PARTICIPANT COURSE MATERIALSFinancial Analysis for Microfinance           Institutions         CONSULTATIVE GROUP TO ASSIS...
NOTE The participant course materials contain the main technical messages and concepts delivered in this course. It is not...
OverviewOverview and Goals of the Course                        .............................................................
Overview and Goals of the CourseOverviewInternational best practice in microfinance around the world suggests good financi...
Sustainability =Coverage of financial expense (cost of funds + inflation) +                      Loan loss +   Operating e...
Goals of the Course•   To master the tools needed for understanding the financial position and sustainability of    your i...
Financial Statements    MFIs commonly use four types of financial statements:          1. Balance sheet          2. Income...
Income Statement    An income statement reports the organization’s financial performance over a specified    period of tim...
•    Starts at zero for each period (in contrast to the Balance Sheet which is cumulative     since the beginning of the o...
Portfolio Report and Activity Report  A portfolio report and activity report link the loan portfolio information of the th...
Relationships Between Financial Statements
Formatting Financial StatementsMost MFIs depend on donor funds but do not realize to what extent and that donor moneyis no...
Three Ways in Which MFIs Treat Cash DonationsGoals:    1.   Grants are separated from operating income          2.   Grant...
Sample Income Statement               Financial Revenue                       Operating Expense               Financial Re...
Sample Balance Sheet                  ASSETS                                    Accounts Payable and Other Short-term     ...
Financial analysis is required for many financial                 management decisions:• How to manage the finances to ach...
Indicators for Financial Analysis     An MIS is created to generate information for decision making, the bestinformation f...
Asset/Liability Management• Yield on Gross Portfolio• Portfolio to Assets• Cost of Funds Ratio• Adjusted Cost of Funds Rat...
Efficiency and Productivity• Operating Expense Ratio• Adjusted Operating Expense Ratio• Cost per Active Client• Adjusted C...
Portfolio QualityPortfolio at Risk (PAR) and the Write-off Ratio are the preferred ratios for analysingportfolio quality. ...
recommended to calculate                                                                        this ratio on an adjusted ...
Calculating Portfolio at Risk ratiosRef.                                     DESCRIPTION R9      Portfolio at Risk        ...
Adj R10   Adjusted Write-off Ratio          Value of Loans Written-off + Write-off Adjustment  a  b       Average Adjusted...
Rationale for Loan Loss Impairment andImpairment Loss AllowanceMaintaining loans on the books that are unlikely to be repa...
LOAN LOSSES or WRITE-OFFsoccur only as an accounting entry. They do not mean that loan recovery should notcontinue to be p...
Loan losses or write-offs occur when it is determined that loans are unrecoverable. Because thepossibility that some loans...
Analytical AdjustmentsAdjustments are additional, or hidden, costs incurred by the MFI that we need to recognizefor intern...
REF.      ACCOUNT                  EXPLANATION                               FORMULA           NAME                       ...
is common in many parts of the                        world and is mandated by Section                        29 of the In...
e.                          Market Cost of Funds = c x d   f.                          Interest and Fee Expense on Borrowi...
Asset /Liability ManagementAsset/ Liability Management is the ongoing process of planning, monitoring andcontrolling the v...
Asset/Liability Management Ratios                 Interest rate management Yield on gross      Cash Received from Interest...
LeverageDebt/Equity                       Liabilities                                    EquityAdjusted                   ...
Calculating Asset/Liability Management RatiosRef.                                    DESCRIPTION R4    Yield on Gross Port...
AdjR7    Adjusted Debt to Equity Ratio a    Liabilities b    Adjusted EquityAdjR7    Adjusted Debt to Equity Ratio = a/bR8...
Efficiency and ProductivityEfficiency is related to Productivity in terms of serving clients and keeping costs low.       ...
The overall productivity of the MFI’sActive Clients per           Number of Active Clients                                ...
Calculating Efficiency and Productivity Ratios  Ref.                                DESCRIPTION  R12      Operating Expens...
R16      Client Turnover Ratio  a       Number of Active Clients, beginning of period  b       Number of New Clients durin...
Sustainability and ProfitabilityProfitability and sustainability ratios reflect the MFI’s ability to continue operating an...
Adjusted Return on   _Adjusted Net Operating Income - Taxes_   and donations.  Assets (AROA)              Average Adjusted...
