Financial Appraisal of Investment Projects in Medium and Long-Term Lending of Commercial Banks

provides information to bank managers to decide whether to grant or reject a loan. On the other hand, it helps banks to analyze and manage credit risks after lending.

Like any other business organization, an important goal of commercial banks is profit, and we know that the main source of profit for banks is from medium and long-term lending activities, in which lending activities from investment projects play a very important role. Therefore, each investment project approved for funding must necessarily bring economic efficiency, in order to ensure the safety and development of the bank's operations. And to ensure that the investment project, when funded, can bring profit to the bank, it is mandatory for the bank to conduct an investment project appraisal before deciding whether or not to lend. Thus, it can be said that investment project appraisal plays a very important role in supporting the bank in making the right decision on whether or not to lend to finance the project.

For commercial banks, the appraisal of investment projects, mainly the financial appraisal of investment projects, helps banks draw conclusions about the feasibility, financial efficiency of the project, the ability to repay debt and possible risks to serve the decision to lend or refuse to lend for investment projects. Through the appraisal of investment projects, commercial banks will select and find effective investment projects to lend, ensuring the goal of improving credit quality and limiting risks. For example, for loans where the investor has complete legal documents, good financial status, has a detailed investment project presentation plan, indicating the economic benefits, and when the bank conducts project appraisal, it finds that the project has economic efficiency indicators such as: high profit, payback period, good profitability, the investor's debt repayment ability is guaranteed... then that investment project will certainly be focused on and considered for lending by commercial banks.

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(Source: Nguyen Minh Kieu (2014), “Modern Banking Operations”,

Labor - Social Publishing House, page 369-370)

1.2. Financial appraisal of investment projects in medium and long-term lending of commercial banks

1.2.1. Concept of financial appraisal of investment projects in medium and long-term lending of commercial banks

From the concept: "Financial appraisal of investment projects is the organization of reviewing and evaluating financial forecast tables, on that basis determining the financial benefit and cost streams of the project, comparing these financial benefit streams on the basis of ensuring the principle of time value of money with the initial investment capital to draw conclusions about the financial efficiency and risk level of the project."

(Source: Luu Thi Huong (2004), "Project Financial Appraisal Textbook",

Financial Publishing House, page 36)

Thus: "Financial appraisal of investment projects in medium and long-term lending of commercial banks is the process of scientifically and comprehensively reviewing and re-examining all financial aspects of the project that the customer has established from the perspective of the commercial bank, which is the basis for the commercial bank's lending decision."

1.2.2. Purpose of financial appraisal of investment projects in medium and long-term lending of commercial banks

Banks earn their profits mainly from lending activities. Therefore, each credit granted must be effective, which means ensuring the safety and efficiency of the bank's operations. Therefore, the most important thing for banks is the ability to repay the loan, both principal and interest, on time. Therefore, it is very important for banks to conduct project appraisals in all aspects of technology, market, management organization, finance, etc., of which the financial appraisal of investment projects can be said to be the most important.

An investment project often requires a very large amount of capital, over a long period of time, while businesses have not yet accumulated enough capital, the public's direct investment psychology in businesses is still limited. Therefore, when implementing their project investment, in addition to using their own capital, businesses often mobilize many different sources of capital such as capital mobilized from outside, capital borrowed directly from the state budget, capital borrowed from abroad, but in which the capital source that accounts for a large proportion is capital borrowed from commercial banks. In their business activities, businesses increasingly prefer to mobilize capital to conduct investment through the form of medium and long-term loans from banks rather than issuing stocks or issuing long-term bonds because borrowing medium and long-term capital from banks will make businesses autonomous and capable.

independently control its production and business activities without diluting control of the enterprise with new shareholders in the event of issuing new shares. On the part of commercial banks, lending for investment projects is a traditional business activity, with high profitability but also containing many risks. And to minimize possible risks, commercial banks have no other choice but to conduct appraisal of investment projects, the most important task here is project financial appraisal. The important role of investment project financial appraisal is shown in that it is the most important basis for commercial banks to make their funding decisions.

It can be said that financial appraisal of investment projects is the most important and most complicated content in the project appraisal process. Because it requires the synthesis of all financial, technical, market variables... that have been quantified in the previous appraisal contents in order to analyze and create financial projection tables, appropriate and meaningful financial indicators. And these indicators will be the top important measures to help commercial banks make the final decision: to approve funding or not.

