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Project Appraisal of Micro, Small and Medium Enterprises STATE BANK OF HYDERABAD

A study on investment policy of sbh bank for micro, small and medium enterprises AIM

An analysis of the investment appraisal criterias followed by the STATE BANK OF HYDERABAD (SBH)

Project appraisal is an exercise whereby a lending financial institution makes an independent assessment of various aspects of an investment proposition to arrive at the financing decision. Appraisal exercises are basically aimed at determining the viability of the project, and sometimes also in re-shaping the project so as to upgrade its viability. Here the financier takes a second look critically and carefully at a project as presented by the promoter to a person who is in no way related to the project and is as such able to take an independent view of the project in its totality as also in respect of various components. Since all activities involve risk in a small or large measure, project appraisal aims at sizing up the quality of projects and their long term profitability, minimizing the risk of lending by rectifying their weakness and improving their quality by incorporating into them the features/safeguard misuse by the promoter either because of the lack knowledge or information. The factors generally considered by institutions while appraising a project include technical, financial, ecological and managerial aspects. This makes it necessary to identify the interrelationships among the various elements of a project. For instance, the size of the initial market and the estimates for demand build up would determine the plant capacity and production planning, which in turn affect the profitability and this has a direct bearing on the means of financing. Above all, the management behind the project has a decisive influence on most of these aspects. These considerations imply that project appraisal is viewed as a composite process as against the approach of viewing each aspect individually .

The exercise of project appraisal simply means the assessment of a project in terms of its economic, social and financial viability. Financial institutions and banks make critical assessment of project which are submitted to them by the entrepreneurs for getting loans. They have been traditionally accepted the data given by the entrepreneur as valid while assessing the project. In fact, the emphasis has been largely on the cash flow and financial viability of the project in assessing their suitability for extending the loans.

Scope of Appraisal:
The appraisal of a project is undertaken by the financial institution with the twin objectives of determining the market potential and selecting an optimal strategy. The method of analysis varies from project to project. Nevertheless, certain common aspects of study from the angle of technology and engineering are mentioned below:

Choice of technical process and/or appropriate technology Technical collaboration arrangements, if any Size and scale of operation Location aspects of the project and availability of infrastructural facilities Selection of plant , machinery, equipment together with background, competence and capability of machinery/ equipment suppliers. Plant layout and factory building Technical engineering services Project design and network analysis for the assessment of project implementation schedule Project cost and its comparison with other similar projects, based on technology, equipment, product mix and time spread Determination of project cost estimates and projections etc. Sensitivity analysis

It must be remembered that different aspects of a project are not independent entities but are highly interrelated and a meaningful interpretation of the project depends on the appreciation of this fact.


Objectives of the study:

The objectives of the research study are:

To understand the concepts of project appraisal To study the technical feasibility To study the marketability of the product To study the financial viability to analyze the risks

Need for the study:

The financial institutions and banks have vital role to play in different fact of the project work. They are responsible for appraising the soundness of the project that is presented to them for finanacial assistance. The main purpose of this study is to understand the lending criteria and appraisal technique for financing a project.

A project can be mainly divided into three aspects: Entrepreneur, Enterprise and Environment. The components of each can be well understood with the help of a diagram which is shown below

Basic business idea, Background, Experience, Education, Domain Knowlege



Location Plant and Machinery Land and Building Product, Process Utilities, Technology, Raw Material


Competitor Government Policies Market analysis Demand and supply conditions


Fig (1): Components of a project As can be observed from the above figure, a project can be divided into three components

Database of Study:
The study is based on the primary data submitted by the promoter and secondary source of data. Primary data are collected through interviewing the director of the company, data submitted by the company, discussions with the bank officials and the past financial statements of the sister concern. The secondary from the journals, magazine, websites, etc are used depending on the necessity.


