Chapter 5 - Working Capital Management

WORKING CAPITAL VARIABILITY

INVESTOPEDIA SMALL BUSINESS
What are the components of working capital management?
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BY J.B. MAVERICK Updated Feb 14, 2018
The efficient management of working capital is essential for the
profitability and overall financial health of any company. Working
capital is the cash that companies use to operate and conduct their
businesses.

The aspects of working capital that investors and analysts assess to

evaluate a company are the key elements for a company's cash flow –
money coming in, money going out and management of inventory. This
helps ensure that a company always maintains sufficient cash flow to
meet its short-term operating costs and short-term debt obligations.

These are three main components associated with working capital

management:

1. Accounts Receivable
Accounts receivable are revenues due – what is owed to a company by
its customers for sales made. Timely, efficient collection of accounts
receivable is essential to a company's smooth financial operation.

Accounts receivable are listed as assets on a company's balance sheet,

but they are not actually assets until they are collected. A common
metric analysts use to assess a company's handling of accounts
receivable is days sales outstanding, which reveals the average
number of days a company takes to collect sales revenues.

2. Accounts Payable
Accounts payable, the money that a company is obligated to pay out
over the short term, is also a key component of working capital
management. Companies seek to strike a balance between maintaining
maximum cash flow by delaying payments as long as is reasonably
possible and the need to maintain positive credit ratings while
sustaining good relationships with suppliers and creditors. Ideally, a
company's average time to collect receivables is significantly shorter
than its average time to settle payables.

3. Inventory
Inventory is a company's primary asset that it converts into sales
revenues. The rate at which a company sells and replenishes its
inventory is an important measure of its success.

Investors consider the inventory turnover rate to be an indication of the

strength of sales and as a measure of how efficient the company is in
its purchasing and manufacturing process. Inventory that is too low
puts the company in danger of losing out on sales, but excessively high
inventory levels represent wasteful, inefficient use of working capital.

Abstract
We examine the influence of strategic choice on working capital
configurations and observe how the relationship between working
capital ratio and operational performance differs depending on
strategy. By clustering the strategic factors of the wholesale and retail
industry, we find three categories of strategies: terminal market
strategy, middle market strategy, and hybrid strategy. Using the panel
data of the listed companies of the wholesale and retail industry as our
sample, we analyze the differences in the ways companies configure
working capital, the speed with which working capital adjusts to its
target, and the effects of working capital on performance for
companies that make different strategic choices. The empirical results
suggest that working capital is configured and adjusted to its target in
different ways under different competitive strategic choices. This effect
is finally transferred to influence the relationship between working
capital configuration and operational performance.

1. Introduction
Working capital and strategic choices are two concepts that have been
widely discussed because they impact many aspects of business and
financial management. Since Smith [1], working capital has been
discussed in holistic terms. The current assets, current liabilities, cash
flow, and working capital policy derived from working capital have been
examined primarily for their impact on a firm's value [2–5]. Studies on
working capital management since Frecka fall into three competing
views. Under one view, higher working capital levels allow firms to
increase their sales and obtain greater discounts for early payments
and, hence, may increase firms' value [6]. Working capital
management plays a significant role in the better performance of
manufacturing firms [7]. In this line, authors such as Kim et al. suggest
that working capital decisions affect firm performance significantly and
find that firms with higher values hold a significantly higher investment
in working capital than firms with lower values [8–10]. The second view
suggests that firms with higher working capital levels may face
additional financing expenses which increase their probability of going
bankrupt [11]. Firms characterized by high working capital display high
sensitivities of investment in working capital to cash flow and low
sensitivities of investment in fixed capital to cash flow [12]. From this
view, authors such as Shin et al. argue that the firms with higher profits
are not motivated to manage working capital and firm performance
[13, 14]. Their findings suggest that there is a negative relationship
between working capital and firm performance.

Unlike previous studies, other authors argue that the relationship

between working capital management and corporate performance is
nonlinear [15]. Furthermore, Baños-Caballero et al. find that there is an
inverted U-shaped relation between investment in working capital and
firm performance [16, 17], which implies the existence of an optimal
level of investment in working capital that balances costs and benefits
and maximizes a firm's value.

At the same time, the literature on strategy management theory often

suggests that a firm's overall performance may be contingent upon the
nature of the strategic choices a firm makes [18–21], and the literature
on resource-based theory suggests that a firm's strategic choices may
be made based on superior resources and may represent the means by
which resources are allocated [22–28]. That is, a firm's strategic choice
must consider its resource allocation, and different strategic choices
and/or resource allocations may lead to different performances.
Working capital configuration, an important aspect of company
resources, may be affected by the strategic choices, as well. Using the
Cobb-Douglas model, Hamlin and Heathfield deduced a relational
model of working capital and strategy [3]. They argued that a
competitive strategy influences production flexibility and working
capital management, and companies dedicated to maintaining
competitive advantages should strengthen their working capital
management accordingly. Nath et al. suggest that an enterprise's
marketing capability, operations capability, and diversification strategy
have an integral influence on firm performance [29]. Therefore, the
question is will the working capital configuration change with the
transformation of strategic choices? If it does, will this relationship
affect performance? The prior empirical evidence is largely limited to
the relationships between strategic choices and performance [30–32]
or between working capital and performance [4, 13]. Thus the impact
of strategic choices on working capital and performance has rarely
been examined directly. Therefore, it is important to investigate the
influence of strategy on working capital configuration and the working
capital-performance relationship.

In the present study, the relationship among working capital

configuration, performance, and strategic choices is analyzed. The
study was conducted in the context of research on strategic choices
and working capital configuration (how do strategic choices influence
working capital allocation), which has attempted to explain the effects
of strategic choices on working capital. Therefore, the research
proceeds from the perspective that strategic choices play a deciding
role in the influence of working capital on performance.

In the present study, we choose the Chinese wholesale and retail

industry as the research objects for two reasons. First, statistics show
that the average proportion of current assets to total assets in the
wholesale and retail industry is approximately 50% and that of current
liabilities to total debt ratio is more than 90% (the data are derived
from the Chinese national statistics bureau). The wholesale and retail
industry, a bridge connecting producers to customers, pays more
attention to working capital than any other industry. Second, the
Chinese wholesale and retail industry had been integrating since the
late 1980s and growing rapidly after undergoing expansion and
adjustment in the early and mid-1990s. The competitive strategy and
business pattern of Chinese wholesale and retail enterprises began to
diversify with the emergence of a new retail business pattern and new
wholesale agents. In addition, the Chinese economy is developing
rapidly, with a Gross Domestic Product (GDP) growth rate of
approximately 7% annually. The impact of strategic choices on working
capital and performance in a rapid development industry in a rapid
development country needs to be explored.

