Question 1. What is Finance? How Finance is different from Accounting?
What are important basic
points that should be learned to pursue a career in finance?
ANSWER 1.
Finance can be divided into two main functions.
The first is to ensure that the operation of the business is done properly. For that, the
business needs to source funds.
The second function of finance is how the funds would be distributed for the maximum
return on investments for business once the funds are sourced.
The key difference between Finance and Accounting is that finance is the management of the
money and the investment of different individuals, organizations and other entities, whereas,
Accounting is the process of recording, maintaining as well as reporting the financial affairs of the
company which shows the clear financial position of the company.
But that’s not it. There are many more things in finance that finance executives and professionals
have to pay heed to. For example, people who are involved in finding out which projects are best for
clients to invest in, are performing financial analyses on a regular basis.
Many professionals are also engaged in valuing the companies and finding out which companies to
buy for expansion. Finance is a complex domain and there are many sub-domains inherent within it.
So, you need to find out which sub-domain you like and choose to expand your career in the same
sub-domain. You can go into corporate finance, project finance, investment analyses, equity
research, financial analysis, valuation, risk management and so on and so forth.
Basic points that should be learned to pursue a career in finance are:
Interpersonal skills, Ability to communicate, financial reporting, Analytical ability, Problem-solving
skills, Knowledge of IT software, Management experience.
Question 2. What is project finance? How project finance is different than corporate finance? Why
can’t we put project finance under corporate finance?
ANSWER
Corporate Finance is financing that relies on the balance sheet of the borrower. It would typically be
used by a company that wishes to procure financing for something (including a project such as a new
factory) and is prepared to provide its full faith and security to the lender. Typically, the company
will provide security and collateral to the lenders such as a guarantee from its parent, or debtors and
stock and property.
Project Finance on the other hand is finance that relies on the credit of the project being financed.
So, for example say the US government wants a new toll road to be built, and three companies come
together to form a consortium to build and operate the new road, and none of them wants the road
on its own balance sheet. The bank/s financing the new toll road would consider the possible
number of vehicles using the road, the strength of the operator of the road and all attendant risks,
which as you can see is much more complicated than simple corporate finance. Project Finance
involves much more extensive due diligence than Corporate Finance.
Project Finance is known as non-recourse financing because you have no recourse to the sponsors of
the project, other than what they contractually agree to.
Question 3. Define 20 terminologies related to project finance.
Answer 3.
1. Nonrecourse: - Financing means the borrowers and shareholders of the borrower have no
personal liability in the event of monetary default.
2. Off balance sheet: - It is an accounting practice whereby a company does not include a
liability on its balance sheet. It is used to impact a company’s level of debt and liability.
3. Capital intensive: - A far less visible element of project finance is that it involves huge
amounts of financing because it is used to finance major international development and
infrastructure projects.
4. Numerous Project Participants: - Participation is a loan structure whereby two or more
lenders participate with each other in providing joint financing to a borrower because the
loan would otherwise exceed the legal lending limit of one or both of the lenders.
5. Project Finance Documents: - One of the most important features of project finance is the
extent of project documents.
6. Risk management: - Risk Management is the process of evaluating and managing current
and future financial risk to decrease a company’s exposure.
7. Special Purpose Entities: - Project ownership is ordinarily held in a single-asset, Special
Purpose Entity (SPE) with a limited life formed for the express purpose of owning a project
pursuant to a Project Finance transaction by the project sponsors.
8. Financing cost: - One of the most common features of project financings is the cost which is
generally more expensive than typical corporate financing options.
9. Fiscal Risk: - Risk borne by the Government (by the fiscal position of the country) due to
liabilities associated with PPP transactions.
10. Grantor: - The party which grants a concession, a licence or some other right. See
contracting agency.
11. Hurdle Rate: - Minimum acceptable rate of return on investment.
12. Joint Liability: - Liability that is owed to a beneficiary by two or more obligors. Each joint
obligor has the right to insist that any co-obligor be joined to a dispute as co-defendant. See
also liability.
13. Liquidity: - The ability to service debt and redeem or reschedule liabilities when they mature,
and the ability to exchange other assets for cash.
14. Market Risk: - Changes to the amounts sold or the price received which would have an
impact on gross revenue. Sometimes known as sales risk.
15. Receivable Management: - Receivable Management involves processing activities related to
managing a company’s accounts receivable including collections, credit policies and
minimizing any risk that threatens a firm from collecting receivables.
16. Useful Life: - The period during which an asset will have economic value and be usable. The
useful life of an asset is sometimes called the “economic” life of the asset.
17. Volatility: - The degree of fluctuation that occurs away from a value, such as the mean, of a
series of figures. The greater the volatility in returns, the higher the risk.
18. Annuity: - Repayment of debt where the sum of principal and interest is equal for each
period; also a term used in India for availability payments.
19. Buy-back: - A promise to repurchase unsold production. Alternatively, a promise to repay a
financial obligation.
20. Capital Expenditure: - Long-term expenditure on fixed assets such as land, buildings, plant
and equipment.
Question 4. What are non-recourse debt / loan? What is mezzanine finance explain with example.
Mezzanine financing is a hybrid of debt and equity that ranks below senior debt but above common
stock in a capital structure. Since mezzanine financing is usually structured as subordinated debt,
the terms mezzanine financing and mezzanine debt are often used interchangeably. Both terms are
often shortened to mezz financing and mezz debt.
Due to the risk profile of mezzanine financing, lenders require a higher return than senior lenders
and a lower return than equity investors. Lenders achieve this through a combination of interest
payments and equity participation.
Mezzanine debt is used when a company has maximized its bank and asset-based loans but needs
additional funding to expand operations, make an acquisition, or buy out a partner. Although it’s
unusual, some borrowers only have mezzanine debt due to an inability or unwillingness to borrow
senior debt for several possible reasons (e.g. lack of collateral or reluctance to provide personal
guarantee).
Both corporate and real estate borrowers utilize mezzanine debt, but the focus of this overview is
the corporate market.
Question 5. Explain in detail with reasons of what the sectors are or which type of projects are
suitable fit for project finance?
ANSWER 5
Construction: These are projects that have anything to do with the construction of civil or
architectural work. Predictive methods are used along with agile techniques which will be explained
later on. Furthermore, construction is an engineering project and the process of planning its
execution must be painstakingly done to achieve the desired outcome.
IT: Any project that has to do with software development, IT system, etc. The types of project
management information systems vary across the board, but in today’s world are very common.
Business: These projects are involved with the development of a business idea, management of a
work team, cost management, etc., and they usually follow a commercial strategy.
Service or product production: These are projects that involve the development of an innovative
product or service, design of a new product, etc. They are often used in the R & D department.
Question 6. Are you satisfied with your knowledge of Basics of Project Finance? If yes then explain
the gist of it.
Answer 6. The term "project finance" is generally used to refer to a nonrecourse or limited recourse
financing structure in which debt, equity, and credit enhancement are combined for the
construction and operation, or the refinancing, of a particular facility in a capital-intensive industry,
in which lenders base credit appraisals on the projected revenues from the operation of the facility,
rather than the general assets or the credit of the sponsor of the facility, and rely on the assets of
the facility, including any revenue-producing contracts and other cash flow generated by the facility,
as collateral for the debt.