Calculating Sustainability and Profitability RatiosRef.                                   DESCRIPTION R1    Operational Se...
d    Adjusted Average AssetsAdjR2    Adjusted Return on Assets (AROA) = c/dR3    Return on Equity (ROE) = c/d a    Net Ope...
Use of RatiosRatio analysis is a financial management tool that enables managers ofmicrofinance institutions to assess the...
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CGAP Training Financial Analysis Participant Materials

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CGAP Training Financial Analysis Participant Materials

  1. 1. PARTICIPANT COURSE MATERIALSFinancial Analysis for Microfinance Institutions CONSULTATIVE GROUP TO ASSIST THE POOR
  2. 2. NOTE The participant course materials contain the main technical messages and concepts delivered in this course. It is notintended to serve as a substitute for the full information and skills delivered through the individual courses Skills forMicrofinance Managers training series. During the actual courses, key concepts are presented with case studies, exchange ofparticipant experiences and other activities to help transfer skills. Users interested in attending a training course should directlycontact CGAP hubs and partners for course dates and venues. CGAP would like to thank those who were instrumental to thedevelopment and design of the original course that led to this participant summary and to its update in 2008: Janis Sabetta,Michael Goldberg, Ruth Goodwin-Groen, Lorna Grace, Brigit Helms, Jennifer Isern, Joanna Ledgerwood, Patricia Mwangi, BridgeOctavio, Ann Wessling, Djibril Mbengue, Tiphaine Crenn and all CGAP training hubs and partners. Copyright 2009, TheConsultative Group to Assist the Poor (CGAP).
  3. 3. OverviewOverview and Goals of the Course ........................................................................................ 4Financial Statements ............................................................................................................ 7 Balance Sheet........................................................................................................................... 7 Income Statement..................................................................................................................... 8 Cash Flow Statement ................................................................................................................. 9 Portfolio Report and Activity Report............................................................................................ 10 Non-Financial Data Report ........................................................................................................ 10Formatting Financial Statements ........................................................................................ 12Indicators for Financial Analysis ......................................................................................... 17Portfolio Quality .................................................................................................................. 20 Rationale for Loan Loss Impairment and Impairment Loss Allowance ............................................. 24 Accounting for Loan Loss Impairment and Write-Offs.................................................................... 25Analytical Adjustments ....................................................................................................... 27Asset /Liability Management ............................................................................................. 31Efficiency and Productivity .................................................................................................. 36Sustainability and Profitability ............................................................................................ 40Use of Ratios ............................................................................................................................ 44
  4. 4. Overview and Goals of the CourseOverviewInternational best practice in microfinance around the world suggests good financialanalysis is the basis for successful and sustainable microfinance operations. Some wouldeven say that without financial analysis your MFI will never achieve sustainability.Sustainability means relying on commercially priced and internally generated funds ratherthan on donors for growth.
  5. 5. Sustainability =Coverage of financial expense (cost of funds + inflation) + Loan loss + Operating expenses (personnel +admin expenses) +Capitalization for growth from financial revenue
  6. 6. Goals of the Course• To master the tools needed for understanding the financial position and sustainability of your institution.• To use financial analysis to improve your institution’s sustainability, by 1. Identifying the components, purpose, relationships, and importance of the main financial statement; 2. Learning the formats of income statements and balance sheets to easily separate the effect of donor funds; 3. Analyzing financial statements to monitor profitability, efficiency, and portfolio quality; 4. Adjusting costs for inflation, subsidized cost of funds, and in-kind donations; and 5. Identifying critical factors for moving toward financial sustainability.
  7. 7. Financial Statements MFIs commonly use four types of financial statements: 1. Balance sheet 2. Income statement 3. Cash flow statement 4. Portfolio reportBalance Sheet Assets = Liabilities + Equity A balance sheet is a summary of the financial position at a specific point in time. It presents the economic resources of an organization and the claims against those resources. Assets Liabilities Equity• Represent what is owned by the • Represent what is owed by the • Represents the capital or net organization or owed to it by organization to others. worth of the organization. others • Includes capital contributions of• Are items in which an members, investors or donors, organization has invested its retained earnings, and the current funds for the purpose of year surplus. generating revenue.
