See-Through Modelling. Dominic Robertson

lessons that can be taken from PFI and applied to other industries.

      The appendices include:

       links and references

       dictionary of terminology, including abbreviations

       keyboard shortcuts

       Excel functions

       business maps

       the tree analogy.

      How to use this book

      This guide should be used as a reference. Depending on your role and experience with modelling I would suggest that an efficient approach would be to:

      1 Read this preface and the introduction to understand the objectives of the book

      2 Skim read Part 2 before doing the same with Part 1, just to familiarise yourself with the overall content

      3 Then follow the practical steps of Part 2 while using the theory in Part 1 as a reference guide.

      If you are coming to all this without much experience then do not expect to rush through the book in a week. Rather, consider it your companion over time as you learn new ways of looking at and solving the modelling problem.

      If you are new to modelling you may want to first concentrate on Part 1 to explore some immediately understandable theoretical concepts. If you are an experienced modeller then you can use this book as a reference.

      If you are a finance director then you may want to ensure that someone within the enterprise is tasked with implementing the methods and knowledge contained within this book.

      Introduction

      The commercial problem

      Company directors of PFI projects face some distinct problems:

       How to forecast the future while taking account of the past

       How to properly understand cash in the business

       Is it possible to model the business and learn from past mistakes and experiences?

      These are the commercial problems that this book tries to address.

      I propose a practical solution called the See-Through Modelling operating model and this book gives you the theory and practical detail necessary to build and maintain this model yourself.

      Finance directors and modellers outside of project finance who are dealing with more general financial modelling problems within enterprises other than PFI should consider that the PFI entity is a limited company very similar to other limited companies or even publicly listed companies.

      This book is about how to model legal entities that have accounting and cash issues relating to operations, financing from lenders and rewards to shareholders. The project finance operating model is seeded by the last closing balance sheet in exactly the same way that a corporation requires.

      Operating the asset, after financial close and post-construction

      For the purposes of this book I am assuming that there is a PFI project company in which financial close has occurred and the lenders and shareholders have handed over the capital to fund the construction of the asset.

      The construction company then delivers the finished piece of infrastructure after the planned construction period and the directors and managers of the project company are left with the maintenance and management of the project for the next 25 years or so.

      All companies, whatever industry they operate within, find themselves in an analogous situation to the PFI project company, albeit possibly over longer time horizons.

      The maintenance and management of the project leaves the directors with a few problems to overcome, namely:

       Changing commercial objectives

       Limitations of the financial close model

       The practicalities of operating a project

       Balancing the interests of shareholders and lenders

       Reinvention of modelling methods

       What accountants can and cannot do

       Human error.

      Let’s look at these problems in more detail now.

      Changing commercial objectives

      At financial close the commercial objective was to close and finance the deal; in other words, to make it happen. During operations the commercial objective is to properly describe the finances in order to satisfy the lenders and directors that the project is performing to plan, and so in turn to be able to reward the shareholders as planned.

      Limitations of the financial close model

      Let’s focus on PFI. The financial close model is limited in a number of ways:

       It can’t properly mix actuals and forecast numbers.

       It can’t properly deal with the latest closing balances from the last balance sheet.

       It can’t deal with indexation actuals.

       It can’t deal with a latest tax loss balance.

       It can’t adapt the debtors and creditors to the unfolding reality of operations.

       It can’t deal with the actuals of construction expenditure if they are different to the financial close expectations.

      The practicalities of operating a project company

      Excel models need updating, management accounts need to be mapped into the models, the directors and shareholders ask questions about indexation, life cycle expenditure changes, working capital needs to be understood, VAT can cause havoc to the cash flows, and of course the banks require compliant cover ratios to allow distributions to the shareholders.

      Balancing the interests of the shareholders and lenders

      The lender is the cat that guards the cash and the shareholders are the mice that need small pieces of the cash to survive. Both parties are necessary to begin with and it is also necessary that they can subsequently live with each other.

      Reinvention of modelling methods

      In every project company, in every bank and at every consultancy there are young modellers reinventing modelling for the umpteenth time. This is risky and unnecessary. Thanks to PFI and the large number of projects in operation there have been some distinct modelling advances in recent times. This book outlines these advances.

      What accountants can and cannot do

      There is a feeling amongst some project company directors that the management accountants should be able to build and run a financial model to satisfy the banks and reporting process, but I do not think this is the case.

      The banks require the model used by the project to be audited. While this is a financial check it is also a logical and technical review. The project company’s need for a model audit and the specification of the model audit highlights the fact that models are essentially logical machines with lots of interconnections set within a wider context of fairly straightforward finance.

      Logical machines work best when built by expert builders of logic. I believe these expert builders of logic are engineers and mathematicians with knowledge of finance.

      Human error