SME Finance Asian Development Bank/PSDI Pacific Microfinance Week, Nadi, Fiji, October 2013

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1 SME Finance Asian Development Bank/PSDI Pacific Microfinance Week, Nadi, Fiji, October 2013

2 Agenda 1. What is SME Finance? 2. How should we do it? 3. Excursion: Collateral 4. SE Loan Products a. Marketing b. Applicant Screening c. Credit Appraisal

3 What is SME finance? How should we do it?

4 There is no typical SME... Source: IPC GmbH

5 The SME Finance 'Gap' Banks Corporates SME Finance Gap Large Enterprises Medium Enterprises Small Enterprises MFIs Micro Enterprises

6 Three approaches to fill the SME Finance Gap Bank Investors Upscaling Downscaling Greenfielding MFI

7 MFIs usually work their way up the ladder, starting with Small Enterprise (SE) finance Family owned and managed enterprises More or less formal, but poor financial records Private and business affairs not clearly separated Labor intensive, low productivity Lack management and financial skills Many non financial challenges: power supply, taxation, corruption, red tape, transport, staff skills, succession... One third of start ups fail within three years!

8 Pros and Cons for MFIs to start SE finance PROs Grow with your clients (client graduation) Virgin market Larger loans more profitable Diversification of the loan portfolio CONs Up front expenses Higher operational expenses per client Liquidity constraints Credit risk

9 Various approaches in SE lending Group approach (suits group based MFIs) Individual approach (suits clients better) Relationship lending (costly but effective) Credit scoring (for advanced lenders) Collateral based lending (sometimes challenging in developing countries)

10 Excursion: Collateral

11 Conventional and non conventional securities Endorsement and Third Party Guarantee Mortgage Pledge (Movable Asset) Pawning Guarantee funds Insurance Solidarity Groups / Group funds Blocked Savings Client Graduation / Credit Rating Interlinked Credit (Trader Credit)

12 Collateral Valuation Market Value : conservative discounts for depreciation and possible price changes (20 80%) Psychological value: How much does it hurt the client to be without the collateralized item? Registration cost: consider long term collateral registration Inspection cost (before and after loan disbursement) Enforcement cost : How much will it cost to take possession of the collateral? (Legal system!) Liquidity: Is there a market for property or 2 nd hand assets Real value of collateral in SE lending is often psychological

13 Using Movable Collateral Works in all industries and with many types of movable property: Agriculture: livestock/crops as collateral for seeds or a tractor loan Manufacturing: tools, existing equipment as collateral for new equipment purchases Grocery store: the inventory on the shelves as collateral for a loan Wholesalers: accounts receivable as collateral for a loan

14 ADB s Support to lenders Provide an easier way to use movable property as collateral for loans How the reform process works? Legislative changes that provide for an efficient framework Implementation of on line collateral registry to assist lenders in evaluating borrowers 100% predictable results in the case of default

15 Sample Client Registry Page: Tonga

16 How the reform really works Business case example: restaurant expansion Owner needs a loan, visits lender Lender willing give $$$, but demands collateral Restaurant No land ownership Does own kitchen equipment, chairs, etc. Restaurant owner can pledge movable assets as collateral and keep those assets working while paying off loan Lender registers security interest (collateral) online If owner fails to pay loan, lender can seize the collateral and sell it to pay off the loan

17 SE loan products

18 Typical products in SME Banking PURPOSE Cashflow Management Business Protection & Expansion Profit Enhancement Private Life PRODUCT Working Capital Loan, Money Transfer Services, Check Account, Overdraft/ Credit Line, Credit card, Trade Finance, Factoring, Savings Account Savings Account, Insurances, Guarantees/ Letter of Credit, Term Loans, Leasing, Term Deposits Investment Advice and Investment Products Short and long term Deposit Accounts, Insurance, Credit Card, Housing Loan

19 Example: Working Capital Loan for Trade and Service Businesses

20 Product Features We help you to manage your business cashflow Loan repayment schedule that fits your cashflow Multi purpose: buy stock, buy or repair equipment, vehicle or building We accept property and movable assets as collateral Bronze, Silver and Gold Membership Card Max. loan sizes and duration: 5,000 USD / 1 Year; 10,000 USD / 2 years; 30,000 USD / 3 years Interest rate: 15 20% p.a. (on actual loan balance) Loan decision within 5 working days

