What are the different aspects of credit appraisal?
Aspects of Credit Appraisal
The primary objective of credit appraisal is to determine whether an investment proposal is sound enough to receive bank finance. To reach a lending decision, the bank conducts a critical and systematic evaluation of every important aspect of the project. This process helps identify the project’s strengths, weaknesses, risks, and repayment capacity.
A comprehensive credit appraisal generally covers the following aspects:
- Managerial Aspect
- Organizational Aspect
- Technical Aspect
- Marketing Aspect
- Financial Aspect
- Socio-Economic Aspect
- Environmental Aspect
Managerial Aspect
Among all aspects of credit appraisal, the managerial aspect receives the highest importance. Even a technically feasible and financially profitable project may fail if it is managed by an inexperienced or inefficient team. Therefore, banks carefully examine the competence of the promoters and management before approving a loan.
The managerial aspect covers the following areas:
Academic Qualification
Educational qualification reflects the promoter’s ability to understand and manage the proposed business. Banks prefer promoters whose academic background is relevant to the nature of the project.
Business and Industrial Experience
Experience reduces business risk. A promoter with practical exposure to the industry is usually better equipped to solve operational problems and respond to market changes. The bank also considers family business background, technical knowledge, professional training, and market reputation.
Managerial Ability
Running a business requires much more than technical knowledge. The management must be capable of planning, organizing, directing, coordinating, and controlling all business activities. Leadership qualities, decision-making ability, and communication skills are also taken into account.
Past Performance
Past behaviour often provides a reliable indication of future performance. The bank reviews the borrower’s repayment history, relationship with financial institutions, and previous credit record. Any history of loan default receives special attention.
Management Soundness
Strong organizations are built on strong management teams. During appraisal, the bank evaluates the experience of senior executives, the competence of supervisory staff, and the effectiveness of coordination among different departments.
Organizational Aspect
The organizational structure determines how a business is owned and managed. Banks examine this structure because different forms of business carry different legal responsibilities and financial risks.
The borrower may operate as a Proprietorship Firm, Partnership Firm, Private Limited Company, or Public Limited Company. The bank reviews the ownership pattern, legal status, liability of owners, and governance framework before reaching a lending decision.
Technical Aspect
A project may look attractive on paper but still fail because of technical weaknesses. Technical appraisal ensures that the project can operate efficiently with the proposed technology, machinery, and production process.
The following issues receive special attention:
Location and Site
Choosing the right location is essential for successful operations. The bank examines the availability of raw materials, transportation facilities, electricity, fuel, water supply, proximity to customers, and climatic conditions before approving the project.
Plant Capacity
Production capacity should match expected market demand. An undersized plant limits production and reduces sales opportunities. On the other hand, an oversized plant creates idle capacity and increases operating costs. Therefore, the proposed capacity should be economically optimum.
Technology, Plant and Equipment
The success of many projects depends on appropriate technology. The appraisal reviews whether the proposed machinery is suitable, modern, efficient, and supplied by a reliable manufacturer.
Building and Layout
Factory design affects both productivity and safety. A proper layout allows smooth movement of materials, efficient use of space, easy supervision, and safe working conditions.
Marketing Aspect
No project can succeed without a market for its products or services. Marketing appraisal determines whether sufficient demand exists and whether the business can compete successfully after production begins.
The bank generally examines the following areas:
Situation Analysis
Before financing a project, the bank studies the overall market environment. Market size, historical demand, current demand, supply conditions, and the level of competition are carefully analyzed.
Demand Forecasting
Future demand is never certain. Therefore, the bank estimates future sales using both qualitative and quantitative forecasting techniques. Reliable forecasts improve the quality of investment decisions.
Industry Analysis (Porter’s Five Forces)
Industry conditions directly affect business performance. The bank analyzes rivalry among existing competitors, the threat of substitute products, the possibility of new entrants, the bargaining power of suppliers, and the bargaining power of buyers.
Company Analysis (SWOT)
Every business has strengths and weaknesses. At the same time, external opportunities and threats also influence future performance. SWOT analysis helps the bank evaluate the borrower’s competitive position and long-term prospects.
Marketing Plan
A good product alone does not guarantee success. The bank reviews the proposed pricing policy, distribution channels, and promotional strategies to determine whether the marketing plan is practical and realistic.
Financial Aspect
Financial appraisal determines whether the project is capable of generating adequate returns and repaying the proposed loan. Since repayment ultimately depends on financial performance, this aspect receives significant attention during credit evaluation.
Financial appraisal includes several important analyses.
Income Statement and Balance Sheet
Historical and projected financial statements reveal the financial position of the business. They help evaluate profitability, assets, liabilities, and overall financial strength.
Cash Flow Statement
Profit does not always mean cash availability. For this reason, the bank carefully analyzes projected cash flows to determine whether sufficient funds will be available to meet loan repayments on time.
Financial Projections
Future financial performance is estimated through projected income statements, balance sheets, and cash flow statements. These projections help determine whether the project will remain financially sustainable.
Cost-Volume-Profit (CVP) Analysis
Break-even analysis forms an important part of financial appraisal. It identifies the minimum level of sales required to recover both fixed and variable costs.
Cost of the Project and Means of Financing
The bank examines the total project cost along with the proposed financing plan. It also evaluates whether the balance between equity contribution and borrowed funds is appropriate.
Capital Budgeting Techniques
Investment proposals are evaluated using accepted capital budgeting methods such as Net Present Value (NPV), Internal Rate of Return (IRR), Benefit-Cost Ratio (BCR), and Payback Period. These techniques indicate whether the investment is financially worthwhile.
Sensitivity Analysis
Business conditions may change after project implementation. Sensitivity analysis measures the impact of changes in sales, costs, prices, or other important assumptions on the project’s financial viability.
Socio-Economic Aspect
Some projects create benefits that extend beyond financial profit. This aspect is particularly important for infrastructure projects such as power generation, irrigation, and transportation. In these cases, national interest may receive greater emphasis than commercial return.
The appraisal considers factors such as opportunity cost, shadow pricing, employment generation, income distribution, development of small-scale industries, improvement of infrastructure, and enhancement of the quality of life.
Environmental Aspect
Modern banking places great importance on environmental sustainability. Before approving a project, the bank evaluates its environmental and social impact to ensure compliance with regulatory requirements.
Bangladesh Bank requires an Environmental Risk Rating (EnvRR) for all credit proposals above Tk. 25 lakh for SME loans, Tk. 1 crore for Corporate loans, and Tk. 1 crore for Real Estate loans.
Projects receiving a High EnvRR require additional environmental covenants in the loan agreement. Banks must also complete an Environmental Due Diligence (EDD) checklist, including both General and Sector-Specific assessments for environmentally sensitive industries.
Industries such as Textile, Tannery, Ship-breaking, Chemicals, Cement, Agri-business, and Housing receive special attention because of their higher environmental risk.
Credit Operations and Management, Module: C, 6th BPE 2(b), 98th BPE 3(c), 99th BPE 4(a)
