Term Loan Appraisal

A new manufacturing unit wants a term loan – will the

bank appraise it ?

What to look at ?

Credit Worthiness Cash Flows

Risk

Credit Worthiness

Personality of the borrower

Repayment capacity of the

borrower

Willingness to repay

Management talents

Results of economic activities

3 stages of any new business

ProjectImplementation Gestation Period Earning Profits

3 stages of any new business

ProjectImplementation

This is the period when no cash is generated from the operations. During this period the movement of money is only from bank to the borrower.

3 stages of any new business

Gestation Period

The unit comes into operation and starts generating cash but takes time to reach the break-even point.

Interest is accrued during this period to include it into the cost of product.

No money movement takes place between the borrower and the bank.

3 stages of any new business

Earning Profits

This is the stage when enough cash flows are expected to be generated from the business to meet the instalments (including interest and principle).

The cash-flows should be at least 1.5 times the instalments amount.

The movement of money is from borrower to bank now.

Evaluation of a Business

Economic Evaluation Management Evaluation

Technical Evaluation Financial Evaluation

Economic Evaluation

The demand of the product is evaluated. There should be a demand-supply gap, price advantage, timing and other such benefits.

The prime attention is that the project should survive the three stages of the business (implementation, gestation and operations).

Economic EvaluationThus the bank prefers loans where there is a large gap between the

supply and current demand.E.g.:Where a manufacturer of tables needs a loan:1) Demand = 10000 Units

Supply = 12000 UnitsNew Project = 2000 Units

2) Demand = 10000 UnitsCurrent Supply = 8000 UnitsNew Project = 2000 Units

3) Demand = 10000 UnitsCurrent Supply = 2000 UnitsNew Project = 2000 Units

The market already has enough supply(prices might also fall).

Not enough demand supply gap.

Large gap, thus the product has a wide market.

Management Evaluation example:A “Lalaji” from Bihar (with enough land there),

seeing the rise in IT Industry, too wants to start a new IT Company.

Management EvaluationExample:A “Lalaji” from Bihar (with enough land there),

seeing the rise in IT Industry, too wants to start a new IT Company.

Bank might rate him good with the entrepreneur skills but rate him very low for the lack of experience in the business.

Management EvaluationExample:A “Lalaji” from Bihar (with enough land there),

seeing the rise in IT Industry, too wants to start a new IT Company.

“Lalaji” still enthusiastic about the business hires 2 genius (one from Infosys and another from Wipro).

Management EvaluationExample :A “Lalaji” from Bihar (with enough land there),

seeing the rise in IT Industry, too wants to start a new IT Company.

“Lalaji” still enthusiastic about the business hires 2 genius (one from Infosys and another from Wipro).

Bank still rates low. Like “Lalaji” took them from Infosys and Wipro, someone else might take them away from him someday too.

Bank needs to have safety and surety of survival throughout the three periods.

Management EvaluationThus the “promoters” MUST be in

the core of the business.

Good Collaterals are often taken as enough security to skip any other evaluation.

However a term loan is a loan where the instalments are to be paid by earning from the assets (not from selling the assets – though bank can always do so).

Technical Evaluation

Technical Evaluation is closely linked to the Economic and Managerial Evaluation. The technical competencies of the Management and technicalities are evaluated in economic specifications.

These ensure the technical feasibility of a project as to whether a particular capacity machine is available in market or not and all other such technical evaluations.

Financial Evaluation

This is the ultimate part of the evaluation process where all the things are summed up in the terms of money.

The cash flows are estimated, the instalments periods are fixed, the interest rate is computed and the project is made bankable.

Financial Evaluation

The interest rates are fixed based on the degree of risk. This risk is computed based on the concepts of probability and margin of safety.

Margin of Safety- is how much output or sales level can fall before a business reaches its breakeven point.

Thus where the margin of safety is riskier, the interest premium applied is also higher (above the PLR – Prime Lending Rate)

RISK

“The only man who sticks closer to you in adversity than a friend is a

creditor.”

A Good Bank ?

Overall, a good bank is not the one that rejects “not-so-good” loans, but the one that makes every loan appraisal bankable.

Thank u