As soon as a project reaches financial close there are costs being incurred and balances to be tracked and so this means that costs and receipts need to be monitored. Ultimately, the implications of this is that the model needs to be regularly updated and this is where the problems start with most project finance models designed for financial close.
Transaction models vs. tracking models
The cause of this problem is that financial models generally are solely designed for structuring and optimising the debt and equity structures and the generation of scenarios in the lead up to financial close. They are not refreshed / re-engineered prior to the covenants being reported.
Even if ‘actuals functionality’ is considered from the outset the duplication and additional thinking required for a model to accommodate actual information would really obstruct the intense and fluid process in the lead up to financial close. Therefore it is best left for shortly after financial close at which point the model should be rebuilt. Yes I said, rebuilt….
Why should a financial model be rebuilt after financial close?
This generally isn’t such as big a job as it sounds because a lot of the thinking has already been performed in the original financial close model. This decision gives the sponsor / banks / project team the opportunity to strip out all of the excess functionality which is no longer needed as well as modelling the project accounts as they were documented.
The transaction model is unlikely to have considered this functionality. This also provides the opportunity to set up the framework so that the project company’s CFO or Financial Controller can update for funds in and out of the accounts and keep the balances updated in a way that although designed for covenant reporting it can also handle scenarios.
How to build functionality for reporting of actual data?
In a nutshell an exact replica of the integrated financial statements is created which are selected in preference to any projected / modelled values if the period is an ‘actual’ period. There are some lines that need to be fed back into the calculation sheets such as calculation costs and principal repayments so that other lines are properly calculated.
A good introductory tutorial can be found on Navigator Project Finance
Avoid the frustrations of tracking actual data
The majority of the common frustrations I regularly hear from both financiers and sponsors once a project moves into construction and monitoring phases would be avoided if the following are considered:
- When a scenario is run only the columns beyond the current date are varied.
- Updating the model wasn’t a big exercise and could be done with confidence
- Covenants such as DSCR can be reported to lenders in a way that is easily verified
- The models’ balance sheet agreed to that of the project company quarter on quarter
What about the model audit?
The big hurdle standing in the way of rebuilding a reporting model is that the project documents generally are legally tied to the Base Case Financial Model which was audited in the lead up to financial close.
If all parties acknowledge that the time is right to move into a monitoring phase for the model then a detailed reconciliation can be constructed which shows that in the base case and identified scenarios and sensitivities the new model behaves in the same way as the original. Even with audited models this approach generally results in new errors being uncovered.