  8. 8. Income Statement An income statement reports the organization’s financial performance over a specified period of time. It summarizes all revenue earned and expenses incurred during a specified accounting period. An institution prepares an income statement so that it can determine its net profit or loss (the difference between revenue and expenses). Revenue ExpensesRefers to money earned by an organization for Represent costs incurred for goods and servicesgoods sold and services rendered during an used in the process of earning revenue. Directaccounting period, including expenses for an MFI include• Interest earned on loans to clients • Financial costs• Fees earned on loans to clients • Administrative expenses• Interest earned on deposits with a bank, etc. • Provision for loan impairment An income statement• Relates to a balance sheet through the transfer of cash donations and net profit (loss) as well as depreciation, and in the relationship between the provision for loan impairment and the impairment loss allowance.• Uses a portfolio report’s historical default rates (and the current impairment loss allowance) to establish the provision for loan impairment.• Relates to a cash flow statement through the net profit/loss as a starting point on the cash flow (indirect method).
  9. 9. • Starts at zero for each period (in contrast to the Balance Sheet which is cumulative since the beginning of the organization’s operation).Cash Flow Statement A cash flow statement shows where an institution’s cash is coming from and how it is being used over a period of time. A cash flow statement• Classifies the cash flows into operating, investing and financing activities. o Operating activities: services provided (income-earning activities). o Investing activities: expenditures that have been made for resources intended to generate future income and cash flows. o Financing activities: resources obtained from and resources returned to the owners, resources obtained through borrowings (short-term or long-term) as well as donor funds.• Can use either o The direct method, by which major classes of gross cash receipts and gross cash payments are shown to arrive at net cash flow (recommended by IAS) o The indirect method, works back from net profit or loss, adding or deducting noncash transactions, deferrals or accruals, and items of income or expense associated with investing and financing cash flows to arrive at net cash flow. Note: The Balance Sheet and Income Statement are accounting reports. The figures can be influenced by management’s choices regarding accounting policies. A Cash Flow Statement cannot be changed by any accounting policy.
  10. 10. Portfolio Report and Activity Report A portfolio report and activity report link the loan portfolio information of the three previously discussed statements—income statement, balance sheet, and cash flow. The purpose of the portfolio report is to represent in detail an MFI’s microlending activity, present the quality of the loan portfolio, and provide detail on how the MFI has provisioned against potential losses. Unlike other statements, the design of this report varies from MFI to MFI. The content, however, should be consistent and must include the following: • Portfolio activity information, • Movement in the Impairment Loss Allowance, and • A Portfolio Aging Schedule.Non-Financial Data Report In addition to the information collected in the preceding reports, important operational and macroeconomic data must be captured to calculate key financial ratios. In order to provide tools that will give managers and others a complete picture of an MFI’s financial condition, the non-financial data report includes data on products and clients served by the institution, as well as data on the resources used to serve them.
  11. 11. Relationships Between Financial Statements
  12. 12. Formatting Financial StatementsMost MFIs depend on donor funds but do not realize to what extent and that donor moneyis not limitless. We want to create financial statements that will show the impact of donorfunds on the MFI’s financial position and its relationship to sustainability.So what’s different ?• INCOME STATEMENT – ♦ Donor funds are treated “below the line.” ♦ Donor money is recorded after the net income (after taxes before donations).• BALANCE SHEET – There are three separate sources of equity from the income statement: ♦ Retained earnings/losses–current year (minus cash donations) ♦ Donations–current year ♦ Other equity accounts– including net nonoperating incomeThis is important because it allows one to see over time the proportion of equity thatis from the MFI itself versus the amounts contributed by donors.
