Horti-Business Management (2+0)

Principles of credit management - 3r concept

1. Return
2. Repayment capacity
3. Risk bearing ability
1. Returns from an investment: The first R of credit

• The returns from an investment, the first test of credit, has great significance to both creditor and borrower. It requires that both borrower and lender are satisfied about the returns from credit which cover the principal and interest.
• However, the following points may be kept in mind while calculating the expected returns from the borrowed funds.
• Estimate the gross returns by multiplying average yields with its corresponding expected average prices, the conservative prices should be used for safety purpose. These gross returns should be worked out both with and without borrowed funds.
• Estimate the total cost both with and without borrowed funds, these costs should be slightly on higher side to take into account the risk.
• Estimate the additional cost and additional returns from the investment, do not use average cost and average returns.
• The use of credit becomes an economically sound proposition, if the net cash income is more due to the use of borrowed funds, with a sufficient margin for income variability.
2. Repayment capacity: The second R of credit

• The repaying capacity is the amount of money that a farm family would be able to spare from their total earnings so as to repay the loan after meeting his farm and family expenses. Ability to repay a loan is influenced by the income generating capacity of the farm business, off farm earnings, the liquidity of the farm as reflected by the balance sheet and the cash flows on the farm (with due consideration for farm and family obligations). Furthermore, the ability to repay may be influenced by numerous factors but willingness to repay a loan is quite essential.
Types of repayment

• Self-liquidating loans: - These are loans to acquire goods or services that are completely used up in one production season or in annual production process. These are infact, the short-term loan (operating expenses) which become a part of working expenses in the single production process. In estimating repaying capacity the borrowed funds are not deducted as costs are included in working expenses. The repaying capacity for such loans should be determined as below:
• Repaying capacity = (Gross income including off-farm income) minus (living expenses + working expenses excluding proposed loan + taxes and L.I.C. premiums + other loans and repayments due).
• Non-liquidating loans: - These are loans where resources acquired are not expended or consumed up in a single production process, i.e. the acquired resources are consumed over a number of years. Such loans do not completely become a part of the first year’s costs and returns from such investments are spread over a number of years. A loan for the purchase of tractor or land reclamation is an example of non-liquidating loan, i.e., all the medium and long term loans are non-liquidating loans. These loans may contribute indirectly to the repayment capacity by enabling the farmer to produce more net income than otherwise would be possible without the use of such resources. The repaying capacity for such loans is worked out as:
• Repaying capacity = (Gross income including off farm income) minus (working expenses including seasonal loans + living expenses +taxes and LIC premiums + repayment of other loans due).
3. Risk bearing ability

• Risk bearing ability, the third R of credit, determines the quantum of credit which can be safely used by the farm-firm. It means the ability of borrower to withstand the unexpected low incomes, unpredictable losses and expenses and to continue the farming. It provides the “last line of defence” in the use of credit.
• The risk bearing ability of a borrower depends upon the following factors:
1. Ability and willingness to save.
2. Ability to borrow, i.e., credit worthiness of the borrower as a person, especially in bad times.
3. Ability and willingness to adjust and withstand the adverse conditions, i.e., reducing both operating and living expenses in bad periods.
4. Equity and net worth, the backbone of risk bearing ability. The risk bearing ability can be enhanced by certain measures such as:
a. Taking crop, livestock and other insurances.
b. Adoption of financial strategies (e.g. internal cash or asset rationing, internal and external credit rationing and reducing farm and family expenses.)
c. Adoption of suitable marketing strategies (such as hedging, forward contracts for sale of farm products and purchase of input supplies to reduce price risk).
d. Adoption of suitable production strategies (such as flexible production programmes, use of plant protection, weedicides and other farm practices, growing less risky or more stable farm enterprises, diversification of farm production programmes).
e. Building up of owner’s equity or net worth through savings and personal credit through fair dealings.