Features of a Cash Flow Waterfall in Project Finance

The cash flow waterfall ensures that each cash flow item occurs at the correct seniority to other items. This tutorial outlines key categories of cash flow items and how to present the cash flow waterfall in comparison to the cash flow statement in a project finance model.

In project finance, a project’s cash flow is summarised using a cash flow waterfall, which shows the priority of each cash inflow and outflow. The cash flow waterfall ensures that each cash flow item occurs at the correct seniority to other items. The cash flow waterfall becomes especially important when illustrating debt repayments of many debt tranches with reducing seniority.

The concept of cash flow waterfall is also covered in more details in the Corality Academy’s project finance modelling training course, and in further detail in the advanced debt modelling and project finance course. The theory course of project finance is also covered in the Concepts & Applications course.

Cash flow waterfall categories

A cash flow waterfall is simple in its approach, as all cash flow items are placed in the order in which they occur. The main categories of a cash flow waterfall, in order of occurrence are:

• Revenues: Operating revenues and other income
• Expenses: Operating expenses and capital expenses
• Tax
• Debt service: Principal repayments and interest paid
• Distributions
• Net movement in cash balance

Key summary lines of cash flow waterfall

The cash flow waterfall is used to calculate key cash flow lines, which are used in different parts of project finance modelling. Key lines of the cash flow waterfall are:

• Cash flow available for debt service (CFADS): This is the most significant line which drives all debt repayment calculations and ratios, including debt service coverage ratio (DSCR), project life coverage ratio (PLCR) and loan life coverage ratio (LLCR)
• Cash flow before funding: This line is useful as a quick check against funding, to ensure that initial construction costs are being met by debt or equity
• Cash flow available for debt service reserve (or other reserve) account (DSRA)
• Cash flow available to equity to calculate distributions
• Net cash flow

Screenshot 1 is a high level illustration of a typical cash flow waterfall. Each category will be separated into individual line items, such as individual operating costs.

It clearly shows that by going down the page, you are able to identify the timing and seniority of each cash flow and the highlighted key cash flow lines.

Comparison of a cash flow statement and a cash flow waterfall

Grouping of cash flows

The cash flow statement presents information in three key categories: Cash flow from operations; cash flow from investing; and cash flow from financing, which are standalone from one another.

Seniority of cash flow items

The cash flow statement does not order cash flows in order of seniority, thereby making it less efficient when analysing a project’s debt repayment ability. The cash flow waterfall clearly shows the amount of cash flow at each level as described in the term sheet.

Investors or Financiers?

The cash flow statement provides information that can be readily analysed from an external investor’s perspective, whereas the cash flow waterfall provides information that can be easily analysed by the banks.

Screenshot 2 is an illustration of a cash flow statement. When compared with the structure of the cash flow waterfall in screenshot 1, the differences are easily identified.

Points to consider in cash flow waterfall modelling

The term sheet specifies the seniority of certain categories, such as reserve accounts.

The addition of an annual cash flow waterfall significantly improves the usability of the model, as it facilitates analysis at a high level. This is efficiently coded using the SUMIF formula based on calendar year, financial year or operating year.

Ensure that debt is being repaid according to seniority of the tranches.

This is especially important in downside sensitivity or scenario analysis, where the operating cash flows are highly stressed.

The cash flow waterfall is used to calculate the net movement in the cash balance and also the cash closing balance.

Adding an integrity check to this line that indicates whether the closing cash balance (or balance carried forward – balance C/f) is negative is a critical component of a complete model. If this integrity check is not added, a project can appear to be funded by a negative cash balance which is not a realistic scenario.

More recommended financial modelling resources

There are numerous other financial modelling tutorials, blogs and webinars available for your reading.

Some of the more popular courses that relate to this topic include:

• Financial Modelling for Mining Projects
• Financial Modelling for Oil & Gas Projects
• Best Practice Project Finance Modelling
• Advanced Project Finance Modelling