For new energy projects, investment decisions are based on IRR and payback period, while post-implementation performance is measured by the income statement. These two metrics often yield conflicting conclusions: a project may show a healthy IRR but thin book profits, or positive accounting profit with consistently negative cash flow.
The differences come from three sources.
First, subsidy and electricity revenue recognition timing differs from actual cash receipt; second, the selected depreciation period directly affects profits in the early years; third, project financing interest is classified as a financing activity in cash flow projections but as an expense on the income statement. These three factors combined inevitably cause divergence between the two sets of figures.
II. View subsidy receivables separately.
Subsidy receivables are reported as assets but do not represent immediately available cash. Listing subsidy receivables separately with expected payment dates prevents using future cash flows to fund current expansion.
3. Longer depreciation periods are not always better
Extending depreciation periods smooths current profits but underestimates funds needed for equipment replacement. A more prudent approach is to base depreciation on the equipment's actual economic life and set aside a dedicated reserve in the budget for future replacements.
4. Project-level Financial Statements
Consolidated group financial statements can mask the true condition of individual projects. We recommend preparing separate balance sheets, income statements, and cash flow statements for each project company. Focus particularly on operating cash flow and debt service coverage ratios rather than relying solely on net profit.
In asset-heavy industries, profit is accounting language and cash flow is physical language. Mastering both ensures sound decision-making.