Project Appraisal by Financial Institutions before granting Term Loans


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Project Appraisal by Financial Institutions before granting Term Loans:

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Credit Appraisal Process:
Before a credit facility is sanctioned to any borrower firm, the proposal should be rigorously appraised. The appraisal process should involve an in-depth study of the financial, commercial, technical and managerial aspects of the borrower. An assessment of the financial requirement of the borrower should be made in order to arrive at the amount of credit to be considered by the bank. Even though the data supplied by the client is the base data for analysis, greater reliance is to be placed on data obtained from independent sources.

Appraisal:
1)      The term loan appraisal and its processing requires careful scrutiny in view of the complexities involved. The essence of the term loan appraisal is to assess the ability of the unit to repay the loan and interest, from the surplus generated by utilizing the fixed assets acquired. For this purpose, the techniques of project appraisal should be employed in all cases irrespective of loan amount or whether it is considered for the purchase on one item of machinery or for setting up entirely a new unit.
2)      Project appraisal involves detail study of the arrangements made for production, marketing and financing. It examines a systematic way whether the resources are properly utilised to produce the best results, i.e. whether the project is viable. Any venture, which is put on stream, should sustain itself without external support and only then it can be treated as viable. Viability study can be made on the following aspects:
A)    Technical Feasibility.
B)    Commercial and Economic Viability.
C)    Financial Feasibility.
D)    Managerial Competence.
Areas of Project Appraisal:
1)      Market/Marketing Appraisal
1)      Examine the reasonableness of the demand projections by utilizing the findings of available market survey findings/reports. Industry association projections, planning commission projections and independent market surveys.
2)      Assess the adequacy of the marketing infrastructure in terms of:
a)      Promotional effort,
ii)  Distribution network,
iii) Transport facilities,
iv) Stock levels, etc.
3)      Judge the knowledge, experience and competence of the key marketing personnel.
2)      Technical Appraisal:
Focuses mainly on the following aspects:
                    i.      Product mix.
                  ii.      Capacity.
                iii.      Process of manufacture.
                iv.      Engineering know-how and technical collaboration.
                  v.      Raw materials and consumables.
                vi.      Site and location.
              vii.      Building.
            viii.      Plant and equipments.
                ix.      Manpower requirements.
                  x.      Break-even point.
3)      Financial Appraisal:
It seeks to assess the following:
i) Reasonableness of the estimate of capital cost: to ensure that –
a)      Under-estimation (Padding) of costs is avoided.
b)     Specification of machinery is proper.
c)      Proper quotations are obtained from potential suppliers.
d)     Contingencies are provided.
e)      Inflation factors are considered.
ii) Reasonableness of the estimate of working results based on:
a)      A realistic market demand forecast.
b)     Price computations for inputs and outputs that are based on current quotations and inflationary factors.
c)      An appropriate time schedule for capacity utilisation.
d)     Cost projections that distinguish between fixed and variable costs.
iii) Adequacy of Rate of Return – General Norms for financial desirability (However a certain degree of flexibility is allowed).
Debt-Equity Ratio: 1.5:1
Internal Rate of Return (IRR): 15% to 20%
Return on Investment (ROI): 20% to 25% after tax
Debt-Service Coverage Ratio (DSCR): 1.5 to 2.0
Debt-Service Coverage Ratio is calculated as:
=        ∑ PAT + Depreciation + Interest on Long Term Loan
∑ Interest on Long Term Loan + Loan repayment Installment
iv) Appropriateness of the Financing pattern
a)      Debt-Equity Ratio norm of 1.5:1
b)     Promoters should contribute 20% to 25% of the project cost.
c)      Stock exchange listing requirements in case part of the equity is proposed to be raised by the public.
d)     Promoters capacity and means to contribute a reasonable share of the project finance.
4)      Economic Appraisal:
Also referred to as “Social Cost Benefit Analysis” and is labelled as “Partial Little Mirrless” approach. It involves evaluation of the project from the social angel. Economic appraisal involves analysis of the critical factors, socio-economic benefit, availability of labour, import substitution, technology absorption, impact on ecology, value addition, FOREX earnings, etc.
Economic Indicators –
              i.      Economic rate of return.
            ii.      Effective rate of protection.
          iii.      Domestic resource cost.
5)      Managerial Appraisal:
        i.            How resourceful are the promoters?
Judged in terms of the –
a)      Prior experience of the promoters.
b)     Progress achieved in organizing various aspects of the project.
c)      Skill with which the project is presented.
      ii.            How sound is the understanding of the project by the promoters? Assessed in terms of the –
a)      Credibility of the project plan including

the organization structure
the estimated costs
the financing pattern
the assessment of various inputs and the marketing programme
the details furnished to the financial institution
    iii.            How committed are the promoters?
Gauged by the –
a)      Resources (financial, managerial and other applied to the project).
b)     Zeal with which the objectives of the project, both short term as well as long term, are pursued.
c)      Assessment of the caliber of the key technical and managerial personnel working on the project, the schedule for training them, and the remuneration structure for rewarding and motivating them.

Managerial Competence:
The essence of managerial appraisal is to ensure that the project is in the hands of people competent to implement it and carry on the business efficiency. The ability of the people behind the project is the most important factor determining its future.
In applying the above norms, however, a certain degree of flexibility is shown on the basis of the nature of the project, the risks inherent in the project, and the status of the promoter. The review is done by qualifies and experienced personnel available in the institutions and/or outside experts – particularly where large and technologically sophisticated projects are involved.
Ecological Analysis:
In recent years, environmental concerns have assumed a great deal of significance. Ecological analysis should be done particularly for major projects which have significant ecological implications like power plants and irrigation schemes, and environmental polluting industries (like pharmaceuticals, chemicals, leather processing to name a few). The key questions raised in ecological analysis are:
a.      What is the likely damage caused by the project to the environment?
b.      What is the cost of restoration measures required to ensure the damage to the environment and whether it is contained within acceptable limits?

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We, at BMS.co.in, believe in sharing knowledge and giving quality information to our BMS students. We are here to provide and update you with every details required by you BMSites! If you want to join us, please mail to contact@bms.co.in.

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