  13. 13. Three Ways in Which MFIs Treat Cash DonationsGoals: 1. Grants are separated from operating income 2. Grants are fully disclosed in equity IAS 20 Recommends Income approach Considerations: Where to record them When to record them Income Statement Balance SheetOperating Profit/Loss Assets LiabilitiesAll Cash Grants/Donations Equity...for current year Donations Current yearOperating Profit/Loss Assets LiabilitiesGrants for Operations Equity DonationsGrants for Loan Funds Current yearGrants for Fixed Assets...for current year
  14. 14. Sample Income Statement Financial Revenue Operating Expense Financial Revenue from Loan Portfolio Personnel Expense Interest on Loan Portfolio Administrative Expense Fees and Commissions on Loan Depreciation and Amortization Expense Portfolio Financial Revenue from Investments Other Administrative Expense Other Operating Revenue Net Operating Income Financial Expense Net Non-operating Income/(Expense) Financial Expense on Funding Non-operating Revenue Liabilities Interest and Fee Expense on Deposits Non-operating Expense Interest and Fee Expense on Net Income (Before Taxes and Borrowings Donations) Other Financial Expense Taxes Net Financial Income Net Income (After Taxes and Before Donations) Impairment Losses on Loans Donations Provision for Loan Impairment Donations for Loan Capital Value of Loans Recovered Donations for Operating Expense Net Income (After Taxes and Donations)Source: SEEP Framework, 2005
  15. 15. Sample Balance Sheet ASSETS Accounts Payable and Other Short-term Liabilities Cash and Due from Banks Long-term Time Deposits Trade Investments Long-term Borrowings Net Loan Portfolio Other Long-term Liabilities Gross Loan Portfolio Total Liabilities Impairment Loss Allowance EQUITY Interest Receivable on Loan Portfolio Paid-In Capital Accounts Receivable and Other Assets Donated Equity Other Investments Prior Years Net Fixed Assets Current Year Fixed Assets Retained Earnings Accumulated Depreciation and Prior Years Amortization Total Assets Current Year LIABILITIES Reserves Demand Deposits Other Equity Accounts Short-term Time Deposits Adjustments to Equity Short-term Borrowings Total Equity Interest Payable on Funding Liabilities Total Liabilities + EquitySource; SEEP Framework, 2005
  16. 16. Financial analysis is required for many financial management decisions:• How to manage the finances to achieve the strategic goals of the institution• How to increase profitability• How to reach self-sufficiency/breakeven point• How to increase efficiency especially reducing the cost per client• What is the optimum level of each different operational expense including the cost of funds• How to manage the costs of human resources as part of overall human resource management• How to deal with the effect of inflation• What is the loan impairment allowance policy• What is the write-off and rescheduling policy• What interest rate should the MFI charge on products?• How to manage liquidity—i.e., how to keep solvent at the same time as disbursing the maximum number of loans, setting a target level of liquidity• What is the best financing structure, i.e., how much debt including from commercial sources and how much capital do you need?• What should the asset structure be?• How to manage the fixed assets, i.e., the depreciation policy, how to finance them, are they insured, are they safe?• What are currency risks and can they be minimized?• How to undertake trend analysis and to compare actual performance against planned performance
  17. 17. Indicators for Financial Analysis An MIS is created to generate information for decision making, the bestinformation for that purpose is in the concise form of a financial or management indicator. Waterfield and Ramsing, p. 39.Indicators generally compare two or more pieces of data, resulting in a ratio that providesmore insight than do individual data points.Sustainability and Profitability• Operational Self-Sufficiency• Financial Self-Sufficiency• Return on Assets (ROA)• Adjusted Return on Assets (AROA)• Return on Equity (ROE)• Adjusted Return on Equity (AROE)
  18. 18. Asset/Liability Management• Yield on Gross Portfolio• Portfolio to Assets• Cost of Funds Ratio• Adjusted Cost of Funds Ratio• Debt to Equity• Adjusted Debt to Equity• Liquid RatioPortfolio Quality• Portfolio at Risk (PAR) Ratio• Adjusted Portfolio at Risk (PAR) Ratio• Write-off Ratio• Adjusted Write-off Ratio• Risk Coverage Ratio• Adjusted Risk Coverage Ratio
  19. 19. Efficiency and Productivity• Operating Expense Ratio• Adjusted Operating Expense Ratio• Cost per Active Client• Adjusted Cost per Active Client• Borrowers per Loan Officer• Active Clients per Staff Member• Client Turnover• Average Outstanding Loan Size• Adjusted Average Outstanding Loan Size• Average Loan Disbursed
  20. 20. Portfolio QualityPortfolio at Risk (PAR) and the Write-off Ratio are the preferred ratios for analysingportfolio quality. The other ratios are more limited as noted in the ‘measurement’ columnbelow. INDICATOR RATIO MEASUREMENT The most accepted Unpaid Principal Balance of all loans with measure of portfolio payments > 30 Days past due + Value of quality. The most (R9) Renegotiated Loans common international Portfolio at Risk Gross Loan Portfolio measurements of PAR are PAR > 30 days and > 90 days. By Age But can vary with terms of loan. Adjusted Unpaid Principal Balance of all loans The adjusted PAR reduces Adjusted PAR Ratio with payments > 30 Days past due + Value of the Gross Loan Portfolio Renegotiated Loans by the Write-off Adjusted Gross Loan Portfolio Adjustment. Value of Loans Written Off Represents the percentage Write-Off Ratio Average Gross Loan Portfolio of the MFI’s loans that has been removed from the balance of the gross loan portfolio because they are Value of Loans Written Off + Write-off unlikely to be repaid. MFIs’ Adjusted write off Adjustment write-off policies vary; ratio Average Adjusted Gross Loan Portfolio managers are
  21. 21. recommended to calculate this ratio on an adjusted basis. Shows how much of the Impairment Loss Allowance portfolio at risk is covered Unpaid Principal Balance of all loans withRisk Coverage Ratio by the MFI’s Impairment payments > 30 Days past due Loss Allowance. The adjusted ratio Adjusted Impairment Loss Allowance Adjusted risk incorporates the Adjusted Unpaid Principal Balance of all loans coverage ratio Impairment Loss with payments > 30 Days past due – Write-off Allowance Adjustment and Adjustment the Write-off Adjustment.