From promoters point of view:
Project Appraisal for a promoter is a process of re-examining the various critical aspects by the third party and is found viable, an indication to follow the appropriate direction. If nonviable drop the project and create an opportunity to identify the other appropriate project without losing much and thus safeguarding their interest. Ultimately it strengthens the national economy by identyfiying a good project.

From bank/institutions point of view:

Project Appraisal installs confidence that the deployment of funds is being done in an appropriate manner, thus yielding good financial results and profit.


Micro, Small and Medium Enterprises (MSME) sector has been recognized as an engine of growth all over the world. The sector is characterized by low investment requirement, operational flexibility, location wise mobility, and import substitution. The MSMEs constitute over 90% of total enterprises in most of the economies and are credited with generating the highest rates of employment growth and account for a major share of industrial production and exports. In India too, the MSMEs play a pivotal role in the overall industrial economy of the country. It is estimated that in terms of value, the sector accounts for about 39% of the manufacturing output and around 33% of the total export of the country. As per available statistics, this sector employs an estimated 31 million persons spread over 12.8 million enterprises and the labor intensity in the MSME sector is estimated to be almost 4 times higher than the large enterprises. In India, the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 is the first single comprehensive legislation covering all the three segments. In accordance with the Act, these enterprises are classified in two: - (i) manufacturing enterprises engaged in the manufacture or production of goods pertaining to any industry specified in the first schedule to the Industries (Development and regulation) Act, 1951. These are defined in terms of investment in plant and machinery; (ii) service enterprises engaged in providing or rendering of

services and are defined in terms of investment in equipment. This is shown in the following figure

Enterprises Manufacturing Enterprises (Ceiling on investment and machinery) Service Enterprises (Ceiling on investment in equipment)

RS 25 lakh Rs 5 crore Rs 10 crore

Micro Small Medium

Rs 10 lakh Rs 2 crore Rs 5 crore

Fig (2): Nomenclature and Classification of MSMEs in India


Small and Medium Enterprises (SMEs) are often confronted with problems that is uncommon to the larger companies and multi-national corporations. There are still wide spread variations in the success rate, in terms of actual setting up and successful running of enterprises. The new entrepreneurs generally face difficulties in availing full benefits under available schemes of the Governments / Financial Institutions, completing and complying with various formalities and legal requirements under various laws/regulations, in selection of appropriate technology, etc. Other problems include lack of IT support and IT literacy, lack of human resources, lack of experience using consultants and so on. In order to bridge the gap between the aspirations of the potential entrepreneurs and the realities, there is a need to support and nurture the potential first generation entrepreneurs by giving them handholding support during the initial stages of setting up and managing their enterprises. Accordingly, the scheme called Rajiv Gandhi Udyami Mitra Yojana (RGUMY) has been launched to provide handholding support and assistance to the potential first generation entrepreneurs, who have already successfully completed EDP/SDP/ESDP or vocational training from ITIs, through the selected lead agencies, like Udyami Mitras. This helps such entrepreneurs in the establishment and management of the new

enterprise, in dealing with various procedural and legal hurdles as well as in completion of various formalities required for setting up and running of the enterprise, etc. The work profile of Udyami Mitras include networking, coordinating and follow up with various Government departments/ agencies/ organizations and regulatory agencies for channelizing the benefits available under various schemes to the first generation entrepreneurs and help them in setting up their enterprise Some of the other governmental measures for small and medium enterprises include: The Ministry of Micro, Small and Medium Enterprises has been implementing the Scheme of Surveys, Studies and Policy Research with a view to

