Cash flow is central to the private party's success in a Partnerships Victoria project. The project must have clear and defined revenues to cover its cost structure and debt service obligations, which are likely to comprise:
• project costs -
- management and operating costs (including materials and labour);
- maintenance and replacement capital expenditure (lifecycle costs);
- insurance premiums;
- tax costs;
• debt service obligations -
- interest expense;
- principal repayments; and
- fees and charges.
In addition, investors will expect to receive a return on equity commensurate with the development and long-term project risk they have taken.
In order to monitor the underlying business health of a Partnerships Victoria project, the contract director must have a deep understanding of cash flows and, in particular, the drivers for revenue streams. A user-pays revenue stream (used in a toll road project) is significantly different from an availability payment mechanism (used in government party availability project). The user-pays system transfers demand risk to the private party (so the private party will only receive payment if the project assets are used), whereas the availability mechanism transfers performance risk and not demand risk (so the private party will receive payment provided the project assets are available for use, and the private party has performed in accordance with the performance requirements). In projects where the private party takes the demand risks (and benefits), it has some 'blue-sky' revenue potential, whereas in an availability PPP, upside revenues are very constrained. As a result, the private party's drivers are likely to be different for each of these two types of project.
Cash is the key driver of business health and vitality. By monitoring the cash flow impacts on the project, the contract director will be in a better position to identify the early warning signs of a project potentially in financial stress.
To fully understand the cash flows, the contract director needs to consider both past performance and projected future performance of each of the elements in the cash flow.