Tracking Financial Performance Standards of ... - Sa-Dhan

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Tracking Financial Performance Standards of Microfinance InstitutionsEach of these aspects are described below3.2.2.1 Financial ExpensesThere are two kinds of financial expenses for an MFI. There are:1. Interest on Debt or borrowings - interest paid to banks and other financial institutions for money loaned(by them) to the MFI (refer IS 7, Table 8 a).This interest is stated as a percentage figure on an annual basis and depending on the loan term it is workedout. Different lenders usually have different methods of calculating interest – i.e. on a declining balance,flat, simple or compound basis.In most cases, financial institutions do not use the flat rate of interest. Rather, they use the decliningbalance interest method in conjunction with simple or compound interest 9 .Please note that the principal repayment of a bank loan is not included as a financial cost.2. Interest Paid on Deposits - interest payments earned by clients who deposit savings in the organisation(refer IS 8, Table 8 a).Please note that, in a technical sense, interest should be paid on savings, which is debt and not equity.While some MFIs do this, most do not and this is certainly a legal violation as savings is a liability onwhich interest must be paid to the borrower. Also, not all MFIs are allowed to mobilise savings3.2.2.2 Operational ExpensesThere are two kinds of operational expenses:1) One that involves an outflow of cash, which are called as cash operational expenses. This includes salaries,administrative expenses, travel, occupancy and miscellaneous expenses. Please see the box for definitions.Operating Cash Expenses - Some Definitions1. Operating Expenses are related to the management of the loan fund, whether it is held as outstandingloans or investments/deposits. For a single - purpose financial institution, all costs should be included.2. For multi-purpose institutions, all direct costs of financial operations and an appropriate portion ofthe institution’s overhead should be included.The main categories are:1. Salaries and benefits - amounts earned by staff for services rendered (refer IS 14, Table 8 a).2. Administrative expenses - costs incurred in administering the organisation such as stationary, insurance,legal fees, etc (refer IS 15, Table 8 a).3. Occupancy expenses - expenses made for (1) lease of land and/or buildings for the purposes of loanfund management over a specified time period, and (2) expenses for utilities, such as electricity,water, and telephone (refer IS 16, Table 8 a).4. Travel - expenses for transportation, room and board, etc., of staff members working on behalf of theorganisation (refer IS 17, Table 8 a).5. Other Expenses - other expenses related to the loan fund’s operations, such as training costs, loss oncurrency conversion, etc (refer IS 19, Table 8 a).9While banks predominantly use compound, other wholesalers and donors use simple interest32
Financial Statements of a Microfinance Institution2) The other, which doesn’t involve an outflow of cash, which is called as non-cash operational expensesEXPENSESNon-Cash Operational ExpensesDepreciationLoan Loss ProvisionTotal Non-Cash Operational ExpensesThe major non-cash operational expenses for an MFI are1) Provision for Loan Losses – The loan loss provision (refer IS 11, Table 8 a) is the allowance made forexpected defaults on the loan fund (See section 4.2.1 in next chapter for further detail). This is usually based onan aging analysis of loan accounts and allocation of risk rates based on historical default rate or best practices(explained in detail in sec 4.2.2 in chapter 4).The loan loss provision is the (non-cash) amount expensed in a period to increase the loan loss reserve {Seesection 3.3.2 (c)} to an adequate level to cover probable defaults of the loan portfolio. Although a loan lossprovision (a non-cash expense) is treated as a direct expense of the credit programme when the provision ismade, the loans will not yet have been written off as actual loss. Some organisations include the loan lossexpense with the operating costs. It is important to separate the loan loss expense from other operating costs,as an indicator of portfolio quality.2) Depreciation Expenses – Depreciation (refer IS 18, Table 8 a) is an annual, non-cash expense that is determinedby estimating the useful life of each asset. Using the most common method, called straight-line depreciation,an asset with an estimated useful life of five years would have one-fifth of its purchase price reflected as anexpense in each of five years. Depreciation represents a decrease in the value of property and equipment toaccount for that portion of their useful life that is used up during each accounting period. Land theoreticallydoes not lose value over time and therefore is not depreciated. Legal aspects also sometimes curtail the maximumdepreciation amounts based on a slab rate classification for each depreciable item such as cars, computers etc.3.2.2.3 Gross Surplus/Deficit from the OperationGross Surplus/Deficit from the Operation (refer IS 21, Table 8 a) is derived after Total operating income (referIS 6, Table 8 a) less all expenses related to the MFI’s core financial service operations, including total operatingexpenses (refer IS 20, Table 8 a), total financial expenses (refer IS 9, Table 8 a), and loan loss provision expense(refer IS 11, Table 8 a). It does not include donations, revenues expenses from non-financial services. ManyMFIs choose not to deduct taxes on revenues or profits from the net operating income; rather they are includedas a separate category. MFIs are encouraged to indicate if taxes are included in this account.3.2.2.4 Net Surplus/Deficit from the OperationNet Surplus/Deficit from the Operation (refer IS 23, Table 8 a) is derived after total income (operating andnon-operating, including all donations) less total expenses and taxes (if any). Some MFIs prefer to present netincome before donations and taxes. If so, the MFI should label it as such (such as net income before donations).The issue of treatment of grant income (received for acquisition of assets and meeting operational cost) as nonoperationalincome is dealt ahead. They are reported below the line (after gross surplus deficit from operation)in the income statement.33
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REFERENCESBarrel, Margaret, Michael
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