Constructing the economic model of a port project consists of identifying, from the SPC’s point of view, all of the forecasted cash flows to be generated by the investment. They fall into three main categories: capital expenditure, operating revenue and expenses, and tax-related matters.
Investment breakdown. The production of a capital expenditure (Capex) statement requires the gathering of data that are usually fixed and set out in the various contracts defining the project: the concession contract, construction contract, equipment supply contract, and so forth. The investment breakdown must be sufficiently detailed. The total amount of the investment should be broken down by type of homogenous assets; that is, assets that have similar working lives and methods of depreciation. Capex categories relevant to port projects might include buildings, open areas, port equipment, infrastructure, superstructures, and dredging work. The categorization of Capex must also take account of the type of work envisaged; for example, refurbishment of existing structures and/or new works.
Investment phasing. Traditionally, determining the investment phasing at the set-up stage satisfies two requirements: it records the Capex flows required by the project in the economic model and it fixes the value of the basis of the instruments providing cover against exogenous financial risks (rates and foreign exchange). Also, investment phasing enables the financial analyst to structure the project as accurately as possible according to its ability to support its method of financing. Investment phasing also allows the analyst to reassess the appropriateness of the investment decision by testing real options, for example, to defer the execution of the project, to defer progress of the works, to abandon the project, to reduce activity, or to make the project more flexible.
Investment currencies. The amount and the required currency of payment by the SPC must correspond to each item on the investment statement. The equivalent of this amount in the model’s reference currency can be found by calculating the exchange rate initially set in the macroeconomic hypotheses. The foreign currency breakdown of the Capex thus enables the SPC to ascertain its exposure to exchange risks throughout the life of the concession contract, that is, allowing its net exchange position to be calculated.
Economic depreciation and tax allowances statements. A depreciation statement must accompany the Capex statement for each of the identified headings. It is based on knowledge of the period of depreciation of each asset and the method of depreciation authorized by the tax legislation of the host country of the project, for example, straight-line or double-declining balance.
Confusion often arises between the notions of amortization, depreciation, and tax allowances. This confusion usually stems from the improper use of the same expression to express three different financial concepts. Amortization refers to the capital repayments of financial loans. Depreciation is designed to adjust the economic value of an asset according to the loss of economic value it undergoes with time. Appropriations to depreciation appear in the profit and loss account, while accrued depreciation appears on the balance sheet, which gives as true as possible an account of the assets of the company. Tax allowances represent the deductions that the tax authorities allow on the investments the SPC makes. While they are, generally speaking, based on the depreciation of the asset, considerations of economic policy also enter into the equation for tax allowances. This is to encourage investors by allowing them to write off their assets over periods shorter than the economic life of the asset. In terms of financial analysis, this overdepreciation leads to an underevaluation of the entity’s financial results at the beginning of the investment cycle and an overevaluation at the end of the cycle.
In the case of port projects, understanding the notion of depreciation is complicated by the nature of the assets entered on the SPC’s balance sheet. If the depreciation methods seem easy as far as port equipment or new infrastructure works are concerned, the fact remains that the question of the length of ownership or of the potential life of the refurbished assets is far from obvious. For example, what is the residual working life today of a fully refurbished 30- year-old concrete quay?
Similarly, the distinction that must be made between appropriations to depreciation, which by their nature are not cash flows (referred to as calculated charges), and maintenance charges, which are cash flows, is not always easy. For example, should one depreciate dredging works, and if so by what method, when the maintenance charges relating to maintaining depths close to the quay or in the access channel are already included in the charges account of the profit and loss account? Prevailing practice, in fact, is not to depreciate dredging works and access channels.
Residual value of the investment at the end of the concession. There is always an “exit” for any investment, whether it is liquidated, ceded to the concessioning authority, or sold. Thus, inevitably there is a need to assess the residual value of the investment. There are several methods based on the notion of value in use or replacement value. In the port sector it is very difficult to assess the residual value of infrastructures that do not have a true market value at the end of the concession. Therefore, when a residual value methodology is not defined by the project (for example in the concession agreement) Use of the book value of the assets at the end of the term or project horizon is recommended.
