1. A term loan is granted for a fixed term of not less than three years intended normally for financing fixed assets acquired/to be acquired with a repayment schedule normally not exceeding 7 years.
2.A term loan is a loan granted for the purpose of acquisition of capital assets, such as purchase of land, construction of factory buildings, purchase of machinery, modernization, renovation or rationalization of plant, and repayable from out of the future earnings of the enterprise, in installments, as per a pre-arranged schedule.
From the above definition, the following differences between a term loan and the working capital credit are apparent:
i.The purpose of the term loan is for acquisition of capital assets.
ii.The advance is not repayable on demand but only in installments ranging over a period of years.
iii.The repayment of the loan is not out of the sale proceeds of the goods and commodities whether given as security or not. The repayment is out of the future earnings of the industrial unit.
iv.The security is not the readily saleable goods and commodities but the fixed assets of the units.
3.The repayment of a term loan depends on the future income of the borrowing unit. Hence the primary task before granting term loans is to ensure that the anticipated income from the unit would provide the necessary amount for the re-payment of the loan. This will involve a detailed scrutiny of the scheme, its financial, economic and, technical aspects, a projection of future trends of output sales, estimates of cost/ income, and profits.
Project appraisal
4.There are four broad aspects of appraisal, namely:
a)Technical feasibility.
b)Economical feasibility
c)Financial/commercial feasibility, and
d) Managerial competence.
a. Technical feasibility
The examination of this item consists of an-assessment of the various requirements of the actual production process. If is in short a study of the availability, cost, quality and accessibility of all the good's and services, needed.
i) The location of a project-is highly relevant to its-technical feasibility and hence .special attention will have to be paid to this feature.. Projects whose technical requirements could have been well taken care of in one location sometimes fail because they are established in another place where conditions are less favorable. One project was located near a river to facilitate easy transpor¬tation by barge but lower water level at- certain seasons made essential transportation almost impossible. Too many: projects have become uneconomical because sufficient care had not been taken in the location of the project e.g. A woolen scouring and ' spinning 'mill needed large quantities of good water but was located in a place which lacked, ordinary supplies-of water, and the limited water supply required expensive softening treatment'. The accessibility to the various resources has meaning only with reference to location. Inadequate transport facilities or lack of sufficient power "or water for instance; .can adversely affect an otherwise sound industrial project.
ii) Size of the Plant — One of the most important technical feasibility considerations affecting the feasibility of a new industrial enter¬prise is the right size of the plant. The size of the plant must be such that it will give an economical product which will be competitive with those of the alternate sources of supply. A smaller plant than the optimum size may result in increased production cost and may not be able to sell its products at competitive prices.
iii) Type of Technology — An important feature of the technical feasibility relates to the type of technology to be adopted for the project. Sometimes, new technical processes are adopted from abroad without due regard to the difference in-conditions. A new technology will have to be fully examined and tried before it is adopted. An underdeveloped country like ours can rarely afford to be the first or nearly the first to try out what is 'new. It is equally important to avoid adopting equipment or processes which are obsolete or likely to become outdated soon. When certain projects were started with the old process, it was later found that the products were no longer competitive. The principle underlying the technological selection is that an underdeveloped country cannot afford to be "the first to adopt the new nor yet the last to cast the old aside".
iv) Labour — The labour requirements of a project need to be assessed with special care. Though labour in terms of unemployed persons is abundant in the country, there is shortage of skilled/trained personnel. The quality of labour required and the training facili¬ties made available to the unit will have to be taken into account.
v) Technical Report — A technical report using resources like the Small Industries Services Institute/Directorate of Industries, Banks Consultancy Cells, external consultants, etc. should be obtained with specific comments on the feasibility of the scheme, its profitability, whether machinery proposed to be acquired by the unit under the scheme will be sufficient for all stages of production, the extent of competition prevailing, marketability of the products etc. wherever necessary.
b) Economic feasibility
An economic feasibility appraisal has reference to the earning capacity of the project. Since earnings depend on the volume of sales, it is necessary to determine how much output of the unit or the additional production from an established unit the market is likely to absorb at given prices.
i) A thorough market analysis is one of the most essential parts of project investigation. This involves getting answers to three questions:
a) How big is the market?
b) How much is it likely to grow?
c) How much of it can the project capture?
