Two months too late, here are my brightest memories of Meskel
Monthly Archives: November 2012Image
Working with consultants has its perks. Not only do they offer a fresh analytic perspective, but they also provide advanced industry knowledge. Most recently I was introduced to the “5 Cs of credit approval” applied to rural entrepreneurs in developing Ethiopia. Each “C” is used to assess whether a loan applicant is eligible for credit:
When evaluating an applicant, it’s essential that the individual is trustworthy, honest and reliable. You must determine their willingness to repay and entrepreneurial zeal. The challenge here is to gauge their proclivities through indirect questions:
- Cross-check references – credit and repayment history (if available), reputation among the community, partners, customers, suppliers, family relations, employees (punctual wage payments)
- Extract examples of the applicant resolving strenuous circumstances in the past (think job interview)
- Compare their lifestyle and spending habits to income level
- Distinguish their degree of openness in answering questions
The majority of owners do not keep a formal record of their financials, forcing the loan officer to depend on the individual’s oral account of the business. To evade false information, verify numbers with competitors and speak with the applicant on multiple separate occasions. If the character is questionable, rejection is the only reasonable decision.
Assess the business’s capacity to repay. Primarily, the cash inflows and outflows are the lifeblood of the company. Without cash or profitable operations, the company will fail to repay. Management, technical and labour capacity also contribute to the health of the business. Examine:
- Income statement – operating profitability
- Cash flow statement – monthly operational debt service ratio (operating cash / debt payment; 2 and higher indicates a strong candidate)
- Sensitivity analysis (ie: reduced sales, higher input costs)
- Other sources of income
Most if not all small and medium enterprises deal in cash. Credit is seldom used but informal lending is practiced. Typically, cash is the critical factor. Incorporating household expenditures in the income statement is advisable to be conservative. Businesses with less than 6 months experience are unlikely to be approved. In the case of microfinance loans, analyzing the character and capacity to repay is enough.
Less important than Character and Capacity, Capital refers to what is financing the business. Basically, a balance sheet:
- Assets: cash, accounts receivable, fixed assets
- Liabilities: debt, accounts payable
- Equity: Family contribution (equity)
- Current ratio, liquidity ratio, level of indebtedness
Typically the more equity, the better the indication that the entrepreneur is committed to the success of the business (although my supervisor argues the opposite – anyone know a study on whether equity or debt financing is more correlated to default?). Most applicants lack debt so the balance sheet is simply constructed by plugging for equity.
Assets the applicant is willing to pledge to the borrower in order to secure the loan. Obtain the market, historical, marketability and psychological values of the assets like buildings, land, equipment and vehicles. Certain assets, regardless of their actual worth, can be advantageous to secure because of their perceived psychological value. For example, a processing machine may have a low resale value but in seizing the machine, the processor cannot conduct business thereby motivating them to repay responsibly. Surprisingly, assets tend to appreciate in value because of Ethiopia’s high inflation. A well-used year old machine may be worth more today than at the time of purchase. Collateral can be a make or break factor for banks because collateral ensures the bank will recover the costs of default. Unfortunately, if entrepreneurs lack brick (or other non-mud) buildings, it is very difficult to obtain a loan. To overcome insufficient collateral, banks can partner with a third party through a credit guarantee agreement. MEDA has one such agreement with an Ethiopian bank.
The external environment impacts the applicant. Market factors, economic indicators, inflationary risk, competition, politics and legislation, and other conditions should be taken into account.
Applying the 5 Cs
I’m working with a bank and two loan applicants and will post about it soon. The descriptions above are brief, and are simply intended to be a starting point and guiding structure to appraising a client.
Last week I had the fortunate opportunity to travel to the orderly and refreshing Bahir Dar. The sweet Lake Tana air and busy Bajajs welcomed me on my drive to the Summerland Hotel (which I would warmly recommend – just don’t sleep under the blanket or eat their chicken sandwich)
Honeymooners come swoon by the lake’s shallow banks, while the city booms with the industrious sounds of construction. Sometimes I have to blink a few times and recite to myself I am in Ethiopia. I am in Ethiopia. And I have to stop from thinking except that this place looks nothing like it! Flowers in a multitude of colours I could not begin to name freckle the city’s wide boardwalks. Bright bertukans (oranges) and mooz (bananas) radiate bountifully from the market stands. Bahir Dar is a breath of sprightly air.
As I visited Bahir Dar for MEDA purposes, I had the pleasure of meeting the field staff. I also received the pleasure of eating a sheep, which I saw as a lifeless lamb in the office garden at 10, a carcass being skinned and sliced at 10:30, and scrumptious morsels on a bed of injera by 12:30. The concept of eating something so connected to a living thing disturbed me but not enough to deter me from the tender meat. The experience revealed some truth of what we eat when we consume meat. For the staff, the slaughtered lamb was a symbol of celebration in moving to a new office.
As for my assignment, I can not express through writing how thrilled I was to work on a business plan for Ato (Mr.) Belay, a rice processor. Ato Belay is investing in improved processing equipment, not only to increase his production but also to benefit farmers. My Ethiopian coworker, Alem, and I interviewed Ato Belay to collect his financial data. I was so delighted to put my accounting skills freshly acquired from business school to work that I stayed up all night making elaborate financial statements and projections. Only to discuss the statements the following morning with Alem and have them reasonably simplified. After finalizing the business plan, Ato Belay sent the business plan to the local government office. He hopes to get approved for increased land acquisition in order to support his soon-to-arrive new processing machine. I sincerely hope the proposal is sufficient. Ultimately, Ato Belay will be responsible for creating financial statements, which is why MEDA intends to train rice processors in bookkeeping.