Glossary

IRR (Internal Rate of Return)

Internal Rate of Return (IRR) is the discount rate at which the net present value of a series of cash flows equals zero. It is the generic form of a metric that appears in financial models in several more specific variants, most commonly Project IRR and Equity IRR, each defined on its own cash flow basis. This page defines the generic IRR concept and the Excel functions used to calculate it; for the project finance-specific variants, see Project IRR and Equity IRR.

Illiquidity Discount (Marketability Discount)

An illiquidity discount, also called a marketability discount, is a reduction applied to the value of a private or otherwise illiquid interest relative to a comparable, freely tradable public asset. It reflects the fact that an illiquid interest cannot readily be converted to cash — there is no active market, a sale process takes time, incurs transaction costs, and may not achieve full value, and the holder bears the risk of an adverse market move during that process. Illiquidity discounts are commonly applied in private company valuation and are conceptually distinct from, though frequently combined with, a minority discount.

Implied Multiple

An implied multiple is a trading multiple, most commonly EV/EBITDA, that is mathematically back-solved from a DCF's terminal value rather than being an input to the DCF. Where a DCF's terminal value is calculated using the perpetuity growth method, dividing the resulting terminal value by the terminal year's EBITDA (or another relevant metric) produces the implied exit multiple. This implied multiple is then compared against observed trading multiples for comparable companies as a sense check: if the perpetuity-growth-derived terminal value implies an exit multiple far outside the range of what comparable companies actually trade at, that divergence signals the terminal value assumptions warrant closer scrutiny.

Income Statement

The income statement measures a company's or project's profitability over a period, moving from revenue down through cost of goods sold, operating expenses, depreciation and amortization, interest, and tax to arrive at net income. In a financial model it is the statement most readers look to first, and its net income line is the single figure that connects it to both the balance sheet and the cash flow statement in an integrated three-statement model.

Independent Model Audit

An independent model audit is a financial model audit performed by a party who is separate from both the model's author and the party relying on the model's output. Independence is one of the two features, alongside systematic coverage, that distinguish an audit from a lighter touch review. Independence can be provided by an internal team separate from the model's builder, a third-party advisory firm, or a deterministic audit engine run by a party other than the model's author — what matters is the structural separation between who built the model and who is checking it, not the specific form the checking party takes.

Indexation Mechanism

An indexation mechanism is the contractual formula that links a revenue or cost line to a specified price index, most commonly a national consumer price index, adjusting the payment over time in line with measured inflation. In project finance, indexation mechanisms are most prominently used for availability payments in PPP and concession structures, but also apply to operating cost escalation and, in some transactions, to the debt itself. The specific index, base period, and any cap or floor are contractual terms that must be implemented in the model exactly as defined, since a generic inflation assumption cannot substitute for the actual formula.

Infrastructure Model

An infrastructure model is a financial model built to analyse the economics of a long-life infrastructure asset — such as a toll road, power plant, pipeline, social infrastructure facility, or water treatment plant — typically structured under project finance principles. It models the asset's revenue, costs, debt service, and equity returns over a period that typically spans 20 to 40 years or more. Infrastructure models are characterised by: - Long modelling horizons (often matching the concession or asset life) - Revenue streams that are either demand-driven (traffic, throughput) or availability-based (capacity payments) - Non-recourse or limited-recourse debt secured primarily on project cash flows - Detailed debt service and covenant compliance mechanics - Sensitivity analysis built around regulatory, volume, and cost risk

Intercompany Elimination

Intercompany elimination is the process of removing transactions between entities within the same consolidated group — intercompany sales and purchases, loans and associated interest, dividends, and unrealized profit sitting in inventory transferred between group entities but not yet sold externally — from the consolidated financial statements. Each individual entity correctly records these transactions on its own books, but from the group's perspective they are internal movements, not external economic activity, and including them would double-count revenue, cost, and balance sheet items that never left the group.

Interest During Construction (IDC)

Interest during construction (IDC), also called capitalized interest, is the interest that accrues on project finance debt drawn during the construction phase, before the project reaches commercial operations and begins generating revenue to service that debt. Because there is no operating cash flow available to pay this interest as it accrues, IDC is typically capitalized, added to the total funding requirement and financed as part of the debt facility, rather than paid in cash during construction. IDC is calculated on the cumulative drawn balance, which itself depends on the total funding requirement, creating a circular reference that is one of the most common structural features of a project finance construction-phase model.