  22. 22. Calculating Portfolio at Risk ratiosRef. DESCRIPTION R9 Portfolio at Risk PAR > 30 Days a b Value of Renegotiated Loans c a+b d Gross Loan Portfolio R9 PAR Ratio = c/dAdj R9 Adjusted Portfolio at Risk Ratio Adjusted PAR > 30 Days a b Value of Renegotiated c a+b d Adjusted Gross Loan PortfolioAdj R9 Adjusted PAR Ratio = c/d R10 Write-off Ratio Value of Loans Written-off a b Average Gross Loan Portfolio R10 Write-off Ratio = a/b
  23. 23. Adj R10 Adjusted Write-off Ratio Value of Loans Written-off + Write-off Adjustment a b Average Adjusted Gross Loan PortfolioAdj R10 Adjusted Write-off Ratio = a/b R11 Risk Coverage Ratio Impairment Loss Allowance a b Portfolio at Risk > 30 days R11 Risk Coverage Ratio = a/bAdj R11 Adjusted Risk Coverage Ratio Adjusted Impairment Loss Allowance a b Adj PAR > 30 days - Write-off AdjustmentAdj R11 Adjusted Risk Coverage Ratio = a/b
  24. 24. Rationale for Loan Loss Impairment andImpairment Loss AllowanceMaintaining loans on the books that are unlikely to be repaid overstates the value of theportfolio.IMPAIRMENT LOSS ALLOWANCEis an account that represents the amount of outstanding principal that is not expected tobe recovered by a micro-finance organisationit is a negative asset on the Balance Sheet and reduces the Gross Loan Portfolio. (Analternative presentation is to show it as a liability.)PROVISION FOR LOAN IMPAIRMENT is the amount expensed on the Income and Expenses Statement. ↑ It increases the Impairment Loss Allowance
  25. 25. LOAN LOSSES or WRITE-OFFsoccur only as an accounting entry. They do not mean that loan recovery should notcontinue to be pursued. ↓ They decrease the Impairment Loss Allowance and the Gross Loan PortfolioAccounting for Loan Loss Impairment and Write-OffsAn impairment loss allowance indicates the possibility that an asset in the Balance Sheet is not 100%realizable. The loss of value of assets may arise through wear and tear such as the depreciation ofphysical assets, loss of stocks, or unrecoverable debts.The provision for loan impairment expenses the anticipated loss of value in the portfolio gradually overthe appropriate periods in which that asset generates income, instead of waiting until the actual loss ofthe asset is realized.Provisions are only accounting estimates and entries, and they do not involve a movement of cash, likesaving for a rainy day.A provision for loan impairment charged to a period is expensed in the Income Statement. Thecorresponding credit accumulates over time in the Balance Sheet as an allowance shown as a negativeasset:The accounting transaction is: Dr Provision for loan impairment Cr Impairment loss allowance
  26. 26. Loan losses or write-offs occur when it is determined that loans are unrecoverable. Because thepossibility that some loans would be unrecoverable has been provided for in the accounting books throughallowances, loan losses are written off against the impairrment loss allowance and are also removed fromthe gross loan portfolio.The accounting transaction is: Dr Impairment loss allowance Cr Gross loan portfolioWrite-offs do not affect the net portfolio outstanding unless an increase in the impairment loss allowanceis made. When write-offs are recovered, they are booked in the Income Statement as Value of LoansRecovered which reduces the Provision amount.Adapted from: Joanna Ledgerwood. Financial Management Training for Microfinance Organizations, Calmeadow, 1996.