In terms of operations, commercial banks with the motto of operating effectively and safely, the bank's financial appraisal of investment projects helps:

Firstly , the bank has a relatively solid basis to determine the efficiency of capital investment as well as the project's ability to recover capital, more importantly, to determine the investor's ability to repay debt through the method of appraising the project's financial indicators such as the project's payback period, which indicates the time it takes for the investor to recover the capital invested in the project; the project's profits; the project's true value, etc.

Second , banks can predict possible risks that may affect the project implementation process when appraising by using the sensitivity analysis method on the project's financial indicators. For example, banks can assess the impact on the project's efficiency when there is a risk of exchange rate or interest rate due to the impact of the economy or sudden changes in input material prices, labor prices, etc. through analyzing the sensitivity of the project, measuring the percentage change of financial efficiency indicators corresponding to the percentage change of input factors such as interest rates, exchange rates, etc. On this basis, detect and add measures to overcome or limit risks, ensure the feasibility of the project, and at the same time consult with State management agencies and investors to make the right investment decisions.

Third , the bank has a plan to limit credit risk to the lowest level when

loan valuation: reasonable loan amount at which the bank can recover capital 5

In case of risks; the loan period and interest rate must bring profit to the bank but still ensure the investor's ability to repay the debt; the disbursement period and reasonable disbursement method must be able to control the cash flow into the project in accordance with the project's implementation progress and ensure that the money is used for the right purpose, for example, the investor must provide complete documents related to the project during the implementation process; the debt collection period and reasonable debt collection method must ensure the bank's interests but create conditions for the project to operate effectively.

Financial appraisal of investment projects carefully and following the correct appraisal process will help reduce risks of medium and long-term loans, help banks gain profits and ensure the stability of loans.

1.2.3. Contents of financial appraisal of investment projects in medium and long-term lending of commercial banks

1.2.3.1. Assessment of the financial capacity of the enterprise

Any feasible project is established on a foundation of the financial capacity of the investor. Therefore, the financial appraisal of the investor's business is extremely important. In this work, the analyst mainly uses financial indicators for analysis. This is a very effective method to comprehensively assess the financial situation of the business. The commonly used indicators include the following 4 basic groups:

 Liquidity indicators

 Performance indicators

 Indicators of capital balance ability

 Profitability indicators are divided into 4 groups of indicators:

 Liquidity indicators

The two most important liquidity ratios are the current ratio and the quick ratio:

 Current payment capacity.

Current Ratio =

Current Asset Value Current Liability Value

The current ratio is a measure of a company's short-term solvency, indicating the extent to which the claims of short-term creditors are covered by assets that are likely to be converted into cash within a given period.

with the maturity of those debts. This ratio is often compared with the industry average value of the industry in which the business is doing business. At the same time, it is also compared with the values of this ratio of the business in a previous period. This ratio > 1 is good.

On the other hand, in many cases this ratio does not really accurately reflect liquidity, because if the inventory is difficult to sell, easily depreciates or is damaged and accounts for a large proportion, it is very difficult for the business to turn them into money to pay off debts. Therefore, it is necessary to pay attention to the ratio of quick payment ability.

 Fast payment ability.

Current Asset Value – Inventory Value

Quick Payability =

Current Liability

This indicator reflects the ability of assets to be easily converted into cash for short-term debt at the time of analysis. This indicator > 0.5 is good. If this indicator is too high for a long time, it is not good because it may be due to the business having stagnant assets, leading to a decrease in capital efficiency. If this indicator is too long, it is not good because it may be due to signs of financial risks appearing, the risk of bankruptcy.

 Operating capacity ratios:

These ratios measure the level of activity and the efficiency of those activities in relation to the level of assets of the business, they include the following four indicators:

 Inventory turnover ratio

Inventory turnover ratio net sales

Cost of goods sold

Average inventory value

This ratio measures the level of sales related to the inventory level of finished goods and raw materials. If this ratio has a low value, it shows that the business is not really effective in consuming products so the inventory volume is large.

 Average collection period

Average collection period =

Value of receivables

Average daily revenue value

The average collection period indicates how many days it takes to collect one day's revenue. A low average collection period indicates that the business is not

Capital stagnation in payment stage, the enterprise's ability to recover capital is fast and the enterprise does not encounter "bad debts".