Based on the diverse arguments of the above-mentioned studies and

to explore the role of strategic choices in working capital and
performance in a rapid development industry, we argue that working
capital and its capacity to drive operational performance are not
always consistent for companies employing different strategies.
Specifically, this study seeks to answer the following two empirical
questions. First, do firms that make different strategic choices have
different working capital configurations, especially when making the
adjustment from current working capital to target working capital?
Second, if firms with different strategic choices make different working
capital decisions, will this finally transfer to business performance in
the Chinese wholesale and retail industry?

As the first step of our investigation, we must understand the category

of strategy that a company adopts. Describing a strategy with the data
at our disposal is the first problem we face. To capture strategic
characteristics and measure a strategy with financial statement level
data, we explored the index to distinguish strategies based on two
important strategic value propositions, “efficiency”, and “cost”. By
excavating 10 indicators reflecting capital investment efficiency and
cost control ability and clustering the sample according to the
characteristics of these 10 indictors, we classify the strategies of listed
companies in the wholesale and retail industry into three categories.
Based on the strategy recognition and the two-stage working capital
adjustment model, the adjustment speed of working capital and its
influential factors on different strategic choices are analyzed and
compared by panel data. Furthermore, the relationship between
working capital ratio and operational performance and the marginal
influence of working capital on performance are also examined by
panel data analysis. To clarify the essential role that strategy plays in
working capital and the working capital-performance relationship, we
compare the statistic parameters for samples belonging to different
strategies. The empirical results suggest that working capital is
configured and adjusted to its target in different ways depending on
different competitive strategic choices. This effect is finally transferred
to influence the relationship between working capital configuration and
operational performance. The marginal influence of the working capital
ratio on performance is different with different strategies.

This study contributes to the working capital management literature in

a number of ways. First, we construct a model of working capital
adjustment based on the target adjustment model of the capital-
structure or target debt ratio (leverage) [33] and conduct an empirical
study on the adjustment path of working capital under different
strategies. Second, the paper investigates the relationship between
investment in working capital and firm performance according to
different strategies of firms and the marginal influence of working
capital ratio on performance with different strategies. Third, we
estimate the models by using a panel data methodology to eliminate
unobservable heterogeneity and use the generalized method of
moments (GMM) to address possible endogeneity problems.

2. Hypothesis
2.1. Hypothesis Regarding Working Capital Adjustment
There is a specific working capital level which objectively creates
enterprise value maximization. Previous work has verified that there is
a target working capital level. For example, Baños-Caballero et al.
proved that a target cash flow cycle exists in enterprises [34]. If there
is a shortage of working capital, enterprises will probably borrow
money at a high interest rate at the wrong time to maintain regular
operations and credit, thus affecting the ability to pay interests and
dividends. However, a high working capital level means there is a
substantial amount of liquidity that does not create more economic
benefits, which implies that enterprises may lack investment
opportunities and potential development will be influenced. Enterprises
should maintain a proper working capital level.

Therefore, enterprises need to adjust the holdings and composition of

working capital to adapt to market needs. Due to the differences in
adjustment costs (such as interest, rent, and conversion cost) and
different maintenance costs (if they did not plan to do anything),
enterprises' working capital adjustments are different in different
strategic types. The clients of enterprises with a terminal market
strategy are a single person whose purchasing behavior is at will.
Enterprises cannot actually forecast the person, place, time, and
product categories of purchase behavior. They may pursue differences,
spend more money on temporary marketing outlays to meet
customers' needs, and keep more short-term loans to maintain
differentiation. Therefore, they may not be concerned much with the
adjustment of working capital. However, enterprises with a middle
market strategy tend to have fewer monetary funds to reduce
opportunity costs and reduce external financing costs to avoid interest.
The clients of companies with a hybrid strategy are diverse, meaning
that they may be a person or a company. The business of these
companies is complex, and therefore they may pay more attention to
liquidity and working capital policy and adjust it as soon as possible.

H1. Companies with a hybrid strategy make the adjustment from a

current working capital ratio to a target working capital ratio the
fastest, while companies with a terminal market strategy are slowest
and companies with a middle market strategy are in the middle.

2.2. Hypothesis Regarding the Working Capital Influence on

Performance
We define working capital ratio as (current assets-current
liabilities)/current assets. This index reflects not only short-term debt
paying ability but also the financial strategy of a company. When
working capital ratio falls within a reasonable range, the larger the
working capital ratio is, the more long-term the capital is invested in
current assets. That is, the more conservative the financial policy that
the company employs, the less the financing risk is undertaken by the
company. Thus the company has more stable capital as to guarantee
the continuity of business operations and, in turn, to safeguard the
stable profit of the company. Therefore, we propose hypothesis 2A.

H2A. The link between working capital ratio and performance is

positive.

Because the strategic objectives of different strategies are different,

the internal resource allocation scheme, cost control techniques, and
differentiation extent are different for companies that make different
strategic choices, including the working capital configuration. Given
that many scholars have demonstrated that either working capital or
strategy will influence performance and we have discussed above how
strategic choices will affect working capital management, we hold that
performance will differ based on different working capital management
plans and strategic choices. In this case, the marginal influence of
working capital ratio on performance will be different with different
strategies.

H2B. The marginal influence of working capital ratio on performance

will be different with different strategies.

3. Data and Variables

3.1. Data Sources
In this paper we demonstrate through empirical analysis the influence
of strategic choices on working capital management and the way that
working capital affects performance. This analysis requires three types
of data: indicators in the depiction of strategy, indexes describing
working capital configuration and performance, and data for control
variables. For this reason, our sample covers financial data in the
annual financial statements from 2008 to 2012 of 113 Chinese listed
companies in the wholesale and retail industry. All of the data in this
paper are collected from the China Stock Market & Accounting
Research Database (CSMAR) (GTA Information Technology Co., Ltd.,
Shenzhen, China) and TinySoft (TinySoft Corp., Shenzhen, China) in
China. The selection criteria of our sample are as follows. First, firms
that are B-shares enterprises and oversea-listed companies are
excluded. Second, we choose data concerning the listed companies in
the wholesale and retail industry from 2008 to 2012 as the research
object because the data from this time period is the most complete and
development is relatively fast in this time window. Third, we eliminate
sample items with data missing from one or more than one years to
ensure the data integrity. A total of 475 observations of 95 listed
companies in the Chinese wholesale and retail industry from 2008 to
2012 remained.

3.2. Variables
3.2.1. Strategy Variables Porter identifies two generic ways in which a
firm can gain a sustainable competitive advantage: cost leadership and
differentiation [35]. The wholesale and retail industry is no exception.
To obtain competitive advantage, wholesale and retail enterprises that
pursue low costs pay more attention to cost and expense control, the
assets turnover cycle, and capital use efficiency. Companies that
pursue differentiations focus on products, sales, and service. Therefore,
we select indicators of capital investment efficiency, cost control, and
development ability.
Capital Investment Efficiency. Capital investment has been considered
a key indicator of strategic evaluation. Based on capital investment
status (plant, equipment, current assets, etc.), we can judge capital
quality, operating efficiency, management level, and cost control
capacity [36]. Therefore, the ratio of fixed assets to profit, fixed asset
turnover ratio (sales to net fixed assets), and current asset turnover
ratio are used to measure capital investment efficiency.

