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Sa-Dhan Newsletter Volume 5 Issue 1
Operational Costs of Delivering MicroFinance
a jeep for Rs 400,000/- the money for the price of the jeep
expected amount of loans not repaid. This is again a matter
would have been paid all at one time. But do we end up using
of judgment. For example, if an agency has given out 100
the jeep in that year only? No. It will possibly be used over
loans of Rs 10,000 each, they would have an outstanding
the next five years. Then how much is the cost in that year?
balance of Rs 1,000,000.
Possibly only Rs. 80,000 (being Rs 400,000/5). This sum of
Let us assume that Rs 5,000 of each of these loans were
Rs 80,000 is not going out in the very same year. But the
supposed to come back within the year. Say, five people out
cost is being incurred. This is often reflected as depreciation.
of those 100 did not pay their due amount. Thus the agency,
This cost will be continue to be incurred over the five years
which was expected to have Rs 500,000 outstanding, would
that the jeep is in use though the actual cash may have flowed
have received back Rs 475,000 (being Rs 5,000 of the 95
out earlier.
people) and an outstanding of Rs 525,000 only.
This is reflected in the form of depreciation of assets. These
At this time, the agency will have to make an assessment that
assets are purchased in a particular year and are used for
how much of this Rs 25,000 they will be able to recover in
several years thereafter. There are different norms about how
a reasonable period of time. Usually this judgment is made
much of the value of the asset can be/ need to be treated as
on the basis of how long the money has remained due. For
expense in a year. These are the norms of depreciation,
example, if the agency, in its best judgment feels that they
specified in the Income Tax Act. Using these norms, as
would be able to recover Rs 20,000, they make a provision
specified in the law, amount of depreciation is calculated. In
of Rs 5,000 that they 'think has a high chance of not coming
the example in Table 1, Rs 89,251 has been booked as
back'.
depreciation expenses. This, in other words, means that
assets worth Rs 89,251, bought at different points of time
But please note that this is not a cost where a 'specified sum
in the past has been 'used' this year.
of money is required to be paid before something can be
acquired'. There is a judgment involved in deciding the
Therefore the total operating cost for this agency is: Rs
amount of the cost. However, there are tradeoffs involved. If
1,186,321 only (being = Rs 1,097,070 + Rs 89,251).
you do not use the judgment judiciously at one point in time,
Cost of Loan Losses
you may find a lot of the assets gone. Even trying to keep
There is a third element of cost of a micro-finance agency.
the operational costs low may enhance the loan losses.
Unlike the operating costs, which are easily perceived as
In the example above, the management of the agency has,
expenses for doing an operation, these become costs in an
in its best judgment, held that it would not able to recover
indirect way. These are loan amounts that did not come back.
Rs 37,500 out of its outstanding portfolio. Therefore a
provision for that amount has been made.
Every time a loan is extended to some person, there is a
chance that the loan amount will not come back. This has two
To sum up, in the example given in Table I, we find the
kinds of implications for an MFI. The business of an MFI is
following situation:
giving money and collecting a 'price' for the service, which
comes back in the form of an interest. Once a loan extended
Sl.# Elements of Income/Cost
Amount
%age of
does not come back, first thing it does is to reduce the income
total cost
that was expected in the form of interest. This is reflected in
1
Income from Operations
601,252
the reduced income. But it also takes away some of the
2
Other Income
71,980
capital, which does not come back. Therefore, though not
'spent' this becomes a cost for the agency. And, this
Total Income
673,232
constitutes the Cost of Loan Losses.
1
Financial Costs
225,884
16%
There are two ways in which these costs are treated:
2
Operating Cost
1,186,321
81%
provisioning and writing off. The whole credit business is
3
Cost of Loan Losses
37,500
3%
based on some beliefs. When I am giving the money out, I
Total Costs
1,449,705
believe that it will come back, with the interest. At what point
Excess of income over
(776,473)
of time that belief is broken is a matter of judgment. If the
money does not come back on the day it was scheduled to
expenditure
come back (due date), some may start considering it 'doubtful'.
About the Author:
While some others may like to wait for a few days, before
they consider the promise broken.
Sankar Dutta is a Management graduate, who has been
involved in professionalising rural development activities for
Therefore, unlike most other operating costs, in Cost of Loan
close to a decade. He has been involved in the promotion of
Losses, the management needs to judge when it has become
statewide network of primary co-operatives in Madhya Pradesh,
a cost. When the agency is very sure that the money is not
going to come back in any way, it treats the money given out
and the professional NGO, PRADAN. He was a faculty
as an expense and no longer as a loan outstanding. This is
member at IRMA and has launched the International
called writing off the loan. As this involves giving away an
Management Appreciation Programme specially designed to
asset of the organization (loan outstanding is an asset), it is
cater to the needs of NGO's during this time.
a serious decision.
He has worked as the Vice President (Operation & Human
But in order to avoid sudden writing off of all the bad loans
Resources) in BAISX which is involved in extending Financial
at one point in time, prudent financial institutions, at the end
Assistance and technical support to the rural producers . He
of a financial period make a provisioning, based on the
is presently Dean of The Indian School of Livelihood.
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