CFADS is a measurement of how much cash you have available to make your debt interest and principal repayments. It is commonly used to “sculpt” your repayments, and it is a component of some of the most common Project Finance ratios such as the Debt Service Coverage Ratio (DSCR), the Loan Life Coverage Ratio (LLCR) and the Project Life Coverage Ratio (PLCR).
WHY ALL THIS FUSS AROUND CFADS?
Whilst EBITDA is commonly used in the corporate world as an approximation for cash – that is exactly what it is, an approximation. In Project Finance, cash is of the highest importance due to a multitude of reasons (limited recourse being the main one), and an approximation simply will not do.
Thus, in Project Finance, the term to focus on is CFADS. CFADS is the essence of Project Finance and if you are starting off in Project Finance – this is where to start.
If your background is in Corporate Finance, the closest equivalent you will find when crossing the bridge from Corporate to Project Finance is Free Cash Flow (FCF). FCF also focuses on cash, takes many shapes and forms and is widespread across the industry, but this is a discussion for another day.
SO HOW IS CFADS CALCULATED?
The example calculation below shows the breakdown of a typical CFADS calculation. Debt repayments start after the start of operations when the project starts generating cash (January 2021 in the example).
* Example of a simple Cash flow waterfall
These are the main constituents to take into account when calculating CFADS. Note that you may also want to make adjustments for VAT if applicable.
WHERE DO YOU FIND CFADS?
If you have ever gone through any company’s annual reports, you will note that there are several reports that will always be included. The three main ones being an Income statement, a Balance sheet, and a Cash flow statement.
In Project Finance; however, the report of highest importance is none of the above. Instead, a Cash flow waterfall is often the main focus. A Cash flow waterfall simply lists the cash inflows and outflows as they occur. Importantly, it does this in terms of seniority, meaning that after taking into consideration your Revenue and Operating expenses, cash obligations that have a higher seniority (e.g. senior debt) are found further up in the Cash flow waterfall, whilst cash obligations with a lower seniority (e.g. distributions) are found further down in the Cash flow waterfall.
IS IT REALLY THAT SIMPLE?
In terms of the items included and adjustments made – pretty much. However, in terms of how these items are measured – not always. One good example is tax.
It is an over-simplification to assume that the tax line in your Income statement equates to Tax actually paid. In most tax jurisdictions there are many adjustments between the accounting profit and the taxable profit. Furthermore, the timing of tax payments is impacted by many factors (for example accumulated tax losses during the construction period).
Put simply, the tax that should be deducted in the cash flow waterfall is the tax that will actually be paid in the period that you are calculating CFADS.
NEXT STEPS?
This is a high level summary explaining CFADS, and also the first part in the series of Project Finance Basics. Be sure to keep up to date and follow the coming parts, which eventually will be summarised in a Whitepaper – covering the most commonly used terms in Project Finance modelling.