Cost Control. Enterprises with a cost leadership competitive advantage

have a strong motivation to control cost and improve operational
efficiency. They strive to lessen costs by controlling different types of
expenses, the financial cost of external financing, the selling cost for
marketing, and the administrative cost for day-to-day administration.
Conversely, enterprises that pursue differentiations always give priority
to marketing capability cultivation. They emphasize the importance of
advertisements, service, brand, and so forth, and they are most likely
to finance through debt and stock when necessary [36, 37]. In addition,
enterprises may ignore financial expenses control and spend more on
advertisements and distribution channels in pursuit of differentiations.
Thus, the ratio of management expenses to profit, the ratio of financial
expenses to profit, the ratio of sales expenses to sales, and the ratio of
costs to income are selected to reflect how much enterprises spend on
cost control or differentiation.

Development Capability. Enterprises committing themselves to

differentiation usually tend to invest capital in fixed assets to enlarge
their business scope and market share. They sell different products to
different target customers by swapping and recombining a variety of
resources [38]. Thus, they can easily acquire brand loyalty and gain
more profit compared to competitors. Conversely, enterprises devoted
to lessening costs always invest less in fixed assets. Therefore, the
relative gross margin, the growth rate of fixed assets, and the growth
rate of sales proceed are used to reflect development capability.

3.2.2. Measures of Firm Size Firm size plays an important role in

strategy in the wholesale and retail industry. For example, large firms
tend to improve their bargaining ability using size as a chip and enjoy
various preferential supply policies to achieve economies of scale.
Because firm size is not suitable to be used as an indicator to represent
strategy, we describe strategic types with firm size and strategic
indicators. Firm size is measured by the natural logarithm of total
assets.
3.2.3. Measures of Working Capital Generally, working capital refers to
the difference between current assets and current liabilities. This
concept implies the financial strategy that a company observes. If
working capital is less than 0, the current liabilities are larger than
current assets. In this case, the company advocates a radical financial
strategy. Otherwise, if the current assets are much larger than current
liabilities, that is, part of long-term capital is invested in short-term
assets, then the company employs a conservative financial strategy.
From this point of view, the larger the working capital is, the more
radical the financial strategy is observed and the safer the short-term
liabilities are. Therefore, we adopt this definition of working capital in
this study. However, to control for the impact of size, we use the
proportion of difference between current assets and current liabilities to
current assets to represent working capital, namely, the working capital
ratio, designated as working capital.
3.2.4. Measures of Working Capital Influencing Factors Management
Efficiency of Working Capital. Enterprises with a large-scale inventory
and high efficiency in accounts receivable management apparently
invest less in current assets to achieve the same growth rate of sales.
Conversely, enterprises with a small-scale inventory and low efficiency
in accounts receivable management have more working capital to
achieve an objective growth rate of sales. Therefore, we select the
inventory turnover ratio and accounts receivable turnover ratio to
measure working capital efficiency.
Growth Opportunities. In general, if operations' management efficiency
remains the same, working capital size will increase with the sales
growth. However, the relationship between growth opportunities and
working capital is controversial. On the one hand, sales growth leads to
the growth of accounts receivable and inventory. On the other hand,
enterprises with better performance will easily attract outside
investment and therefore do not need much more cash and short-term
loans that can be invested in other plans to gain more profit. Growth
rate of sales proceed is used to measure growth opportunities.

Operational Cash Flow. Enterprises would be willing to increase their

current working capital in the short term if they expected that they
would have more development opportunities and future cash flow [39–
43]. The more operating cash flow the enterprises have, the higher
their working capital management level is. Therefore, enterprises'
working capital and debt will remain at a low level [44]. Operating cash
flow to total assets is used to measure cash flow to eliminate the
influence of firm size.

Fixed Assets Ratio. The increase in structural assets investment, such

as fixed assets, intangible assets, and long-term investments, will lead
to the reduction of working capital. Therefore, the fixed assets ratio will
affect working capital. The ratio of fixed assets to total assets is used.

3.2.5. Measure of Performance There are many variables that can

reflect performance, such as revenue, capital usage ratio, and return
on assets (ROA). However, revenue and capital usage ratio can only
reflect business performance to an extent, while ROA can
comprehensively reflect business performance [45]. We define ROA as
earnings before interest and taxes (EBIT) relative to total assets.
3.2.6. Control Variables Industry development will influence companies'
business performance, so we use the steady of industry demand to
control the change of the whole industry. Industry demand uncertainty
captures the volatility of industrial demands and is measured by the
standard deviation of the industrial average net sales from 2008 to
2012. Many studies have demonstrated that initial performance will
affect current performance, and thus we add the steadiness of industry
demand and initial performance of the model to control the influences
of industry and firm and improve the accuracy of the model to study
the marginal influence of working capital on performance for different
strategies.
3.2.7. Measures of Working Capital Structure and Efficiency In the
wholesale and retail industry, companies place great value on working
capital management to achieve a high turnover rate of current assets.
As a result, working capital forms a very important strategic resource
influencing strategic choice and is, in turn, constrained by strategy. To
investigate the differences in working capital structure and the
operational efficiency of working capital under different strategic
choices, we decompose current assets into cash, inventory, and
receivables and decompose current liabilities into short-term financial
assets in terms of the working capital structure. In addition, we use the
inventory turnover ratio and accounts receivable turnover ratio to
reflect working capital efficiency.
All of the variable definitions are reported in Table 1.

Table 1
Table 1
Variable definitions.
4. The Classification and Identification of Strategy
Although enterprises have different types of advantages and
disadvantages in relation to their competitors, the two most basic
competitive advantages that form the fundamentals of competitive
strategy are low cost and differentiation [35]. Researchers commonly
measure enterprises' strategies by considering their abilities to keep
costs low and products differentiate. In the wholesale and retail
industry, low cost or cost control is even more appreciated given the
nature of the industry.

We classified strategies in the wholesale and retail industry by

clustering the sample of strategic factors. All of the data used in this
paper are on financial level data because they permit an explicit gauge
for measuring “realized strategies” rather than “intended strategies”
[46]. In addition, by using financial statement level data, these
measures are not prone to the perceptual biases noted in the strategy
literature [47]. With two independent factors obtained from the factor
analysis, a hierarchical cluster analysis was conducted with the goal of
verifying whether there were differences between groups of firms and
then determining the optimal cluster number and types of strategy.

