Project finance is the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure, in which project debt and equity used to finance the project are paid back from the cash flow generated by the project.
Our company on behalf of our financial partners is responsible for identifying potential PPP projects, confirmation and the Due Diligence process on this issue.
PPP (Public-Private Partnership)
PPPs are long-term contracts between a private party/company and a government entity, for providing a public asset or service, in which the private party bears significant risk and management responsibility and remuneration is linked to performance. Transferring responsibility to the private sector for mobilizing finance for infrastructure
investment is one of the major differences between PPPs and traditional procurement. Where this is the case, the private party to the PPP is responsible for identifying investors and developing the finance structure for the project. However, it is important for public sector practitioners to understand private financing structures for infrastructure and to consider the potential implications for government.
Public – Private Partnership Types:
BOT – BUILD OPERATE TRANSFER
BOO – BUILD OWN OPERATE
BOOT – BUILD OWN OPERATE TRANSFER
DBF – DESIGN BUILD FINANCE
DBFO – DESIGN BUILD FINANCE OPERATE
DBO – DESIGN BUILD OPERATE
BTO – BUILD TRANSFER OPERATE
DBFOM – Design Build Finance Operate Manage
LROT – Lease Renovate Operate Transfer
DCMF – Design Construct Manage Finance
BOOR – Build Own Operate Remove
OPERATIONS OR MANAGEMENT CONTRACTS
Proper use of debt financing is beneficial to your business in a number of different ways.
First, debt financing almost always costs substantially less than equity financing (the exception being when the business is approaching bankruptcy or very high levels of debt). If you get a loan with the bank, it might cost your business 5% to 7% in annual interest expense. Imagine what it would cost to use equity for the same amount!
If your company’s book equity were to trade on Wall Street this week, what would the price be? One could see the pricing result in a minimum 33% return on equity just to get interest of investors, let alone buyers. Equity financing is very expensive because the risk of equity ownership is so high. Bebt financing, on the other hand, is much less
expensive and much more readily available.
The second benefit of proper use of debt financing is the potential for enhanced return on assets (ROA). For instance, assume that a business holds large amounts of cash balances instead of using a line of credit to assist in the financing of current assets like accounts receivable and inventory. The cash balances are earning interest income at a rate of 1% to 2% per year. If the company could borrow at a rate that, after tax, is lower than the return of the financed asset, then it would be very prudent to do so. Getting rid or low return cash and substituting low interest debt will raise the ROA.
One big problem with debt financing occurs when business owners start using short-term financing for long-term assets or long-term financing for short-term financial goals. Term debt financing should be used for long term asset financing and short-term debt, like lines of credit, should only be used for working capital financing. Total annual
interest expense (relative to revenues) should never exceed the net operating income margin. This is negative leverage and must be avoided at all costs.
Few companies can financially function without the use of debt financing and even those that produce enough cash flow to avoid the use of debt should seriously reconsider that choice. Debt financing is just far cheaper than equity financing. A prudent financial balance is essential but outright avoidance of debt because of what the misuse of
debt can cause is shortsighted and damaging to the company.
An additional concept for debt management uses a concept called the loan constant. We cover the loan concept in-depth here, including how to calculate it for all of your loans.
The higher the loan constant, the more disadvantage to the loan. If you wanted to pay off loan balances and didn’t know which ones to pay first, you can use the loan constant to determine where to start.
Simply start paying the highest loan constant value loans first, working from highest to lowest. Loan constants generally increase as time goes on rather than decrease from the original calculation.
Use your debt capacity wisely!