Financial Review
A financial review of a PPP project is a critical process that evaluates the financial feasibility of the project. It ensures that the GCA has a clear understanding of the project's financial structure, obligations, and expected returns. The purpose of a financial review is to:
- Assess viability: Determine if the project is bankable and financially sustainable.
- Support decision-making: Inform negotiations, risk allocation, and government support mechanisms.
- Ensure transparency: Provide clarity on costs, revenues, and fiscal implications for all parties.
A financial model is a key component of the financial review. The compiles inputs like construction and operating costs, revenue projections (e.g., tolls, tariffs), debt and equity structure, tax rates & depreciation, inflation, escalation indices etc. The outputs of a financial model include Profit & Loss (P&L) statements, cash flow projections, Internal Rate of Return (IRR), Net Present Value (NPV), Debt Service Coverage Ratio (DSCR) etc. to help assess the financial viability of the PPP project.
Key steps for a financial review of a PPP includes – estimating project costs, estimating project benefits, setting-up the financial model, assessing the cash flows and financial indicators of the project, undertaking sensitivity analysis, assessing fiscal affordability, and concluding on the financial feasibility of the project.
Refer to the Generic Financial Model Tool in this toolkit along with its user guides and sample financial model for select sectors for more details while preparing the financial model and undertaking financial review of a PPP project.
Estimating Project Costs
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An estimation of the project cost includes all relevant costs caused by the project during its expected lifetime (whole-life cost). A sufficient understanding of the project conditions is required (land status, requirements for special equipment, and expected outputs) for undertaking this estimation. It includes:
- Estimation of capital expenditures, lifecycle costs in the maintenance and operation of the infrastructure based on the early (schematic) design.
- Initial contingency cost for significant risks that may have a material cost impact on the project.
- Costs of measures to prevent or mitigate social and environmental impacts.
- In this section, describe the key assumptions for project-specific cost estimates based on the initial design. Provide suitable references to justify costs. The cost estimates should also consider project specific characteristics, such as remote location, difficult site conditions, and local availability of inputs (human resources, raw materials, support services, etc.). List the assumptions of the cost estimates (with reference to sources and justifications) and calculations clearly explained.
- Usually, the summary project cost is presented in a table organised into various categories like – land acquisition and resettlement, site preparation, civil construction, plant & machinery (purchase and installation), measures to prevent or mitigate social and environmental impacts, provision for price increases during the construction period, provision for contingencies etc.
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Operations and Maintenance (O&M) are the ongoing expenses required to keep the infrastructure asset functional, safe, and efficient throughout its lifecycle after construction is completed. Operations costs are costs related to the day-to-day functioning of the infrastructure. They include:
- Staffing and labour: Salaries for operational staff, technicians, and management.
- Utilities: Electricity, water, fuel etc.
- Consumables: Materials used in operations (e.g., chemicals for treating water).
- Technology systems: Software licenses, IT support, and system upgrades.
- Security and safety: Surveillance, emergency response, and safety compliance.
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Maintenance costs are costs associated with preserving the infrastructure’s condition. They include:
- Routine maintenance: Regular inspections, minor repairs, cleaning, and servicing.
- Preventive maintenance: Scheduled activities to prevent breakdowns (e.g., resurfacing roads, HVAC servicing).
- Corrective maintenance: Unplanned repairs due to wear and tear or failures.
- Major maintenance / lifecycle replacement: Periodic replacement of components (e.g., bridge joints, lighting systems) to extend asset life.
- O&M costs should take into consideration the configuration of the project, technology, and issues with respect to life cycle costs. Usually, the summary O&M cost is presented in a table organised into various categories like fixed, variable, routine, and replacement O&M costs.
Estimating Project Benefits
- Project benefit assessment comprises assessment of the revenues to the project from the viewpoint of the PPP, the user, and the GCA. This section will describe the revenues earned from various sources of the project (revenue from users, revenue from commercial activities, and cash receipts from the GCA). The estimates and forecasts for revenues must be clearly documented and explained. The sources of data must be indicated; assumptions and calculations must be explained. Assumptions on macroeconomic variables (exchange rates and inflation) should be based on data and forecasts of relevant authoritative institutions.
- The section will include a table on the various sources of revenues for the project under the following categories:
- In case of revenues from user charges, provide revenue forecasts based on the demand for the project infrastructure service. The demand forecasts include demand volume (initial volume and growth rate), the tariff/ price and the price elasticity of demand. Where relevant, the impact of the quality of the service on the volume of demand and the willingness to pay have been determined.
- User charge revenue is calculated by multiplying the demand volume with applicable tariff. These revenue estimates also include adjustments to demand based on annual increase in usage volume and periodic adjustments to tariff in line with inflation and other macroeconomic parameters.
- In case of availability payment (AP), compute the payment required from the GCA for providing the infrastructure service based on a financial assessment that considers all costs for providing the infrastructure service, returns on the financing mix for the project etc. The assessment should also include details regarding the project's potential for cash revenue or for generating income
Setting up the Financial Model
- Activities to obtain Government Support and / or Government Guarantees are regulated further in accordance with the laws and regulations governing Government Supports (including Project Development Facility (PDF), Viability Gap Funding (VGF) and Availability Payment (AP)) and / or Government Guarantees.
