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‘Term Loan Appraisal’ Technique

by BankersClub | Nov 1, 2016 | Articles, Lending |

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‘Term Loan Appraisal’ technique is explained in this article.

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Terms Loans are granted to finance Capital Expenditure like plant & machinery,

land and building or setting up an entire unit. Term Loans have a specific

repayment period and are generally repayable in installments.

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Cash generating capacity of the unit is the main consideration while appraising

Term Loan. The concern of a lending institution is whether, the unit generate

sufficient cash flows to serve the Term Loan installment and interest during the

repayment period.

Fully managed infrastructure means

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You may like this – What is working Capital?

Term Loan Appraisal consists of following assessment:

Management Evaluation

First step in Term Loan Appraisal is evaluating the Management of prospective

borrower. It is to be ascertained that whether promoters have background,

experience and knowledge to implement and run the project. Experience and

qualifications and expertise of Key persons working in the entity in the functional

areas, such as production, purchases, sales, administration, finance etc should

also be evaluated.

Technical Feasibility

It is to be analyzed that how the technical requirements of the project can be

met. For example availability of infrastructural facilities, raw materials, labour

and other utilities, technology required for the manufacturing process etc.

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Profitability of the unit to very large extent depends upon productivity of the

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unit, accordingly, it is to be assessed that if the product mix, quality and

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quantity can produced as projected and whether the projections Updates
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Economic Viability
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Economic viability of a unit depends upon the sales. Accordingly, sales

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projections should be analyzed critically and assessed keeping in view:
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a) demand and supply of the product and its substitutes

b) proposed selling price per unit (to be compared with prices of competing

products)

c) quality of the product (also to be compared with quality of competing

products)

Financial Viability

Determining Financial viability is a very important step in Term Loan Appraisal,

since the repaying capacity of the project depends on financial viability of the

project.

1. Financial viability study is done to ascertain that whether cost of project and
means of finance as envisaged are realistic, whether the profitability projections
are realistic and whether the project is capable of generating sufficient cash for
servicing the debt and interest.
2. Estimates of cost of production and other establishment expenses should fully
cover all items of expenditure and there should be neither understatement nor
over statement of expenditure. Items of cost and expenditures should be
analyzed and it should be ensured that these are reasonable.
3. It should be ascertained that proper arrangements have been made for
necessary finance to be available during the period of construction, erection of
plant and machinery etc. as and when required.
4. Profitability of the project depends upon the sale price, sales volume and cost
of production and establishment and sales overheads. Sales price should be
compared with the competing products and sales volume can be ascertained
based on installed capacity and capacity utilization of the project. It should be
seen, if sufficient raw material, labor and other utilities like power, water are
available for the projected level of production. Only production is not the criteria
for the profitability, rather the product should be sold in order to earn profit,
hence there should be adequate marketing arrangements to sell the quantity of
products which are manufactured.
5. Items of cost/ expenditure should be analyzed according to the nature of cost,
whether fixed, variable or semi variable. Fixed costs are fixed for a given period
of time and will be incurred irrespective of level of production, such as rent.
Variable costs varies with the production. Semi-variable costs are partly fixed
and partly variable.
6. Repayment of Term Loan should be fixed after studying Cash flow statements
according to the cash accruals. Like us on Facebook!
7. Basic ratios which are to be considered are debt/Equity ratio, Debt Service
Coverage ratio, Tangible Net Worth/ Outside Liabilities ratio, Profit/Sales ratio,
Sales/Tangible Assets ratio, Current ratio.
8. While examining the cost of production & profitability, the break-even point of
the project should be worked out. BEP indicate the minimum level of output as
percentage of full capacity at which the project starts yielding profits.

READ Analysis of Holding Period in Banks for Working

Capital

Break-even point is calculated as under:

Break-even point = Total Fixed Cost .

(Sales volume in units) (Sales price per unit – Variable Cost per unit

Break-even point = Total Fixed Cost x Sales

(Sales volume in rupees) (Sales) – (Variable Costs)

Also Read – Filing of Charge with CERSAI for Movable & Intangible Assets now

mandatory

Data to be obtained from the borrower for Term Loan Appraisal:

i) Cost of project and means of financing

ii) Profitability projections (upto the period till TL repayment is completed)

iii) Cash-flow estimates (upto the period till TL repayment is completed)

iv) Projected Balance Sheets (upto the period till TL repayment is completed)

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