USAID – Workshop on agricultural sector financing

AGRICULTURAL CLIENTELE AND CREDIT RISK ANALYSIS

Workshop on July 22 and 23, 2011

FINANCIAL ANALYSIS MEASUREMENT

Financial analysis is simple: compare, compare, compare

• Comparison of results with the projections and the objective

• Comparison of the results for the period with previous results and by analyzing trends

• Comparison of results with those of other farms or comparable businesses (activities)

THE PRINCIPAL AREAS TO BE MEASURED

• Analytical tools or indicators may be divided into five categories or key sectors as follows:

Profitability Measures the ability to generate profits

Effectiveness Measures the costs of operations compared with the returns. It shows the extent that management is competent in operating the business

Solvency Measures the financial health and stability of the business compared with its equity

Liquidity Measures the ability of the business to repay its debts on current assets

Repayment capacity Measures the capacity to repay the loan

Risk Measures sensitivity to prices and to production

PROFITABILITY

• Measures the ability of the producer/the business (activity) to generate a profit

• Measures effectiveness

• Measures operational sustainability

• Makes it possible to evaluate the return on Investment

PROFITABILITY INDICATORS

• Profit margin = Net Earnings/Net Sales > 0 and to be compared to other comparable businesses

(In the case of production activities, it concerns net income compared with net sales resulting from production. For business and wholesaler activities, income can also be viewed as the margin before costs.)

PROFITABILITY INDICATORS (continued)

• Profitability = Total Income/Total Costs = normal 2 x level of compensation of savings paid by the bank for the same period and mini = > to the loan interest charged for the same period. (Ex.: if the interest is 1%/month, then for a retail activity with a monthly capital turnover, the mini is 1% of the net profit. For cereal production, the mini profit is 8% for the period.)

(Indicate the ability of the business to generate a profit compared with costs. This concerns a return on the project without taking into account the present values of income flows and of costs, no more than the difference of risk between the business or the rotation on investment, but very useful for the smallest projects

LIQUIDITY

Indicate the ability of a producer or a business (activity) to cover their short-term debts with their short-term assets (the money available in the short term). It is essential that the projects not encounter a liquidity problem in order to meet their obligations

• Liquidity ratio = Current assets/Short-term debts = normal 200% andmini = 150% for any credit project

RETURN/EFFECTIVENESS

Inventory turnover speed:

• Used to analyze the production and the commercial effectiveness of an industrial and commercial activity that manages inventories

• It must be used in comparison with that of other similar activities in order to be significant

• Analysis is recommended before and after a loan

Ratio = Cost of sales (or inventories sold)/average inventory

SOLVENCY

• Measures the capital leverage

• Indicates the ability to cover debts with its own capital in case of liquidation

But be careful, a solvent business can present risks of non-liquidity, hence the interest in completing the study using liquidity ratios

SOLVENCY (continued)

• Ratio = Total debts/Capital = normal 50% and mini 75%

(Common indicator for all types of businesses. It indicates the ability of the business to repay its debts from its equity. For activities with a higher risk, the ratio must be lower. And it is still necessary that the debts be < equity because in case of liquidation, the resale of shares is always weaker.

.

DEBT CAPACITY

• Debt capacity = Total Debts/Global Net Household Income: normal = 35% for production loans, real estate loans and in general, for projects that have periodic repayments and maxi = 50% for the small low-risk loans

• Measures the capacity to repay a loan

• The indicators give an approximation of the ability to amortize a loan and interest costs, without major difficulties

REPAYMENT CAPACITY

Expresses an estimate of the capacity to repay the loan by including family and other expenses and the measurement is expressed as an amount and not as a %

• + Total Income (all the sources) - Debts (including credit in the process of being put into place) - Family Expenses - Depreciation (amortization)

=Balance for repayment and reserves

For agricultural loans, it is advisable to use cash flow analysis

REPAYMENT CAPACITY (continued)

• Compares the capacity to repay in comparison with all income and expenses (business and household)

• Is generally calculated for all months

• Is an indicator of the appropriate repayment capacity for agriculture and the activities with unequal and/or multiple source income flows

REPAYMENT CAPACITY: CASH FLOWThe Cash Flow Analysis (the Flow of Income and Expenses) is a simple and INVALUABLE analysis for the business (activity) with multiple activities