  27. 27. Analytical AdjustmentsAdjustments are additional, or hidden, costs incurred by the MFI that we need to recognizefor internal management purposes, for example, when calculating and analyzing efficiencyand profitability ratios. They are not to be included in the audited financial statements;they are internal adjustments. Which costs does an MFI incur that are not reflected in the expenses? •Subsidies •Inflation •Portfolio at risk
  28. 28. REF. ACCOUNT EXPLANATION FORMULA NAME 1. Subsidies Examines the difference between {(Average Short-term Subsidized an MFI’s financial expense and the Borrowings + Average Long-termA1 financial expense it would pay if all Borrowings) x Market Rate for Cost of Funds its funding liabilities were priced at Borrowing} – Interest and Fee market rate. Expense on Borrowings The difference between what the MFI is actually paying for a donated or subsidized good or service and what it would have to pay for the same good or Period Estimated Market Cost ofA2 In-kind Subsidy service on the open market.. [Accounts] – Period Actual Cost Common examples of these in- of [Accounts] kind subsidies are computers, consulting services, free office space, and free services of a manager. 2. Inflation The rationale behind the inflation adjustment is that an MFI should, at a minimum, preserve the value of its equity (and shareholders investments) against erosion due (Equity, Beginning pg Period x to inflation. In addition, this Inflation Rate) – (Net FixedA3 Inflation adjustment is important to Assets, Beginning pf Period x consider when benchmarking Inflation Rate) institutions in different countries and economic environments. Unlike subsidy adjustment, recording an inflation adjustment
  29. 29. is common in many parts of the world and is mandated by Section 29 of the International Accounting Standards (IAS) in high inflation economies. 3. Portfolio at Risk Intended to bring as MFI’s Gross Loan Portfolio x [Allowance Impairment Impairment Loss Allowance in line A4 Rated] – (Impairment Loss Loss Allowance with the quality of its Gross Loan Allowance) Portfolio. Intended to identify loans on an MFI’s books that by any reasonable standard should be written-off. This adjustment can A5 Write-off significantly reduce the value of Portfolio at Risk > 180 days an MFI’s assets if persistent delinquent loans are not counted as part of the gross loan portfolio. Calculating Adjustments DESCRIPTION Adjustment for SubsidizedA1 Cost of Funds a. Average Short-term Borrowings b. Average Long-term Borrowings c. Average Loang and Short Term Borrowings d. Market Rate, End of Period
  30. 30. e. Market Cost of Funds = c x d f. Interest and Fee Expense on Borrowings g. Adjustment for Subsidized Cost of Funds =e - f Adjustment for In-kindA2 Subsidies a. Personnel Expense b. Administrative Expense c. Adjustment for In-kind Subsidies = a + bA3 Inflation Adjustment a. Equity, Beginning of Period b. Inflation Rate c. Inflation Adjustment to Equity = (a x b) d. Net Fixed Assets, Beginning of Period e. Inflation Adjustment to Fixed Assets = (d x b) f. Net Adjustment for Inflation = c - e Adjustment for ImpairmentA4 Loss Allowance a. Adjusted Impairment Loss Allowance b. Actual Impairment Loss Allowance c. Adjustment to Impairment Loss Allowance = a - b >0A5 Adjustment for Write-off PAR > 180 days Past Due
  31. 31. Asset /Liability ManagementAsset/ Liability Management is the ongoing process of planning, monitoring andcontrolling the volumes, maturities, rates and yields of assets and liabilities. The basis offinancial intermediation is the ability to manage assets (the use of funds) and liabilities(the source of funds). Asset/liability management is required on the following levels:• Interest Rate Management: The MFI must make sure that the use of funds generates more revenue than the cost of funds.• Asset Management: Funds should be used to create assets that produce the most revenue (are most “productive”).• Leverage: The MFI seeks to borrow funds to increase assets and thereby increase revenue and net profit. The term leverage indicates the degree to which an MFI is using borrowed funds. At the same time, the MFI must manage the cost and use of its borrowings so that it generates more revenue than it pays in Interest and Fee Expense on those borrowings.• Liquidity Management: The MFI must also make sure that it has sufficient funds available (“liquid”) to meet any short-term obligations.