Table 2 reports the factor analysis results. As the value we obtain from
the Kaiser-Meyer-Olkin test (KMO) is 0.6886, the P value of the Bartlett
test is 0.000, and the overall contribution is 96.54%; the sample is
suitable for factor analysis and consistent with our expectations. The
results indicate that there are two factors. The first factor (eigen value
is 2.44) comprises three indicators, namely, the ratio of fixed assets to
profit, the ratio of management expenses to profit, and the ratio of
financial expenses to profit. Because all of these indicators reflecting
this factor are related to the input-output relationship, we designate
the factor input-output efficiency. The higher (lower) the value is, the
lower (higher) the input-output efficiency is. The second factor (eigen
value is 2.38) is comprised of four indicators, that is, the ratio of sales
expenses to sales, the relative gross margin, the ratio of costs to
income, and the fixed assets turnover ratio and the current assets
turnover ratio. All of these indicators reflect capital investment and
efficiency, and thus we name it capital investment efficiency. The
higher (lower) the value, the higher (lower) the companies' cost
consumption and assets turnover ratio. In conclusion, the higher
(lower) the factor scores, the more likely the firms' expenditures on
capital are large (small). In this case, all of the expenses of enterprises
are high, which can reflect that companies seek different and expanded
markets based on their own ability. Conversely, the lower the factor
scores are, the more likely the enterprises spend less on capital and
control costs strictly.

Table 2
Table 2
Factor analysis results.
Based on the two factors obtained from the factor analysis, we create a
strategic classification through hierarchical clustering and K-mean
value clustering and classify strategies into three classes according to
the characteristics of the two factors, as shown in Table 3. Furthermore,
an analysis of variance (ANOVA) is adopted to examine the difference
in these two factors for companies operating different strategies.

Table 3
Table 3
Factors in different classes.
Firms in cluster 3 are high in input-output efficiency, capital investment
efficiency, and firm size, with values of 0.29, 0.38, and 21.67,
respectively. With these characteristics, we hold that enterprises in this
class may pay more attention to brand promotion, marketing, product
design, and characteristics improvement, and they may thus dedicate
themselves to shortening the cycle of new product development,
increasing product categories, and improving product packaging. These
characteristics coincide with wholesale companies. In addition, the
ratio of wholesale companies is 73.20%, so we designate it the middle
market strategy.

As shown in Table 3, firms in cluster 2 have a low level of input-output

efficiency, capital investment efficiency, and firm size, with values of
−0.32, −1.29, and 21.28, respectively. Thus, we hold that enterprises
in this class may advocate cost controlling, economies of scale, and
using the advantage of value chain to realize trading internalization
and to maximally reduce purchasing expenses. They try to carry out
market segmentation to increase product sales, extend market share,
develop new markets, spread market risk, and expand advantages.
These characteristics are similar to retail companies. Furthermore, the
ratio of retail companies is 75.23%, so we name this the terminal
market strategy.
The values of input-output efficiency, capital investment efficiency, and
firm size of enterprises in cluster 3 are in the middle of the three
classes. We claim that enterprises in this class pay attention to cost
control, brand promotion, and new production development at the
same time. However, they primarily achieve a reasonable balance
between cost control and differentiation and do not excessively
emphasize either side. Their capital investment efficiency is relatively
moderate and reasonable. Companies in this class have both wholesale
and retail businesses, and the ratio of these companies is 82.72%.
Therefore, we name the third strategic type the hybrid strategy.

5. The Working Capital Configuration in Different Strategic Choices

5.1. Working Capital Structure and Operational Efficiency under
Different Strategic Choices
The ANOVA results are presented in Table 4.

Table 4
Table 4
Working capital allocation for the whole sample and comparison across
the three strategies.
The mean value of the working capital ratio in the three strategic
choices is different. It is the highest in the middle market strategy and
the lowest in the terminal market strategy.

In the middle market strategy, the average inventory turnover rate is

27.9, and the average accounts receivable turnover ratio is 41.85.
However, in the terminal market strategy, the average inventory
turnover rate is 13.99, and the average accounts receivable turnover
ratio is −3.11. Based on the results shown above, we can conclude that
working capital management efficiency in the middle market strategy
is the highest, while that in the terminal market strategy is the lowest.

In the middle market strategy, enterprises' average ratios of

receivables and inventories to current assets are 16.77 and 30.81,
respectively, which are higher than those in the terminal market
strategy and the industry average. Meanwhile, the average ratios of
cash to current assets and short-term loans to current liabilities are
28.23 and 29.46, respectively, which are lower than the industry
average and those in the terminal market strategy. The ratios of cash,
inventories, receivables to current assets, and short-term loans to
current liabilities in the hybrid strategy are in the middle. Therefore, we
can conclude that the efficiency and structure of working capital are
different with different strategies.
Because the credit policy of companies in the middle market strategy is
relatively easy and the size of investment in working capital is high, the
working capital efficiency and the ratios of receivables and inventories
to current assets in the middle market strategy are the largest, while
the credit policy of companies in the terminal market strategy is
relatively strict and the cash holdings are large, meaning that they
have a high short-term debt paying ability and thus usually keep
relatively high short-term borrowing to lower financing costs and
opportunity costs. Therefore, the ratio of cash to current assets and the
ratio of short-term loans to current liabilities in the terminal market
strategy is the largest.

The results above verified the validity in classifying firms into three
types and proved that working capital management is different with
different strategic choices. To assess whether strategic choices
influence working capital management, we analyze the working capital
adjustment speeds of the different strategic choices in the following
section.

5.2. The Difference in Working Capital Adjustment Speed and Its

Influential Factors in Different Strategic Choices
5.2.1. Model of Working Capital Adjustment Many scholars have proven
that there is a target working capital rate in a company. In an ideal
condition, the current working capital level should be equal to the ideal
value. However, because of the adjustment cost, the actual working
capital level will not be fully equal to the ideal value. Because
companies need to possess a certain amount of cash, accounts
receivable and inventory due to the instability of business
management, current assets, and current liabilities, the composition of
working capital is constantly being replaced. Based on the target
adjustment model of the capital-structure or target debt ratio
(leverage) [33], the adjustment model on working capital is as follows:
WCi,t=(1−α)WCi,t−1+αβ0+α∑j=1nβjXi,t,j+μi,t+dt+vi,t,
(1)
where WCi,t is the working capital level of firm i at time t, X i,t,j is a set
of j working capital level determinants of firm i at time t, including
company's operating condition, cash flow and working capital
management efficiency, and company asset allocation, and μ i,t is the
error term. The target-adjustment coefficient α measures the relevance
of the transaction costs and is assumed to be a samplewide constant,
which represents adjustment degree. The error term in our models has
been split into three components: first, the individual or firm-specific
effect μ i,t, second, d t, which measures the time-specific effect by the
year dummies, and finally, v i,t, which is the random disturbance.
5.2.2. Analysis of Working Capital Adjustment Using Model 1 and the
sample of listed companies in the wholesale and retail industry from
2008 to 2012 specified above, and by GMM estimation of the panel
data, we obtain the results shown in Table 5.
Table 5
Table 5
Determinants of working capital in three strategic types.
The GMM results show that there is no second-order serial correlation
and it is valid to use time dummy variables. The previous year's
working capital ratio has a positive influence on the current working
capital level, and the relationship is significant at the one-percent level.
The size of the coefficient of the lagged working capital level variable
(1 − α), as specified in Table 5, was in the range of 0.267 to 0.500 for
the sample as a whole. Accordingly, the parameter α, which measures
the adjustment speed of the current working capital ratio towards a
target working capital ratio, distributes over the range of [0.500,
0.733]. Thus working capital adjusts to a quite normal degree for the
adjustment cost in the wholesale and retail industry. However,
disparities in adjustment speed are found to be significant among the
samples of firms with different strategic choices though the adjustment
is in a normal range. On average, firms operating the hybrid strategy
enjoy the highest adjustment speed, while those in the terminal market
strategy adjust their working capital in the lowest speed.

