Financial Aspects

in Renewable
Energy
2 FEBRUARY 2018
Agenda
Financial Terms & Terminology

Financial Models

Starting a business

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Terms &
Terminology
PROJECT FINANCIALS

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Plant capacity-related terms
Capacity Utilization Factor (CUF)
◦ Ratio of ‘actual’ output of a power plant vs its ‘theoretical maximum’ output, both calculated over
specific period of time (generally over a year)

Performance Ratio (PR)

◦ Ratio of ‘actual’ output of a power plant vs its ‘theoretical maximum’ output under pre-defined
conditions

Annual generation
◦ Plant capacity * 365 days * 24 hrs X CUF
◦ Also known as ‘estimated generation’ in colloquial parlance

Assured generation
◦ Output obtained after reducing ‘estimated generation’ by a factor to accommodate unexpected
plant downtimes, etc.

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CUF and PR – which is better?
CAPACITY UTILIZATION FACTOR
Ratio of ‘actual’ output of a power plant vs its
‘theoretical maximum’ output, both calculated in
a year
CUF is a measure of ‘how well a plant is utilized’
Studies from MNRE reports that, the avg. CUF of
solar PV plants in India is 15-19%
Simplicity of evaluation and direct correlation of
CUF with revenue makes it more favorable option
to investors
CUF = Output / Capacity
Ex: 100 KW DG runs for 12 hrs daily
◦ CUF = 100*365*12 / 100*365*24
◦ CUF = 50%
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PERFORMANCE RATIO
Ratio of ‘actual’ output of a power plant vs its
‘theoretical maximum’ output under pre-defined
conditions
Takes into account irradiation, module
temperature, grid availability, etc.
‘Irradiation’ automatically excludes night-time
hours, when there is no generation
PR = Achieved Output / Theoretical Output
◦ Ex: PR = 1400 KWH / 1650 KWH
◦ PR = 84.84%
Extensively used outside India to measure solar
power plant performance – now increasingly
being adopted in India
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Project Costs
Project cost
◦ Calculated Project Cost + Interest during construction

◦ If during the construction period no interest is being paid to the bank then
Interest during construction is usually capitalized with the capital cost of the
project

◦ This would result in change in the equity and loan part as well whereas, the
cost component of ‘Plant & Machinery’ and ‘Buildings’ will not be affected

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Depreciation
Common language –
◦ Cost incurred due to reduction in the value of an asset over time, in particular,
due to wear and tear
Accounting language –
◦ Method of reallocating the cost of a ‘tangible asset’ over its useful life span

Businesses ‘depreciate’ long-term assets for both tax and accounting

purpose
◦ Depreciation for tax purposes, affects the balance sheet of a business or entity
◦ Depreciation for accounting purposes, affects the net income that gets reported
Generally this cost is allocated as ‘depreciation expense’ among the periods
in which the asset is expected to be used

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Salvage Value & Depreciation
Salvage Value (a.k.a. Residual value)
◦ Is the estimated ‘resale value’ of an asset at the end of its useful life
◦ Salvage value is subtracted from the cost of a fixed asset to determine the
amount of the asset cost that will be depreciated
◦ Salvage value is used as a component of the depreciation calculation
◦ Concept can be misused in fraudulent manner to estimate a high salvage value
for certain assets  results in the under-reporting of depreciation and therefore
of higher profits

Methods of depreciation
◦ Straight Line Method (SLM) and Written Down Value (WDV) methods are the
most used methods for calculating depreciation.
◦ SLM is allowed by the Companies Act, 2013
◦ Income-tax Act, 1961 requires depreciation by WDV Method only

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Depreciation – Single Line
Method (SLM)
Designed to reflect the consumption pattern of the underlying asset
Used when there is no particular pattern to the manner in which the asset is to be
used over time
Depreciation expense is ‘evenly’ recognized over the estimated useful life of an asset
Steps to determine depreciation by SLM
◦ Determine initial cost of the asset that has been recognized as a fixed asset
◦ Subtract estimated salvage value of the asset from the amount at which it is recorded on
books
◦ Determine estimated useful life of the asset – standard useful life for each class of assets
◦ Divide the estimated useful life (in years) into equally to arrive at straight-line depreciation
rate
◦ Multiply the depreciation rate by the asset cost (less salvage value)
Once calculated, depreciation expense is recorded in the accounting records as a
debit to the depreciation expense account and a credit to the accumulated
depreciation account

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Accumulated Depreciation
Accumulated depreciation is the total depreciation for a fixed asset that has
been charged to ‘expense’ account since that asset was acquired and made
available for use

Accumulated depreciation is a contra asset account - it appears on the

balance sheet as a reduction from the gross amount of fixed assets reported

The amount of ‘accumulated depreciation’ for an asset will increase over

time, as depreciation continues to be charged against the asset.

