Project Financing II - Project Management, Entrepreneurship & Small Businesses Video Lecture | Entrepreneurship & Small Businesses - B Com

hello friends in our previous video on
project finance what we have seen is
that how the cost of project is framed
how the means of finance are planned and
what kind of coverage ratio should be
there to take care of the debt if the
project has taken any debt that was a
exercise in short about the future
projections now let us talk in this
video about how these projections are
calculated arriving so generally any
project which you set up for any
manufacturing activity the repayment
period for loan is about 6 to 8 years or
may be some time 10 years and
accordingly you to prepare the
projections for those six or eight or
ten years now how do you prepare the
projections so the most important part
is you are revenue this sales and how
the sales figure comes in with your
capacity your production and how much of
the goods produced are sold so the first
thing is you have to calculate the
capacity of this plant so which are the
critical machineries which are producing
the goods and have bottlenecks the main
machinery whichever have the lowest
production capacity the total production
has to be kept kept at that level so
this is the production capacity of the
plant at the maximum efficiency then you
have to give some discount for
operational efficiency so suppose the
project plant capacity is say 100 ton a
day the maximum capacity utilization
capacity can be say 85 or 90 percent but
this all depends on the
technical people how are they arriving
it the capacities which differs from
project to project plant to plant
now what you do is that in the first
year there are generally more
bottlenecks there are teething problems
so the first year you take the capacity
at a lower maybe say 60 70 percent of
the capacity plant capacity in the
second year you take it to 80 percent
and in the third year onwards you go to
the optimum maximum capacity that is
around 90 percent of the total plant
capacity once you arrive at the capacity
and the product then go for cost of
production now how the cost of
production is calculated is that your
raw material consumption your plant
overheads your labor in wages and
salaries for manufacturing of the goods
any labor charges which you have paid
the power and fuel which has been
incurred for producing these things this
all becomes direct cost so this is your
direct cost and then some indirect cost
like the overall administrative expenses
marketing expenses financial expenses
depreciation of the plant many people
they take depreciation in the direct
manufacturing cost because it is
permanent fixed so after having
calculated based on various formulas in
the information given by the technical
people you arrive at the total cost of
production or cost of sales because
production is before your financial
expenses and marketing expenses
administrative expenses that is the cost
of production but with all this is the
cost of sins once you arrive at the cost
of sale say suppose it is 72 your
selling price of 100 so then you just
compare with the peer industries or the
peer group whether their cost is also
coming around the same if it is a new
item something new product then you have
to make your best judgment based on the
available information and then from the
whatever the profit left you have to
take care of the taxation as per the
taxation
and regulations and the policies and
this is how the profitability is
calculated so suppose first year you had
taken at 60% so the whole thing will be
calculated on 60% but some of the
expenses may remain high like general
administrative expenses salary expenses
which are fixed in nature so next year
when you go for 70% of the capacity your
profit will be higher because some of
these expenses are going to remain
stagnant only the variables will change
and maybe third years 80% 10 or from
fourth year if you are taking 90 percent
accordingly your profitability will
increase so once you calculate the
profitability like this the future
projections for whatever is the
repayment period of the loan six seven
eight or ten years then the final number
which comes in gives you to help you to
calculate the ratio to service this loan
that is the debt so how the debt service
coverage ratio is calculated you take
the net profit of every year add
depreciation in it to arrive at the cash
profit also the interest component on
the term alone also you add into it to
arrive at a figure cash flow before
servicing the interest even and then
from that figure what you have the
dividing factor is the term loan
installments and the term loan interest
these two together are added and the
upper figure the higher multiplier which
you have the profitability the cash
generation you divide that with the
repayment obligations and this is how
your ratio the debt service ratio comes
in the debt service ratio average should
be in the range of minimum one point
seven two two times coverage because
then the bank or institutions or anybody
who has given you the loan feels
comfortable that you have got one and a
half times the cover or two times of the
cover to take care of his debt
obligation because if something goes
wrong even 5% here or there
for that you have to check the
elasticity that is why the ratio should
be very comfortable so this is how you
calculate the profitability the future
projections your repayment capacity and
with this capacity only generally the
bank's they calculate the repayment
cycle the loan repayment cycle are you
capable to repay or not many a times it
so happens that in the initial years the
profitability is low so in that case the
bank's walk out a ballooning installment
system where in the initial years your
installments repayment installments are
less and in the later years where the
profitability is good the installments
are higher however in case of interest
mind it well you have to service it from
the day one only to the extent of the
project implementation period the
interest you can take in the cost of
project but the remaining interest even
if the profitability is low has to be
taken in the profit and loss account so
these are the basic facts basic methods
to calculate the projections for future
and to also satisfy your lender that
your coverage ratio is comfortable to
take care of the loan now let me talk
about something like collateral
securities now many bank the insists for
collateral
though there are many schemes for SMEs
for a smaller loan up to one crore or
something where the bank should not
insist for any collateral but generally
in case of specially for your working
capital loan they need Cola turns so
collateral security is what is that the
promoters or the company own any surplus
asset which has not been mortgaged to
any bank or institutions which is free
that securities can be offered to the
bank as a collateral in the bed times
like this the bank insists for higher
puritans may be to the extent of 100
percent of the working capital
facilities or sometime 50 percent but
generally for a good company a running
company 30 to 40 percent of the
collateral is
sufficient according to me and for a
smaller SME you may at least flatly say
that the promoters have no asset so no
collateral can be offered unless the
promoter have it now how do you
calculate that working capital this will
complete this whole of your project
financing your application part the
working capital is consisting of all
your current assets - the current
liability is the working capital now
what the banks are really concerned or
cut or they consider is your stocks your
book debts and from that to reduce your
payables your creditors towards
purchases this is how they calculate the
net working capital requirement out of
that you are margin of 25 or 30% and the
remaining becomes the working capital
limits to be sanctioned by the banks the
limits again can be of two types one is
the fund based limit another one is a
non fund based limit fund basis cash
credit where you get the fund against
your stocks or book debts and the non
fund base are the bank guarantee or the
letter of credit that is LC because
sometime your supplier wants you to
issue LC so that you can supply you the
goods on credit so you need non-fun
based facility also with this friends
you have completed your cost of project
in the earlier video we saw how it was
calculated then you are completed now
the total projections you arrived at the
various ratios all this financial
information this information put
together with the company information
the promoter information they project
the technology and other supporting
evidence has become your whole bank loan
application this is how we do we take
care of the project finance thank you