Microfinance portfolio report as the manager’s car key (1)

Those who are familiar with modern-day preachers would have noticed that they use two approaches in presenting the word of God to their congregation. These approaches are by preaching (having a free reign and floating freely with the message) and by teaching (presenting the technical or, if you like, the more intellectual forms of their messages). This column, as the title implies, is actually intended to serve as a handbook for micro, small and medium entrepreneurs, their customers as well as their regulators; to support the drive towards appropriate conduct and promote capacity building among operators.

By their very nature, handbooks promote knowledge by summarizing and presenting information about a given subject for the benefit of all who are interested in the subject. Our handbook aims to do the same. It encapsulates both the author’s opinions and also his understanding of the technical materials on his subjects of interest.

During the last several weeks, this column has come in the form of “preaching”, in the sense that we were not constrained by rules or definitions in our discussions, and in our approach to the issues raised. We have approached the issues mainly as opinion. Now we shall change the gear a little, for the next few weeks, and do some “teaching” – giving prominence, to some limited extent, to the technical aspects of our subjects. This will allow our audience not only to float in several directions of the issues we present but also enrich their knowledge, enhance their technical capacity and help to highlight what is international best practice in the field of interest.

Managers of successful microfinance institutions will agree that there is one secret they do not always share with the competition. That secret is their love for and closeness to the companies’ portfolio reports. No matter how competent the keepers of the books are, or how close the managers are to their clients and customers, those who succeed in this business keep, not just an eye, but many open eyes, on their portfolio reports. The portfolio reports, to them, are like the keys to their cars. They never can go home at the end of the busy work day without looking for the car keys.

The reason for this affinity is not very farfetched. The portfolio report, which summarizes the status of all the loans granted by the institution at a given period, contains the seed of life, death and prosperity for the institution concerned. The way a pension fund manager looks at his End of Day (EoD) Report should be of interest to managers of microfinance institutions. Good fund managers with assets marked to market will not end their day without consulting the EoD report.

Credit administration and monitoring constitute vital aspects of a lending activity and the portfolio report is the most important instrument for monitoring the lending portfolio. So why is this document – the portfolio report – so valuable? Simply put, it is a document which provides very relevant information on all the facilities granted by the institution. For instance, it is the portfolio report that shows the quality of what we have in the loan portfolio – whether they are performing or not. It is also the portfolio report that shows the size of the operations of the company – whether the company is big on lending or small. Microfinance practitioners would agree that scale of operation is a critical factor in the sustainability of a lending programme. So we can gauge this scale from the portfolio report.

Any institution that has credit as its main business may face difficulties with regard to efficiency and productivity, if it fails to maintain a critical mass of loan portfolio requisite for cost recovery and coverage. This is one of the reasons why commercial banks go after both deposit liabilities and risk assets with the same zeal. This is also why things get rougher for a financial institution when the regulators place “Holding Action” on them, for any reason, thereby preventing them from making further loans. So loans are the livewire of any lending institution. No matter how much money they make from other income streams, a high level of interest income is always a very significant success factor.

Commercial banks and bank MFIs are in business to lend money and they may whither if they “do business” with what enters their loan books, or if they do not lend at all. Of course, they may make a lot of money from many other sources, but the main source of the survival of any lending programme is loans. This is why the loan book, and by extension, the portfolio report, is more than a vital piece of paper to any lending institution.

Since it is the loan portfolio that often brings in much of the needed revenue, it must therefore be handled with utmost care. The management of the loan book should not be firmed out to unreliable subordinates. Even if the best men are handling it, the manager must not sleep on it. Events in the loan book bring the bulk of the revenue and have great potential to send the institution out of business. Therefore, portfolio reporting must not only be accurate, it must be produced regularly and above all, it must be produced timeously.

A look at some of the most critical components of the portfolio report would give an indication why every good manager must watch it very closely, and indeed, have a quick look at it before shutting down for the day. These components include the ‘Value of the Portfolio Outstanding’. This element refers to the principal amount of outstanding loan facilities. As loans are granted and pay down received, some amount is always outstanding. Some institutions include their projected interest income from the outstanding loans in this quantity. This is being done in some environments but it is not best practice. Such practice tends to obscure the difference between outstanding principal amount and projected interest income.

While the outstanding loan is an asset to the company, we must recognize that interest income is part of company revenue. By including accrued interest in the outstanding portfolio we are recognizing income before it is earned. Of course, this is not one of the most elegant accounting conducts. It means we are capitalizing the interest income not yet received, thereby making it an asset in the balance sheet. It is more elegant not to recognize income, interest inclusive, until it is received.

Our friends in the accounting profession will be quick to remind us of the accounting principle that forbids us from acting otherwise. This way we do not overstate the value of assets with revenue that may fail to come. Besides, capitalizing projected interest income might facilitate the entry of errors into the records or, at best, simply complicate the accounting entries and records.

 

Emeka Osuji