PROJECT APPRAISAL / CREDIT APPRAISAL

Project / Credit appraisal is a skill which has to be acquired by study and supplemented by practice.

Intuitive guess work has little place in appraising the credit rating or credit needs of a corporate unit. The

credit managers of banks and Non Banking Finance Companies (NBFCs) are duty bound to accept or reject

a proposal on the basis of its viability or non - viability.

TECHNIQUES USED IN CREDIT APPRAISAL

A. BY THE BANKS OR FINANCIAL INSTITUTIONS.

B. BY THE COMPANY (BORROWER).

Project / Credit appraisal is done by banks or financial institutions by obtaining credit information of the

borrowing company.

Credit information of the borrowing company can be obtained by the following sources:

1. BANKS AND FINANCIAL INSTITUTIONS:

The source of primary information can be from the banks and financial institutions themselves which are

the most original, the most detailed and by far the most trustworthy source, and as much relevant

information as possible may be sought from the prospective banks.

2. BANK REFERENCES:

Information about the general financial health of the companies would come from the bankers with

whom the company has its account, but also the bankers who might have lent to the company. Getting a

reference through the company’s bankers makes it easy to get correct information and the lending banker

may remain disguised.

3. TRADE REFERENCE:

They are references from the company’s customers, suppliers, etc. Supplier’s information would be

particularly useful because, that would give an idea of the usual payment policies of the company.

4. CREDIT RATING AGENCIES:

Credit rating agencies like CRISIL – Credit Rating Information Services of India Limited, An RBI credit rating

agency is CARE – Credit Analysis and Research Limited & other agencies are ICRA – Investment

Information and Credit Rating Agency of India, & DCR INDIA – Duff and Phelps Credit Rating India Private

Limited, & ONICRA Credit Rating Agency of India Limited are the main credit rating agencies in India.

These agencies provide ready and detailed information required by banks and financial institutions for

financing the capital requirements of the companies which are credit rated by these agencies.

5. PUBLISHED BOOKS:

Preliminary and basic information about a company may be taken from printed sources like the Stock

Exchange Year book, Corporate Path finder’s data base, etc.

6. COMPANY FINANCIAL REPORTS:

One of the most convenient and commonly used tools of credit evaluation by the banks is the company’s

annual accounts which are statutorily prepared annually and laid before the shareholders. Apart from the

annual accounts, a listed company has to publish half yearly un audited results in the newspapers twice a

year.

7. PRESS REPORTS

The financial press comes out regularly with reports about companies. All the three leading financial

papers in India – The Economic Times, The Financial Express and Business Standard publish some sort of

periodic guides which give some key ratios and figures about well known companies.

Key indicators and periodic guides given in the above financial papers and magazines help bank to assess

Companies financial standing and can take a positive decision regarding financing the capital

requirements of the company.

8. STOCK MARKET OPINION:

Investor’s perception is best judged by the market opinion about the company. This market opinion also

has an indirect impact on the company’s health. Hence, a bank or a financial institution may also refer to

shareholders or share dealers to know the market sentiments about the prospective company.

9. CHARGES REGISTERED:

Charges created on the assets of a company have to be registered with the Registrar of Companies. This

information which would indicate to what extent the company’s assets – present and future are charged.

OTHER TECHNIQUES USED IN CREDIT APPRAISAL:

1. Personal discussion

2. Factory visit

3. Study of financial statements

1. PERSONAL DISCUSSION:

This is the most significant source of primary information which is original, detailed and most trustworthy.

Type of borrower:

History of the company, background of the promoters, nature of the company’s business, that

is whether first generation entrepreneur (newly started) or established (in the field).

a. Character:

If the customer is honest and is prompt in paying the dues that he has undertaken to pay.

b. Market, product (share of market, competition, price, sales volume).

c. Investor’s perception (dividend policy).

2. FACTORY VISIT:

Under factory visit information collected are:

a. operating capacity

b. infrastructure and other utilities

c. labour relations

d. internal control system for raw material (imported, indigenous)

e. ISO certificate

3. STUDY OF FINANCIAL STATEMENTS:

Financial statements contain a wealth of information. If properly analyzed and interpreted, they can

provide valuable insights into a firm’s performance and position.

Financial analysis determines the significant operating and financial characteristics of a firm form

accounting data and financial statements. The goal of such analysis is to determine the efficiency and

performance of the firm’s management as reflected in the financial records and reports.

Analysis can be done through:

A. Ratio Analysis

B. Trend analysis

C. Reading of notes to accounts and other information

A. RATIO ANALYSIS:

Ratio analysis is the science of deriving certain conclusions by a study of such ratios. Some uses of ratios

are:

To compare different companies in the same industry.

To compare different industries.

To compare performance in different time periods.

The ratios to be looked into are:

Liquidity ratio

Profitability ratio

Efficiency ratio

Leverage ratio

B.TREND ANALYSIS:

Trend analysis can be through:

a. Intra firm comparison that is review of the trend of the ratios over the years within the firm

and

b. Inter firm comparison.

The trend analysis may even be related to absolute figures, such as growth in rates, net worth

etc.

C.NOTES TO ACCOUNTS

Financial statements are dressed - up accounts to give the best possible performance outlook of a

company. Careful reading and analysis of the notes on accounts, one can gauge the policies of the

management, performance of the company, and its future planning.

These can be obtained from:

These would include:

The notes to accounts

Directors report

Auditor’s report

Other data published in the annual report.

A.BY THE COMPANY (BORROWER):

The company should make sure that the following information required for processing credit requests are

collected by the company for submitting it to the bank or financial institution in order to obtain the

required credit facility:

1. Basic background information on the company:

This includes:

Name, domicile and ownership of the company

Names of shareholders and directors

Nominal and paid up capital

Legal status

Line of business (full description of the business activities)

Brief history of the company highlighting major developments in the methods of trade,

product mix and other factors central to the performance of the company.

2. Required facility:

This should include the following:

Amount

Type of credit facility

Purpose of facility (details of the end –use of the facility requested)

Tenor of facility

Schedule of draw downs.

3. Key industry dynamics:

The company should highlight key industry players as well as provide comparison of its performance and

standing in the industry compared with its competitors.

Information should also be provided on the following:

The company’s competitive advantages vis-à-vis the other players giving details of the critical success

factors:

list of major competitors and their market share

market share of the company

list of major buyers with details of the selling terms

list of major suppliers with details of the terms of purchase

key industry risks as well as how the company mitigates them

description of the trade cycle of the business

Seasonality of the operation giving details of peak and slack seasons.

4. Management:

The company is required to provide:

A detailed organization chart

Information on the key personnel (of the rank of departmental heads and above) which

should include, the name ,age, educational background, years of experience, line of

operations and ports held present position and description of duties and responsibilities.

5. Management information system:

Details of the planning, controlling and monitoring systems which have been put in place have to given.

6. Financials:

The following should be provided:

Projected financial statements like Profit & Loss account, Balance sheet along with

explanation needs to be given for any material negative or positive variances in the

financial statements.

Projected Cash flow projections as well as underlying assumptions

Analysis of trade debtors and creditors

7. Security:

List of properties to be pledged;

Value of each property (as supported by a professional valuation) ;

Whether the property is being used to secure loans from another lender ; if so details of

commitments are needed ;

Location of the property proposed as security.

8. Present banking relationship:

The bank requires full details of the present credit facilities being enjoyed at the moment. In particular:

Types of facilities

Amount approved

Date approved

Outstanding balance

Repayment terms

Due date

Securities provided

Ability of the company to meet its current borrowing obligations.