Finance Self Study Guide for Staff of Micro Finance Institutions. Pre-Test

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Jocelyn Pearson
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1 Finance Self Study Guide for Staff of Micro Finance Institutions Pre-Test Objectives: Through this pre-test, you will gain a better appreciation for the subjects to be covered in this guide and your own current level of knowledge and understanding of them. Therefore, you should not be concerned if you are unable to answer any or all of the questions as that is the purpose of the guide to help you learn about finance in microfinance organizations. You should give yourself 45 minutes to complete it. 1. What do cash inflows and cash outflows refer to and how do they affect borrowers? 2. What is the difference between a fixed asset loan and a working capital loan? 3. List the fixed assets and working capital items of a carpentry business. 4. Define i) financial costs and ii) transaction costs for a borrower and give examples. Calmeadow 1

2 5. What is the difference between calculating interest on a flat basis versus a declining basis? 6. List the items considered when calculating the effective cost of a loan to a borrower. 7. Define i) fixed costs and ii) variable costs and give examples. 8. What is meant by the break-even point? 9. What is the formula for the Portfolio at Risk ratio? 10. What does liquidity mean? Write down the formula for the liquidity ratio. Calmeadow 2

3 11. Choose the best answer: i. Contribution Margin equals a. Revenue variable cost b. Revenue fixed cost c. Fixed cost variable cost d. Revenue (fixed cost + variable cost) ii. The numerator of the repayment ratio includes a. Amount received + past due amounts b. Amount received + prepayments c. Past due amounts + prepayments d. Amount received prepayments iii. Which two costs listed below are considered transaction costs? a. Opening a chequing account b. Loan fees c. Interest cost d. Child-care costs to attend a meeting iv. Managing portfolio quality should focus on a. Amount past due formula b. Portfolio at risk formula c. Repayment rate v. What is the percentage of interest to total costs if interest is P450 and total costs are P2,800? a. 16% b. 15% c. 7% vi. If savings are used to fund the loan portfolio, the average costs of funds is lower for an organization. a. True b. False c. Depends vii. Effective cost includes a. All financial and non-financial costs b. All direct financial costs c. Only interest d. None of the above viii. Irregular cash flows generally occur in a. Grocery shop b. Carpentry workshop c. Cow fattening Calmeadow 3

4 12. What does aging of arrears mean? 13. How is the Loan loss reserve determined? How does the Loan loss reserve differ from the Loan loss provision? 14. List three categories of costs incurred by a micro-finance organization. List a fourth cost that is considered when determining the long-term viability of a micro-finance organization. 15. Write the formula for i) operational self-sufficiency; ii) financial self-sufficiency. 16. What is the formula for the Idle Funds Ratio? Calmeadow 4

5 ANSWERS Calmeadow 5

6 1. What do cash inflows and cash outflows refer to and how do they affect borrowers? Cash inflows refer to revenue earned by a business while cash outflows refer to payments or purchases made by the business. 2. What is the difference between a fixed asset and working capital loan? Fixed asset loans are those made for the purchase of an asset which is used in the income generating business. Fixed assets are those assets which are used in the production process but typically have a life span of more than one year. Working capital loans are generally loans for current expenditures that occur in the course of the business. Working capital refers to the investment in current or short term assets. 3. List the fixed assets and working capital items of a carpentry business. Fixed Assets: Working Capital: - mitre saw - lumber - lathe - nails - sander - sand paper 4. Define i) financial costs and ii) transaction costs for a borrower and give examples. i) Financial costs include interest, fees, forced savings, group fund and insurance fund contributions. ii) Transaction costs refer to either money paid out to access the loan or opportunity costs foregone. Examples of transaction costs are child care and transportation costs to attend meetings and other transaction costs such as time away from the business, plus the opportunity cost of savings. 5. What is the difference between calculating interest on a flat basis vs. a declining basis? The declining balance method means that the interest is calculated as a percentage of the amount outstanding during the loan term. The flat method means that interest is calculated as a percentage of the initial loan amount and not the amount outstanding (declining) during the loan term. 6. List the items considered when calculating the effective cost of a loan for a borrower. - interest - cost of forced savings or group fund contributions - fees - interest calculation method 7. Define i) fixed costs and ii) variable costs and give examples. i) Fixed costs are those incurred on an ongoing basis and are not dependent on the level of production. They are costs which remain the same regardless of whether the operation makes one product or several hundred. Examples of fixed costs are rent, depreciation, maintenance, salaries, insurance, utilities and fees. ii) Variable costs are those that are directly related to production and vary depending on the volume produced. Examples are raw materials, direct labour, transportation and commissions. 8. What is meant by the break-even point? The break-even point of a service or product is reached when total revenue equals total costs. Calmeadow 6

