Teaching notes Session 4 & 5

PROJECT ANALYSIS

Obtaining the financing needed to fund the cost of project requires satisfying
prospective long-term lenders about technical feasibility, marketing and creditworthiness.
Financiers also need to be satisfied about environment, ecological and social impact of the
project.

The process in banking parlance is known as pre-credit appraisal process. Pre-credit

appraisal is most critical part of lending process as through this process bank/lenders takes
decision to accept or reject a loan proposal. The terms and conditions on which the loan is
sanctioned are also decided through the appraisal process. The quality appraisal ultimately
determines quality of loan assets. The process of project analysis appraisal commonly
involves assessment of-

a) Managerial Analysis determines capacity and competence of the proponent to do

business. A lender must do proper due diligence through background check of the
proponent, his work experience, his qualification, his market report and his past
credit history so as to satisfy himself about honesty, integrity and business ability of
the applicant. In case of legal person like Limited Liability Company, he should
examine its charter to satisfy that it can engage itself in a particular line of
business; it has requisite powers to borrow and execute documents. Lender should
examine the adequacy and suitability of the management structure, quality of
management and management capability under stress, personnel policies including
succession planning, bargaining power with suppliers and financial strength. Since
majority of loan default occurs due to managerial inefficiency, it is essential that
managerial competence be assessed beyond doubt when a loan proposal is
appraised. A KYC norm for proper identification of the borrower is also completed
through this process.
b) Technical analysis involves assessment of availability of technology- latest or
proven to produce required quantity and quality of goods. It also involves assessing
availability of skilled manpower, availability of raw material, availability of
machinery, pollution or environment clearance required if any so that project can
be completed without time or cost overrun.
c) Market analysis is done through demand forecasting and stimulating demand
through product promotion and selling strategies. Market appraisal also involves
assessment of competitive advantage which unit enjoys, economic and social
trends which may have bearing on the demand of the product, who are the major
buyers, whether market demand is stable, seasonal or permanent, what substitutes
are already available in the market, what is extent of competition from abroad,
what are import restrictions, what product range and product mix is available,
what distribution set up is required for marketing the product, how government
policies are likely to impact the future of the industry, and whether raw material,
skilled labor, power etc. is available for uninterrupted product of the unit. Overall

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Teaching notes Session 4 & 5

objective of market appraisal is to satisfy that industry outlook is promising, there is

no tariff or other barriers for growth and environmental and political factors are
favorable.
d) Social cost benefit analysis: Social problems arise largely due to conflicts between
economic development and natural resources. Economic losses and social costs
from environmental degradation often occur long after the economic benefits of
development have been realized. Most often, the development projects provide
economic benefits and better living environment, but they also affect local people
adversely. Social impact assessments help in understanding such impacts. In large
project social impact analysis is one of the critical assessment tool for accepting or
otherwise of project financing.
e) Environmental and ecological impact analysis: Like social impact analysis,
environmental and ecological impact analysis is also done to understand impact of
the project on environment and ecology of the country. Through impact analysis it
is also determined what project will have to do to restore or balance the ecology or
environment.
f) Financial analysis is determined by assessment of cost of project and Promoters
ability to raise requisites resources to meet the project cost. This also involves
analyzing financial health of the project by examining debt equity ratio, interest
coverage ratio, debt service coverage ratio and loan life coverage ratio. In large
projects cash flow is critically analyzed to ensure that project will be able to serve
its commitment. For the purpose of determining the viability of the project and
the ability of the borrower to service its loan and give a reasonable return on the
capital; estimates of cost of production, profitability, cash flow and projected
balance sheets are obtained from the borrower/s at least for the period of
repayment of debt. These are inter-related and are prepared on the basis of the
estimated cost of the project, sources of finance envisaged and various
assumptions regarding capacity utilization, availability of inputs and their price
trend, selling price of end product etc. The lender should critically look into the
important assumption capacity utilization, cost of raw material, estimates of wages
and salaries, estimates of administrative expenses, selling prices assumed and
provision made for depreciation and statutory taxes. Verification/scrutiny of
profitability is the core of qualitative appraisal of a project. The entrepreneurs are
very often tempted to present a rosy picture. A prudent and skillful lender should
not only critically verify the figures furnished by the project sponsor but he should
also satisfy himself with the basis of various assumptions on which sales and
profitability estimates have been arrived at. Assessment of financial requirement of
the borrower for acquiring fixed assets and for meeting working capital
requirement is final part of appraisal process. Terms and conditions of loan, interest
rate, margin, security- both primary and collateral, repayment terms, period of limit
and documents to be executed are all determined through this process.

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Teaching notes Session 4 & 5

It may be noted that each project has got its own strength and weakness. Such
strength and weakness may further vary from project to project even in same industry.
Accordingly, for the purpose of financing a particular project assessment should be
based on evaluation of the strengths and weakness of the individual projects. The
inherent protective factors, competitive edge, level of technological up gradation,
operational efficiency, managerial capability, cash flow trend, liquidity, past trend of
servicing debts, government policies and status affecting the industry/ project need to
be critically examined.

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