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Critical aspects of Tecno Economic Viability Study for projects

By CA Subhash Nathuramka B.Com.(Hons.), FCA, FCS


Email: snathuramka@yahoo.com
Principal Consultant, Columbus Capital Management Ltd, Mumbai
Introductory
Banks, financial institutions generally insist on preparation of a detailed techno
economic viability study report ( commonly known as project report) before
considering the proposals for financing any project be it an industrial project or
any other project in the nature of commercial or trading outfit. Such a report
provides the basic foundation

for the financing proposal to go forward for

further appraisal and scrutiny of the lending bank. The project report deals with
all the relevant factors having a bearing on the project be it technical,
commercial, financial or managerial

to ascertain whether the project is

technically feasible and economically viable.


Who prepares the project report ?

The borrowers themselves if they have got specialized personnel;

The professional consultancy companies, merchant bankers

Approved chartered engineers on the panels of banks

Project consultancy Firms

It is always advisable to assign the task of preparation of a project report to the


individuals, firms which enjoy high credibility in the eyes of the lending banks
and institutions. Specialization made in a particular industry or field should also
be given due weightage.
Project Report need to be objective and fair
There is a tendency to prepare a project report keeping in view the parameters
followed by the lenders. At times the assumptions are modified to fit into the
norms of the lenders. However it is always advisable to make an independent
and fair assessment of all factors critical to the formation and survival of the
project. Achieving financial closure alone cannot and should not be the objective
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of a project report. In addition to forming the basis for making a proposal to a


bank for obtaining finance a project report can be of use in many ways. It can be
helpful in timely implementation of the project. The project may even be
modified, curtailed, enhanced or even abandoned on the basis of findings of a
project report. It is therefore essential that the project report is prepared in an
objective and fair manner.
Case for an integrated multi dimensional approach to ensure a correct
and fair assessment of the project.
The muti dimensional approach should have following ingredients(i)

Both technical and economic assessments have to be in line with each


other. For example determination of installed capacity as also the
assessment of utilization of capacity has to be done in a realistic level
to enable a fair

analysis of projections and ratio analysis. Similarly

input output norms, process loss, raw material consumption norms,


inventory norms have a direct bearing on the economic assessment.
Any financial analysis without sound technical assumptions may prove
to be unreliable.
(ii)

Why is appraisal of a promoter so critical?

Amongst all factors viz. man, machine, material and money man is the
live factor who manages all other factors .

The estimates, projections generally never work out in the manner


they

are

perceived

and

ultimately

entrepreneurship, adaptability

the

confidence,

of the promoter can only

skill

and

drive the

project through the turbulent periods.

Age, the physical and mental health condition,

Qualification,

experience, background are important. There are more

important

guiding factors also like the ability to withstand an adverse situation ,


tendency to adhere to the laws of the land, policy towards personnel,
track record of implementation of project etc.
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The appraisal of the promoter is critical as the ability to raise need


based funds, corporate image and ability to attract quality customers,
personnel largely depend upon the image and track record of the
promoter.

The heart and soul of the promoter have to be with the project
all the time. In the ultimate analysis the project must belong
to the promoter and the promoter must belong to the project.

(iii)

Selling arrangement is one of the key factors which can make or mar
a project. Even with a very positive business scenario specific plans
have to be put into place before actual sale can be achieved. Achieving
the sale targets in the initial years is critical to avoid the situation of
debt trap. The promoters with requisite background and experience,
engagement of suitable personnel can certainly help.

(iv)

In the present business environment it is necessary that the project


has suitable

backward and forward linkages. A stand alone

project may prove to be a risky proposition. For example an integrated


sugar cum cogen project would be more viable than a stand alone
sugar project. Addition of distillery to the sugar cum cogen project may
give additional strength to the company. Reliance group has, over the
years, successfully

demonstrated the benefits of forward and

backward linkages. At the same time it would be better if the unit is


not dependent on one market ( indigenous or overseas ) only. Multiple
products are preferable over single product. Multiple locations ( within
a company) are preferable to single location.

It is therefore essential

that there is a suitable business model to support the project.


(v)

A long term project has to be seen with a long term perspective. If a


particular sector or project is having a short term negative outlook (
but with a medium and long term positive outlook) the project may be
taken up as by the time the implementation completes the scenario
would turn from negative to positive. Similarly if a particular sector or
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project has a short term positive outlook ( but with a medium and long
term negative outlook) the decision may be not to go for the project.
(vi)

Steady flow of funds is more important than the security cover. High
weightage should be given

to the steady flow of funds to ensure

timely payment of dues of the bank. Adequate security itself cannot


guarantee the payment of dues unless there is an adequate cash flow
in the system. It is therefore very important to

determine with

accuracy as to when and in what quantum the funds would flow into
the system.
(vii)

Risk factors and their mitigation- The project specific risk factors
need to be identified and the manner in which those factors are dealt
with has to be explained. For example sugar is a seasonable industry
and is heavily dependent on monsoon. To mitigate the factor such a
project should be preferably located in an area where irrigation
facilities are more than sufficient, ground water levels are good,
rainfall in the area is above average etc.

