Two important outputs of the financial model are the free cash flow of the project and the free cash flow of the investor (shareholder).

The free cash flow of the project, for each period, represents all the revenues less the expenses incurred, including capital and operational expenditures.

An important parameter of the financial model is the contract term, since it directly affects several of its conclusions. This is typically a variable preliminarily defined during the design of the financial model and is confirmed or adjusted during the structuring of the project. Some of the issues that should be considered in setting the contract term, which are further developed in chapter 5, are as follows;

Building the financial model is essentially a financial exercise, that is, it does not primarily deal with accounting results. Its bottom line conclusion, the Equity Free Cash Flow, is a financial concept rather than an accounting concept. However, the financial model also needs to produce projected financial statements of the project company, consistent with applicable accounting policies, for the entire duration of the contract. These should include the yearly income statements and the balance sheet.

The revenues represent all the inflows used by the Project Company to meet its costs.

The revenues from government payments, when they are included in the revenue regime, can be considered an output of the commercial feasibility exercise since they are determined by the affordability assessment (see section 8.3).

A considerable cost associated with the project is the cost of capital or the costs of obtaining the financial resources to implement the project. To correctly estimate these costs, the financial model must accommodate a fundamental problem in project finance[14]: where the required money for the initial investment will come from.

The operating costs or operating expenditures (Opex) and reinvestments (infrastructure renewals or life-cycle costs) are commonly distributed throughout the entire duration of the contract. Most of those costs are outputs of the technical requirements, but they must be organized in terms of yearly sums[13], and their eventual variations through time should be incorporated.

Some typical items that should be included in the operational expenditure estimates are as follows.

The initial capital expenditures (initial Capex) group represent the expenses incurred from the private consortium’s preparation of its proposal until the commissioning of the asset. These expenses commonly occur before the project company obtains any revenue. The expenses are mostly obtained from the design of the technical requirements. Some typical items that should be included in the estimates of capital expenditures are listed below:

A relevant group of data that should be put into the Model are the macroeconomic assumptions. General inflation, relative inflation, base interest rates, risk-free interest rates, and exchange rates are key elements for long-term estimates.

General inflation and relative inflation are the first group of assumptions. It is generally good practice to construct the model in nominal terms (that is, including projected inflation).

At the Appraisal Phase, the project must be accurately described in financial terms to allow for several feasibility exercises to produce meaningful results. For example, the following appraisal exercises in box 4.5 use some variation of the financial description of the project.

PPP contracts allocate risks between the government and the private partner. In fact, risk allocation is one of the most important tasks conducted during the whole of project preparation since it underlies most of the PPP’s potential advantages, as presented in chapter 1.5.2.