7 9. What is the formula for the Portfolio at Risk ratio? Portfolio at Risk = outstanding balance of loans with payments past due portfolio outstanding (including past due amounts) 10. What does liquidity mean? Write down the formula for the liquidity ratio. Liquidity refers to the ability of a business to meet the immediate demands for cash, for loan disbursement, bill payments, and debt repayment. Liquidity Adequacy = Cash & Expected Cash Inflows in the Period Anticipated Cash Disbursements in the Period 11. Choose the best answer: i. Contribution Margin equals a. Revenue variable cost b. Revenue fixed cost c. Fixed cost variable cost d. Revenue ( fixed cost + variable cost) ii. iii. iv. The numerator of the repayment ratio includes a. Amount received + past due amounts b. Amount received + prepayments c. Past due amounts and prepayments d. Amount received less pre-payments Which two costs listed below are considered transaction costs? a. Opening a chequing account b. Loan fees c. Interest cost d. Child-care costs to attend a meeting Managing portfolio quality should focus on a. Amount past due formula b. Portfolio at risk formula c. Repayment rate v. What is the percentage of interest to total costs if interest is P450 and total costs are P2,800? a. 16% b. 15% c. 7% vi. If savings are used to fund the loan portfolio, the average costs of funds is lower for an organization. a. True b. False c. Depends vii. Effective cost includes a. All financial and non-financial costs b. All direct financial costs c. Only interest d. None of the above viii. Irregular cash flows generally occur in a. Grocery shop b. Carpentry workshop c. Cow fattening Calmeadow 7

8 12. What does aging of arrears mean? Aging of arrears refers to recording the amounts in arrears based on the length of time in arrears. For example, arrears are often aged 1-30 days, days, days, etc. Aging of arrears (or Portfolio at Risk) provides portfolio quality information to estimate the required Loan loss reserve. 13. How is the Loan loss reserve determined? How does the Loan loss reserve differ from the Loan loss provision? A Loan loss reserve is an accounting entry (as discussed in the Accounting Study Guide) which represents the amount of outstanding principal that is not expected to be recovered by a microfinance organization. The amount of the Loan loss reserve should be based on historical information regarding loan default and the aging analysis and should be calculated periodically (monthly, quarterly, etc.) to determine whether a Loan loss provision needs to be made to increase the Reserve. The Loan loss reserve is recorded as a negative asset on the Balance Sheet as a reduction of the Outstanding Portfolio (or as a liability). The Loan loss provision is the amount expensed on the Income Statement. Loan loss provisions increase the Loan loss reserve while Write-offs decrease the Reserve. 14. List three categories of costs incurred by a micro-finance organization. List a fourth cost that is considered for long-term viability of a micro-finance organization. - financial costs - Loan loss provision - operational costs - imputed cost of capital 15. Write the formula for i) operational self-sufficiency; ii) financial self-sufficiency. i) Operational Self-Sufficiency = Operating Income Operating Expenses + Financing Costs + Loan loss provision ii) Financial Self-Sufficiency = Operating Income Operating Expenses + Financing Costs + Loan loss provision + Imputed Cost of Capital 16. What is the formula for the Idle Funds Ratio? Idle Funds Ratio = Cash & Near Cash Total Outstanding Portfolio Calmeadow 8

Finance Self Study Guide for Staff of Micro Finance Institutions SOLUTIONS TO EXERCISES

Finance Self Study Guide for Staff of Micro Finance Institutions SOLUTIONS TO EXERCISES Lesson 1: Principles of Credit 1. What is meant by cash inflow and cash outflow? Cash inflows refer to revenue earned