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Project finance models are specific techniques companies use to assess business projects. The rationale behind this activity is to assess project risk, create a financial mix, and raise funds to pay for the project. Companies complete project finance models at various times during the year; models may include risk-based, market, and capital budget. In most cases, a company uses these techniques whenever a large project comes up in the business environment. It is possible to use one or more models in the normal course of business depending on the project at hand.
Risk assessment is typically a common activity in project management. Therefore, one of the most popular finance models takes a risk-based approach. Internal and external risks are both under review in this model. Companies define what risks are most important to consider, how to avoid them, and what to do if unexpected risks arise during the project’s lifetime. Though risk analysis is usually present in all project finance models, a risk-based model bases decisions primarily on risk itself.
Market-based project finance models look more at the market and current business or economic conditions. Companies may use a tree diagram that determines the success of a project based on the entrance of competitors or the behavior of consumers. This model is important because either of these conditions may result in lower financial returns for the project. Lower financial returns can turn a profitable project into a loser if the expected return on investment decreases below the cost of capital. This scenario results in a business paying more for a project than they expect to take in.
A capital budget is usually among the most popular project finance models. Companies request a capital budget for each project from the accounting department. The budget defines the cost of each project and the amount of external funds needed to cover costs. In some cases, all forms of project finance models may require the use of capital budgets. A company often, however, uses a capital budget for internal purposes when the project benefits mostly the company.
In most scenarios, there is no magic bullet for project finance models. Companies must simply define the project and select a model that best suits the scenario. The use of models allows a company to approach each major business alteration from a logical base. Upper management often requires a project model to assess the effect of adding a new project to the company. Essentially, project finance models are a type of decision support material.