In many ways, the modelling of project finance applications is similar to the modelling of financial statements, but there are also some differences; these topics are explored in this blog.
Most project finance models require some form of integrated financial statements to be established and therefore the basic principles of FSM (financial statement modelling) apply to both cases; for example, methods use to forecast revenues, or other operational items, or to show the effect of various scenarios are essentially the same. Similarly, circular references may or may not arise in both cases (usually as a choice in the approach used), and where circular references arise these may be resolved using Excel’s own iterative method or by writing a VBA macro to be able to more explicitly conduct such iterations (and work with models with “broken” calculation paths, in which there are no circularities within the worksheet calculations, only an iteration controlled by choosing to run the macro).
On the other hand, there are some differences between the applications that has bearing on the structure of the models and cases shown:
- Full life versus partial life forecasting. Project finance calculations usually forecast the full life span of a contract or asset or an associated project. Financial statement models are most often applied to businesses that in principle have an indefinite life. Thus, for valuation purposes, a project finance model will usually explicitly value the forecast cash values (using discounting techniques), whereas cash flow valuation based on a financial statement forecast usually requires some form of calculation to estimate terminal values (i.e. a succinct formulae to estimate that future value that has not been explicitly modelled).
- Equity/debt focus. Financial statement modelling most often has an equity focus, as a consequence debt drawdowns/payoffs are treated as balancing items (rather than assuming that equity would be issued to cover financing shortfalls, or bought back in the case of cash excess). In project finance modelling, the focus is usually from a debt perspective, with the debt capacity (or authorised facilities) being fixed and any additional financing requirement (for example that may result in a poor operational scenario) would be supplied through an (implied) equity injection. In addition, equity focus approaches may often use more optimistic base case operational scenarios that would debt-focussed approaches, which tend to assume more pessimistic cases, and assume project debt capacities that would still be serviceable in such cases.