What ratios and indicators to use in project finance

Equity investors (sponsors) and debt investors (creditors) have different needs in terms of financial ratios and key measures, because they have different risk profiles and different goals.

NPV and IRR are the key information in corporate finance. In project finance the most relevant indicator is the IRR.

Profitability of a project for shareholders (equity investors)

The shareholders provide equity financing during the construction phase. The equity investment is done progressively (often via a milestone investment scheme: have a look at this article on the capital budgeting of a project). So the most relevant information for a sponsor is the equity disbursement schedule and the debt-to equity (or gearing) ratio.

The shareholders are progressively repaid during the operational phase, using the free cash flow to sponsors, or more precisely dividends. Indeed not the whole amount of Free cash flow to shareholders is actually paid as some of it is reserved for creditors and contingency.

Profitability of a project for creditors (debt investors)

Creditors provide funds to the project via a work-in-progress milestone payment schedule. Then the loan is repaid as debt service (principal + interest) on a predefined schedule (amortizing, bullet, compensation scheme…).

The payment and debt service schedule are important in the profitability of the project. Note that the principal is the present value of all the installments of the loan at the end of the construction, and not the sum of the face values of the loan.

In the amortizing repayment schedule, the principal is paid in several installments and the interests are paid in every period on the outstanding amount only.

Profitability measures


The internal rate of return is the interest rate that must be used so that the NPV of the project is 0.

The IRR is good for comparing a project return to a cost of funding for the creditor.

This approach doesn’t really give advantage to projects that repay the principal earlier in time. Creditors usually prefer amortized principal repayment. This is also preferred by the SPV because it is easier to extract cash from the operations progressively instead of all at once. Financial sustainability is different from profitability.

Coverage ratios

DSCR Unlevered free cash flow vs debt service: Debt service cover ratio

The DSCR can be calculated for every year of operation independently.

$$ DSCR = {\Free\ \cash\ \flow\ \available\ \for\ \creditors} / {\Debt\ \service} $$

This describes the cushion of cash available to the project to repay the debt service. Higher DSCR are required for more risky projects. It can be computed for every year of operation.

DSCR defines if a project is bankable, if it can currently be financed or not, so it is a very important ratio.

It is rather similar to Interest Cover Ratio, but gives a larger overview of the sustainability of the debt and bankability of the project.

DSCR is used to:

  • Size the debt: Repayment (not interest though) must be calibrated to achieve a constant DSCR: $ {\Repayment} = {\Cash\ \Flow\ \After\ \Debt\ \Service} / {\Target\ \DSCR} - \Interests $
  • Check that debt payment is possible at some point:
    • If not (if the DSCR is less than 1)  the project is in Lock-up: it won't pay any dividend nor any less senior debt until it can pay the more senior debt.
    • If yes but the DSCR below a certain level, cash sweeps can apply: the project needs to repay more and money is directed to the most senior tranche of the debt

LLCR Loan Life cover ratio

This is the present value of all the free cash flow to creditor on the whole life of the loan (until it has been fully repaid) compared to the outstanding amount of the loan. It is a summary measure that applies to the full life of the project unlike the DSCR which is a year-by-year measure.

$$ LLCR = {\Discounted\ \Free\ \cash\ \flow\ \available\ \for\ \creditors} / {\Outstanding\ \amount\ \of\ \the\ \loan} $$

$$ LLCR = {{∑_k^n {\UFCF_t} / (1+i)^t} + \Debt\ \Repayment\ \Reserve _0} / {\Outstanding\ \amount\ \of\ \the\ \loan} $$

Matthieu Liatard
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