Financial modelling: Looking into the future

Being able to model the effects of different economic and environmental scenarios on a company's performance and cashflows is often an important part of any due diligence process. A rigorous model can improve the confidence among banks and is often a requirement in guaranteeing bank financing. "Forecast modelling is extremely important in securing funding, especially for asset-based, project finance type, deals," says Luigi Pettinicchio of the renewable power team at HgCapital. "Forecasting has always been important; however, we see that banks have now become more demanding," he adds.

Stephen Aldridge, managing director at financial modelling consultancy firm Numeritas, agrees that, without a forecast model, it can be difficult to get financing. "Banks are becoming more used to seeing robust forecast models and it is important that GPs and their advisers keep up." Aldridge also adds that banks are now more interested in the worst case scenarios than they were a few years ago, meaning that it is vital to be able to show a robust business.

Investments in projects such as wind- or solar-farms in particular have been subjected to the need for accurate modelling. The physical restriction in the infrastructure of a wind farm sets it aside from a retail firm, for example. While a retail firm can open new shops in attractive areas in an attempt to improve its revenues, this is not possible with a wind farm as changes to costs or increases in demand cannot be made. This means that there is a greater need to ensure that the business case is correct prior to an investment.

To ensure the business case is just right, it is important to get the forecast model correct. There are a number of considerations that need to be made when creating a forecast model. "A forecast needs to be tidy so that banks can confidently rely on the model. It also needs to be linear and user-friendly enough to keep it auditable without detracting from the need to be accurate," says Pettinicchio.

When making predictions about the future, assumptions about the key drivers of a business have to be made. Aldridge stresses the need for these assumptions to be defensible: "If you don't challenge your assumptions, someone else will." A thorough commercial due diligence process can be one way to test and challenge assumptions, such as if current trends in demand will continue.

It is also important to have adjustable parameters that meet the needs of the different parties involved in a deal. "A GP will look at the returns a specific investment can make while also providing risk management. The bank will be focusing on risk and on setting covenants and repayment schedules that are achievable," says Aldridge. "A forecast is an important focal point of communication; it is a common tool that each party can view independently."

Being able to predict the effects of different scenarios on cashflows of a company, and therefore ability to pay interest on debt, has become vital for financiers. Using forecast models can increase banks' confidence in a transaction and help GPs get the funding desired.

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