regularly/periodically collect, from primary, secondary and other sources, relevant and reliable data on various aspects and features of micro, small and medium enterprises (MSMEs) engaged in manufacturing and services (whether in the category of tiny/small scale industries, khadi, village industries or coir) as a composite group or specific segments thereof. It aims to study and analyze, on the basis of empirical data or otherwise, the constraints and challenges faced by the MSMEs as well as the opportunities available to them, in the context of liberalization and globalization of the economy. It further aims to use the results of these surveys and analytical studies for policy research and designing appropriate strategies and measures of intervention by the Government, by itself or in public private partnership mode, to assist and enable these enterprises in facing the challenges and availing of the opportunities with a view to enhancing their efficiency and competitiveness as well as expanding generation of sustainable employment by them. Micro, Small and Medium Enterprises Development Act, 2006 has been enacted to facilitate the promotion and development as well as enhance the competitiveness of micro, small and medium enterprises and for matters connected therewith or incidental thereto. For this, it included the establishment of specific funds, notification of particular schemes/programs, progressive credit policies and practices, preference in Government procurements to products and services of these enterprises, following more effective mechanisms for mitigating their

problems etc. It provides the first-ever legal framework for recognition of the concept of enterprise which comprises both manufacturing (those engaged in the manufacture/production of goods pertaining to any industry) and service (those engaged in providing/rendering of services) entities. Under the Act, three tiers of enterprises, namely micro, small, and medium have been defined for the first time. The Act also provides statutory consultative mechanism at the national level with balanced representation of all sections of stakeholders, particularly, these enterprises, and with a wide range of advisory functions.
The progressive de-reservation of products in the MSMEs aimed at providing opportunities for technological up gradation, promotion of exports and economies of scale, with a view to encourage modernization and enhance competitiveness in the sector. As on 13 March 2007, 125 items were de reserved. As on 8th February, 2008, 79 items more were de reserved. At present, the total number of items reserved for exclusive manufacture in the micro and small scale sector is 35. The National Manufacturing Competitiveness Program (NMCP) has been launched to provide support to the manufacturing sector, particularly small and medium enterprises sector, in their endeavor to become competitive. It consists of 10 components and programs as the initiatives for development and promotion of MSMEs. Credit is one of the critical inputs for the promotion of small and medium enterprises. It is a part of the priority sector lending policy of the banks. Accordingly, several schemes and policies have been undertaken to provide adequate credit to such enterprises. One of such scheme is the Credit Linked Capital Subsidy Scheme (CLCSS) which was launched to facilitate technology up gradation by upfront capital subsidy to small, micro and medium enterprises, including tiny, khadi, village and coir industrial units, on institutional finance (credit) availed by them for modernization of their production equipment (plant and machinery) and techniques in specified sub-sectors/ products approved under the scheme.

The assessment of a project, from all the possible dimensions, is the most important aspect of the financier/lender. In the wake of global financial crisis, whose roots are traced back mostly to the sub prime-lending, the process of project appraisal and the accuracy with which the entire process is carried out assumes more significance than ever. In this context it is imperative to identify those parameters which are instrumental in the success of a form/project. Below are the excerpts from a few studies, which have carried out research on similar lines at this. Burns and Fletcher (2008), concentrate on a variety of items ranging from the problems of SMEs face to the items the lenders concentrate on while extending the credit. Problems associated with SMEs receiving external finance may be attributed to the fact that the vast majority is privately held and owner managed. As compared to the publicly traded firms, privately held firms lack access to important financial instruments such as issuing new public stock. Bankers therefore emphasize on the information on the borrowers ability to repay the loan; alignment of risk preferences; and risk sharing affect their willingness to grant credit. Results suggest that features that reduce the risk to the bank and shift the risk to the borrower have the largest impact. Findings suggest that banks place the strongest emphasis on the tangible accounting figures SMEs present, and factors that shift the risk from bank to the borrower. Moodys Investors Service report (2005), articulates the importance of Debt Service Coverage Ratio, the most important in any project financing decision. The work concluded that loans for none-core properties default far more frequently than do loans backed by core assets. The work quotes that in all classes of commercial ventures, the lower the debt coverage service ratio (DSCR), the greatest the risk of default. The depth of a cash flow delinquency, as measured by a lower DSCR, is critical to likelihood of default. Moving down the coverage scale, the probability of a default progressively increases, according to this work. Ziwei and Tang (2008), have compiled a set of criteria that are helpful to assess the sub-contractors performance. Through factor analysis, the 15 most important subcontractor performance appraisal criteria and their underlying relationships are

identified. A few of such criteria are: Workmanship, Progress, Resources control, Health and safety, Environmental protection, Organization, General obligations, Industry awareness, Attendance to emergency, Attitude to claims, Relationship, Communication. The results indicate that the three overarching factors for subcontractor performance appraisal are 'team interaction', 'accomplishment of project goals' and 'track record'. The identified appraisal criteria lay a solid foundation for the development of a centralized subcontractor performance appraisal system to facilitate performance reporting, data sharing and benchmarking.