• Is invaluable since agricultural households have irregular or seasonal flows of income and expenses

• All monetary income and business (activity) and household expenses are included

• The current monthly balance must be positive (in order to be able to cover costs)

• Is also a loan planning tool essential for determining the amounts and the time limits for disbursement and repayment

REPAYMENT CAPACITY: CASH FLOW (continued)

• To be developed together with the applicant with the three “following advantages”:

- better understanding and apprehension by the client

- better adherence/commitment by the client for the repayment plan

- greater reliability of data

CASH FLOW

Cash-flow Analysis:

Initial cash + All Income from the business + Other Income (including family) - Operating expenses - Investments - Loan Amortization - Interest payments - Family Expenses

=Final cash (must be positive for each period)

CASH FLOW STATUSActual Actual Actual Actual Actual Actual Actual Actual Actual Actual Actual Actual Projected Projected Projected Projected

1-Jan-08 1-Feb-08 1-Mar-08 1-Apr-08 1-May-08 1-Jun-08 1-Jul-08 1-Aug-08 1-Sep-08 1-Oct-08 1-Nov-08 1-Dec-08 1 Jan-09

2 Feb-09

3 Mar-09

2 Apr-09

1. BEGINNING CASH BALANCE 0 0 0 0 0 0 0 0 0 0 0 0 0 -2.464 -4.928

Cash inflows :

2.1 Sales Revenue 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

2.1.1 Incomes from service

2.1.2 Incomes from trade 2.2 Loan Proceeds 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

2.2.1 Term Loan Proceeds - - - - - - - - - - - - -

2.2.2 OVD proceeds

2. TOTAL CASH INFLOWS 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cash outflows

3.1 Cash operating expenses 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

3.1.1 Service - Cost of goods sold 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

3.1.2 Trade - cost of goods sold 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

3.1.3 Salaries and wages

3.1.4 Transport expenses - - - - - - - - - - - - - - - -

3.1.5 Utilities - - - - - - - - - - - - - - - -

3.1.6 Income Taxes Paid - - - - - - - - - - - - - - - -

3.2 Purchase of capital assets - - - - - - - - - - - - - - -

3.2.1 Purchase of factory - - - - - - - - - -

3.3 Loan payments 0 0 0 0 0 0 0 0 0 0 0 0 0 2.464 2.464 2.464

3.3.1 PCB second loan installments

3.3.2 PCB third loan installments 3.3.3 RBKO loan installments 2.401 2.401 2.401 3.3.4 RBKO CLC payment 63 63 63

3.4 Other expenses 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

3.4.1 Family living expenses

3.4.3 Construction family expenses

3. TOTAL CASH OUTFLOWS 0 0 0 0 0 0 0 0 0 0 0 0 0 2.464 2.464 2.464

4. CASH SURPLUS (DEFICIT) 0 0 0 0 0 0 0 0 0 0 0 0 0 -2.464 -2.464 -2.464

5. ENDING CASH BALANCE 0 0 0 0 0 0 0 0 0 0 0 0 0 -2.464 -4.928 -7.392

6. Cash available 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

7. Principal and Interest Payments 0 0 0 0 0 0 0 0 0 0 0 0 0 2.464 2.464 2.464

8. Debt Service Ratio N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A 0,00 0,00 0,00

Name of applicant: Nuhi Morina Address of applicant:Ferat Dragaj 76, Prishtine Date Statement was prepared:December 08, 2006

SAMPLE CALCULATION SHEETSchéma de production pour les produits agricoles

Les revenus de la production agricole

Culture

Espace (h)

Récolte (kh/h)

Récolte totale (kg)

Propre Consommation

(kg)

Ventes (kg)

Prix au kg

Revenu Mois

1 2 1x2=3 4 3-4=5 6 5x6=7

Frais pour la production agricole

Culture Apport Quantité

d'hectares Espace Prix Unitaire Frais Mois

1 2 3 1x2x3=4

SAMPLE CALCULATION SHEET FOR FAMILY EXPENSES

Revenus et des dépenses de la famille - feuille de calcul

Mois 1 Mois 2 Mois 3 Revenue Emploi à plein-temps

Travail à mi-temps

Femme

Membre de la famille

Paiement

Revenu locatif

Pension

Total des autres revenus

Frais Logement

Nourriture

Electricité

Téléphone

L'eau

Des autres frais

Médicaux

Vêtements

Divertissements/enfants

Construction de maisons/ meubles

Total des autres frais

OTHER INDICATORS (RATIOS)