- The description of the financial model will include details on the financial model structure, key assumptions (inflation, interest rates, demand forecasts etc.), time horizon, base year etc.
Assessing the Cash Flows and Financial Indicators of the Project
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This step includes casting the financial model to assess the financial feasibility of the project. The financial model will include:
- Projection of project investment and operating cash flow over the duration of the project;
- Modelling of the financing structure, including at equity, senior debt, and subordinated debt;
- Projection of financing cash flow based on the financing structure;
- Modelling of cash waterfall;
- Projection of income statement and balance sheet;
- Calculation of key financial ratios, including gearing ratios, return to shareholders, Financial Internal Rate of Return (FIRR), Weighted Average Cost of Capital (WACC), and Debt Service Coverage Ratio (DSCR).
- The FIRR is the stream of net project cash flows of the project (revenues less expenses). The WACC measures the cost of capital (debt and equity), weighted by their proportion and cost. The project is financially feasible if the FIRR exceeds the WACC. If the FIRR is less than the WACC (for example, if the affordable user fee is too low), the project in its current form is unlikely to generate any significant interest amongst PPP investors. Therefore, the GCA needs to look for other sources of revenues such as land value capture or other sources of commercial revenues linked to the project.
- The feasibility should also consider reducing the scope of investment, if there are dispensable investments that might make the project more feasible (for example, smaller capacity or less expensive technology). Finally, the feasibility study should explore different opportunities for public contributions (for example, capital contributions from the GCA during the construction phase to offset the cost of construction or during the operations phase to augment the project revenues stream).
Undertaking Sensitivity Analysis
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A sensitivity analysis should be carried out to assess the effect of certain project risks on the financial feasibility of the project. The usual sensitivity tests include
- Increase of construction costs (usually around 20 percent);
- Increase of operating costs (usually around 10 percent);
- Lower demand (typically decreasing revenues by, say, 10 percent); and
- Delay in project completion or operation
- Assessing sensitivities helps identify key project risks that may need to be mitigated. The Pre-FS can address those key risks to make the project more attractive for PPP. For some risks, the Pre-FS can explore guarantees from Indonesia Infrastructure Guarantee Fund (IIGF) to protect the PPP from the risk, or some part thereof.
Assessing Fiscal Affordability
- Describe the fiscal costs for the GCA based on the above financial analysis. These include payment under the Availability Payment Scheme or construction grant payments to improve affordability of the project under User Pays Scheme or any other form of fiscal support for enabling the PPP.
- List the expected annual payments, potential for cash revenue or generating revenue etc and calculate the present value of the expected payout over the life of the project.
- The Pre-FS will also assess the fiscal capacity of the GCA to implement the PPP project. This is done by comparing their fiscal capacity in accordance with regulations and indications of the calculated project's cost-benefit. Through this calculation, the GCA is expected to draw conclusions about their fiscal capacity to fund the project according to their allocation based on the chosen investment return method.
- The section also needs to include an assessment of the affordability of project services for users (households, passengers, citizens, patients, and so on). This is typically done through direct ‘willingness to pay’ surveys with potential users of the service to be provided or estimated by looking at what potential users are spending on alternative services, and so on. However, the GCA may be concerned with ensuring that services to certain parts of the population are particularly affordable, or even less expensive for the poorest, and affordability concerns are also addressed for certain businesses or industry that are important to economic growth. Details of such cross-subsidisation through tariff regime may also be included in this section.
Concluding the Financial Feasibility Assessment
- Concluding the financial feasibility involves summarising the key financial findings and providing a clear judgment on whether the project is financially feasible, sustainable, and attractive to both GCA and IBE.
- The conclusion needs to summarise he most critical financial metrics derived from the financial model: Internal Rate of Return (IRR) – for both project and equity; Net Present Value (NPV) – at appropriate discount rates; Debt Service Coverage Ratio (DSCR) – average and minimum etc. These indicators should be compared against benchmark thresholds to assess financial feasibility.
- The fiscal impact and affordability should conclude whether the project is affordable for the GCA, especially if public funds or guarantees are involved; summarise any Viability Gap Funding (VGF) or government support required and discuss the impact on public finances, including contingent liabilities and long-term fiscal exposure.
- Recap key financial risks identified (e.g., cost overruns, demand shortfalls). Present results of sensitivity analysis (e.g., impact of lower traffic volumes or higher interest rates). Indicate whether the project remains viable under adverse scenarios.
- Comment on the project's attractiveness to lenders and investors. Tie this up with feedback (if any) from market sounding and confirm whether the financial structure is aligned with market norms.
- Finally, clearly state whether the project is financially feasible. Recommend next steps, such as refining the financial model; adjusting risk allocation; seeking government approvals or guarantees and safeguards to be considered before proceeding to the procurement phase.