(viii)

With the withdrawal of income tax concessions ( like exemption of tax


on export profits) the assesses are left with lesser scope for tax
planning. Due to this factor more and more entities are prone to
purchase additional fixed assets to get

the benefit of depreciation

under the I.T. Act. In addition to this some sector specific incentive
schemes are also prevalent like Technology Upgradation Fund Scheme
(TUFS) under which textile units get benefit of interest subsidy.
Similarly under Sugar Development Fund rules the units get the benefit
of soft loan for setting up baggase based power projects as also for
ethanol projects based on molasses generated by sugar plants. In
genuine cases such benefits enhance the viability of the project.
However if other relevant factors are not in place a project set up
merely on the foundation of benefits may not work.

Structure of capital costs for a typical industrial project


Particulars
Basis and Documents
Comments
Critical factors
to be referred
Land and Site
Suitability
Sale Deed,
Market value
Development
of location
land records
not
from the
admissible
like 7/12
even if
point
of
Extract
view
of
substantially
Search report
workers,
higher than
of lawyer
customers
actual cost
,suppliers,
customers
Suitability and
adequacy of
Availability
land to be
of
seen
infrastruct
ure
facilities
like
power,
manpower
, transport
facilities
etc.
Building and
Approved
Built up area,
civil works
Building Plan
height
of
building to be
Estimates by
specified.
Architect
Credentials of
Work orders
Architect,
structural
engineer,
contractor to
be
established
Plant
and
Competitive
Credentials of Satisfactory past
Machinery
Quotations
critical
and record of similar
machinery
and
major
Purchase
supplier
to be
equipment
Orders
suppliers
to ascertained
Invoices
be
supporting for
established
govt. taxes
Machine
layout,

Pre-operative
Expenses

Contingency
Margin money
for
working
capital

Cal. of interest
during
implementation, cost
of stamp duty,
upfront fee, legal
and professional fee
Segregation of firm
and non firm costs
25% of ( stock,
debtors, other
current assets) less
S. Creditors ( for first
year)

Machine
balancing to
be examined
Utility
of
equipment
for project to
be
ascertained
Besides basic
cost
taxes,
duties,
freight,
insurance,
handling
charges,
electrical,
foundation
charges to be
included
DG
sets,
transformers,
testing
equipment to
be included
Need to be aligned
with implementation
schedule

2 to 3% of non firm
costs is usually
taken
Need to be aligned
with working capital
assessment

Working Capital
should be tied up
with the term
loan

Structure of Means of Finance


Description
Promoters Share Capital

Basis and
Documents to be
referred
Shareholding
Pattern, IT returns,
Personal
Balance
Sheets

Comments

Promoters capital can not be


out of borrowed funds
It is generally brought in first
( before the release of bank
loan)
Interest free unsecured IT returns, Personal Such loans are in the nature
Loans from promoter Balance Sheets
of quasi equity. However
group
nowadays the banks prefer to
classify
them
as
term
liabilities.
Private Equity
Letters of consent, It is generally brought in first
buyback
( before the release of bank
loan)
agreements,
Credential
of
parties
Internal Accruals
Audited Accounts,
ready/
liquid
availability
of
surplus
after
servicing of existing
loans
Suppliers Credit
Agreement
Payment schedule to be
suitably incorporated in the
projections
Soft Loans, Subsidies Govt.
schemes, There should be alternative
from Govt.
their terms
arrangement of funds till
sanction/ release of such
loans, subsidies is made.
Term Loan from Bank (s)
In case of more than one
bank tie up with all banks is a
must before release will start.
How the assessment of various risks is made?
Financial Risk
Parameter
Acceptable level/considerations
Current Ratio ( Current Assets: Current 1.33
Liabilities)
Promoters Contribution ( as % of cost 33.33% of the cost of the project
of project)
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TOL/TNW(
Total
liabilities/Tangible Net Worth)
Debt/Equity Ratio

outside Not more than 3:1

1.5 to 2:1 ( It can be more depending


on the nature of project e.g.
infrastructure project)
PAT/Net Sales (%)
Should be more than 5%
PBDIT/Interest
More than 2.5
Trends in performance
Should be upward trend
Gross Average DSCR (Debt service 1.75 to 2 ( Should also been seen on
coverage ratio) Profit before interest year to year basis during the tenure of
and depr. ( after tax) during the tenure loan)
of loan /interest on term loan plus
repayment obligations
Achievement in projected profitability
Should achieve at least 90% of
projections
Average security coverage ( quantum 25% to 30%
of term loan in relation to fixed assets
charged)
Collateral Security
25% ( can be relaxed depending on
the
financial
standing
of
the
company/promoter)
Business Risk
Technology
Should be able to meet the
competition. Should preferably be
ahead of the competition
Capacity Utilization vs. BEP
Should be 25% to 30% above the BEP
User/Product Profile
Product should be well accepted by the
user and should be able to withstand
competition.
Consistency in quality
Should be consistent
Distribution Network
Should be adequate
Consistency of cash flows
Should be consistent
Business Model
Whether
there
are
adequate
forward/backward linkages, whether
the business is based on the strengths
of the borrowers
Receivables profile
Good quality of receivables is
considered a plus factor.
Industry Risk
Competitive edge, industry outlook,
regulatory risk and other industry
specific risks ( like seasonal nature
etc.)