It should be noted that the word “operating” is used here as opposed to the word “construction.” This distinction enables one to identify all the revenues contributing to the formation of the gross operating surplus, the true balance of the operating account. The summary statement of operating revenues and expenses includes:
Operating Revenue and Charges in Terminal Management Operations. The various sources of revenue produced by the operation of a port project stem directly from the contents of the concession granted by the port authority. The revenues break down into categories within the framework of a port project:
The main items making up operating charges include maintenance charges, personnel charges, and the operating royalty due under the concession contract.
Operating Finance Requirement. Traditionally, a company’s operating finance requirement is determined from an analysis of the company’s operating cycle: production, storage, and marketing. In the case of a terminal operator, the operating cycle is simply the delivery of the service rendered to its customers. It corresponds to the cash advance or working capital that the company must have at its disposal between the time it begins operating and the time it begins receiving payment for its services. There are four factors that determine a company’s need for working capital:
Operating Account Balance. The gross operating surplus (GOS) is the first indicator of revenue produced by the operation of the SPC. It is measured by subtracting operating charges from operating revenue. In practice, it forms the balance of the operating account. In jargon, the SPC is said to achieve basic equilibrium if its GOS is positive. Changes in the operating finance requirement should be deducted from the calculated GOS. One then gets the operating cash surplus (OCS), which is a cash flow, unlike the GOS, which is an accounting aggregate. The OCS will subsequently be included in the cash flow statements.
Tax flows are all the cash flows resulting from the impact of the tax system on the project. In addition to the deductibility of financial charges, which will later need to be built into the financial model (cash flow statements), the tax flows relate to taxes on company profits and the (total or partial) carrying over of tax losses from previous years.
Traditionally, corporation tax is calculated by multiplying a rate, which can vary from country to country, by a basis of taxation, which is determined according to the type of investment made. While it is easy to obtain the rate of corporation tax, calculating the basis of taxation is difficult as it requires principles of accounting established by the tax legislation of the host country.
Tax losses from previous years can be carried forward over a number of years depending on national legislation. Losses carried over in this way can then be considered as a tax credit granted to the SPC. In the financial model, this calculation is important to include to avoid overestimating the impact of corporation tax on the net profitability of the investment.
A financial model of the project traditionally involves the production of three financial statements: the cash flow statement, the income statement, and the balance sheet.
Cash flow statements show all the company’s incoming and outgoing cash flows. They therefore include all the cash flows involved in the establishment of the operating cash surplus and all Capex.
Capex stems directly from the choice of the financial resources needed to accumulate financial capital. It refers to equity and debt invested in the company by capital providers (shareholders and lenders).
Equity-related capital expenditure refers to increases in capital granted to the project by shareholders on the one hand and a return paid on the invested capital on the other. With regard to the latter, this is directly related to the dividend payment policy decided upon by the shareholders and accepted by the lenders.
The most commonly used method for modeling dividends consists of distributing the maximum profit (after tax and any reserve obligations) up to the value of the available cash. Models usually provide what are called reserve accounts, the purpose of which is to freeze any cash flow surplus from the project until the total value of these accounts reaches a certain minimum level (usually set by the banks). This minimum level is usually set at six months of debt service.
Capex related to financial debts and quasi-equity is entered in a flow statement called a debt service account. Traditionally, there are five headings in this account, which are:
The order of subordination of the loans must be clearly shown in the model.
In virtually all tax systems it is common to allow the deduction from income of the financial charges of the SPC. These financial charges represent the interest paid by the company on the loans it takes out. However, repayment of the loan principal, which relates to the project’s assets, has already been depreciated in the operating profit/loss and is not a deductible expense.
The purpose of the profit and loss account is to determine the amount of corporation tax, the net profit/loss, and to model dividend payments to shareholders. The main stages of the calculation enable the principal interim financial balances to be determined:
It should be stressed that an extraordinary profit/ loss forecast is fairly exceptional in this type of operation.
The SPC’s balance sheets enable the company, investors, and others to monitor the changes in the financial structure of the company throughout the life of the project. It should be remembered that, unlike an accounting balance sheet, the items on the asset side of a financial balance sheet are shown at their gross value. The deduction of the accrued depreciation of these gross values appears under the liabilities of the SPC.