As argued by Ozkan [48], the adjustment decision is a trade-off

between the adjustment (transaction) cost involved in moving towards
a target ratio and the cost of being diverted from optimal ratio. If the
latter is greater than the former, then the estimated coefficient (1 − α)
should be close to zero, and firms will try to adjust their working capital
ratio to the target as soon as possible. Based on the estimated
adjustment speed, convergence towards a target seems to explain
much of the variation in firms' working capital ratios. Specifically, firms
adopting the terminal market strategy reported a target-adjustment
coefficient that, although statistically significant, is close to 0.5 and,
therefore, makes effects of the adjust very small. Instead, firms that
adopted the middle market strategy move quicker towards their target
working capital than those that adopted the terminal market strategy
to maintain working capital and adapt to market changes actively.
However, firms with the hybrid strategy adjust their working capital to
the equilibrium level the most quickly. Because enterprises' capital
investment efficiency is moderate and close to the industry average in
the hybrid strategy, they pay more attention to business management,
and therefore their working capital ratio is closer to the target working
capital ratio and their working capital adjustment speed is the fastest.
These results support hypothesis 1.

As previous studies have shown, working capital structure depends on

several firm-specific characteristics. The results generally show that the
choice of working capital level is a negative function of the inventory
turnover ratio and the accounts receivable turnover ratio. When
working capital management efficiency is higher, working capital
holdings are lower. Of the three strategies, working capital
management efficiency has the greatest effect on working capital in
the terminal market strategy, and the relationship between the
accounts receivable turnover ratio and working capital is not
significant.

The link between operating cash flow to total assets and working
capital ratio is negative in the terminal market strategy. When
operating cash flow grows as a result of business activities, enterprises
may have good working capital management ability, and thus firms
tend to hold less working capital. However, the link between operating
cash flow to total assets and working capital is not significant.

The relationship between fixed assets to total assets and working

capital ratio is always negative, and it is slightly stronger for
enterprises with the terminal market strategy. When there are more
fixed assets, the working capital ratio is lower.

The relationships between the growth rates of sales proceed and

working capital ratio are different in the hybrid strategy and the middle
market strategy. The positive link between the growth rate of sales
proceed and working capital ratio indicates that enterprises have more
free money to allocate to working capital and meet the temporary
needs of diversification. Conversely, a negative link between the
growth rates of sales proceed and working capital ratio is exhibited by
the hybrid strategy. Enterprises with this strategy neither overused nor
oversaved capital. Therefore, when the growth rate of sales proceed is
larger, the enterprises tend to allocate more money to business. The
link between the growth rate of sales proceed and working capital ratio
is not significant in the terminal market strategy.

6. Influence of Working Capital on Performance in Different Strategies

Strategic fit is a core concept in normative models of strategy
formulation, and the pursuit of strategic fit has traditionally been
viewed as having desirable performance implications [49, 50].
Strategic and organizational theory argues that particular structures
are more appropriate for given strategies, and changes in
environmental conditions and organizational resource or structures
require changes in the choice of strategy. The internal resources must
be fitted, integrated with strategy, and could be converted into a
competitive advantage [51]. According to the empirical analysis of
working capital adjustment, investment in working capital and the
ratios of working capital structure and efficiency significantly change
under different strategies. Furthermore, the effects on the target
working capital ratio are different depending on factors such as
working capital management efficiency, operating cash flow, business
operations, asset allocation. Based on these findings, we analyze the
moderating effects of strategic choice on the relationship between
working capital management and corporate performance as well as the
marginal effects of working capital on performance under different
strategies. In addition, we analyze the fit between the strategic choice
and working capital management based on strategic fit theory.

6.1. Other Variables

6.1.1. Measures of Strategic Types We use dummy variables to reflect
strategic types. As we have three types of strategy in the wholesale
and retail industry, we design two dummy variables, IO and IS, to
represent these three types of strategy in the following way. We use I to
reflect the strategy that a company employs, A to reflect the hybrid
strategy, B to reflect the terminal market strategy, and C to reflect the
middle market strategy:
IO={1I∈A0I∈A,  I∈CIS={1I∈B0I∈A,  I∈C.
(2)
If IO = 0 and IS = 0, then the company employs the middle market
strategy, which is the reference point for the hybrid strategy and the
terminal market strategy.

6.1.2. Measure of Interaction Factors of Marginal Influence To

investigate the differences in the way that working capital affects
performance, we design interaction factors of strategy and the working
capital ratio by multiplying dummy variable that reflect the strategy
and the standardized working capital ratio; namely, IO × WC and IS ×
WC (Table 6). If IO × WC ≠ 0 but IS × WC = 0, then the sample of
companies operating the hybrid strategy is represented. If IO × WC = 0
but IS × WC ≠ 0, then the sample of companies operating the terminal
market strategy is represented, and if IO × WC = 0 and IS × WC = 0,
then the sample of companies operating the middle market strategy is
represented.
Table 6
Table 6
Measures of interaction of margin influence.
6.1.3. Selection of Working Capital Ratio Table 7 and Figure 1 report the
distribution of working capital across the whole industry We can
conclude that most of the working capital ratios are between [−2,1]
and those between [−6.5, −2] only take 4.4% of the sample.
Companies whose working capital ratios are between [−6.5, −2] have
substantially more current liabilities than current assets. In other
words, the working capital management of these companies is very
radical and is not the same as normal working capital management.
Thus, we eliminate these risk samples to better reflect the working
capital management of most normal companies.
Figure 1
Figure 1
Distribution of working capital in the whole industry.
Table 7
Table 7
Distribution of working capital ratio.
6.2. Model
We add control variables to control the influence of factors, with the
exception of working capital, that affect firm performance. The
interaction terms are also added in Model 2 to discuss the marginal
effect of working capital on performance in different strategies:

ROAi,t=α1+γ1WCi,t+γ2IOi,t+γ3ISi,t 
+γ4IO×WCi,t(1)+γ5IS×WCi,t(2) +γ6IDU+γ7ROAi,t−1+εi,t.
(3)
IO × WCi,t (1) reflects the working capital ratio in the current hybrid
strategy. IS × WCi,t (2) reflects the working capital ratio in the current
terminal market strategy. IDU is the control variable and captures the
volatility of industrial demands. ROAi,t is the dependent variable. α 1 is
the intercept. γ 1, γ 2, γ 3, γ 4, γ 5, γ 6, and γ 7 are the coefficients.
According to the model and dummy variables, we assert that γ 1
reflects the marginal effect of working capital on performance. α 1
reflects the intercept of performance in the middle market strategy. (γ
1 + γ 4) reflects the marginal effect of working capital on performance.
(α 1 + γ 2) reflects the intercept of performance in the hybrid strategy.
(γ 1 + γ 5) reflects the marginal effect of working capital on
performance. (α 1 + γ 3) reflects the intercept of performance in the
terminal market strategy.

6.3. Working Capital-Performance Relationship in Different Strategies

Based on Model 2 and GMM estimation of the panel data, the results of
the regression analysis of the influence of working capital on
performance in different strategies are reported in Table 8. Model 1
included working capital and controls; Model 2 added the effects of the
different strategies (IO and IS) and their interactions with working
capital (IO × WCi,t (1) and IS × WCi,t (2)). Wald Test and R-square for
these models indicate significant explanatory power.

Table 8
Table 8
Influence of working capital on performance in different strategies.
In models 1 and 2 in Table 7, the effects of working capital on
performance are positive and significant (γ 1 = 0.012, P < 0.011 in
Model 1; γ 1 = 0.032, P < 0.004 in Model 2). These results strongly
support hypothesis 2A, which indicated that the level of working capital
would have a positive relationship with firm performance.

Hypothesis 2B predicted that the strategic choice would affect the

relationship between the level of working capital and firm performance.
In Model 2 of Table 8, the interaction of strategic choice IO and working
capital is not significant (γ 4 = −0.018, P < 0.136), but the interaction
of strategic choice IS and working capital is negative and significant (γ
5 = −0.019, P < 0.098). These results suggest that the terminal market
strategy moderates the effect of the level of working capital on firm
performance, as we predicted in hypothesis 2B.

6.4. Marginal Effect of Working Capital on Performance in Different

Strategies
To further examine the marginal effects of working capital on
performance in the different strategies, we first take the partial
derivatives of the performance in Model 2 with respect to the working
capital ratio. ∂ROA/∂Working Capital reflects the marginal influence of
working capital on performance:

∂ROA∂Working Capital=γ1+γ4IOi,t+γ5ISi,t.
(4)
According to the regression results of models 1 and 2 in Table 7, the
marginal effects of working capital on performance in different
strategies and in the industry as a whole are shown in Table 9.

Table 9
Table 9
Margin effects of working capital on performance in different strategies
and in the whole industry.
Based on Table 9, we can see that the marginal influence in the middle
market strategy is the highest, while that in the terminal market
strategy is the lowest.
Most companies with the terminal market strategy are retail
companies, which are characterized by scattered trading volume,
frequent trading times, different sizes of business outlets, wide
distribution of business, and so forth. Compared with wholesale
companies, the volume of business of these companies is smaller.
Therefore, they pay more attention to the increase in capital turnover
rate and capital liquidity, and thus the ratio of operating fund to current
liabilities is higher. Due to the dependency of working capital in the
operating process, the generation of business performance mostly
relies on “small profits but quick turnover” and capital liquidity.
Therefore, the marginal effect of working capital on performance is
very low.

However, companies with the terminal market strategy mostly are

wholesale companies, which usually distribute in large cities. These
companies differ from retail companies insofar as they have a bigger
trading size, lower trading frequency, more rational trade, fewer
transaction projects, and so forth. Therefore, they pay less attention to
capital liquidity compared with terminal market companies, and their
generation of performance mostly relies on trading volume. Thus the
marginal effect of working capital on performance is the largest.

Companies with the hybrid strategy operate both wholesale and retail
businesses, so the current liability needs and the capital turnover rate
are relatively in the middle. Thus, the marginal influence of working
capital on performance is in the middle, as well. These results support
hypothesis 2B.

According to the intercept and margin calculated above, we draw

schematics to analyze the marginal effects as shown in Figure 2.
Meanwhile, when we observe the source data of ROA, we find that
there are 37 observations that are below 0, while the other 438
observations are above 0.

Figure 2
Figure 2
Marginal effects of working capital on performance in current
strategies.
According to Figure 2, the companies with the middle market strategy
should pay more attention to the marginal impact of working capital on
firm performance than companies with the terminal market strategy or
the hybrid strategy. The level of working capital is higher, the effect of
working capital on performance is higher, and company performance
will also be better. Table 10 reports the performances in the different
strategies when the working capital ratio is in different intervals.

Table 10
Table 10
Performance in the different strategies when the working capital ratio is
in different intervals.
When the working capital ratio is lower than −1.63, the performance in
the terminal market strategy is the best and the performance in middle
market strategy is the lowest. When the working capital ratio is
between [−1.63, 0.75], the performance in the hybrid strategy is the
best and the performance in middle market strategy is the lowest.
When the working capital ratio is between [0.75, 0.95], the
performance in the hybrid strategy is the best and the performance in
the terminal market strategy is the lowest. When the working capital
ratio is higher than 0.95, the performance in the middle market
strategy is the best, and the performance in the terminal market
strategy is the lowest. In conclusion, when the working capital ratio is
in different intervals, the performance in the three strategies will
appear different phenomena.

6.5. Marginal Effect of Working Capital on Performance in the Industry

as a Whole
Based on Table 9, we can conclude that the marginal effects of working
capital on performance in current strategies are higher than the overall
level in the industry as a whole.

According to the analysis above, we draw the schematics

comprehensively. Figure 3 shows the marginal effects of working capital
on performance in the current strategies and the industry as a whole.

Figure 3
Figure 3
Margin effects of working capital on performance in current strategies
and the whole industry.
We can see that, when the working capital ratio is above 0.35 in the
industry, the performances in the three strategies are higher than the
industry level. When the working capital ratio is below 0.35, the
performances in the terminal market strategy and the hybrid strategy
are higher than the industry level, while the performance in the middle
market strategy is lower than the industry level.

