Aug 12 2008
Business or commercial loans – Credit appraisal
Almost all of the industrial enterprises whether they are into manufacturing, trading or service sector, need bank finance in order to run the businesses. So every one approaches the bank at some point of time for business loan whether it is for running day to day business or for setting up of a new project. A banker appraises the proposal and then decides whether to lend the money or not. Some tips on what goes behind the credit appraisal of the proposal by the banker.
First and foremost thing which is looked into is the industry and business activity the borrower is into. It may so be the case that borrower is running a business activity and wants to expand but the activity according to the banker is from sunset category meaning the industry is not going to grow in future. They will analyze the industry from macro aspect and see the total demand and supply situation of that industry. Lets us take an example, in steel manufacturing industry suppose a business loan application comes which is for a project loan for expansion plans. Total demand for the products by the industry is say 90 mn tns and production capacity is say 120 mn tns. So any expansion will create additional capacity in the industry which may not be viable to sell. This is just one example. Normally this kind of analysis is made to see the viability of the business. Marketability of the product is another aspect.
Next is the management aspect. It will be seen who are the people who are running and managing the affairs of the company. What are their credentials. Larger organization are professionally managed but it is seen who are the ultimate promoters of the company. For smaller organization this aspect becomes more important because at the end of the day business is dependent on one promoter or family. So complete background checks are done regarding what business experience they have, what education qualification they have. Since when they are into the current line of business.
After this, the complete financial analysis is done which includes the analysis of income and expenditure statement, cash flow statement and balance sheet. In small and medium enterprises, Profit and loss account is always derived from bottom in order to assess the lowest possible tax outgo. So completely relying on the financials and deriving a comfort may not be correct. Most of the sales is not accounted for in the books of accounts. So financial analysis gives some idea about the financial position of the entity but it does not reflect the true picture. So the question arises whether to rely on the financial data provided by the customer or not. For this endless discussions are held with the promoters to understand their true worth and true scale of business. Reference checks are made from the business associates in order to assess the credibility.
Then what is seen is the credit report of the borrower in the past. If the borrower is already enjoying some bank finance from other bank then the conduct is checked by seeing whether repayment of the loan taken has been done in time or not etc. Some time bank statements are also scrutinized. Kind of security the borrower is offering also forms important part of decision making. Comfort is derived on the nature of collateral security meaning a residential property will always be preferred than a industrial property.
Risks from each angle are identified and mitigants are put in the final proposal. Then the banker decides whether to lend or not. Each of the above parameters can not be validated on stand alone basis so the entirety has to be looked into before making a decision. It is always stressed upon that “Banker should take a known risk rather taking an unknown risk”.