A financial model supplies insight and value to a project throughout its development cycle and throughout the operational phase. It is the key document that supplies confidence in a project’s viability to all stakeholders, from those who have the first idea to create it to the people who supply the funding to make it a reality, and every stage in between, supplying a platform that ties together the impact of all development, structuring, and strategic decisions taken by the project team and allows the assessment of decisions that will impact the project. At each stage of the project’s development, financial models provide a reasonable estimate of the financial performance that can be expected with the information at hand.
As a project progresses through its development, technical, commercial, financial, environmental, and regulatory governing factors and specifications are continuously refined. This process in turn refines the financial models, progressively supplying a higher degree of confidence in its estimate of financial performance.
Some key purposes for financial models are detailed below:
- Development guidance and optimization
As a project is developed, various configurations, specifications, and scenarios about construction and operation are considered. The use of a financial model allows project development teams to assess the potential impact of each of the options considered.
Given the multi-disciplinary and complex nature of large projects, it is often a combination of factors rather than only financial ones that dictate the development direction of a project. A project’s development will be guided by what is practically possible given the technical, regulatory, environmental, and legal constraints. However, this is supported by a financial model which can assess the profitability of development options that are available as a result of these practical constraints.
- Investment Decision Guidance
Investors rely heavily on financial models to guide their decision on whether or not to fund a project. In addition to due diligence exercises, in which they explore every potential risk exposure, a highly detailed, bankable level, financial model is the ultimate informer of the investment decision.
Financial models give investors visibility of the risk and return metrics and measures that are most important to them. Simply put, investors want to achieve a certain level of financial return, within a level of risk exposure that they are comfortable with, and financial models serve to provide them with this information. Investors are even able to have the foresight of risk and return at incremental points in time over a project’s entire life. Such a level of detail allows investors to be aware of potential risks during a project’s life and mitigate these risks through revised project structuring during the development phase.
Debt investors typically supply the majority of funding for projects and as such often require financial models developed to a much deeper level of detail than equity or hybrid investors. These models are also used to inform the imposition of strict covenants and conditions upon the construction and operation of a project in order to reduce the risk exposure.
- Capital Raising
Before a project can be presented to potential investors for funding, it needs to be financially assessed by the project development and financial advisory team (project team). This is to ensure that, to the best of the project team’s knowledge, the project is financially viable.
Typically, a bankable level financial model will be produced to provide this information. This allows the project team to “dry run” the project through a mock-vetting in order to prepare for taking the project to the investor market. This process may result in minor refinements of the project as informed by the financial model developed at this stage. These refinements place a project in the best state for marketing to investors.
For projects in the operational phase, project teams and owners use financial models to assess potential refinancing options and the impact of operational changes on ongoing risk and return.
- Risk Identification
By creating a financial model, which estimates a project’s operational and financial performance over its life, the risk factors brought on by the agreements and conditions governing the construction and operation of a project can be found. These may be anything from a profit-limiting relationship between the contracted price escalation structures for costs and products to specific months in the project’s life where debt agreements are at risk of being breached. By supplying foresight of these inherent risks, a financial model can be used to decide how to mitigate them as well as assess the effectiveness of the mitigation measures.
Merchantec Capital has extensive experience creating financial models that aid projects in various development stages. Whether you are looking to raise capital, inform investment decisions, or mitigate risk, we supply expert guidance and insight. Contact us to talk further about your financial modelling needs.
