Cooperative Financing 5

WEL WEL COME COME TO TO AMBO AMBO UNIVERSITY UNIVERSITY TRAINING ON Cooperative Finance

Cooperative Cooperative Financing Financing Chapter I.

II. III. IV. V. VI.

Topic

Financial Management Financial Planning Budgeting Financial Analysis Risk Management Managing Operation, Credit and liquidity

Chapter one: Financial management  Finance is the life blood of any organization and so is in cooperatives  A cooperative society needs finance to establish, operate, expand and maintain the organization  It is not Finance alone but management of finance that determines the operational results of business  Thus, the need of financial management arise

Role of Finance in an Economy Financial Intermediaries

FUNDS

• Fig1

FUNDS

FUN DS

Lenders (Savers) -House-Holds -Business firms FUNDS -Government -Foreigners

Financia l Markets

FUND S

Borrowers (Spenders) -Business firms -Government -Households -Foreigners

Role of Finance…  Direct Finance:-borrowers borrow funds directly from lenders in financial markets by selling them securities (also called financial instruments), which are claims on the borrowers, future income or assets.  Indirect Finance:-funds can move from lenders to borrowers by a second route, that involves middleman or a financial intermediary that stands between the lenders savers and the borrowers’ spenders and helps transfer funds from the lendersaver to the borrower- spender.

Financial management  The topic of finance can generally be broken into three general, yet related areas:  Financial management deals with the management of finances of a business enterprise: Sources and Utilization  Investments deals with financial markets and security pricing, and  Financial institutions deals with financial firms such as banks

Financial management  Financial management: is the management of capital sources and uses so as to attain a desired goal.  It is the process of planning for, acquiring and utilizing funds in ways that maximizes an organization’s welfare.  Capital sources: investors and creditors Capital uses: assets owned (real and financial assets), operational costs

Objective of financial Management  Simply put, the objective of financial management is to maximize the value of the firm.  We can state this objective simply, but it is much more complex.  The management of the firm involves many stakeholders, including owners, creditors, and participants in the financial markets,

Objective…  Macro level; to make intensive use of scarce/economic capital resources  Micro level: considered at firm level, deals with over all objectives of the firm  Under the above levels, financial management deals with:

Objective… a) Profit maximization: the earned profit are the yardsticks of its production, sales, and managerial efficiency. Profit maximization has been considered to be important for the following reasons:  Profit is the standard for measuring efficiency of management,  Survival is difficult without profit maximization,  Attainment of social economic welfare is possible by profit maximization

Profit maximization…  For expanding business activities profit maximization has to be achieved,  In the absence of profit business activity would remain at static level

b) Maximization of Return:- provides basic guideline by which financial decisions should be evaluated  Maximization of return is more explanatory, because it shows information on profit and investment combined

C. Maximization of worth

• All financial decisions are taken such a way so as to maximize the owner’s (members’) wealth. The elements in the maximization of the worth of the firm are: Increase in Profit, Reduction in cost, Source of funds, Minimize Risks, Long run Value

Principles of Coop Finance WITH REGARD TO PROFIT

• Principle 1: It’s the total profit in the system (cooperative-level and member-level added together) that matters.  Can’t look only at cooperative-level.  Can’t look only at Member-level.  Must “measure” both.

• Principle 2: Cooperative investment decisions should be a two-step process.  Evaluate co-op profit potential as a private firm.  Then estimate member level profits.

• Principle 3: Negotiate and report the “distribution” of the two levels of profits.

Functions of Financial management • The functions of financial management can be divided into two groups: a) Executive Functions;  Financial Forecasting,  Investment decisions,  Corporate Asset structure determination,  Management of Income,  Deciding on new sources of finance,  Analysis and appraisal of financial performance

Executive function…  Advising the top management,  Managing the flow of internal funds,  Cost control,  Pricing decisions,  Profit planning

b. Incidental or Routine Functions • These include:

Record keeping and reporting, Preparation of various financial reports, Cash planning, Credit management, Custody and safeguarding the financial assets, Providing top management with information on current and productive financial conditions of the business as a basis for policy decisions on purchases, marketing, pricing, etc

Basic Factors influencing Financial decisions •

The financial manager has to exercise a great skill and prudence while taking financial decisions a) External Factors:- Comprise environmental factors that affect the structure, conduct, and performance of the organization. These are factors outside the control of the managers b) Internal Factors:- these are factors which are related with internal conditions of the organization