 Fixed asset turnover

Fixed asset turnover

determine

Net revenue Fixed assets value

This ratio shows how much revenue one dong of fixed assets generates in a year. If this ratio is higher than 1, it reflects the good performance of the business, and the efficiency of using fixed assets is high, because one dong of fixed assets will generate more than one dong of revenue.

 Capital structure index:

 Debt to total assets ratio

Debt to Equity Ratio

total assets

Total liabilities Total assets

Total debt here includes short-term debt and long-term debt payable. Creditors usually prefer companies with low debt ratios because they have a higher ability to pay debts. On the contrary, shareholders want high debt ratios because this increases the ability to generate profits for shareholders. However, to know whether this ratio is high or low, it is necessary to compare it with the average debt ratio of the industry.

The lower the debt ratio, the greater the protection for creditors in the event of a business going bankrupt and having to liquidate its assets.

 Interest coverage ratio

Ability to pay

interest

EBIT

Interest expense value

This ratio indicates how well a company can meet its interest obligations. The higher the interest coverage ratio, the better the company's ability to pay interest to its creditors. A low interest coverage ratio indicates a dangerous situation, a decline in economic activity could reduce EBIT below the interest payments the company must make, leading to insolvency and bankruptcy.

If the ratio is greater than 1, the company is fully capable of paying interest. If it is less than 1, it shows that either the company has borrowed more than it can afford, or the company is doing so poorly that the profits earned are not enough to pay interest.

 Profitability ratios:

 Return on Sales (ROS)

ROS =

Profit after tax Net revenue

This ratio reflects how much profit after tax is generated for every dollar of net revenue. It can be used to compare with the ratio of previous years or compared with other businesses to evaluate the profitability of the business.

 Return on total assets (ROA)

Profit after tax

ROA =

Total asset value

The return on total assets ratio measures how effectively an asset invested in a business generates after-tax profit.

 Return on equity (ROE)

Profit after tax

ROE =

Equity value

The ROE index helps evaluate the profitability of equity, it shows how much profit after tax one dong of equity generates.

(Source: Nguyen Minh Kieu (2014), “Modern Banking Operations”,

Labor - Social Publishing House, page 404-415)

1.2.3.2. Appraisal of financial aspects of investment projects

Financial appraisal aims to assess the profitability to meet the financial obligations of the project, through the synthesis of technical financial variables calculated in the previous appraisal to provide input data for calculating socio-economic efficiency. Appraisal of the financial aspect of the investment project includes:

a. Appraisal of total investment capital of the project

The total investment capital of a project includes all the capital needed to establish and put the project into operation. It is the basis for planning to mobilize and manage investment capital, determining the investment efficiency of the project. From the perspective of a project, the investment capital for a project includes 3 parts: investment capital in fixed assets, investment capital in initial current assets and reserve investment capital.

 Investment capital in fixed assets includes all costs related to the formation of fixed assets from the investment preparation stage to the investment implementation stage and the project construction completion stage, specifically:

 Preparation costs (pre-operation costs): Are costs used to prepare research and establish investment project documents.

 Cost of purchasing machinery, equipment, production tools, means of transport.

 Costs of new construction or renovation of factories and infrastructure.

 Technology transfer costs (in case of one-time payment).

 Staff training costs

 Other costs: These costs arise during project implementation and are not directly related to the creation or operation of fixed assets.

 Initial investment in current assets is the minimum amount of capital needed to ensure the reserve of current assets to meet the operational needs of the project. Including:

 Production capital: Cost of raw materials, electricity, water, spare parts, packaging, wages...

 Circulating capital: unfinished products, inventory, finished product inventory, goods sold on credit, cash capital, marketing costs...

 Reserve investment capital:

In a market economy, factors such as construction material prices, labor costs, etc., often fluctuate. In addition, during project implementation, technical risks or unusual costs may arise. Therefore, it is necessary to set aside a reserve fund to be ready to respond to any unexpected events that may occur. Thanks to this source of capital, when an incident occurs, the investor can easily respond proactively and flexibly. Avoid unnecessary losses for the project.

Accurate calculation of total investment capital is extremely important for the feasibility of the project because if the estimated investment capital is too low, the project may be stalled, not implemented on schedule or even not implemented. On the contrary, calculating too high will result in a lot of debt, high interest payments, and reduced profitability of the project. Therefore, the appraiser needs to consider and evaluate whether the total investment capital of the project has been reasonably estimated compared to reality. After comparing, if the appraiser finds a big difference in any content, he must focus on carefully analyzing and understanding.

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