Project Finance – Overview, Guide, What You Need To Know.
November 27, 2019
The financing of long-term infrastructure, industrial projects, and public services using limited financial structures are termed as project finance. Loan for project funding will be reimbursed by utilizing the generated cash flow. Projects are regarded as separate entities from their parents so it especially attracts the private sector as an organization can fund major projects off-balance sheet and can earn better margins when a client, unlike any other financial strategy, opts for the scheme. A cost-benefit analysis typically serves to determine whether the economic advantages exceed the cost. Research and verification are particularly important for the long-term growth of projects.
Advantages of Project Finance:
- Effective Debt Allocation: Project financing allows sponsors to increase their debt more than the parent's ability. Credit can be viewed separately and may not be influenced by its sponsors’ credibility. Flexible credit arrangements can be negotiated depending on the merit and potential of the project.
- Risk Management: Projects are regarded as separate entities from their parent so the risk factor is greatly diversified and diluted. Parent company shareholders are immune to the project's destiny fluctuations. The risk is also reduced when multiple entities are involved.
- Economies of Scale: In project finance, two modern organizations agree to come together only if they both see a significant benefit from the association.
Disadvantages of Project Finance:
- Complexity: Projects finance is based on several contracts between multiple parties, each involving complex negotiations. Usually, maintaining a record of cash flow is difficult between the concerned parties unless proper discretion is exercised.
- Compliance and Documentation: The project finance venture is set off by the government's radars. Banks and financing firms perform extreme due diligence even before increasing the limit of finance. SPV has a separate legal status so the bank and financial institution can make recoveries only against the assets and cash flows of the SPV which is the time taking process.
- Expert assistance: Project finance entails complicated deals and multiple parties. It requires specialists and experts in setting up a complex business-driven and credit-availing system involving huge costs.