According to the above analysis, the results suggest that the strategic
choice moderates the effects of the level of working capital on firm
performance, and the marginal effects of working capital on
performance are different with the different strategies. Furthermore,
the strategic choice should fit the level of working capital. The
performance would be promoted significantly if the strategic choice is
matched with the level of working capital. That is, the company should
adjust the level of working capital that corresponds to the different
strategic choices to improve firm performance, or enterprises should
choose the competitive strategy that best fits with the different levels
of working capital to enhance firm performance and competitiveness.

7. Conclusion
This paper studies the influence of competitive strategic choice on the
working capital configuration and working capital-performance
relationship using the wholesale and retail companies listed in the
Shenzhen and Shanghai stock market as the research object.

Previously, empirical financial studies ignored the role strategic choices

play as a determinant of working capital. The results of the present
analysis indicate that the strategic choices developed by the wholesale
and retail industry do indeed affect their working capital management.
That is, strategic choices will influence management efficiency, the
composition, and the adjustment speed of working capital. Strategic
choices are clearly a determining factor in working capital
management and deserve more attention in future investigations.

Furthermore, with respect to the analysis of working capital

determinants (growth opportunities, operational cash flow,
management efficiency of working capital, and fixed assets ratio),
different strategic choices seem to have different effects on these
determinant factors. Another important result of this analysis is that
the influence of strategic choices on working capital will finally transfer
to performance.

In conclusion, as there is a target working capital ratio and there are

limits of transaction cost and size, the working capital ratio we
discussed should be in a particular optimal interval. In this interval, the
adjustment extent in the hybrid strategy is greater than that in the
other two strategies, and its performance is the best and most stable,
while the marginal influence of working capital on performance is in the
middle. Once a company chooses the hybrid strategy and its working
capital policy has been established, the change of working capital will
not change its performance excessively because the marginal influence
of working capital on performance is not that high. Therefore,
companies with this strategy will not pay much attention to working
capital. Conversely, companies with the terminal strategy have a lower
turnover rate and more cash and short-term borrowings to maintain
differentiation, and their working capital adjustment and the marginal
influence of working capital on performance is the lowest. Thus they
pay little attention to working capital policy. To maintain a better
performance, the working capital rate of these companies should be as
low as possible. In the middle market strategy, the turnover rate is the
largest, and inventories and receivables to current assets are the
highest to provide their products to clients as fast as possible. Although
the adjustment extent is in the middle, they should also be mindful of
working capital because the marginal influence of working capital on
performance is the greatest, which can lead their performance to
become unstable. Based on the conclusions above, the hybrid strategy
is the best strategy choice for companies in terms of performance in a
fast developing wholesale and retail industry situated in a relatively
fast developing market.

Therefore, while an assessment of working capital management must

take into account strategic choices, this conclusion implies that
strategic choice is a feature that differentiates between firms on the
basis of their financial behaviors. One practical implication of our
research is that when managers of wholesale and retail companies
make decisions regarding their working capital policy, they should be
concerned with the consistency between working capital and their
strategic choice because it may influence the working capital
adjustment and therefore lead to a different performance. Thus, the
effects of strategy on working capital and the coherence between
strategy and working capital should receive the utmost attention.

Acknowledgment
This work is supported by the National Natural Science Foundation of
China under Grant nos. 71031004 and 71221001.

Conflict of Interests
The authors declare that there is no conflict of interests regarding the
publication of this paper.

Article information
ScientificWorldJournal. 2014; 2014: 953945.
Published online 2014 Jul 8. doi: [10.1155/2014/953945]
PMCID: PMC4121159
PMID: 25121141
Chuan-guo Li,* Hui-min Dong, Shou Chen, and Yan Yang
Business School of Hunan University, Changsha 410082, China
*Chuan-guo Li: moc.361@uhougnauhcil
Academic Editor: Tiaojun Xiao
Received 2014 Mar 11; Revised 2014 Jun 18; Accepted 2014 Jun 19.
Copyright © 2014 Chuan-guo Li et al.
This is an open access article distributed under the Creative Commons
Attribution License, which permits unrestricted use, distribution, and
reproduction in any medium, provided the original work is properly
cited.
Articles from The Scientific World Journal are provided here courtesy of
Hindawi Limited
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CASH MANAGEMENT

Accounting Best Practices: Cash Management

By Bruce Mayer, Peg Nolan, Steve Wolfe
Our vision for this accounting best practices series is to examine fundamental financial tools and
best practices for co-ops that promote overall financial health and the ability to improve. In
previous articles, we reviewed best practices for the balance sheet (Cooperative Grocer Nov.–Dec.
2011), the income statement Jan.–Feb. 2012), and internal controls (March–April 2012).

This final installment covers cash management. Understanding cash flow keeps the doors of your
co-op open and is essential if you want to build your co-op's future. It can answer the question: "If
the income statement says we are making money, why don't we have any cash?"

Note: Please don't guess! A qualified accountant or experienced co-op consultant can be an
important resource for you in analyzing your cash management practices and needs.

Cash management is big

Cash management is multifaceted in that it involves every aspect of your co-op's organization and
requires you to understand and develop sources of cash, know how cash is generated by your
business, learn how to structure debt capital, and, in a crisis, how to generate cash in a hurry.
Together your balance sheet, income statement, and cash flow statement are a map that you can
use to understand how to be successful and make money and profit for your members.

How does your cash flow?

It is not unusual to have a circumstance where the co-op has a cash shortage at the same time as its
income statement shows a positive net income. How can this be? A cash flow statement (see
template, page 22) narrates the story of where cash came from and where it was spent. It
summarizes all cash received or paid out by the co-op within a specified period of time.

In business, cash is generally invested to support the increase of non-cash assets such as inventory
or fixed assets or to decrease liabilities such as payables or principal payments on long-term debt.
Note: interest payments on your debt are expensed as "other expenses" on your income statement.)

Usually there are only two entries from your income statement that appear on a cash flow
statement. They are net income (positive or negative) and depreciation and amortization (a non-
cash expense). All other items are reflections of changes made to your balance sheet over the time
period specified.

Always know your cash needs

Grocery operations require a significant amount of cash to operate smoothly. To avoid cash
shortages, a co-op general manager (GM) needs to assess how much cash is needed at any given
time. It is a best practice for GMs to know their co-op's cash needs well enough to anticipate and
plan for cash shortfalls.

Co-ops that are managing their cash closely must develop a budgeting process that allows them to
anticipate cash shortfalls. A best practice is a weekly cash budget that should then be monitored
against the actual bank balances. Doing this ensures that you know that there is enough cash
available to keep the doors open.

Evaluating sources of cash

Once you know your cash needs, you can put together a long- and short-term plan for generating
cash in advance of running out. If you can anticipate your needs well enough in advance, equity or
debt issuance are good options. Shorter-term, useful strategies for generating cash quickly include
slowing cash outflows through delaying payment of invoices and reducing inventory.

