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Financial institutions appraise a project from the marketing, technical, financial, economic, and managerial angles. The principle issues considered and the criteria employed in such appraisal are discussed below:
Market Appraisal
The importance of the potential market and the need to develop a suitable marketing strategy cannot be overemphasized. Hence, efforts are made to: Examine the reasonableness of the demand projections by utilizing the findings of available surveys, industry association projections, Planning Commission projections, and independent market surveys.
Assess the adequacy of the marketing infrastructure in terms of promotional effort, distribution network, transport facilities, stock levels, etc. Judge the knowledge, experience, and competence of the key marketing personnel.
Based on the information gathered from secondary sources and through the market survey, the market for the product may be described in terms of the following: Effective demand in the past and present Breakdown of demand Price Methods of distribution and sales promotion Consumers Supply and competition Government policy
Given the importance of market and demand appraisal, it should be carried out in an orderly and systematic manner. The key steps in such analysis are: Situational analysis and specification of objectives Collection of secondary information Conduct of market survey Characterization of the market Demand forecasting Market planning
Technical Appraisal
Analysis of technical and engineering aspects is done frequently when a project is being examined and formulated. Other types of analysis are closely intertwined with technical appraisal. The broad purpose of technical analysis is (a) to ensure that the project is technically feasible in the sense that all the inputs required to set up a project are available, and (b) to facilitate the most optimal formulation of the project in terms of technology, size, location, and so on. While technical analysis is the preserve of the technical expert, the financial analyst participating in the project appraisal exercise should be able to raise issues relating to technical appraisal using common sense and economic logic.
The technical review done by the financial institutions focuses on the following aspects: Product mix Capacity Process of manufacture Engineering know-how and technical collaboration Raw materials Consumables Location and site Building Plant and equipment Labor requirements Break-even point
An important aspect of technical appraisal is concerned with defining the materials and inputs required, specifying their properties in some detail, and setting up their supply programme. Materials may be classified into four categories: 1.Raw materials 2.Processed industrial materials and components 3.Auxiliary materials and factory supplies 4.Utilities
The technical review is done by qualified and experienced personnel available in the institutions and outside experts, especially where large and technologically sophisticated projects are involved.
Financial Appraisal
To meet the cost of the project, the following means of finance are available: Share capital Term loans Debenture capital Deferred credit Incentive sources Miscellaneous sources
The financial appraisal seeks to assess the following: Reasonableness of the estimate of capital cost Reasonableness of the estimate of working results Adequacy of the rate of return Appropriateness of the financing pattern
Reasonableness of the Estimate of Capital Cost
While assessing the capital cost estimates, efforts are made to ensure that Padding or under-estimation of costs is avoided Specification of machinery is proper Proper quotations are obtained from potential suppliers Contingencies are provided Inflation factors are considered
Reasonableness of the Estimate of Working Results
The estimate of working results is based on A realistic market demand forecast Price computations for inputs and outputs that are based on current quotations and inflationary factors An appropriate time schedule for capacity utilization Cost projections that distinguish between fixed and variable costs
Adequacy of Rate of Return
The general norms for financial desirability are as follows:
Internal rate of return: 15 percent Return on investment: 20-25 percent after tax Debt-service coverage ratio: 1.5 to 2
In applying these norms, however, a certain degree of flexibility is shown on the basis of the nature of the project, the risks inherent in the project, and the status of the promoter.
Appropriateness of the Financing Pattern
The institutions consider the following in assessing the financing pattern:
A general debt-equity ratio norm of 1.5:1 A requirement that promoters should contribute 12.5 percent to 22.5 percent of the project cost Stock exchange listing requirements The means of the promoter and his capacity to contribute a reasonable share of the project finance
Economic Appraisal
The economic review looks at the project from the largest social point of view. The methodology adopted by the financial institutions for the purpose of economic evaluation is labeled as ‘Partial Little Mirrless’ approach. Along with the calculation of the economic rate of return as per this approach, they also look at two other economic indicators: 1.Effective rate of protection 2.Domestic resource cost
The economic review done by financial institutions is not very rigorous and sophisticated. In addition, the emphasis placed on this review is rather limited. Yet, a beginning has been made. On the basis of the experience gained, the methodology would be improved and the emphasis increased.
Managerial Appraisal
In order to judge the managerial capability of the promoters, the following questions are raised: How resourceful are the promoters How sound is the understanding of the project by the promoters How committed are the promoters
Resourcefulness
This is judged in terms of the prior experience of the promoters, the progress achieved in organizing various aspects of the project, and the skill with which the project is presented.
Understanding
This is assessed in terms of the credibility of the project plan including, inter alia, the organizational structure, the estimated costs, the financing pattern, the assessment of various inputs, the marketing programme, and the details furnished to the financial institution.
Commitment
This is gauged by the resources applied to the project and the zeal with which the objectives of the project, short-term as well as long-term, are pursued. Managerial review also involves an assessment of the caliber of the key technical and managerial personnel working on the project, the schedule for training them, and the remuneration structure for rewarding and motivating them.
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