Credit Appraisal and Assessment

Credit Appraisal

Credit appraisal process is an essential part for investment decision and project selection. Credit appraisal may be defined as a detailed evaluation of the credit proposal to determine the technical feasibility, economic necessity, marketing prospect, financial viability of the project and managerial competence required for its successful operation. The main objectives of credit appraisal are:
a) To decide whether to accept or reject the investment proposal.
b) To recommend, if it is not designed properly, in which way it should be redesigned or formulated so as to ensure better technical, financial, commercial and economic viability.

Thus credit appraisal assist to ascertain expected rate of return of the investment. It enables a person to select the proposal, which will be best suited to him in view of its managerial, financial, technical and socio-economic aspects. Credit appraisal  simply means pre-investment analysis of an investment proposal with a view to determining, its commercial and socio-economic feasibilities i.e. to examine as to whether a proposed project is going to take up for implementation and finance is commercially profitable, economically viable and at the same tune and socially desirable.
Importance of Credit Appraisal
From the viewpoint of Bank/Financial Institution credit appraisal is essential for (a) Identification of right borrower with acceptable level of credit risk (b) Evaluation of the commercial, technical, and socio-economic feasibility of a project and Compliance with banking and legal laws of the country.

From the viewpoint of the Borrower credit appraisal is vital for
(a) Being sure about the overall viability of a project to be undertaken.
(b) A way to receive suggestions to improve any shortcomings of the project
From national point of view:
(a) Optimum utilization of resources
(b) Achievement of national objectives 

Different Aspects of Credit Appraisal
The main task of the appraisal exercise is to justify the soundness of an investment
proposal by the financier by means of a critical and systematic analysis of different
elements of a credit proposal. There are various techniques available for appraising or
evaluating a particular credit proposal. Generally financial institutions apply following
techniques and feasibility tests to evaluate a particular credit proposal
(A) Commercial Feasibility:

  1. Managerial Aspect
  2. Technical Feasibility
  3. Marketing Aspect
  4. Financial Viability
  5. Organizational

(B) Socio-economic/Environmental Feasibility

Managerial Aspect:
For managerial and organizational appraisal it is necessary to evaluate Academic Qualification, Business and Industrial Experience, Managerial Ability, Skills of the Manager and Management Team, Past Performances of the Promoter and Management Soundness.
In credit proposal one should describe proposed arrangement for executive management of the concern both during the construction period and for regular operations thereafter. Appraisal report also includes the particulars of proposed key technical, administrative and accounting personnel. If the management is incompetent even a good project may fail. It is rightly pointed out that if the project is weak, it can be improved upon, but if the promoters are weak and lack business acumen, it is difficult to correct the situation. It is therefore, natural that the financial institution very carefully appraises the managerial and organisational aspects before sanctioning assistance for a project.
Technical Aspect:
The importance of technical appraisal in project evaluation needs no exaggeration. Technical appraisal of a project broadly involves a critical study of Location and Site, Size (Plant Capacity), Technology, Plant and Equipment, Building and layout.
The following questions will be answered while assessing the technical feasibility:
Soundness of the engineering design of the project.
Inputs of the project at reasonable costs.
Maximum economic advantage gain from the location of the project.

Marketing Aspect:
Marketing aspect is very important from banker’s point of view because it is ultimately the sale of the goods in the market that will generate necessary cash flow for repayment of bank loan. Therefore, bank must carefully analyze marketing aspect of the project to understand demand and supply gap, detail marketing plan, feasibility of the projected sales, marketing channels etc.
Marketing Analysis is important to analyze the aggregate demand of the proposed products/services in the future and to estimate the market share of the project under appraisal. Marketing Analysis Generally Address the following Issues:
.-A brief description of the market
– Analysis of the past and present demand and supply
– Estimate future demand of the product
– Estimate projects share of the market
– Analyze structure of the competition and elasticity of demand.
– Information about consumer behavior, intentions, attitudes, preferences and requirements
– Determine distribution channel and marketing policies in use
Below Tow considerations are taken into account while analyzing the marketing aspect:
(1) Company’s external or macro-environment: Industry and competitive conditions
(2) Company’s internal or micro-environment: Competencies, capabilities, resource strengths and weaknesses, and competitiveness.

Industry Analysis:  The main objective of the industry analysis is to identify the main
sources of competitive forces that lie within the industry and strength of these forces. The
key analytical tool is the ‘Portars’ five forces model of competition which are
Assess strength of each of the five competitive forces (Strong? Moderate? Weak?)
1. Rivalry among competitors
2. Competition from substitute products
3. Competitive threat from potential entrants

4.Bargaining power of suppliers and supplier seller collaboration
5. Bargaining power of buyers and buyer seller collaboration

Company Analysis: The important tool that is used to analyze the company
competitiveness is SWOT analysis.  SWOT represents Strengths, Weaknesses, Opportunities and Threats.

Financial Aspects:

The main purpose of financial appraisal are:
(1) To assess if the proposed project is viable in terms of its operation in the future years
and its financial soundness
(2) To see whether the project will be able to generate sufficient surplus after meeting all
operating costs and other day to day transactions to meet its long-term debt obligations.
The financial appraisal of a project thus covers the following issues:
(a) Preparation of Financial Statements: Income Statement and Balance Sheet
(b) Analysis of Income Statement and Balance Sheet
(c) Cash Flow Statement Analysis
(d) Financial Projection and Preparation of Projected Financial Statements
(e) Cost-Volume-Profit Analysis
(f) Cost of the Project and Means of Financing
(g) Capital Budgeting Techniques
(h) Sensitivity Analysis
(i) Assessment of Working Capital Requirement

 Socio-Economic Aspect:
In case of certain projects like irrigation projects, power projects, transporting projects,  other infrastructures projects national profitability or the net socio economies benefits consideration are as important as, and sometimes more important than, commercial profitability considerations. For evaluation of national or socio economic benefits, the following aspects are generally considered.
(1) Opportunity cost.
(2) Shadow prices
(3) Employment generation
(4) Income distribution
(5) Self-reliance
(6) Development of small Scale and ancillary industries
(7) Improvement of infrastructure
(8) Improvement of quality of life and well-being of the society etc.
Environmental Aspect:
One of the basic flaws in project planning and design is the complete negligence or minimal consideration of environmental and social costs and dependence only on economic analysis for project preparation and investment. A failure to understand and internalize the adverse or negative impacts on environment during project preparation
could lead to several undesirable consequences, which may ultimately negatively effect on growth and development for which the project was proposed. It is argued that sound environment management reduces the unforeseen obstacles and bottlenecks that may otherwise hamper the delivery of project objectives while helping to improve the
environmental performance of project operations. The key environmental issues resulting from agricultural, mining, manufacturing, and urban operations include:
(a) Severe degradation of air quality due to industrial and vehicular pollution
(b) Contamination of land and water resources due to pesticides, chemical, fertilizers,
and dumping of hazardous wastes
(c) Depletion of mineral reserves.

(d) Contamination of surface and ground water sources due to discharge of sewage and
industrial wastes
(e) Deforestation

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