Financial Analysis and Structuring for Sustainable Investments in Water and Sanitation Services
Explore the key principles of financially sustainable investments in Water and Sanitation Services (WSS), including cost recovery, working capital management, and strategies for financial sustainability. Learn about the importance of positive cash flow, foundation for sustainable utilities, and determining cash flow solutions. Discover insights on improving sector performance, using subsidies effectively, and comparing financial metrics like NPV and FIRR.
- Financial Analysis
- Sustainable Investments
- Water Sanitation Services
- Financial Sustainability
- Sector Performance
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Analyzing and Structuring Financially Analyzing and Structuring Financially Sustainable Investments Sustainable Investments The World Bank
Cost Recovery At minimum, operating revenues need to recover operating costs and administrative expenses Basic Requirements for Financially Sustainable WSS Investments Working Capital The system must be able to sustain an adequate level of working capital Positive Cash Flow The projected cash flow must remain positive for all years of projection period
Foundation for a Sustainable Utility Expand Coverage/ Service Poor Communities Financial Viability Cost Recovery Break Through Financing Limits Improved Management
WSS Providers Must Have Sufficient Working Capital to Pay Their Ongoing Bills Working Capital is measured by the Current Ratio which essentially calculates current assets over current liabilities. At minimum, the Current Ratio should be 1.2. However, a much higher ratio may indicate that short term assets are not used efficiently. A ratio of less than 1.0 may indicate cash flow problems or the inability to convert revenues into cash.
Determining the Cash Flow Solution
Improve sector performance and close revenue gap Use subsidies sparingly and for transition Bring in government as real owners in the financing challenge Make use of all sources of financing Use concessional finance correctly Strategy for Financial Sustainability
FIRR vs. NPV? The NPV is the value of the sum of projected cash flows discounted at the cost of capital. Any value over zero indicates adequate return, but the higher positive value show a higher return. The NPV calculation Does not give you re the exact rate of return. Just tells you that you are either above or below your threshold level. The Financial Internal Rate of Return is the rate of return expressed as a percentage that the Project yields. Through extrapolation you can equate the two by either increasing or decreasing the discount rate so that the NPV equals zero. In other words if your NPV is 0 at 15% discount rate then the FIRR should be 15%. However, the FIRR can produce different values of the same cash flow and can produce the wrong number. Moreover, the FIRR formula assumes that the cash surpluses are reinvested at the FIRR rate which is not necessarily correct. In order to correct this problem the Modified IRR formula was developed which deals separately with the reinvest rate. The formula for NPV and FIRR are exactly the same for the economic analysis. In that case they are usually referred to as the ENPV or the EIRR. The difference is how you calculate the costs and benefits. The financial analysis only includes cost and benefits that accrued to the project, not externalities that accrue outside the project to the wider economy.
Which Project is More Financially Sustainable? Project Project FIRR FIRR Year 1 Year 1 Year 2 Year 2 Year 3 Year 3 Year 4 Year 4 Year 5 Year 5 WACC WACC Go/No Go No 1 -150 40 60 30 -50 10% 7.7% No 2 9.1% -50 -50 -50 -50 250 7% No 3 2.6% -100 20 25 30 32 2%
Revising Capex Program by Allowing PIP to Take Effect Reducing CAPEX Program Altogether Ways to Close the Financial Sustainability Gap
Shape Financing Structure Ways to Close the Financial Sustainability Gap Improve Cost Recovery Modify CAPEX Program
Blending with Concessional Loans or Commercial Finance Full or Partial Grant funding for CAPEX Shaping the Financing Structure Reverse Engineering to Determine Loan Amount that Can be Sustained Restructuring Unsustainable Debt
12 Direct Grants Concessional Loans Government Support Tax and Other Financial Incentives Guarantees
How Financing Can be Structured to Address Sustainability Cash Flow Problems Bank Loan/Credit Agreement to Government Subsidiary Loan Agreement Financially Sustainable Terms to the Utility Terms to government Local currency financing Extended grace and maturity periods Lower cost of funds Grant allocation
14 Government Support Options
15 Attempts to lower the overall cost of capital to an investment Stretch out repayment obligations through long term sources. Hence meet both cash flow and efficiency considerations. Can work with higher leverage structures with enhancements such as performance bonds Approach of Blended Finance
16 Common Transaction PPP Structures Common Transaction PPP Structures Structure Characteristics Typical Private Finance with 35-65 capital structure, 15 year, 3 year grace. Straight Private Deal Private financed deal with up-front government subsidy component. Least Govt. Subsidy Viability Gap fund made available through ODA replaces upfront grant from Government. Viability Gap Financing ODA can increase debt component . WB has gone up to 85% debt with tenures of as high 30 years and 10 years grace. ODA Hybrid I Can add government grant component to the hybrid I structure. ODA Hybrid II
17 Effects of Blended Finance Structures for PPPs Effects of Blended Finance Structures for PPPs
EFFECTSOF BLENDED FINANCEON NET PRESENT VALUEAND CASH FLOWS
Incorporate Performance Improvement Program in Project OPEX Support for a Transitional Period Improving Cost Recovery Extended Commissioning Period Adjust Tariff to Justified Levels
Biggest Trickling Disbursements and Losing the Benefit of Grace periods Taking on More Debt than the Utility Can Sustain Loans in FX Currencies Mistakes Our Clients Make Our Loans
