30th October 2019

Written by Matthew Bernath and Lance Rubin

Introduction to the co-author

Matthew is an entrepreneur, engineer, CFA® charterholder, trainer and Excel addict with a love for finance, data science, process optimisation, data visualisation and building businesses.

As a qualified engineer, Matthew has consulted to five of the largest South African banks and numerous corporates and parastatal. 

He runs regular, highly rated in-house and public Excel, VBA, financial modelling and dashboards training courses. With practical insight and a broad client base,

Matthew has never been rated less than 5 out of 5 for subject matter expertise.

Before joining RMB's Infrastructure Finance division, Matthew was a Director at Seoketso (an advisory, technology and training firm) and prior to that Head of IT & Operations Consulting at a consulting firm. 

As a member of KPMG’s Green IT team, he honed his love for green and renewable energy.

Why is he so passionate about the topic

Underlying every large deal is a financial model which holds all of the deal complexity, logic and structure in one place. 

I often say that if you understand the financial model, you understand the deal!

Infrastructure finance involves both financial structuring and building large projects which benefit the public with new roads, renewable energy resources and even new social infrastructure assets like schools, hospitals and police stations to name a few.

It’s a really tangible form of finance, on the one hand you have a highly structured financial model, but on the other hand you can go and visit the wind farm or ride the train that you helped to finance.

Topic and context in no more than 3 sentences

Project or Infrastructure Finance is arguable one of the most complex forms of financial modelling and the outcome most beneficial for the public, compared to other corporate finance and M&A like an initial public offering (IPO).

Ask any professional financial modeller and they will agree with this aspect. Until you have built a project finance model, you have not gone beyond the realms of complexity in all areas of modelling as compared to most of the traditional business focused financial modelling:

• Project Finance revolves around the financing of long-term infrastructure construction and operations like roads, bridges, renewable energy projects, specialised real estate and property and many more that make our world work and look like it does today around us.

• The debt and equity funding for projects are often highly structured and long dated (up to 30 years) resulting in them being complex transactions to negotiate and build a model.

• It's very heavily cash flow based, but is also an audited 3-way model with a balanced balance sheet. The project won’t get funded no matter how good the cash flows look if the balance sheet doesn’t balance and the model is wrong!

If you had to teach this topic in a class to school kids what key tips would you give them to focus on

To understand why a project finance model (think of a very big Excel spreadsheet, unlikely to be a Google Sheet) is so complex, firstly we must understand project finance.

Amongst banks and investors it is also known as Infrastructure Finance as infrastructure (roads, bridges, buildings, energy supply, schools, hospitals, police and justice buildings etc) is what it typically finances.

It’s the really big big calculator with lots of potentially complex formulas to help people decide if they are going to build a road, bridge or even a new power source for people to use.

When you wake up in the morning you turn on the lights, the power station that supplies electricity for you to do so (and your homework you love doing) has been project financed.

If it wasn’t for Project Finance we would all be sleeping in the dark (sadly the homework you can’t get rid of that easily)!

When you go to the kitchen to make breakfast you will be using more electricity. If it wasn’t for Project Finance and the modelling that sits behind it you would have to start a fire to warm up water for tea or coffee.

Schools are often referred to as social infrastructure and also form part of project finance and likely to have a complex financial model behind it - social infrastructure can also refer to public transport such as trains.

Project finance is a form of finance that benefits the public at large as its core purpose (its why?).

What practical steps can people take now to learn more

There is a lot of research on project finance available online, and also many example project finance models and model templates. 

The best place to start is by spending time drilling down into an existing project finance model and understanding how it works, how the distinct construction and operations phases are modelled, how the funding is structured and how revenue is generated and expenses incurred.

Think of it like unpicking a rainbow ball of wool into each of the different colours before the cat and the kids got hold of it and mixed it up for you.

A project finance model should (in most, but not all cases) be approached in two parts:

Construction phase

• Where the project is being built and debt is generally not being serviced (but sometimes interest is serviced by drawing down on the debt). This is often referred to as interest capitalisation.

• The interest during construction is capitalised onto the balance sheet and the payment for such interest is added to the amount owing to the funders.

• This often results in interest on interest and compounding which is why small movements in interest rate can actually have very big impacts on the overall viability of the project and why interest rates tends to be locked in using interest rate swaps.

Operations phase

• Where the project is built and starts to generate some revenue, albeit often at a suboptimal rate initially and then later in a more stable and economic manner. This initial period is often referred to as a ramp up phase as more aspects of the project asset become operational. The debt is also required to be serviced for both interest and debt repayments.

• To guard against operational fluctuations there is often various multiple cash reserves required to be established and also built up as part of the commencement of operations as a buffer.

Cash is paid from the projects through what’s called a cash flow waterfall that can often be fairly complex especially when reserves are building up and being depleted over the construction and operations period.

Where are good places (links) to find out more on the topic

The Financial Modelling Podcast has episodes and blog posts on the complexity of project finance modelling.

Corality and Operis are also great places to look for examples and explanations online.

How important is this skill in the context of learning FM?

Building a project finance model from scratch will enable a financial modeller to understand the importance of structuring a model to be flexible, and be able to run multiple different scenarios. 

Due to the changing nature of a project finance deal from origination to close, the more modular and well built a model is, the easier it will be to work with going forward. 

A project finance model has all of the traditional financial modelling elements, together with some more complex elements such as distinct operations and construction periods, Debt Service Reserve Accounts that are funded as part of project costs and usually some macros to avoid circular references.

How does all this disruption, AI and automation talk impact this topic

Project finance models are unlikely to be significantly automated in the short term due to their bespoke nature. That said, model templates do exist and there is room for automation in scenario analysis and understanding the optimal hedging structure to minimise both risk and hedging costs.

If you want to find out more and follow the rest of the article series be sure to download the Financial Modelling App

If you want to find more information on financial modelling and content visit the Model Citizn website.