Critical Aspects of Techno-economic Viability Study for Projects Subhash Nathuramka, FCS, Principal Consultant, Columbus Capital Management

Limited, Mumbai. Submission of a project report, otherwise called the techno-economic feasibility study is a prima facie requirement for obtaining finance from banks or financial institutions. What are the objectives of such report, how it should be prepared and what factors ought to be considered while drafting it, have all been spelt out in this article. INTRODUCTORY Banks and 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 foundation for the financing proposal to go forward for further appraisal and scrutiny of the lending institution. 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. Professional consultancy firms, 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 NEEDS 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 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 the timely implementation of the project. The project may 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. CORRECT AND FAIR ASSESSMENT OF THE PROJECT An integrated and multi 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 have to be done in a realistic manner to enable a fair analysis of projections and ratio analysis. Similarly input-output norms, process loss, raw material consumption norms, inventory norms all have a direct bearing on the economic assessment. Any financial analysis without sound technical Articles Articles 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 the confidence, skill and entrepreneurship, adaptability of the promoter can only drive the project through 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. 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 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 seasonal 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. STURCTURE OF CAPITAL COSTS FOR A TYPICAL INDUSTRIAL PROJECT Particulars Basis and Documents Comments Critical factors to be referred Land and Site Development Sale Deed, land records Market value not admissible Suitability of location like 7/12 Extract even if substantially higher from the point of view Search report of lawyer than actual cost of workers, customers suppliers, customers Suitability and adequacy of Availability of infrastructland to be seen ure facilities Critical Aspects of Tecno Economic Viability Study for Projects Articles Like power and transport facilities and also man power. Building and civil works Approved Building Plan Built up area, height of building Estimates by Architect to be specified. Work orders Credentials of Architect, structural engineer, contractor to be established Plant and Machinery Competitive Quotations Credentials of critical and Satisfactory past record of major equiptment suppliers similar machinery and Purchase Orders to be established supplier to be ascertained. Invoices Machine layout supporting for govt. taxes 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 Pre-operative Expenses Cal. of interest during Need to be aligned with implementation, cost of stamp implementation schedule

duty, upfront fee, legal and professional fee Contingency Segregation of firm and non 2 to 3% of non firm costs is firm costs usually taken Margin money for working 25% of (stock, debtors, other Need to be aligned with working Working Capital should be capital current assets) less S. Creditors capital assessment tied up with the term loan. (for first year) STRUCTURE OF MEANS OF FINANCE Description Basis and Documents to be referred Comments Promoters Share Capital Shareholding Pattern, IT returns, Promoters capital cannot be out of borrowed Personal Balance Sheets funds. It is generally brought in first (before the release of bank loan). Interest free unsecured Loans from IT returns, Personal Balance Sheets Such loans are in the nature of quasi equity. promoter group However nowadays the banks prefer to classify them as term liabilities. Private Equity Letters of consent, buyback agreements, It is generally brought in first (before the release Credential of parties. of bank loan). Internal Accruals Audited Accounts, ready/liquid availability of surplus after servicing of existing loans. Critical Aspects of Tecno Economic Viability Study for Projects Articles Articles Suppliers Credit Agreement Payment schedule to be suitably incorporated in the projections. Soft Loans, Subsidies from Govt. Govt. schemes, their terms. There should be alternative 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 Liabilities) 1.33 Promoters Contribution(as%of Cost of Project 33.33% of the cost of the project TOL/TNW (Total outside liabilities/Tangible Net Worth) Not more than 3:1 Debt/Equity Ratio 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 coverage ratio) - Profit 1.75 to 2 ( Should also been seen on year to year basis during the before interest and depr. ( after tax) during the tenure of loan/ tenure of loan) interest on term loan plus repayment obligations Achievement in projected profitability Should achieve at least 90% of projections Average security coverage (quantum of term loan in relation 25% to 30% to fixed assets charged) Collateral Security 25% (can be relaxed depending on the financial standing of the company/promoter) Business Risk Should be able to meet the competition. Should preferably be ahead of the competition Capacity Utilization versus 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 Critical Aspects of Tecno Economic Viability Study for Projects Articles Integrity/Corporate Governance, Track record, payment Name of the borrower, promoters, directors appearing in the record, managerial competence/commitment, expertise, list of RBI defaulters list, CIBIL defaulters list is viewed organization structure and system, experience in industry, adversely. credibility, compliance with statutes, strategic initiatives, length of relationship etc. are considered Qualitative Factor 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, BBB- is considered to be investment grade rating. Anything above CARE, FITCH etc.) under Basel II norms 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-a-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.

