Available cash is crucial in project finance. It can mean the difference between smoothly repaying your lenders or having to renegotiate your debt tenor and amortization schedule. The latter not only damages your credibility but also strains your relationship with lenders, something every project manager wants to avoid.
Traditional EBITDA measures often fall short in project finance because they include non-cash expenses (thanks to accrual accounting) and exclude other key cash expenses incurred during the project’s life. This is why many analysts turn to Cash Flow Available for Debt Service (CFADS) as a more accurate measure of a project’s capacity to handle debt repayments. CFADS is a key input for calculating the Debt Service Coverage Ratio (DSCR), which compares CFADS (numerator) with the debt service amount (denominator). Debt service, in this context, is simply the sum of principal repayments and interest charges.
In another lesson, I’ll show you how to create a debt repayment schedule step-by-step. If you’d like more personalized help, you’re welcome to book a private training session with me.
To calculate CFADS, a common starting point is EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). From there, you’ll subtract the following:
- Capital charges
- Operating cash expenses (e.g., utilities)
- Changes in working capital (e.g., a decrease in accounts receivable when cash is collected from customers or an increase in inventory, like purchasing materials for a toll road repair project).
Other adjustments include tax cash outflows and labor or lease cash expenses. On the flip side, if there are cash inflows from any of these items, you’ll add them back. It’s worth noting that every project is unique, so adjustments will vary. If an expense has already been accounted for in EBITDA and is cash-based, no further adjustment is necessary. However, under accrual accounting, you need to reflect the timing of expenditures rather than the actual cash disbursement. This is where things can get tricky for those unfamiliar with accounting or financial modeling techniques.
CFADS will almost always be lower than EBITDA due to these adjustments, but it’s a far more accurate measure of debt service capacity. How does CFADS typically change over a project’s lifetime? Let’s break it down:
- During construction: CFADS is often very low or even negative due to heavy construction costs and fixed asset investments. Lenders usually provide a “grace period” during this phase, where no principal or interest repayments are required.
- Early operations: Once construction ends and the project begins operating, most of the CFADS is directed toward servicing interest and principal repayments, leaving little for equity holders. This stage is critical for the project’s financial sustainability.
- Project stabilization: As operating revenues stabilize, debt is systematically repaid, and any remaining cash can be distributed to equity shareholders.
- Post-debt tenor: After all debts (including subordinated debt) are repaid, equity holders can claim the full CFADS amount.
Typical DSCR values range from 1x to 1.30x, depending on the project and lender requirements. A value of 1.30x can be interpreted as:
Your cash flow available for debt service must be equal to your debt service expenses plus a 30% buffer on top of that.
The higher the ratio, the more conservative the lenders are in the project.
In renewable energy projects, probabilistic models are often used to estimate CFADS. Conservative lenders tend to rely on a P-99 model over a one-year timeframe. For example:
“According to my statistical model, there’s a 99% probability that my project will generate more than X amount of energy over the next year.”
Lenders often combine probabilistic models with pro-forma cash flow projections, using the most conservative estimates to minimize risk. This mix ensures that projects are financially robust, even under less-than-ideal conditions.
By focusing on CFADS and understanding its role across a project’s lifecycle, you gain a clearer picture of its financial health and ability to meet debt obligations.
Key readings:
- Renewable Energy Fianance (Theory and Practice) by Santosh Raikar and Seaborn Adamson