21 Direct Product Marketing Existing Clients Recommended Clients Visit Potential New Clients Mobile Marketing Unit Marketing Events (fairs, exhibitions) Product Presentations (e.g. for business associations) Target desiredmarketsegment

22 Fictional Case: Applicant runs a Fast Food Restaurant (VFC) Loan amount request: 5000 USD Loan purpose: stock purchase

23 Loan Application Eligibility Criteria (esp. financial track record and business experience) Loan request reasonable? (purpose, amount, duration, own contribution) Income sources for loan repayment (business and household) Acid Test: 50% of average monthly net cashflow to cover loan repayment Screen out hopeless cases

24 Criteria APPLICATION SCORE CARD RESULT Does the applicant have a good financial track record? Does the applicant have good business experience? Own contribution? Household income sources Yes (regular savings and loans) = 10 Yes (regular savings only) = 7 Irregular savings but no loan repayment problems = 5 Loan repayment problems in the past = 0 More than 5 years without business problems = 10 More than 5 years but minor business problems = years without problems = 5 Less than 3 years = 0 More than 30% = % = 8 Up to 20% = 5 No own contribution = 0 More than 3 sources = 10 3sources= 8 2 sources = 5 Only from business = 0 Acid test Positive = 10 Negative = 0

25 Application Scoring Results for VFC 43 POINTS Screen out hopeless cases RESULT RESPONSE POINTS Continue with loan application processing POINTS Discuss with Senior LO whether to continue BELOW 20 POINTS Inform client that he/she is not eligible for a loan at this stage.

26 The 5 C's of the Credit Appraisal Character stable and honest Capacity to repay the loan Capital sufficient to carry debt Collateral suitable as loan security Conditions favorable for the business

27 The Credit Appraisal consists of... Site visits to collect and cross-check information Character Assessment Business Assessment Financial Assessment

28 Character Assessment Reputation Family problems Honesty Loan defaults Savings pattern Conclusion: Is the client likely to default on the loan due to character weaknesses or due to problems in his/her private life?

29 Business Assessment (SWOT) Management (operations, finance, marketing, etc.) Business infrastructure and technologies Skills of workers Dependency on suppliers / buyers Competition and market outlook (demand, prices) Product quality / Customer feedback Conclusion: Is the client likely to default the loan due to business weaknesses or threats? If business start up: are the financial reserves sufficient for possible problems in the first and second year?

30 Financial Assessment Balance Sheet Income Statement Cashflow Statement

31 Conclusions from Financial Assessment Balance Sheet Is the debt capacity of the client sufficient for the loan? Can the client offer collateral? Has the client managed to build up assets and equity over time? Income Statement / Cashflow Is the client's business profitable (even under bad conditions)? Is the client's loan repayment capacity and savings capacity sufficient for the loan? What is the most suitable loan schedule for the proposed loan amount?

32 Balance Sheet of VFC ASSETS USD LIABILITIES+EQUITY USD Current Assets: Cash on hand Bank account Savings account Receivables Stock Fixed Assets: Home property Business property Furniture Kitchen Mini Van , ,000 45, ,000 10,000 20,000 5,000 Current Liabilities: Payables (suppliers) Loans Others 6, Long term Liabilities: Loans Others 0 0 Equity 180,650 TOTAL 186,850 TOTAL 186,850

33 Balance Sheet Analysis Collateral value / Loan amount = 35,000 USD movable assets; 145,000 USD property >> very strong collateral position Debt to Equity Ratio = 3% (before loan), 6% (after loan) and 17% (after loan and without immovable fixed assets) >> capital base of the business is strong (= additional debt capacity) Current assets/ Current liabilities = 110% >> Liqudity situation of the business is quite weak; standing with suppliers should be checked

34 Income Statement Year 2012 USD Sales 150,000 Cost of Goods Sold (COGS) (50,000) Gross Profit 100,000 Operating expense (staff, utilities...) (60,000) EBITDA 40,000 Interest 0 Depreciation / Amortiziation (15,000) Taxes (5,000) NET INCOME 20,000

35 Income Statement Analysis Sales per staff 15,000 USD / employee (compare this to other fast food restaurants for evaluation) Profit margin = (Net income before taxes) / Sales = 17% (compare this to other fast food restaurants to assess profitability) Sensitivity to dropping sales and price changes simulate different scenarios, e.g., 10% sales decrease results in Net Income before tax of 10,000 USD (can the family live on that?)