The original cost of the asset is known as its ‘gross cost’, while the original
cost of the asset less the amount of accumulated depreciation and any
impairment is known as its ‘net cost’ or ‘carrying amount’

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Depreciation – Single Line
Method (SLM) - Example
ABC Corporation purchases a radial drilling machine for $60,000
It has an estimated salvage value of $10,000 and a useful life of 5 years

ABC calculates the annual straight-line depreciation for the machine as:
◦ Purchase cost of $60,000 – estimated salvage value of $10,000 = Depreciable
asset cost of $50,000
◦ 1 / 5-year useful life = 20% depreciation rate per year
◦ 20% depreciation rate x $50,000 depreciable asset cost = $10,000 annual
depreciation

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Depreciation - Written Down
Value Method (WDV)
‘Written-down value’ is the value of an asset after accounting for
depreciation or amortization, and it is also called as ‘book value’ or ‘net
book value’
It is calculated by subtracting ‘accumulated depreciation’ from the asset's
‘original value’
It reflects the asset's ‘present worth’ from an accounting perspective
Depreciation is calculated by a method known as diminishing balance –
value of the asset is reduced by a set percentage every year
Formula for calculation –
◦ Rate of Depreciation = 1 – (s/w)^(1/n)
◦ s – salvage value at end of period n
◦ w – written down value at present
◦ n – useful life of the asset (as defined by Schedule-II of Companies Act for different asset classes)

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Depreciation - Written Down
Value Method (WDV) – Example
Suppose an asset is purchased for ₹ Year WDV at Depreciat WDV at
10 lakhs and its estimated useful life start ion end
is 10 years (lakhs) (lakhs) (lakhs)

0 10 0 10
The salvage value at the end of
useful life is estimated to be ₹ 2.5 1 10 1.295 8.705
lakhs 2 8.705 1.127 7.578
Calculations – 3 7.578 0.981 6.597
◦ WDV Rate = 1 – (2.5/10)^(1/10) = 4 6.597 0.854 5.743
12.95% (approx.)
5 5.743 0.744 4.999
◦ Depreciation for year-1 = 10,00,000 *
12.95% = 1,29,500.00 6 4.999 0.647 4.352
◦ New WDV for subsequent year will be 7 4.352 0.564 3.788
previous WDV minus Depreciation
already charged 8 3.788 0.491 3.297
9 3.297 0.427 2.87
10 2.87 0.37 2.5

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Accelerated Depreciation
Depreciation of fixed assets at a fast rate early in their useful lives
◦ This type of depreciation reduces the amount of taxable income early in the life
of an asset, so that tax liabilities are deferred
◦ Later when most of the depreciation has already been recognized, the effect
reverses, so there will be less depreciation available to shelter taxable income
◦ The result is that a company pays more income taxes in later years
Net effect of accelerated depreciation is deferral of income taxes to later
time periods

Renewable projects in India

◦ All renewable projects have historically, been eligible to avail depreciation of 80%
of asset value – plant and machinery
◦ But this rate has been reduced to 40% from April 2017 onwards
◦ Net result – payback period of solar projects has increased by around 8-10% than
the original value

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Plant, Machinery & Buildings
Plant & Machinery
◦ A plant or machinery asset is a long-term fixed asset that is used to produce or
sell products and services for a company
◦ These assets are tangible in nature and are expected to produce benefits over
several years and are hence they are capitalized
◦ In other words, when a piece of equipment is purchased, an expense is not
recorded immediately. Instead, cost of the asset is allocated over its useful life

Buildings & Civil Works

◦ Building is also a long-term asset account which shows the cost of a building
(excluding the cost of the land)
◦ Buildings will be depreciated over their useful lives by debiting the income
statement account Depreciation Expense and crediting the balance sheet account
Accumulated Depreciation

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Working Capital
‘Working Capital’ is the capital required for day to day operation
Working capital = Current Assets – Current Liabilities
Working capital is a measure of a company's efficiency & its short-term financial health

The working capital ratio (Current Assets/Current Liabilities) indicates whether a company
has enough short term assets to cover its short term debt
◦ WCR < 1  indicates negative W/C (working capital)  such a company may run into trouble
paying back creditors in the short term
◦ WCR > 2  the company might have too much inventory & is not investing excess assets
◦ A generally acceptable ratio  1.2 < WCR V 2.0

CERC guidelines:
◦ WC = 1 month O&M Expenses + Maint. spares (15% of O&M expenses) + 2 months receivables

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Financial Statements
Profit & Loss Statement (P&L)
◦ Is a financial statement that summarizes the revenues, costs and expenses
incurred during a specific period of time, usually a fiscal quarter or year
◦ Provides information about a company's ability – or lack thereof – to
generate profit by increasing revenue, reducing costs or both
◦ It is also referred to as "income statement," "statement of operations,"
"statement of financial results," & "income and expense statement"