The first step in this direction is to consider the current situation, taking account of the total output of-the product concerned and the existing demand, for it with a view to establishing whether there is an unsatisfied demand-for -the product. Two general indicators of the existence of •unsatisfied demand are tire-price level and the prevalence of controls. Where demand .is greater' than the available supply and there are no controls, prices would be at high levels in relation to production costs, yielding abnormal profits to producers, similarly, if price controls', rationing or like "measures.-are enforced in respect of certain, items, they are obvious evidences the fact-that all demand is not being met by current reduction.
ii) Future – Possible future changes in the volume arid patterns of supply and demand, will have to be estimated in order to assess the long term prospects of-the Industry. Forecasting of demand is a complicated matter but one of viitai importance. It is complicated because a variety of factors affects the demand for a product e.g. Technological advances could bring substitutes into market while changes in tastes and consumer preference might cause sizeable shifts in demand.
Generally, demand for any product is fairly responsive to changes in price and income. People will reduce their consumptions of a commodity which has raised its price. The degree of response in demand to changes in price cannot be the same for all commodities e.g. The demand for basic necessities might continue to remain the same irrespective of increase in price. On the other hand, demands for luxury articles-might go up sharply with a rise in income of all.
iii) Intermediate product — The demand for an "intermediate product" (goods used as inputs for further production ) will depend upon the demand and supply of the ultimate product (e.g jute bags, paper for printing. The market analysis in this case should cover the market for the ultimate product. An example is the spinning industry which produces yarn and sells it to weaving and knitting industry in the country. The growth pros¬pects of the weaving and knitting business are dependant on the market for finished woven or knit goods. It is the ultimate demand which really determines the long term market, potential for spinning industry.
iv) Competition — How much of the potential market can the project capture? This depends mostly on the cost of production of the unit, its proximity to the major markets to its products and its sales organization. The most important is the price. If the production cost is low, the unit will be sure of a market, domestic or foreign. There need be little fear of competition, for its cost advantage will enable the project to be well established before competition becomes a danger. The cost of the product to the ultimate consumer depends on the distances of the market from the industry. If the market is close by the unit will have the advantage of less transportation charges. In this connection, the existences of similar industries in the area assume importance and their cost of production will have to be ascertained.
An efficient sales organization can be the touch stone of success especially in the case of small industries without much bargaining power.
c) Financial feasibility
Data from the applicant should be analyzed to ensure that the project meets the following minimum financial criteria:-
i) The estimated cost of the project is reasonable, complete and has reasonable chance of materializing as per anticipations.
ii) The financial arrangement is comprehensive without leaving any gaps and ensures cash availabilities as and when needed.
iii) The estimates of earnings and operating costs are as realistic as circumstances permit.
iv) The project has reasonable margin of safety ensuring that bor¬rower will be able to repay.
The basic data required for the financial feasibility appraisal can be broadly grouped under the following heads:
i) Cost of the project including working capital,
ii) Cost of production and estimates of profitability
The estimate of profitability and the break-even point will enable the banker to draw up the repayment, programme, start-up time etc. The profitability estimates will also give the estimate of the Debt service coverage which is the most important single factor in all the term credit analysis. A study of the projected balance sheet of the concern is essential. A dynamic analysis is necessary for the appraisal of a term loan to ensure that the concern will continue to have a sound financial position even after the imple¬mentation of the proposed scheme.
Break-even point:
In a manufacturing unit, if at a particular level of production, the total manufacturing cost equals the sales revenue, this point of no profit/no loss is know as the break-even point.
The break-even point can be worked out mathematically:
Break-Even Point = Fixed Cost
Unit sales price — Unit variable cost
(in quantity of)
Break-even point is expressed as a percentage of full capacity. A good project should have break-even point not higher that 75%.
Debts/Service Coverage
The debt/service coverage ratio serves as guide to determining the period of repayment of a loan. This is calculated by dividing cash accruals in a year by amount of annual obligations towards repayment. The cash accruals for this purpose should comprise net profit after taxes with depreciation provision added to it.
Cash accruals
Debt/Service =____________________________
Coverage Ratio Maturing annual obligations
This ratio is valuable. Although it varies from industry to industry but a ratio of 2 and above is generally desirable. The repayment programme should be so stipulated that the ratio is comfortable.
d. Managerial Competence
In a dynamic environment, the capacity of a enterprise to forge ahed of its competitors depends to a large extent, in the relative strength of its management. Hence it has been remarked that an appraisal of management is the touch stone of term credit analysis. The study of the managerial competence thus assumes importance, if there is a change in the administration and managerial set up, the success of the project may be put to test. The integrity and credit worthiness of the personnel in charge of the management of the industry as well as their experience in management of industrial concern should be examined. In high cost schemes, an idea of the unit's key personnel may also be necessary.