Term Loan Appraisal

A new manufacturing unit

wants a term loan – will the
bank appraise it ?
 What to look at ?
Credit Worthiness

Cash Flows
 Credit Worthiness
Repayment
Personality of capacity of the
the borrower borrower

Results of
Willingness to Management economic
repay talents activities
3 stages of any new business

Project
Gestation Period Earning Profits
Implementation
3 stages of any new business

This is the period when no

cash is generated from the
operations. During this
period the movement of
money is only from bank to
Project
the borrower.
Implementation
 3 stages of any new business
Gestation Period
The unit comes into
operation and starts
generating cash but
takes time to reach the
Interest is accrued
break-even point.
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
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.
Earning Profits
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 Evaluation
Thus 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
The market already
Supply = 12000 Units has enough supply
New Project = 2000 Units (prices might also fall).

2) Demand = 10000 Units

Current Supply = 8000 Units Not enough demand
New Project = 2000 Units supply gap.

3) Demand = 10000 Units

Large gap, thus the
Current Supply = 2000 Units
product has a wide
New Project = 2000 Units 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 Evaluation
Example:
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 Evaluation
Example:
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 Evaluation
Example :
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 Evaluation
Thus 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