Balance Sheet
◦ Is a financial statement that summarizes a company's assets, liabilities and
shareholders' equity at a specific point in time
◦ These three balance sheet segments give investors an idea as to what the
company owns and owes, as well as the amount invested by shareholders

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Financial Statements (contd.)
P&L STATEMENT
It is one of the financial statements of a
company and shows its ‘revenues and
expenses’ during a particular period
Indicates how the revenues (money
received from Sales, i.e. “top line”) are
transformed into net income (result after
all revenues and expenses have been
accounted for, known as “net profit” or
“bottom line”)
Purpose is to show management and
investors, whether company made or
lost money during the reporting period
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BALANCE SHEET
It is a summary of financial balances of a
company as of a specific date, such as
the end of its financial year
It includes the company's assets,
liabilities and shareholders' equity at a
specific point in time
In other words, it is a snapshot of a
company's financial condition at a
particular moment in time
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Balance Sheet - contents
ASSET LIABILITIES

Long term asset Outstanding loan

◦ Project (net fixed asset)
Shareholder’s equity
◦ Land
Reserves & Surplus

Current asset
◦ Receivables
◦ Bank Balance
◦ Spares in O&M
◦ FD in Bank

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Earnings & Taxes
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
◦ Is an indicator of a company's ‘financial performance’ and used as a proxy for the earning
potential of a business
◦ Can be used to analyze and compare profitability among companies as it eliminates the
effects of financing and accounting decisions
◦ It is a non-GAAP measure that allows for a greater amount of discretion in what is and what
is not included in the calculation
◦ It is a good metric to evaluate profitability, but not cash flow

Profit Before Tax (PBT)

◦ It is a profitability measure that looks at a company's profits before it has to pay corporate
income tax by deducting all expenses from revenue including interest and operating
expenses, except for income tax
◦ This measure combines all of the company's profits before tax – operating, non-operating,
continuing operations and non-continuing operations
◦ PBT exists because tax expense is constantly changing, and taking it out helps give an
investor a good idea of changes in a company's profits or earnings YOY

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Earnings & Taxes (contd.)
Profit After Tax (PAT)
◦ In accounting terms, PAT is the amount calculated after deducting interest
and taxes from PBT
◦ This amount is reported in the balance sheet of the company as the retained
earnings of the period
◦ With this amount, the dividends for the period are declared and distributed
amongst the shareholders of the company

Net Cash Flow

◦ Refers to the difference between a company's cash inflows and outflows in a
given period
◦ Net Cash inflow = Cash flow from Operation (EBITDA) – Cash out flow
(Interest + Tax)

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Debt Service Coverage Ratio
(DSCR)
Debt Service coverage ratio gives information whether a project would generate enough
revenue to cover its debt servicing (Principal repayment + Interest Payment)
In other words, it is a measure of the cash flow available to pay current debt obligations.
A higher value of DSCR means better debt service coverage and better repayment
prospects. For a project to be financially viable and attractive, DSCR should be greater
than 1.

DSCR = Net Operating Income / Total Debt Service

◦ Net Operating Income = Net Income + Amortization & Depreciation + Interest Expense + Other
Non-cash Items
◦ Total Debt Service = Principal Repayment + Interest Payments + Lease Payments

DSCR < 1 means negative cash flow

◦ Borrower will be unable to cover or pay current debt obligations without drawing on outside
sources (or borrowing more)

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Internal Rate of Return (IRR)
Is a metric used in capital budgeting to measure the profitability of potential
investments. It is sometimes referred to as "economic rate of return” (ERR)
‘Internal rate of return’ gives the expected value of return from the project
over its useful life

To evaluate projects, we usually look at its Project IRR and Equity IRR
◦ Project IRR gives the value of return of the project i.e. combined return on the
gross investment (Loan + Equity)
◦ Equity IRR is calculated to evaluate the return on the investment of the promoter
company/individual/shareholder etc.

Usually bankers who lend money to a project look for better ‘project IRR’
whereas shareholders look towards better ‘equity IRR’

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Internal Rate of Return (contd)
Is a metric used in capital budgeting to measure the profitability of potential
investments
Internal rate of return is a discount rate that makes the net present value
(NPV) of all cash flows from a particular project equal to zero

◦ Ct – net cash inflow during period ‘t’

◦ Co – total initial investment costs
◦ r – discount rate (or IRR)
◦ t – number of time periods
To calculate IRR using above formula, one would set NPV equal to zero and
solve for the discount rate ‘r’, which is IRR
Higher a project's internal rate of return, the more desirable it is to
undertake the project

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Financial models
Rooftop Photovoltaic Solutions / Power Plants
◦ Payback period

Utility scale (a.k.a. Ground-mounted) Power Plants

◦ Equity sharing
◦ Debt

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 Thank you…and All the Best ☺

Feel free to contact me anytime…

Email: amol0101@gmail.com
Mobile: +91.7720005089
Whatsapp: +91.9880630502

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