36 Cash Flow Statement (projection based on past performance) Jan Feb Mar Apr Cash Inflow 12,000 12,500 13,000 12,000 Business Cash Outflow 18,000 11,000 12,000 11,000 Business Cash Inflow 2,000 2,000 2,000 2,000 Household Cash Outflow 1, Household NET CF Own 2500 contribution Loan

37 Cashflow Statement Analysis Net Cash Flow = Repayment Capacity Adjust loan repayment to the net cash flow (+ buffer) Savings potential (acccumulated net cash flow) can be used as risk buffer for unforeseen events Assess sensitivity to dropping sales and price changes for each month (scenario simulation)

38 How to avoid typical pitfalls in Credit Analysis Clients often paint a rosy picture of their businesses If business ratios are much better than industry averages, cross check data and conduct sensitivity analysis Cashflow often paints a more realistic picture than the Income Statement Look at long term trends in the business rather than short term results (e.g., growth of assets and equity)

39 Good loan officers also offer financial advice to their clients... Separate household and business finances Save up for emergencies and lump sum payments, such as taxes and major purchases Pay a salary to yourself and to all household members working in the business Maintain a cashbook and follow up on accounts payable and receivable

40 Thanks for your participation... Questions? More information contact : Sabine Spohn, Pacific Liaison and Coordination Office sspohn@adb.org

41 Case Study: Small Business Loan Appraisal Mr. Miller has a small family business in wholesale food products. His business is located in a busy market place. He needs 30,000 USD to renovate his store after a fire and to pay back an outstanding private loan. In early November, Mr. Miller applies for a Small Business Loan (20% interest p.a.). He says that he can pay back the loan within two years. Miller started his business five years ago with USD 4,000 family capital. At that time, he had a food retail shop in a rented stall on the town market. Step by step, he increased his own capital through retained earnings. Two years ago, Miller purchased a store for USD 8,000 with his own capital and started wholesale trading. Eight weeks months ago, some of the goods in the store were destroyed by a fire. To immediately replace the goods, Miller had to take a private loan of USD 9,000 from a business friend. The loan is repaid monthly in even installments of 950 USD (750 USD principal and 200 USD interest); four installments are still outstanding (December until March). Miller trades fruit juices, pickles, sauces and other processed fruits. Miller's private sales records show that the business had USD 25,000 average monthly sales during the past 12 months, with only little fluctuation throughout the year. Every week, he buys goods worth USD 5,000. At present, he has Accounts Receivable in the amount of USD 1,400, and goods for sale worth 5,000 USD. The client has 3,000 USD cash on hand and in a current account. From this money the client will have to pay one of his suppliers USD 2,000 until the end of this month. There are five employees in the shop, each one earns USD 100 per month. Market security is paid USD 80 per month. The client has his own pick up vehicle (market value USD 3,000) which is used for distribution of goods. The running expenses for the vehicle are USD 300 per month. Utilities cost are approximately USD 160 per month. The client pays monthly taxes of USD 230. Family expenses are USD 500 on monthly average. The family has no other income sources. TASKS: 1. Conduct the "Acid Test" to check whether Mr. Miller has sufficient repayment capacity for the required loan: 50% of average monthly net cashflow > average monthly loan repayment 2. Prepare a "Character Assessment" and write down open questions which need to be clarified with the client or third parties. 3. Prepare a "Business Assessment" (SWOT analysis) and write down open questions which need to be clarified with the client or third parties. 4. Prepare a "Financial Assessment": (a) Balance Sheet; (b) Annual Income Statement for the business; (c) Annual Cashflow for Household + Business; (d) Financial ratios. Write down any open questions which need to be clarified.

42 Average monthly Cash Inflow 25,000 Loan amount Purchases Interest rate Salaries 500 Duration (years) Market security 80 Total interest payment Vehicle expenses 300 Average monthly loan repayment Utilities 160 Taxes 230 Family expenses 500 Average monthly Cash Outflow 21,770 Average monthly Net Cashflow 3,230 50% of Net Cashflow 1,615 Concusion: Acid test positive