Financial Decisions: a) Funds requirement decisions:- is an important financial decision in which the finance manager has to estimate the total funds required for the physical activities of the organization, b) Financing decisions:-the finance manager has to identify the sources from which the funds can be raised, the amount that can be raised from each source and the costs involved

Financial Decisions: c) Investment Decisions:- this involves decisions relating to investment in both capital and current assets. The investment manager has to evaluate different capital investment proposals and select the best in view of the overall objective d) Dividend decisions:-The establishment of dividend policy is another important function of finance manager

II. Financial Planning

 Includes the determination of the cooperatives financial objectives, financial policies, and procedures  It also refers to the process of determining the financial requirements and financial structure necessary to support a given set of plans a) Objectives  Short-term:- market standing, maintain liquidity and proper provision of service

Objectives…

 Long-term objectives: To secure and employ resources in the amounts and proportion necessary to increase the efficiency of other factors of production b. Activities of Financial plan;  Determining the amount of capital needed by a cooperative society to carryout operations smoothly  The pattern of financing, i.e., the form and proportion of various financial sources

Activities of Financial plan

 Determining the suitable policies for the proper utilization and administration of capital c. Characteristics of sound financial Plan: Simplicity,  Long-term view,  Flexibility,  Liquidity,  Economy (Cost of capital should be minimum)

Liquidity Vs Profitability •  a. b. c.

The finance manager is always faced with the dilemma of liquidity vs profitability Liquidity means that: The organization has adequate cash to pay for its bills The firm has sufficient cash to pay for unexpected purchases The firm has enough cash reserves to meet emergencies

Profitability goal  Require the funds of the organization are used so as to yield the highest return,  Apparently, liquidity and profitability goals conflict, thus finance manager should strive for the appropriate balance between the two.

Financial Plan A financial plan processing the above said characteristics helps the management in a number of ways: Successful promotion of a new enterprise, Successful operation of an enterprise, Expansion of business Proper administration of capital, Control and management of asset cash

Factors to be considered in developing financial plan  While developing financial plan a number of factors must be considered, among which the following are the major ones: Nature of the Business, Amount and level of risk, Appraisal of alternative sources of finance, Attitude of Management with regard to financial policies, Plan for the future growth, Government policies,

Need for financial Planning

• As in the case of general planning function, financial planning is important. • “If you fail to plan, You are planning to fail,…” • Financial planning aims at: Maintain liquidity, Indicate surplus resources available for expansion To ensure proper coordination between societies and members, To increase the confidence in the minds the supplies of funds by adopting suitable financial policies

BUDGETING & BUGETING CONTROL

• QUESTION FOR BRAIN STORMING • WHAT IS A BUDGET • IS BUGETING IMPORTANT? • HOW IS BUGETING IMPORTANT IN RELATION TO YOUR ORGANIZATION? – IF ORGANIZATIONS/SOCIETIES DO NOT BUGET WHAT PROBLEMS THEY FACE?

Budget definition: • Budget, forecast of expenditures and revenues for a specific period of time. As a planning document, a budget enables businesses, governments, private organizations, and households to set priorities and monitor progress toward selected goals. To achieve budgetary objectives, it may be necessary to set aside savings or to borrow from outside sources.

Budget… • The personal or family budget is a financial plan that helps individuals to balance income and expenses. • A business budget is generally used as a tool to formulate intelligent decisions on the management and growth of a business venture. • The most complicated budgetary process involves a government budget, which is a plan for the collection and expenditure of monies needed to carry out the social, military, and economic policies of an administration

Budget… • A budget is a tool of managing the future

– As a financial plan the budget projects assets, liabilities, capital, income and expenses

• The need of budgeting

 Budgeting is a process of matching the needs to be achieved with the economic resources in a systematic and cohesive way.  People budget for a number of reason, but the main reason is the economic resource constraint. Benefits of Budgeting:  Periodic planning requires budgeting As a financial road map, the budget provides a plan so that every one in the organization has similar vision of where the ORGANIZATION going during the next budget year

Budget…

 A budget is a motivational device An effective budget is planned several months in advance & represents the combined judgment of staff, management and directors Budgeting provides a frame of reference for performance evaluation- it is a bench-mark against which actual performance is compared Trend (time) analysis may be used as a means of performance evaluation o But it is not recommend- why? Discuss.

Budget…  Budgeting enhances coordination, cooperation and effective communication

Budgeting process provides the vehicle for the exchange of ideas & objectives among people in various organizational segments  Ideally a budget is prepared in a participatory approach, where every responsible person from all segments are invited and have an input in the budget to be prepared Each party involved know and strive to achieve the accepted plan/budget, through coordination of physical resources and cooperation of different segments…e.g. NASA

Accounting & Budgeting • Question for Discussion

 Distinguish between Accounting and Budgeting

Accounting & Budgeting  The process of preparing budget use accounting information that helps: To assess the current situation To assess alternatives while setting goals/objectives To measure actual performance

How to prepare a budget?

