, there are a few basic steps to follow:

• Enter at least 3 years of historical financial information for the 3 financial statements

• Calculate the drivers/ratios of the business for the historical period

• Enter assumptions about what the drivers will be in the future

• Build and link the financial statements following the principles discussed above

The model essentially inverts, where the historical period is hardcodes for the statements and
calculations for the drivers, and then the forecast is hardcodes for the drivers and calculations for the
financial statements.