Just Transition

Just transition is the principle that the shift toward a lower-carbon economy should not disproportionately burden vulnerable workers or communities, most directly those dependent on carbon-intensive industries facing displacement. It increasingly appears as an explicit criterion in transition finance and transition plan assessment, alongside the purely technical decarbonisation pathway a transition plan sets out.

Key Performance Indicator (KPI)

A key performance indicator (KPI) is a defined metric selected to track performance against a specific business objective, calculated with a single documented formula and data source, and tracked consistently across reporting periods so that period-over-period comparison reflects an actual change in performance rather than a change in how the metric was calculated. In a financial model, a KPI should be formula-linked to its source data rather than re-keyed each period, and its formula should be maintained in one location and referenced consistently wherever it is reported.

LBO Valuation

LBO-implied valuation derives the maximum price a financial sponsor could pay for a target and still achieve a target internal rate of return or multiple of money at a defined exit, given an assumed capital structure and debt paydown schedule over the hold period. Unlike DCF, comparable company analysis, or asset-based valuation, which each build a value estimate forward from cash flows, market multiples, or assets, LBO valuation works backward from a required return — it is properly understood as an implied-value technique used alongside the three classical valuation approaches in a private equity context, not as a substitute for them.

LLCR (Loan Life Coverage Ratio)

The Loan Life Coverage Ratio (LLCR) is a project finance metric that measures the ratio of the net present value (NPV) of all projected cash available for debt service (CADS) over the remaining loan life to the current outstanding debt balance. It is a forward-looking coverage ratio that tests whether the project has sufficient projected cash generation to repay all outstanding debt. The LLCR formula is: LLCR is expressed as a ratio: an LLCR of 1.25x means that the NPV of projected cash available for debt service is 1.25 times the outstanding debt balance.

Large Language Model

A large language model, or LLM, is a machine learning model trained on very large volumes of text to predict and generate coherent, contextually relevant language. LLMs form the basis of most generative AI tools used in finance, drafting, summarisation, and conversational assistants, and their fluency is not itself evidence of factual accuracy, a distinction central to using them reliably in a finance context.

Letter of Intent

A letter of intent (LOI), sometimes called a term sheet or memorandum of understanding, is a largely non-binding agreement between a prospective buyer and seller setting out a proposed transaction's indicative price, structure, and key terms, typically including a binding exclusivity provision. Signing a letter of intent marks the transition from preliminary due diligence, based on limited information, to confirmatory due diligence, conducted with full data room access during the exclusivity period it establishes.

Level of Service (LOS)

Level of service (LOS) is the defined standard of performance, availability, or condition an asset owner commits to sustain for a given infrastructure asset or portfolio, expressed in specific, measurable terms rather than a general aspiration. It is the key driver of an asset management plan's renewal and maintenance funding requirement, since a higher committed service standard generally requires more extensive or more frequent intervention than a lower one.

Levelized Cost of Energy

Levelized cost of energy (LCOE) expresses the average discounted cost of generating one unit of electricity over an asset's operating life, combining capital cost, operating cost, and expected output into a single comparable figure. It is the standard metric for comparing generation cost across technologies and projects on a like-for-like basis, independent of each project's specific financing or contract structure.

Levered DCF

A levered DCF is a DCF built around FCFE, levered free cash flow, which is the cash remaining for common equity holders after all operating expenses, capital expenditure, working capital investment, interest expense, and net debt repayment. Because FCFE already reflects the effect of the company's capital structure and financing activity, it is discounted at the cost of equity, the return required by equity holders specifically, rather than a blended cost of capital. The present value of a levered DCF's forecast produces equity value directly, without the enterprise-to-equity bridge required after an unlevered DCF.

Lifting Cost

Lifting cost is the operating cost of producing each barrel of oil equivalent from an already-developed field, typically expressed per boe. It is distinct from finding and development cost, which measures the capital cost of adding new reserves rather than producing existing ones, and is one of the core KPIs used to assess the operating efficiency of a producing asset.

Loan-to-Cost Ratio

Loan-to-cost ratio (LTC) expresses senior debt as a percentage of total development cost, the primary sizing metric lenders apply to construction and development finance, where no stabilised income yet exists to size debt against a coverage ratio. It is distinct from loan-to-value (LTV), which sizes debt against completed asset value, and a development facility is typically governed by both metrics at different points in the project life.