  32. 32. Asset/Liability Management Ratios Interest rate management Yield on gross Cash Received from Interest, Fees and Portfolio Commissions on Loan Portfolio Average Gross Loan Portfolio 100% - Cash Revenue from Loan Portfolio Yield gap Net Loan Portfolio x Expected Annual Yield Financial Expense on Funding Liabilities Cost of Funds (Average Deposit + Average Borrowing) Adjusted Financial Expense on Funding LiabilitiesAdjusted Cost of (Average Deposit + Average Borrowing) Funds Asset Management Portfolio to Gross Loan Portfolio Assets Assets
  33. 33. LeverageDebt/Equity Liabilities EquityAdjusted Liabilitiesdebt/Equity Adjusted Equity Liquidity Management Cash + Trade InvestmentsCurrent Ratio Demand Deposit + Short-term Time Deposit + Short-term Borrowing + Interest Payable on Funding Liabilities + Accounts Payable and Other Short-term Liabilities)
  34. 34. Calculating Asset/Liability Management RatiosRef. DESCRIPTION R4 Yield on Gross Portfolio Ratio = a/b a Cash Received from Interest, Fees,and Commissions on Loan Portfolio b Average Gross Loan Portfolio R4 Yield on Gross Portfolio Ratio = a/bR5 Portfolio to Assets Ratio a Gross Loan Portfolio b AssetsR5 Portfolio to Assets Ratio = a/bR6 Cost of Fund Ratio a Financial Expenses on Funding Liabilities b Average Deposits c Average Borrowings d b+cR6 Cost of Fund Ratio = a/dAdjR6 Adjusted Cost of Fund Ratio a Adjusted Financial Expenses on Funding Liabilities b Average Deposits c Average Borrowings d b+cAdjR6 Adjusted Cost of Fund Ratio = a/dR7 Debt to Equity Ratio a Liabilities b EquityR7 Debt to Equity Ratio = a/b
  35. 35. AdjR7 Adjusted Debt to Equity Ratio a Liabilities b Adjusted EquityAdjR7 Adjusted Debt to Equity Ratio = a/bR8 Liquid Ratio Ratio a Cash b Trade Investments c a+b d Demand Deposits e Short-term Deposits f Short-term Borrowings g Interest Payable on Funding Liabilities h Account Payable and Other Short-term Liabilities i d+e+f+g+hR8 Liquid Ratio Ratio = c/i
  36. 36. Efficiency and ProductivityEfficiency is related to Productivity in terms of serving clients and keeping costs low. RATIO FORMULA EXPLANATION Operating Expense Operating Expense Highlight personnel and Ratio Average Gross Loan Portfolio administrative expenses relative to the loan portfolio the most commonly used efficiency indicator.Adjusted Operating Expense Ratio Adjusted operating Expense The adjusted ratio usually increases Average Adjusted Gross Loan Portfolio this ratio when the affect of subsidies are included. Cost per Active Operating Expense Provides a meaningful measure of Client Average Number of Active Clients efficiency for an MFI, allowing it to determine the average cost of maintaining an active client. The adjusted ratio usually increase Adjusted Cost per Adjusted Operating Expense this ratio when the affect of Active Client Average Number of Active Clients subsidies are included. Measures the average caseload ofBorrowers per Loan Number of Active Borrowers (average number of borrowers Officer Number of Loan Officers managed by) each loan officer.
  37. 37. The overall productivity of the MFI’sActive Clients per Number of Active Clients personnel in terms of managing Staff Member Total Number of Personnel clients, including borrowers, voluntary savers, and other clients. Number of Active Clients, beginning of Measures the net number of clients period + Number of New Clients during continuing to access services during Client Turnover period – Number of Active Clients, end of the period; used as one period measurement of client satisfaction. Average Number of Active Clients Average Gross Loan Portfolio Measures the average outstandingOutstanding Loan Number of Loans Outstanding loan balance per borrower. This Size ration is a profitability driver and a measure of how much of each loan is available to clients.Adjusted AverageOutstanding Loan Adjusted Gross Loan Portfolio The adjusted ratio incorporates the Size Adjusted Number of Loans Outstanding Write-off Adjustment. Measures the average value of each loan disbursed. This ratio is Average Loan Value of Loan Disbursed frequently used to project Disbursed Number of Loans Disbursed disbursements. This ratio or R17 can be compared to (N12) GNI per capita.