Management Risk
Integrity/Corporate Governance, Track
record, payment record, managerial
competence/commitment,
expertise,
organization structure and system,
experience in industry, credibility,
compliance with statutes, strategic
initiatives, length of relationship etc.
are considered.
Qualitative Factors
Factors like contingent liabilities,
auditors qualifications, accounting
policies as to depreciation, inventory,
adherence to accounting standards etc.
are considered.
Comparison
Borrowers
financial
ratios
are
compared with the standard industry
norms and with the ratios achieved by
peers
Loan Rating by External Credit
Agencies ( CRISIL , ICRA, CARE, FITCH
etc.) under Basel II norms

Name of the borrower, promoters,


directors appearing in the list of RBI
defaulters list, CIBIL defaulters list is
viewed adversely.

BBB- is considered to be investment


grade rating. Anything above would
give greater comfort level to the
lending bank.

Other important considerations

Adequate and uninterrupted availability of raw material

Adequate and uninterrupted availability of inputs like power, fuel, water,


transportation, labour

Requisite statutory approvals like NOC from pollution board, clearance


from ministry of environment, SIA registration, conversion of land for
industrial use etc.

Positive industry scenario domestic and global

Policy of the Government

Credit Monitoring Arrangement (CMA) for the existing borrowers CMA


data contain a format of Profit and Loss Account, Balance Sheet and Cash/Fund
Flow Statement which is used by the lending banks to assess/monitor the credit
requirement ( mainly working capital) of the borrower. It generally contains data
for 4 years including two years actuals, one years estimates and one years
projections. The time period may be enhanced to suit the requirement of the
proposal. For seasonal business there is a separate column for peak level
requirement. CMA data provide an important base for the analysis of the credit
proposal. However these have to be corroborated by other critical information
like actual credit summations in the bank account in the immediately preceding
twelve months, record of honouring L/C, B/G obligations, ratio analysis,
observations of statutory auditor, stock auditor, last years actuals vis--vis
estimates earlier submitted, transactions with group companies and related
parties, Comparison of performance with peers in the industry, internal rating by
the bank and rating under Basel II norms etc. Compliance with the terms of
sanction of bank ( like raising of promoters contribution, creation of security,
obtaining proper insurance of properties charged , approval of bank on any
major development relating to

the shareholding pattern, structure of

management, buying and selling of the major equipment, taking up new,


expansion projects, induction of new bank etc. ) is also critical to maintain a
relationship of trust with the lender.
Conclusions
The assessment of techno economic viability of a project involves numerous
factors. Sometimes even a single factor can mar the progress of the project. It is
not possible to conceive a risk free project. However an integrated and balanced
approach can mitigate the risk factors attached with the project. Experience has
also shown that if one were to choose a single most important factor attached
with a project it would always be the promoter and the team attached with the
conception, implementation and running of the project.
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Important Websites and Publications


Reserve Bank of India

www.rbi.org

SBI Capital Markets Ltd.

www.sbicaps.com

Credit Rating Information Services of

www.crisil.com

India Ltd. (CRISIL)


ICRA Ltd.

www.icraindia.com

Credit Analysis and Research Ltd.

www.careratings.com

(CARE Ratings)
FITCH Ratings

www.fitchindia.com

Mitcon Consultancy Services Ltd.

www.mitconconsultancy.org

Mott MacDonald Private Ltd.

www.mottmac.com

Ministry of Corporate Affairs, Govt. of

www.mca.gov.in

India
Credit Information Bureau (India) Ltd.

www.cibil.com

(CIBIL)
Asset Reconstruction Company (India)

www.arcil.co.in

Ltd.
Technology Upgradation Fund Scheme

www.txcindia.com

for Textile and Jute Industries ( TUFS)


Guidance Note on Audit of Banks ( 5th

The Institute of Chartered Accountants

Ed. 2008)

of India, New Delhi

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About the Author


CA Subhash Nathuramka has been associated with

Columbus Capital

Management Ltd. (CCML) , Mumbai as Principal Consultant since 2003. CCML


has an experience of handling project appraisals, financial tie ups of more than
Rs. 1000 Cr. involving more than 100 projects.
Prior to his present engagement he has worked in senior positions at Rajasthan
state industrial development corp. Ltd. (RIICO), Jaipur

where he handled a

number of proposals involving institutional finance. He also held position as


nominee director in a number of companies.
He has been actively involved in the activities of ICAI and ICSI. He was
Chairman,

Jaipur Chapter of NIRC of ICSI. Presently he is associated with

Andheri Oshiwara CPE study circle of Chartered Accountants as core committee


member.
He has more than 25 years experience in the field of project financing, feasibility
studies, corporate affairs and other related fields.
He is commerce graduate (with honours) from University of Rajasthan. He is a
fellow member of The Institute of Chartered Accountants of India. He is also a
fellow member of The Institute of Company Secretaries of India.

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