Project and Term Loan Appraisal Explained
A term loan is repaid from cash the project has not earned yet. Here is how a bank tests whether it will.
A term loan is repaid over years from the cash the project itself will generate. So the bank cannot lean on last year's balance sheet alone. It has to test whether the project will work: can it be built, can its output be sold, can the people run it, and will the cash cover interest and instalments with room to spare.
The CCP syllabus splits this into six heads: technical, commercial (market), managerial, financial, economic and environmental appraisal. Then come project cost and means of finance, cost of production and profitability, break-even and sensitivity analysis, and capital budgeting.
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The Six Heads of Project Appraisal
Technical
The question it answers
Can it be built and run as planned?
What the credit officer checks
Technology, plant capacity, location, site access, raw material, power, water and labour, design and implementation schedule. Banks often take the view of their technical cell or consultants.
Commercial (market)
The question it answers
Can the output be sold, at this price?
What the credit officer checks
Demand and supply of the product and its substitutes, selling price against competitors, quality, marketing and distribution arrangements.
Managerial
The question it answers
Can these promoters deliver it?
What the credit officer checks
Background, experience and track record of promoters, and the key people in production, purchase, sales and finance.
Financial
The question it answers
Will it earn enough to repay?
What the credit officer checks
Realistic project cost and means of finance, cost of production, profitability, cash flows, DSCR, debt-equity, break-even, sensitivity.
Economic
The question it answers
Is it good for the economy?
What the credit officer checks
Wider view than profit: employment, national output, balance of payments. Matters most when government or development lenders are involved.
Environmental
The question it answers
Is it clean and cleared?
What the credit officer checks
An environmental impact statement, ecologically sound disposal arrangements, and the environmental clearances the law requires.
| Appraisal | The question it answers | What the credit officer checks |
|---|---|---|
| Technical | Can it be built and run as planned? | Technology, plant capacity, location, site access, raw material, power, water and labour, design and implementation schedule. Banks often take the view of their technical cell or consultants. |
| Commercial (market) | Can the output be sold, at this price? | Demand and supply of the product and its substitutes, selling price against competitors, quality, marketing and distribution arrangements. |
| Managerial | Can these promoters deliver it? | Background, experience and track record of promoters, and the key people in production, purchase, sales and finance. |
| Financial | Will it earn enough to repay? | Realistic project cost and means of finance, cost of production, profitability, cash flows, DSCR, debt-equity, break-even, sensitivity. |
| Economic | Is it good for the economy? | Wider view than profit: employment, national output, balance of payments. Matters most when government or development lenders are involved. |
| Environmental | Is it clean and cleared? | An environmental impact statement, ecologically sound disposal arrangements, and the environmental clearances the law requires. |
Financial vs Economic Appraisal
Financial appraisal looks at the project's own profit and cash, at market prices, from the investor's and lender's side. Economic appraisal looks at the net benefit to the national economy, and can reprice inputs and outputs to reflect their true cost to the country. A project can be financially sound and economically weak, or the other way round.
Worked Example: Project Cost
A small manufacturing unit. Figures in ₹ lakh.
| Cost head | ₹ lakh |
|---|---|
| Land | 100 |
| Building | 150 |
| Plant and machinery | 450 |
| Pre-operative and organisation costs | 50 |
| Contingencies | 50 |
| Total project cost | 800 |
Worked Example: Means of Finance
Promoters' equity
₹ lakh
240
Share of cost
30%
Term loan from bank
₹ lakh
560
Share of cost
70%
Total means of finance
₹ lakh
800
Share of cost
100%
| Source | ₹ lakh | Share of cost |
|---|---|---|
| Promoters' equity | 240 | 30% |
| Term loan from bank | 560 | 70% |
| Total means of finance | 800 | 100% |
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Reading the Structure
- 1
Means must equal cost
Total means of finance (₹800 lakh) must match total project cost (₹800 lakh). A gap means the project could stall halfway, which is the most common way a viable project turns into a stressed loan.
- 2
Debt-equity ratio: 2.33 : 1
Term loan ÷ promoters' equity = 560 ÷ 240 = 2.33. The higher this goes, the less of their own money the promoters risk, and the thinner the bank's cushion.
- 3
Promoters' contribution: 30%
240 ÷ 800 = 30%. CCP study notes commonly cite at least 20% as the normal expectation. The actual floor is set by each bank's loan policy and can be higher for riskier sectors.
- 4
Contingencies are not padding
A contingency line protects against cost overrun. If it is missing or tiny, the bank should ask who funds the overrun, because the promoter's 30% was sized on the original cost.
Worked Example: DSCR in One Projected Year
DSCR = (PAT + depreciation + interest on term loan) ÷ (interest on term loan + instalment due). The numerator is the cash available to service debt.
| Line | ₹ lakh |
|---|---|
| Profit after tax (PAT) | 90 |
| Add: depreciation | 40 |
| Add: interest on term loan | 45 |
| Cash available for debt service | 175 |
| Interest on term loan | 45 |
| Instalment of term loan | 70 |
| Debt service due | 115 |
| DSCR (175 ÷ 115) | 1.52 |
DSCR Benchmarks Differ
Study material in circulation quotes different floors: some cite 1.5 to 2.0 for term loans, others a net DSCR of 2. There is no single regulatory number. Each bank's credit policy sets its own, and the exam will tell you the benchmark when the question depends on it. Above 1 means the cash covers the debt; below 1 means it does not.
Ratios a Banker Checks in a Project Report
- check_circleDebt-equity ratio: how much of the project the bank funds against the promoters.
- check_circleDSCR, year by year and on average over the repayment period.
- check_circleTangible net worth to outside liabilities, current ratio, profit to sales, and sales to tangible assets.
- check_circleBreak-even point as a percentage of installed capacity: the lower, the safer.
- check_circleProject IRR compared with the cost of capital, and how DSCR holds up under stress (say a 10% drop in revenue or a 15% rise in raw material cost).
How the IIBF Exam Tests This
- check_circleMatching a check to its head: availability of raw material and power is technical; demand and selling price is commercial; promoter experience is managerial.
- check_circleMeans of finance arithmetic: given project cost and a D/E ratio, find the term loan and the promoter share (D/E of 2:1 on ₹900 lakh means ₹600 lakh loan, ₹300 lakh equity).
- check_circleDSCR arithmetic, including which items go in the numerator and the denominator.
- check_circleFinancial vs economic appraisal: profit to the investor versus benefit to the economy.
FAQs
What are the types of project appraisal?expand_more
The CCP syllabus lists six: technical, commercial or market, managerial, financial, economic and environmental appraisal. Financial appraisal also covers project cost, means of finance, break-even, sensitivity and capital budgeting.
What is the difference between project cost and means of finance?expand_more
Project cost is what the project will spend: land, building, machinery, pre-operative costs, contingencies. Means of finance is where that money comes from: promoters' equity, term loans and other sources. The two must be equal.
How is DSCR calculated for a term loan?expand_more
Add profit after tax, depreciation and interest on the term loan, then divide by interest plus the instalment due in that year. A DSCR of 1.52 means the project generates ₹1.52 of cash for every ₹1 of debt service.
How much should the promoter contribute?expand_more
CCP study notes commonly cite at least 20% of project cost, but each bank's loan policy sets the actual requirement.
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