Planning and Appraisal - Project Management, Entrepreneurship & Small Businesses | Entrepreneurship & Small Businesses - B Com PDF Download

Project Appraisal

Project appraisal refers to critical examination and analytical evaluation of the project from different angles. Generally, financial institutions appraise project before extending financial support to the project.

Vasant Desai defines project appraisal as "a process whereby a leading financial institution makes an independent and objective assessment of the various aspects of an investment proposition for arriving at a financial decision”.

In order to ascertain the viability of the project, the financial institutions make an in-depth analysis of the following aspects of the project.

1. Market feasibility analysis

Marketing is the important activity, which brings revenue. The lending financial institutions pay meticulous attention to the ability of the prospective enterprise to market its products or services. The potential of the market determines the fate of the business. Following methods can be adopted for estimating the market for the proposed product or services.

1. Opinion polling method : Under this method, the opinions of end users of the product/service are collected through sample market surveys and dealers’ opinion about the customers’ opinion.
2. Life cycle segmentation analysis : A product has various stages of its life cycle namely introduction stage, growth stage, maturity stage, saturation stage and decline stage. Under these methods, sales of proposed product is estimated at each of these stages. Demand supply position of proposed product/service is estimated to explore the market opportunity. Long run prospects for the business are estimated by taking into account the nature and type of competition, potential demand for the product, quality, after-sales-service, price, design package, marketing channels etc.

2. Technical feasibility analysis

This refers to a careful examination and a through assessment of the various inputs of the project like land, labour, machineries, equipments, transportation, energy sources and technical know-how etc. required to produce the proposed product/ service. The entrepreneur may have technical collaboration with domestic or foreign firm for technological support. In order to select the most appropriate technology, various technological alternatives are assessed. Licensing policy of the government and legal provisions in respect of technology has also to be reviewed.

Generally, technical analysis deals with the following components.

• Location of the project: As the location of the project significantly influences the cost of production and distribution and thereby revenue, it is very important to carefully consider all the relevant factors while deciding about location of the project.
• Site of the project - A site for the project is selected considering the load bearing capacity of the site, flood and earthquake hazards, proximity of transport and other facilities, water and electricity supply, facilities for effluent discharge, ecological factors and so on. Nature of production plays vital role in selection of site. For example, the industries like tanneries, jute production, and rubber production need abundant supply of water; hence they have to be located near the deposits of water.
• Size of the project/plant capacity and scale of operations
• Manufacturing process or technology selected
• Rapidity of obsolescence of technology
• Availability and cost of raw material components required
• Power and water facilities
• Technical viability in the application of the finished product
• Personnel/skilled or trained labour force

3. Financial feasibility analysis

The financial appraisal of the project relates to an investigation of the availability and cost of various inputs needed for production, and the prospects for marketing the product or service profitably. The appraisal of financial aspects primarily involves the scrutiny of the following

a. Cost of the project and means of financing

This includes the estimation of cost of the project and identification of sources of finance. While estimating the cost of the project, the financial requirements both for fixed and working capital should be accurately worked out. The cost of the project generally includes the cost of land and buildings, plant and machinery, fees to be paid for technical know-how, consulting and engineering fees., preliminary and pre-operative expenses, margin money for working capital, miscellaneous fixed assets, interest during construction etc.

After having estimated the cost of the project, the sources of finance shall be identified. This includes the following

Owned funds / equity:  i.e. issue of equity share sand preference shares, reserves and surplus and retained earnings.

Borrowed funds /debt finance:  i.e. debentures, term loans and long-term borrowings, public deposits and deferred payment guarantees.

In this regard, the debt-equity ratio of 2:1 should be generally adhered to.

b. Cash flow estimates

This refers to the projection of the future sources of cash and their application. Cash flow statement helps to ascertain the cash requirements for different purposes and to fix the repayment schedule on the basis of cash accruals.

The financial institutions pay a special attention to the Debt Service Coverage Ratio (DSCR).DSCR establishes the relationship between ‘net profits’ and the ‘repayment of term-loans and interest thereon’ the debt service coverage ratio is preferred at 2:1 level and calculated with the help of the following formula.

Debt service Coverage Ratio = NP after tax + interest on term loan + depreciation + Term loan installment + Interest on term loan