Project Finance

Project FinancingInvestment in a constructed facility represents a cost in the short term that returns benefits only over the long term use of the facility. Thus, costs occur earlier than the benefits, and owners of facilities must obtain the capital resources to finance the costs of construction. A project cannot proceed without adequate financing, and the cost of providing adequate financing can be quite large. For these reasons, attention to project finance is an important aspect of project management. Finance is also a concern to the other organizations involved in a project such as the general contractor and material suppliers. Unless an owner immediately and completely covers the costs incurred by each participant, these organizations face financing problems of their own.

At a more general level, project finance is only one aspect of the general problem of corporate finance. If numerous projects are considered and financed together, then the net cash flow requirements constitutes the corporate financing problem for capital investment. Whether project finance is performed at the project or at the corporate level does not alter the basic financing problem.

In essence, the project finance problem is to obtain funds to bridge the time between making expenditures and obtaining revenues. Based on the conceptual plan, the cost estimate and the construction plan, the cash flow of costs and receipts for a project can be estimated. Normally, this cash flow will involve expenditures in early periods. Covering this negative cash balance in the most beneficial or cost effective fashion is the project finance problem. During planning and design, expenditures of the owner are modest, whereas substantial costs are incurred during construction. Only after the facility is complete do revenues begin. In contrast, a contractor would receive periodic payments from the owner as construction proceeds. However, a contractor also may have a negative cash balance due to delays in payment and retainage of profits or cost reimbursements on the part of the owner.

Plans considered by owners for facility financing typically have both long and short term aspects. In the long term, sources of revenue include sales, grants, and tax revenues. Borrowed funds must be eventually paid back from these other sources. In the short term, a wider variety of financing options exist, including borrowing, grants, corporate investment funds, payment delays and others. Many of these financing options involve the participation of third parties such as banks or bond underwriters. For private facilities such as office buildings, it is customary to have completely different financing arrangements during the construction period and during the period of facility use. During the latter period, mortgage or loan funds can be secured by the value of the facility itself. Thus, different arrangements of financing options and participants are possible at different stages of a project, so the practice of financial planning is often complicated.

On the other hand, the options for borrowing by contractors to bridge their expenditures and receipts during construction are relatively limited. For small or medium size projects, overdrafts from bank accounts are the most common form of construction financing. Usually, a maximum limit is imposed on an overdraft account by the bank on the basis of expected expenditures and receipts for the duration of construction. Contractors who are engaged in large projects often own substantial assets and can make use of other forms of financing which have lower interest charges than overdrafting.

In recent years, there has been growing interest in design-build-operate projects in which owners prescribe functional requirements and a contractor handles financing. Contractors are repaid over a period of time from project revenues or government payments. Eventually, ownership of the facilities is transferred to a government entity.