43 30, % 2 6,201 1,508

44 BEFORE LOAN AFTER LOAN ASSETS ASSETS Cash 3,000 Cash 1,000 Acc. Receiv. 1,400 Acc. Receiv. 1,400 Goods for sale 5,000 Goods for sale 5,000 Vehicle 3,000 Vehicle 3,000 Store 8,000 Store 34,200 Total Assets 20,400 Total Assets 44,600 LIABILITIES LIABILITIES Acc. Pay. 2,000 Acc. Pay. 0 Private loan 3,800 Loan short term 16,150 Loan long term 20,051 Total Liabilities 5,800 Total Liabilities 36,201 EQUITY 14,600 EQUITY 8,399 L+E 20,400 L+E 44,600

45 Annual Income Statement Sales 300,000 COGS 249,600 purchases, salaries and vehicle expenses Gross profit 50,400 Other operating expenses 2,880 security, utilities, private loan EBITDA 47,520 Interest 2,400 interest on private loan Taxes 2,760 Depreciation 1,725 depreciate store over 5 years and vehicle over 2 years NET PROFIT 40,635

46 Nov Dec Jan Feb Mar May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar May Jun Jul Aug Sep Oct Nov Dec Sales 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 CASH INFLOW 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 Purchases 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 Salaries Market security Vehicle expenses Utilities Taxes Family expenses CASH OUTFLOW 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 21,770 NET CASHFLOW I 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 3,230 New Loan 30,000 Own contribution 0 Private loan repayment 3,800 Store renovation 26,200 Loan Repayment capacity 0 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 NET CASHFLOW II 3,230 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 1,615 Accumulated CF 3,230 4,845 6,460 8,075 9,690 11,305 12,920 14,535 16,150 17,765 19,380 Loan balance (beginning) 30,000 28,885 27,751 26,599 25,427 24,236 23,025 21,794 20,542 19,269 17,975 16,660 15,323 13,963 12,581 11,176 9,747 8,294 6,817 5,316 3,790 2, Interest Loan balance (end) 30,500 29,366 28,214 27,042 25,851 24,640 23,409 22,157 20,884 19,590 18,275 16,938 15,578 14,196 12,791 11,362 9,909 8,432 6,931 5,405 3,853 2,

47 Return on Assets 186% profit before tax in relation to total assets Return on Assets after new loan 85% Return on Equity 259% profit before tax in relation to total equity Return on Equity after new loan 451% Break even sales (USD) 256,605 sales minus profit before tax Break even sales change 14% percentage difference between sales and break even sales Profit margin 13% profit before tax in relation to sales Inventory turnover days 60 sales related to inventory Cost Income ratio 84% operating expenses in relation to sales Current ratio 162% current assets in relation to current liabilities Current ratio after new loan 46% Debt to Equity (before loan) 40% total liabilities in relation to total equity Debt to Equity (after loan) 431% Own contribution / Total investment 0% Conclusion: check sales and expenses! check own contribution! check loan amount requested!

48 Checklist: Credit Product Development 1. Research a. Based on our social mission, who are our target clients? b. What do we know about our target clients, esp. about their financial needs? c. What are our research hypotheses (assumptions) regarding financial products that our target clients might want? d. Do we really need a new credit product? Maybe a revised existing product will be okay? e. What kind of relevant information on our target clients is already available? (literature, studies, statistics, etc.) f. What kind of information can we get out of our own data (MIS)? (characteristics of typical loan defaulters versus good clients; regions or sector with high default risk; seasonal fluctuations of loan disbursement and repayment; etc) g. What are the open questions that we need to do some primary research on? h. Which research methodologies are most suitable for our needs and capacities? (interviews, focus group discussions, observation, etc) i. What do we know about our competitors and will we need to do some additional research on them? (esp. on products they offer and what their customers think about them) j. How much time and resources (money, personnel) will we spend on product development? Do we have experienced people in our own institution who can do this, or should we outsource it? 2. Product prototype design (based on research results) a. Based on the research results, what is it that our (future) customers really expect from a new credit product (= core product, e.g., cashflow management; repayment schedule adjusted to seasonal income and expense fluctuations); what are the product features that they would prefer (e.g., max. loan amount; loan duration; interest rate; grace periods), and which augmented features would they like (e.g., financial advice, business training)? b. What can we learn from our competitors? c. How will we price the product (operational costs + cost of funds + loan losses + expected profit)?

