Spot-checking a project finance model in 60 seconds

Most financial models contain serious errors. The challenge is to find out before you rely upon a financial model for an investment decision!

There are a number of quick checks one can apply before going into detailed analysis, and below are three spot checks you can apply within a minute:

Do assets get completely depreciated over the life of the project?
Simply calculate the total of the depreciation line over the life of the project and compare it to the total capital expenditure. In a corporate finance environment this won’t apply as easily and you will need to be a touch smarter but in a project finance model this is a good test.

Does debt get fully repaid in a downside scenario without negative cash balances?
If the model ensures that the project finance debt gets repaid even in the worst downside scenario then it is worth looking into how this is funded. It is not uncommon to see the repayment of debt being ‘funded’ by a negative cash balance which is clearly not logical. This is effectively representing the cash account as a source of capital but without the interest and margin of a true debt account.

Has escalation been applied correctly?
Create a line chart of the key cashflow items and compare the growth in the base case. If this is looking sensible then switch off (or set to zero) all escalation indexes and look at the variations of the chart. In some projects correct calculation of escalation is critical to the success of the project (PPP, infrastructure, utilities) and this is a way to quickly get a sense for the importance and accuracy of the implementation.

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