  38. 38. Calculating Efficiency and Productivity Ratios Ref. DESCRIPTION R12 Operating Expense Ratio a Operating Expense b Average Gross Loan Portfolio R12 Operating Expense Ratio = a/b Adj R12 Adjusted Operating Expense Ratio a Adjusted Operating Expense b Average Adjusted Gross Loan Portfolio Adj R12 Adjusted Operating Expense Ratio = a/b R13 Cost per Active Client Ratio a Operating Expense b Average Number of Active Clients R13 Cost per Active Client Ratio = a/b Adj R13 Adjusted Cost per Active Client Ratio a Adjusted Operating Expense b Average Number of Active Clients Adj R13 Adjusted Cost per Active Client Ratio = a/b R14 Borrowers per Loan Officer Ratio a Number of Active Borrowers b Number of Loan Officers R14 Borrowers per Loan Officer Ratio = a/b R15 Active Clients per Staff Member Ratio a Number of Active Clients b Total Number of Personnel R15 Active Clients per Staff Member Ratio = a/b
  39. 39. R16 Client Turnover Ratio a Number of Active Clients, beginning of period b Number of New Clients during period c Number of Active Clients, end of period d Average Number of Active Clients R16 Client Turnover Ratio = (a+b-c)/d R17 Average Outstanding Loan Size Ratio a Gross Loan Portfolio b Number of LoanOutstanding R17 Average Outstanding Loan Size Ratio = a/bAdj R17 Adj Average Outstanding Loan Size Ratio a Adjusted Gross Loan Portfolio b Number of LoanOutstanding - Write-off AdjustmentAdj R17 Adj Average Outstanding Loan Size Ratio = a/b R18 Average Loan Disbursed Ratio a Value of Loans Disbursed b Number of Loan Disbursed *) R18 Average Loan Disbursed Ratio = a/b
  40. 40. Sustainability and ProfitabilityProfitability and sustainability ratios reflect the MFI’s ability to continue operating andgrow in the future. RATIO FORMULA EXPLANATION Operational Self- _Financial Revenue_ Measures how well Sufficiency (Financial Expense + Impairment Losses on Loans + a MFI can cover its Operating Expense) costs through operating revenues. Measures how well Financial Self- _Adjusted Financial Revenue_ a MFI can cover its Sufficiency costs taking into (Adjusted Financial Expense + Adjusted Impairment account Losses on Loans + Adjusted Operating Expense) adjustments to operating revenues and expenses. Return on Assets _Net Operating Income - Taxes_ Measures how well (ROA) Average Assets the MFI uses its assets to generate returns. This ratio is net of taxes and excludes non- operating items
  41. 41. Adjusted Return on _Adjusted Net Operating Income - Taxes_ and donations. Assets (AROA) Average Adjusted Assets _Net Operating Income - Taxes_ Calculates the rate Average Equity of return on the average Equity for the period. Return on Equity Because the (ROE) numerator does not _Adjusted Net Operating Income - Taxes_ include non-Adjusted Return on operating items or Average Adjusted Equity donations and is Equity (AROE) net of taxes, the ratio is frequently used as a proxy for commercial viability.
  42. 42. Calculating Sustainability and Profitability RatiosRef. DESCRIPTION R1 Operational Self-Sufficiency Ratio a Financial Revenue b Financial Expense c Impairment Losses on Loans d Operating Expense e b+c+d R1 Operational Self-Sufficiency Ratio = a/eAdjR1 Financial Self-Sufficiency Ratio a Financial Revenue b Adjusted Financial Expense c Adjusted Impairment Losses on Loans d Adjusted Operating Expense e b+c+dAdjR1 Financial Self-Sufficiency Ratio = a/eR2 Return on Assets (ROA) a Net Operating Income b Taxes c a-b d Average AssetsR2 Return on Assets (ROA) = c/dAdjR2 Adjusted Return on Assets (AROA) a Adjusted Net Operating Income b Taxes c a-b
  43. 43. d Adjusted Average AssetsAdjR2 Adjusted Return on Assets (AROA) = c/dR3 Return on Equity (ROE) = c/d a Net Operating Income b Taxes c a-b d Average EquityR3 Return on Equity (ROE) = c/dAdjR3 Adjusted Return on Equity (AROE) = c/d a Adjusted Net Operating Income b Taxes c a-b d Adjusted Average EquityAdjR3 Adjusted Return on Equity (AROE) = c/d
  44. 44. Use of RatiosRatio analysis is a financial management tool that enables managers ofmicrofinance institutions to assess their progress in achieving sustainability.They can help answer two primary questions that every institution involved inmicrofinance needs to ask.Is this institution either achieving or progressing towards profitability?How efficient is it in achieving its given objectives?Taken together, the ratios in the framework provide a perspective on thefinancial health of the lending/savings, and other operations of the institution.No one ratio tells it all. There are no values for any specific ratio that is necessarilycorrect. It is the trend in these ratios which is critically important.Ratios must be analyzed together, and ratios tell you more when consistentlytracked over a period of time.
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