• The value of the Loan in relation to the assets of the applicant is the measure of a borrower’s contribution. A borrower with a ratio of 80% or less is considered to have good credit worthiness

• The debt in relation to income is the measure of the monthly debt service compared with monthly income. A borrower with a ratio of 36% or less is considered to have good credit worthiness

• Debt in relation to savings is the measure of the annual service of a borrower’s debt in relation to savings. A borrower with a ratio of 20% or less is considered to have good credit worthiness

RISK INDICATORS

Are necessary in order to measure the effects that a change in the prices and production would have on the project

THE BREAK-EVEN POINT

This is the level of periodic sales that the business must make, at minimum, in order to cover expenses. It estimates the minimum production level needed to cover expenses. Need to know the fixed expenses (staff, rent, etc.) and the variable expenses (raw materials, direct production expenses, etc.)

Break-Even Point= Expenses/Sales (normal: a production of 1.5 of the break-even point and mini a production of 1.2 times the break-even point)

Above the break-even point, the profitability of the business increases very quickly because the fixed expenses are already covered.

THE EQUILIBRIUM PRICE/PRICE SENSITIVITY

Indicates the minimum price needed for a business in order to cover its operating costs, assuming constant production. Very useful, of course, for agricultural loans

Equilibrium price=Total costs/Units produced = 75 to 85% and less if the production risk is involved

THE PRODUCTION EQUILIBRIUM POINT/PRODUCTION SENSITIVITY

Measures the minimum level of production needed to cover all production costs at different product price levels. Often used for agricultural production and transformation industries

Equilibrium point = Total costs/Price = normal 75% of quantities produced or less if the price risk is involved and maxi 90%

PROFITABILITY AND CONTINUITY

• Profit is an average, not an end!

• Sustainability depends in the long term on the manufacture of a profit producing enough revenue to cover costs and the creation of equity, “the cushion” with which to cultivate and construct reserves for future needs and economic changes.

COST CONSIDERATIONS

Small producers and entrepreneurs borrow and save very small sums of money. For them to be able to borrow or save, the costs of doing so must be reasonable

ANALYSIS OF AGRICULTURAL LOANS

ANALYSIS OF AGRICULTURAL LOANS (continued)

THE BASIC RULES OF CREDIT FOR AGRICULTURAL ACTIVITIES

• Always have a secondary repayment source

• Character is important. All the guarantees of the world would not repay the loan “contrary to character”

• There is no substitute for:- Equity- Experience- Visiting your client’s operation/farm- Understanding the business (activity) to which you are lending

• Know the market to which you are lending

THE BASIC RULES OF CREDIT FOR AGRICULTURAL ACTIVITIES (continued)

• Do not be too proud to ask questions

• Update financial information on long-term clients as well as for any new client

• The quality of financial information is essential both for the business owner and for the lender

THE BASIC RULES OF CREDIT FOR AGRICULTURAL ACTIVITIES (continued)

• The goal of the loan must mean something compared with the circumstances of the

applicants in terms of added value and income capacity. And also, the money must be

used for the indicated purpose

• The term of the loan must conform to the depreciation period for the item purchased

• The maximum sum as well as the repayment plan must conform to the borrower’s

financial situation

• The guarantee must be requested in the form of assets or deposits (and even provided by

someone else). In this case, the existence and the value of the assets or the solvency of

the guarantor must be evaluated

SOME PERSONAL AND FAMILY SITUATION FACTORS

• Age• Nationality (only the inhabitants of the country should be entitled to

borrow)• Stable work and regular income (monthly salary)• Marital status and number of children• Stable residence• Bank account with bank • No arrears in tax payment or rent• No other loan pending with other banks or financial institutions• No other person who depends financially on the applicant• No criminal record

THE VISIT TO THE SITE/TO THE FARM AND THE CREDIT APPLICATION FORM

THE GOLDEN RULE

If you were lending your own savings, would you make the loan?