49 3. Pilot test d. Considering all of the above, what should the product prototype look like? (name of product; eligibility criteria; max./min. loan amount; max./min. loan duration; interest rates and fees; etc.) e. How will we market the product? (consider the 7 P's: product, price, place, promotion, people, process, physical evidence) a. Where will we pilot test the product prototype? b. How long will we pilot test the product prototype? c. What is the maximum portfolio size we will allow for the pilot test? d. Who will manage the pilot test? e. What kind of support do staff members need who participate in the pilot test? (training, transport, marketing materials, etc.) f. After the pilot test: What did we learn from the pilot test and do we need to make any adjustments to the product before launching it? 4. Product launch (roll out) a. Who is in charge for the roll out, who are the support team? b. What is our action plan? (activities; duration; locations; responsible persons) c. What is the budget for the roll out? d. What are the training requirements for staff members? e. How will we market the product? (consider the 7 P's: product, price, place, promotion, people, process, physical evidence) f. Will there be any internal resistance to this product, and how will we manage this resistance? 5. Product evaluation (after one year of operation) a. What are the total costs and revenues of the product since its launch? b. How is the sales growth? c. What do customers think about it? d. What do our staff members think about it? e. Which adjustments could we make to improve the product? f. Do we need to do more (market) research? g. Should we stop the product?

50 Checklist: SME Loan Appraisal 1. Loan application a. Does the applicant meet the product eligibility criteria? (e.g., minimum age; minimum years of business experience; more than one income source; etc.) b. Does the applicant have a good reputation and/or banking history? c. What is the purpose of the loan? d. What is the amount required? e. How much is the client's own contribution? f. What is the repayment period proposed by the applicant? g. What are the sources of loan repayment suggested by the applicant? (sale of an asset; sales receipts; ongoing cash flow generated from profits; other revenues; etc.) h. What kind of securities does the client offer? (assets; guarantors; factoring) i. Do you consider the client's loan proposal reasonable and realistic (loan purpose, amount, repayment period, repayment source)? j. Did the client appear honest when giving information? k. If yes, try to do the 'Acid Test': estimate client's total net cash flow for the proposed loan period and assume that only 50% of this amount can be used for loan repayment; is this enough to cover the requested loan (including interest)? If the 'Acid Test' is negative, discuss alternatives with the applicant (longer loan duration or smaller loan amount). l. Conclusion: Does it make sense to proceed with the loan application? 2. Site visit a. Visit the applicant's household to get an impression of his/her life style and family situation, for example: Does the family appear to spend more money than they claim to have? Where does this money come from? Which family members contribute revenues and how much? Which family members depend on the household's financial support and how much do they need? b. Visit the business premises to get a first hand impression of the business activities, and to collect data for character assessment, business assessment and financial assessment (see below for detail aspects to be investigated). c. Talk to third parties (suppliers, buyers, employees, neighbors, business partners, etc.) to get new information or to cross check information regarding the client's character, business management skills and financial situation. d. Re check all questions of #1 (Loan application) e. Conclusion: Does it make sense to proceed with the loan application? 3. Character assessment a. What is the applicant's reputation in the community, and with employees, business partners, buyers, suppliers, competitors, etc.? b. Are there any apparent family problems which could have a negative impact on loan repayment? (e.g., due to extravagant life style, illness, private conflicts, gambling, drug abuse or illegal activities) c. Were the family members forthcoming with information and honest? d. Did the client (or any other household member) ever default on a loan?

51 e. Does the client (or any other household member) have a current outstanding debt, and what is the repayment situation at present? f. Does the client save regularly and build up assets? g. Conclusion: Is the client likely to default the loan due to character weaknesses or due to problems in his/her private life? 4. Business assessment Conduct a SWOT analysis (what are the strengths, weaknesses, opportunities and threats of the business?), including, for example, following aspects: a. Management experience and skills of the business owner and managers: financial management, operational management, HR management, marketing b. What do employees, business partners, suppliers and buyers think about the business? c. Does the business depend very much on one buyer, supplier, investor? d. How successful does the business negotiate with suppliers, buyers, employees, funders? e. What is the industry outlook and how will it impact on the company? f. Who are the key competitors? What are their strengths and strategies? What does the client do to counteract threats? What makes the company competitive (quality, brand name, price, availability, timely delivery etc.)? g. Are the inputs factors under control (availability of raw materials, operating supplies, skilled employees, etc.)? h. Does the business utilise appropriate technologies? What new technologies are expected and what effect will they have on the position of the business? i. Which distribution system does the business use to ensure that the finished products reach the buyers? j. How is the situation for infrastructure and facilities? k. Typical price fluctuations for key inputs and major outputs l. Cost and quality of labor force, machinery, equipment, buildings, storage space, processing facilities, etc. m. Political, legal, reputational risks: compliance with all legal requirements (business registration, tax obligations, etc.); impact of new policies, laws or regulations; impact of political situation in the country. n. Business governance risks: who controls the business? how is governance organized? is the business dependant on one major investor or decision maker? are there related parties (e.g., subsidiaries, other companies, family members) that might pose a risk for the business? quality and reliability of internal controls? contingency plans for emergencies (e.g., who will manage the business if the owner gets sick) o. Risk management/mitigation methods used by the company p. Receivables: what credit terms does the company offer to customers? are customers reliable? does the company efficiently control receivables and cash collection? q. Payables: what credit terms does the company get from suppliers and how reliable are these terms? r. How sustainable are the business cash flows? s. What is the level of available reserves in case of a bad debt?

