1. USAID – Workshop on agricultural sector financing AGRICULTURAL CLIENTELE AND CREDIT RISK ANALYSIS Workshop on July 22 and 23, 2011

2. 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)

3. THE PRINCIPAL AREAS TO BE MEASURED Analytical tools or indicators may be divided into five categories or key sectors as follows: ProfitabilityMeasures the ability to generate profits EffectivenessMeasures the costs of operations compared with the returns. It shows the extent that management is competent in operating the business SolvencyMeasures the financial health and stability of the business compared with its equity LiquidityMeasures the ability of the business to repay its debts on current assets Repayment capacityMeasures the capacity to repay the loan RiskMeasures sensitivity to prices and to production

4. 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

5. 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.)

6. 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

7. 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% and mini = 150% for any credit project

8. 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

9. 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

10. 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..

11. 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

12. 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

13. 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

14. REPAYMENT CAPACITY: CASH FLOW The 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

15. 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

16. 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)

17. CASH FLOW STATUS

18. SAMPLE CALCULATION SHEET

19. SAMPLE CALCULATION SHEET FOR FAMILY EXPENSES

20. 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

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

22. 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.

23. 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

24. 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%

25. 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.

26. 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

27. ANALYSIS OF AGRICULTURAL LOANS

28. ANALYSIS OF AGRICULTURAL LOANS (continued)

29. 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

30. 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

31. 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

32. 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

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

34. THE GOLDEN RULE If you were lending your own savings, would you make the loan?