On behalf of banks/FIs we conduct Techno Economic Viability Study of projects.Technological appraisal and its corresponding impact on the financial status of a project is a risk mitigation process considered prior to deciding whether a Bank or an FI should lend for a particular activity. While acknowledging the fact that no project can be absolutely risk free considering the dynamic environment every business runs in, we carry out Techno Economic Viability Study of projects to help Banks/FIs with taking a call on the acceptability of risk level(s). The following are our focus-areas as regards conducting a TEV Study: Promoters and their background an objective assessment of the promoters, their background, experience, etc. and establishing relevance to the proposed venture. Project Cost and Means of Finance.

Financial Analysis acting as a reality check; levels maintained vis--vis normative requirements and/or industry standards.

Plant & Machinery comments on condition, balancing/adequacy of existing/proposed machinery, technological levels, comments on suppliers etc.

Infrastructure comments on availability and adequacy.

Raw Materials and Finished Products comments on requirement, availability, adequacy, selling proposition, etc.

Marketing Research and analysis of market forces, competition, etc.

Assessment of Working Capital and Term Loan requirement.

SWOT Analysis including risk factors and risk mitigants.

Concluding comments on technical feasibility and economic viability including BEP analysis, DSCR calculations, IRR calculations and sensitivity analysis on sales and major inputs.

KITCO: Industry Specific Financial Consulting

Financial Services had always been a crucial area of activity for KITCO. To fulfill the divergent and challenging consulting needs of the new era that is defined by the rapid globalization and its all implications, the organisation has further equipped itself with industry specific financial consulting expertise that is at par with global standards.

The following is a brief outline of the scope and reach of the services we are capable of to provide.
Formulation of business model including Financial Modeling Defining the structure of equity and debt. Defining the working capital structure Defining the optimum capacity. Market study and identification of target groups. Phasing of infrastructure development Projection of financials.

Techno Economic Viability Study: This study aims at the appraisal of technological aspects of a project and the impact on its financials. The study normally includes: Description of promoters and their background Computation of project cost. Detailed study on the adequacy of the plant and machinery proposed and the technology level of such plant and machinery. Detailed study on the adequacy of the proposed infrastructure facilities. Detailed study on raw materials o Requirements o Availability o Sources and cost Study on the products, bye products and waste produced. Evaluation of marketing arrangements. SWOT DSCR,IRR,BEP and sensitivity analysis.

Identification and evaluation of various sources of funds Assistance to obtain credit facilities from banks /financial institutions/Private Equity Funds Business/Strategic planning Assist the management to set business goals based on

Market Study Analysis. Industry study analysis

Business Restructuring This aims at optimum utilization of resources for maximum output and earnings. It may lead to: Financial / Debt Restructuring: A process that allows a company to reduce and renegotiate delinquent debt in order to improve or restore liquidity. It involves close interaction with client and financial institution. This may also require a viability study to be conducted afresh to find out the sustainability of the existing business.
Organization Restructuring: It involves a walkthrough of existing workflows, policies and
procedures of the organization followed by re arrangement of functions and assets which are found necessary. This will reduce the redundant works and enhance overall efficiency. It may be achieved through Mergers and Acquisitions, Disinvestments Investments by PE Acquisition of Share holding interest This involves the transfer of existing management. We may extend our service in the following areas to facilitate an informed decision making:

a) Business Valuation: A process for estimating the economic value of the promoter interest in the business. Three approaches are prevalent in business valuation b) Financial and commercial due diligence: This exercise helps in identifying and reducing the risks related to the transaction. It is an investigation in to the affairs of the entity with respect to its business. Salient features are. Business oriented analysis Based on factual data Understanding the industry Evaluation of the existing business model and the business practices Assessment of the benefits and liabilities of the proposed transaction.

c) Assisting the client in financing the deal. d) Managing open offers. e) Assisting in closing the deal.