52 t. Securities: What is the real market value of collateral? Can the collateral be sold and at which cost? Is the collateral legally registered? Can the collateral be legally enforced and at which cost? Are guarantors liquid and reliable? u. Conclusion: Is the client likely to default the loan due to business weaknesses or threats? If business start up: are the financial reserves sufficient for possible problems in the first and second year? 5. Financial assessment: Balance Sheet a. Cash on hand: check how much cash the client has at home and on the business premises. b. Savings and other bank assets: check all private and business bank records. c. Accounts receivable: ask client whether any of his/her customers owe him/her money for delivered goods or services. Cross check information with debtors. d. Inventory: check on all inventory items, such as raw materials, stock, etc.; ask client to estimate the value of the inventory and cross check information with purchasing records or by asking suppliers; check the quality of the inventory; based on purchasing records, estimate inventory turnover frequency. e. Finished goods: same procedure as for inventory. f. Loans granted to others: ask client whether she/he or anyone else in the household has lent money to someone else, and under which conditions; cross check information with debtors. g. Movable physical assets (vehicles, machines, equipment): inspect all movable physical assets in the household and in the business; estimate the current market value of these assets; cross check ownership, especially for valuable items which might be used as collateral. h. Fixed assets (land, buildings): ask client for official documents to prove ownership of any fixed assets; estimate current market value of these assets. i. Loans: ask client whether she/he or anyone else in the household has a loan outstanding; check on written loan documentation; cross check information with lenders; cross check with Credit Bureau if available. j. Accounts payable: ask client whether she/he owes money to any of his/her suppliers and under which conditions; cross check with suppliers. k. Owner's equity: add up all assets and all liabilities; deduct total liabilities from total assets to get the estimated equity value. l. Based on the Balance Sheet, several ratios can be calculated, for example: m. Debt to Equity Ratio: a ratio of 0.5 to 1 for small enterprises, up to a level of 2 to 1 for medium enterprises might be considered acceptable. n. Net Working Capital (= current assets current liabilities) should be positive to ensure business liquidity and smooth business operations. o. Accounts Receivables / Accounts Payable should be above 100%, which indicates good liquidity and bargaining power. p. Suitable loan collateral can be identified on the balance sheet. q. Also look at balance sheet trends over time (for existing customers with track record): How did balance sheet items and ratios develop? Did equity increase?

53 r. Conclusion: What is the debt capacity of the client (equity and liquidity ratios)? Can the client offer collateral? Has the client managed to build up assets and equity over time? 6. Financial assessment: Income Statement and/or Cashflow Statement a. Ask the client for records / evidences on all monthly revenues and expenses (including household) for the past 12 months. b. Check when these revenues and expenses have been incurred and when the respective cash transactions actually took place. c. Include depreciation cost for buildings, machinery and equipment in the Income Statement. In the Cashflow Statement, estimate cash expenses for repairs or replacement of buildings, machinery and equipment. d. Use the Income Statement to assess business profitability, profit margin (sales price / cost price), and price sensitivity. e. Use the Cashflow Statement to assess the monthly repayment capacity of the client (allow 50% of the monthly net cashflow for loan repayment). f. Conclusion: Is the client's business profitable? Does the business operate on normal profit margins (compared to industry benchmarks)? How sensitive is the business to price changes for inputs or outputs? What is the client's loan repayment capacity and savings capacity for each month? What is the most suitable loan schedule for the proposed loan amount (shortest possible repayment period and flexible repayment pattern according to repayment capacity)?

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