Cash flow available for debt service (CFADS) is arguably the most important metric in project finance. It determines how much cash is available to all debt and equity investors. Conceptually similar to unlevered free cash flows, CFADS is calculated as follows:
Cash Flow Available for Debt Service (CFADS) = Revenue – Expenses +/- Net Working Capital Adjustments – Capital Expenditures – Cash Tax – Other Items
Revenue = Revenue from operations & other income
Expenses = Operations & maintenance, land lease, other labor etc
Net working capital adjustments = Adjustments to get from accrual to a cash basis
Cash Tax = This is tax paid in cash (not accrual tax expense)
Other items = Examples include annual fees on the senior debt facility and refinancing fees.
CFADS is an important metric and acts as a highly accurate gauge of a project’s ability to take on debt and pay it off. CFADS can replace EBITDA and can be used as a component of key financial ratios such as the debt service coverage ratio (DSCR), the loan life coverage ratio (LLCR), and the project life coverage ratio (PLCR). Together, the three coverage ratios determine a project’s ability to cover debt over both a period of the project, as well as over the entire lifetime of a project.
Determining CFADS is especially important in project finance, where predicted cash flows must be as accurate as possible. In corporate finance, a commonly referenced ratio to measure the ability to service debt is the times-interest-earned ratio. The metric, however, uses EBIT as an estimate of cash flow, making this ratio less accurate to use than a coverage ratio that uses CFADS. Cash flows available for debt service is a better indicator of a project’s ability to repay debt because it takes into account the timing of cash flows and the effects of taxes.
CFADS Uses of Funds
CFADS represents the amount of funds available to be distributed to the various providers of capital. Because debt is paid before equity, it is important to correctly model the order of payments.
Cash Flow Waterfall
In the simple example above, we showed a simple payment hierarchy, with CFADS first going to senior debt, followed by payments to equity.
In practice, required payments for reserve accounts as well as multiple tranches of debt create a more complex hierarchy. This cash-flow hierarchy is modeled as a “waterfall.” In a typical project finance waterfall, the starting line is CFADS, from which debt service is paid out, with the cash-flows remaining split in the hierarchy to other cash uses, for example:
- Debt Service Reserve Account (DSRA)
- Major Maintenance Reserve Account (MMRA)
- Mezzanine or subordinated debt
- Lastly, other equity sources including equity investors and shareholder loans