• Question for discussion Discuss the budget preparation process at your organization The steps involved People involved, etc

How to prepare a budget?  As stated earlier, effective budget is a shared process involving directors, management and staff, if each group has to abide by the results they should have hands in developing the budget  The following are some of the steps involved in the preparation of the budget

Steps involved in the preparation of the budget

Step One: Research 1.The budget of the previous year is evaluated for efficiency/effectiveness Where there substantial amounts of variances? Are there valid reasons for variances? Is the budget effective-did it meets the goals of the organization

Steps involved in the preparation of the budget

2. Internal Environment Analysis An analysis of the internal environment will determine the organization's/RUSACCOS` strengths & weakness This can be done through different analysis: Examination of organizations financial conditions Members/customers satisfaction Saving levels,& loan balance, Staff composition & motivation/commitment

Internal Environment Analysis……  After research on the internal environment is completed:  This will determine the effectiveness/infectiveness of policies  Economic shifts and competitive changes can call for new policies which will in turn affect the budget

 In general the internal environment analysis indicates directors & management the weakness areas to be resolved and the strength areas to be capitalized to move toward the organization goal

3. The external environment analysis

 Another component of the research is external environment analysis which focuses on Traits and Opportunities of the Organization/RUSACCOS  Traits  constraining factors outside the organization: Competition: Global, National, & Local economic conditions Population trends Inflation/Deflation/foreign currency values Government policies and legislations

The external environment…  Opportunities attractive/promising factors outside the organization: Encouraging policies, Location or another type of advantages

Note what is trait for one could be an opportunity for the other!

Step 2 Develop a Goal

 After Research, the next step is to develop a goal.  Directors with the advise of the managers have responsibility to develop the goals  Goals should be Specific, Measurable, Understandable and written in terms of outcome  For example, The RUSACCO aims to increase the volume of loans and savings by 10% and 15%respectively  Each goal is analyzed in terms of the costs and benefits

Step 3 Develop a working Budget  The next step is to appoint the budget committee to develop a budget for each area of the organization  Monetary figures are then allocated to meet the goals as well as associated operational costs  Projections in various goals (loans, investment, savings, etc) are decided  These budgets for various goals are reviewed, revised and merged in to one operating budget

Step 4 Develop final Budget

 The board at this point either approves or rejects the budget  The board is responsible for determining whether the budget is realistic & can meet the organization goal  Thus, after reviewing, the board determines which income or expense items need revision  The budget team makes revision as per the request of the board,  The revised budget once again brought before board for approval

Final budget… Before accepting, the board must consider the following:Are the projections realistic? Do the budget contribute to the Organization goal? Do the budget follow the existing policies?

 Note the supreme authority for approval of the budget lies with the annual general meeting

Managers Responsibilities

 Makes budget proposals to the board  Give technical/expertise advise to the board, because some board members may lack financial/technical expertise  Translates the goals of the organization in to budgets  Provide lessons learned from the previous period budget and actual performance analysis

Step 5. Implementation the Budget  Implementing the budget is the managers job  The managers work with workers to make sure the budget become a reality  Managers also setup a reporting system to make sure that the operations of the organization are kept on the right track

Characteristics of effective budget reporting: Simplicity:- a design that is easily understood  Timeliness:- a regular routine for preparing and examining the reports  Adaptable:- adaptable to various levels of the staff and board  Comparative:- maintain comparisons between the actual and the budgeted income, expenses, etc  Correctable:- contain information whether deviations can be corrected or if estimates need to be revised.

Budgetary Control • Q. for brain storming  What does it mean by budgetary control  Discuss the budgetary control in your organization

Budgetary Control….  Controlling is a process of making sure that the actual performance agrees with what was budgeted  Variance/Deviation is the difference between actual results and budgeted data  A variance could be favorable (F) or Unfavorable (U) Q. When is a deviation said to be Favorable/Unfavorable

Budgetary Control….  If actual performance is better than the budgeted performance, the variance is said to be favorable, if the reverse is true, it is unfavorable.  For Income:  Actual income > budgeted income :- Favorable variance  Actual expense > budgeted expense:- Unfavorable variance

 Note large favorable/unfavorable variances are not desirable by mgt. Discuss why, relate to your real organization