Rastogi, Jain, Yadav (2006), emphasizes on whether there are significant variations in the profile of debt-financing as a result of differences in industry, size and age group of the sample corporate enterprises in India. The study articulates that while industry and size have been observed to be a significant factor influencing composition and maturity structure of debt financing, the empirical evidence does not support the premise that the debt financing decisions vary significantly across age categories. Thompson and Whitman (1973), make a mention of the delay in commissioning the project and the risk associated with it. The risk of delay in commissioning the project is very instrumental, yet very rarely considered during feasibility studies for a capital project, and the results of such studies are rarely updated during the construction phase. Consequently project managers are deprived of reliable data relating to the project as a whole upon which they might base their decisions. Todd, Javalgi (2007), make a mention of the importance of information technology in the performance of a Small and Medium scale Enterprise. It is proposed that the primary method for fostering or promoting the growth of entrepreneurship is through the utilization of technology. Advancements in information technology and improvements in communication infrastructure have resulted in opportunities for SMEs to participate in global markets in both developing and developed countries. Since, governmental reforms in 1991, SMEs in India have been faced with new competitive intensity. Improvements in resource utilization, with special emphasis to information technology, make it possible to sell a variety of products and services from anywhere in the world, around the clock. Maguire, Koh, Magrys (2003), emphasize the importance of information and communication technology in the performance of a SME. They show that the small and medium-sized enterprises (SMEs) using information and communications technology (ICT) to try and gain a competitive advantage over those which do not exploit the technology. This paper provides sound evidence that SMEs can gain competitive

advantage through the use of Information and Communication Technology. More than 70 per cent of the entrepreneurs identified Information and Communication Technology as aiding their business in one or more of the accepted competitive areas. However, there is potential for SMEs to gain further advantages by using an integrated and strategic approach in their use of technology.


Prasanna Chandra (2007), PROJECTS: Planning, Analysis, Selection, Financing, Implementation, and Review (6th edition), Tata McGraw Hill, New Delhi.

Volker Bruns and Margaret Fletcher (April 2008), Capital, Vol. 10, No. 2, pages 171-194.

Banks risk assessment of Swedish SMEs, Venture

Moodys Investors Service report (Aug 2005), Sharp Ramp-Up In One-Year Default Rate For Low-Dscr Loans , Mortgage Banking , Vol.65 Issue 11, p112-112.

Thomas Ziwei and tang (Mar 2008), Delineating the predominant criteria for subcontractor appraisal and their latent relationships. Construction Management & Economics, Vol. 26 Issue 3, p249-259.

Ashish Kumar Rastogi, P.K. Jain, Suendra S. Yadav (2006), Debt financing of corporate enterprises in India : a study showing impact of industry, size and age factors Journal of Advances in Management Research, Vol. 3 , Issue 2 , p54-67 P.A Thompson, J.D Whitman Journal (1973), Project Appraisal by Cost Model Management Decision, Vol. 11, Issue 5, p301-308

Patricia R. Todd, Rajashekhar (Raj) G. Javalgi (2007), Internationalization of SMEs in India: Fostering entrepreneurship by leveraging information technology, International Journal of Emerging Markets, Vol. 2, Issue: 2, p166-180. S. Maguire; S.C.L. Koh; A. Magrys (2007), The Adoption of e-business and knowledge management in SMEs, Benchmarking: An International Journal, Vol. 14, Issue 1, p37-58.