- Concepts, Process and Guidelines
The overall performance of Indian economy is quite impressive which is marching ahead to achieve even a double digit figure of GDP in the near future. All sectors of the economy namely, agriculture, industry, service and infrastructure are performing exceedingly well. Enterprises in these sectors are planning to go in for expansion, modernization and diversification for which demand for term loan would be substantially large. Hence, banks perceive lot of potential to provide term loan in which credit risk is relatively high. Similarly, deficiencies are being observed in credit decisions which have led to mega loan scandals. Hence, it is necessary to improve the quality of appraisal of term loan on one hand and to strengthen due diligence in credit, on the other. Towards this end, the present article guides on appraisal of term loan by discussing both conceptual and operational aspects, besides providing a list of items of due diligence in credit in terms of bank guidelines
Appraisal of Term Loan
- Concepts, Process and Guidelines
Firms engaged in industrial and service related activities require funds for various purposes. To commence business, they are expected to invest in fixed assets comprising land and building, plant and machinery, furniture & fixtures etc. Initially, each firm requires minimum fixed assets. Subsequently, additional plant capacity may be created for expansion or for purchase of new plant and machinery for the purposes of modernization and diversification. Besides, the firms require funds to finance other fixed assets also, which include goodwill, trade mark and other non-current assets. To finance all these fixed assets, each firm raises funds in the form of capital, subsidies and grants from the Government, retained earnings in the case of existing firms, term loan from banks and financial institutions and loans received from non-institutional sources such as friends and relatives etc. Grants and subsidy received from the government are expected to supplement the capital of an entrepreneur and the same are considered as part of long-term funds. Capital and reserves & surplus constitute owned funds (equity or net worth). In general, term loan from banks and financial institutions is the main source of funds for financing of fixed assets. Relatively speaking, for banks, risk in term loan is high since repayment is expected to take place during the next 5-7 years during which there could be many uncertainties in respect of performance of the firm, value of money, erosion in the value of securities, integrity of the borrower etc. Hence, it calls for a detailed appraisal of term loan not only to keep the entrepreneur happy but also to ensure a professional approach in financial analysis and decision making and also to observe due diligence of lending norms, policy guidelines and global best practices. This paper deals with various aspects of term loan to fill up knowledge and skill gaps on the part of credit officers and branch managers in banks and financial institutions.
Term lending – Conceptual Aspects
The essence of term loan appraisal is in assessing the ability of a firm to repay the principal amount and the interest thereon from the cash surplus generated from operations by utilizing fixed assets which are generally financed by banks. For sanctioning of the term loan by banks, it is necessary to carry out financial appraisal carefully by using analytical tools, observing due diligence, paying special attention to risk related aspects & working out strategies to cover risk, adopting the global best practices and using common sense. A request for term loan is made both by newly set up firms as well as existing firms. Relatively speaking, a detailed credit appraisal is needed in case of new firms in the absence of past experience. For...