Following the opening of one expanded co-op, the GM sat down to reconcile the sources and uses
budget with the actual project costs and calculated that when it opened they had about $200,000
remaining in the project budget to sustain them until operations were generating enough cash to
cover costs. This was more available cash than they had anticipated because their construction
costs had come in under budget. Since opening, however, gross sales had leveled off to a weekly
average of $55,000 instead of the $65,000 budgeted in the proformas. Additionally, labor expenses
were higher than budgeted, and monthly inventories showed that the gross margin was too low.
Though gross sales, margin, and labor had been steadily improving, the amount of cash they were
spending to cover initial losses following the opening (their "burn rate") was averaging
$10,000/week. It was during week eight that the GM conducted this analysis, which indicated that
the co-op had about 12 weeks to get operations to a "cash-neutral" position (burn rate of zero
dollars), or they would need to get an infusion of cash. While dollars were coming in as planned
through additional member loans and new member equity, clearly that wasn't going to be enough.
A plan was needed to secure additional cash, as well as to improve operational performance more
quickly. He calculated that they would likely need an additional $100,000 to bridge them to a
cash-neutral position.

Banking relationships
Good cash management includes establishing and maintaining a good relationship with the
banking institution that holds your cash. Many co-ops have been able to obtain needed capital at
critical moments based on their rapport with lenders and others.

Two important notes: One, do not underestimate the value of your business to a bank. Having the
high volume of transactions, large cash balances, and the need for loans and other banking
services makes your co-op attractive to a bank. Two, when evaluating a bank, make sure that you
will have the ability to review bank transactions online. This is critical for cash management and is
also important in allowing for the segregation of duties for internal control over cash.

Line of credit
Having a line of credit available is a best practice and is important to be able to cover any
temporary shortfalls without causing disruption to your operations. It is especially important to
have arranged this well in advance of your need since it will be difficult to negotiate one if you are
in the midst of cash flow issues. These lines of credit typically have requirements to pay them off
annually, so you should not plan to use them for long periods of time. In our co-op expansion story
above, if a line of credit for $100,000 had been established as a part of their expansion plan, they
could have used it to bridge their cash gap, effectively "buying" more time to steady their
operations and develop other capital if needed to ensure cash flow.

Accounts payable management

When cash flow is tight, slowing payment of accounts payable and other liabilities can help
immediately. Some things must be paid on time, such as taxes, especially payroll taxes, and
invoices with early payment discounts or late payment penalties. Keeping communications open
with vendors is critical to avoiding disruptions in delivery or sudden COD requirements.

Reviewing your accounts payable list may generate additional ideas that you can include in your
cash plan strategy. Are there stakeholders in your co-op that may be willing and are positioned to
assist you in your plan to bridge a cash gap? Banks, landlords, vendors, members, your
community, and local government and businesses all have a vested interest in your co-op's
continued success. Having a good plan is key in being able to engage them properly.

Inventory management
One of the largest assets on your balance sheet is inventory. There are a few different ways to
generate cash quickly from your inventory.

Extend your terms. If you can defer payment of vendor invoices by extending your invoice terms
from, say, 10 days to 21 days, your cash should go up by the average dollar amount of 11 days'
worth of invoices. In essence, your vendor becomes a partner in financing your inventory.

Since it is such a large asset, reducing inventory can be another way of generating cash quickly.
This is generally accomplished by carefully decreasing the amount of back stock that you keep on
hand without causing unnecessary out of stocks. A ratio you can use over time to monitor progress
is inventory days (aka days of inventory), which is the average number of days that inventory is
owned by the store before it is sold. The greater the number, the longer the inventory sits in the
backroom or on the shelf before it is sold.

If your back stock is already lean, you could consider intensifying your category management
efforts for ways to generate cash, but this would likely take longer.

A new wellness manager was hired in one co-op, and after six months the store manager
discovered that wellness department inventory had gradually increased by $50,000. The GM was
furious, but upon reflection recognized that the department manager was new to management and
did not have proper training, plus there were no policies in place to prevent such a mishap.

Capital structure and debt management

In general, every business needs to understand its own capital structure and how it can be
managed to optimize return on investment for your members. You can evaluate it by looking at
your debt-to-equity ratio, which shows the ratio between capital invested by the owners and the
funds provided by lenders and other creditors, i.e., how much of your business is financed through
debt and how much is financed through equity. Note: A best practice is to annually review your
debt and interest terms for opportunities that optimize your debt structure to meet your cash needs.

In conversation recently one GM was questioned by her peers about the interest rate their co-op
was paying on their primary loan. Prompted to analyze it, they found that with little work and no
cash they could easily refinance this source of capital, resulting in lower monthly payments and
savings to the co-op of over $10,000 in reduced interest expense over the life of the loan.

Good capital structure does not mean that your co-op has no debt. It means that you are managing
the risks and benefits of available capital and optimizing member benefit. Any time the debt-to-
equity ratio is less than 1:1, there will almost always be a large cash balance. Is there a way for
you to invest excess working capital in your growth, your future, and/or your mission? How much
can you invest without putting your current co-op business at risk? These are only some of the
important questions you will want to ask yourself. Engaging with your peers and experts can assist
you in detecting and answering questions that facilitate your understanding of risk so that you can
protect and leverage your co-op's assets with more confidence.

Members have a role in investing in their co-op's future. Developing ways for them to invest in the
co-op can build less-expensive sources of capital for the co-op. It can also contribute to co-op
profitability by decreasing the amount of interest paid through higher loan rates. And it can deliver
interest to co-op members instead of outside lenders. Larger net profits for the co-op can deliver
larger patronage dividends to members in good years.

In years when the board of directors declares a patronage dividend, it is important to know your
working capital needs before you declare what portion will be delivered to member owners in
cash. An analysis of paying taxes or paying patronage dividends often shows the advantage of
paying patronage dividends, especially if only a portion is paid out in cash. The maximum a co-op
can retain is 80 percent. This serves to reward members who shop at the co-op, and it builds your
balance sheet (member equity) while reducing your tax obligation. Designing the patronage
dividend cash portion so that it can be redeemed as a store coupon can also help to keep more of
the cash portion in the co-op.

Got cash? How can you leverage it well?

Many co-ops maintain very high cash balances. Cash levels should be reviewed regularly to
determine that the co-op is fully leveraging this asset. Since current interest rates on short-term
deposits are low, the use of sweep accounts and transfers to money market accounts or certificates
of deposit will yield very little income.

Investing your excess cash in debt repayment, a co-op loan fund or local community development
organization, or another co-op project may be a way for the co-op to achieve its mission. Since all
co-ops benefit from a stronger co-op community, the use of excess cash to support other co-ops
has multiple benefits. We caution co-ops to conduct a rigorous evaluation of the risks and benefits
before making direct investments. In general, investing in areas associated with your core
expertise is less risky, but we know that there are additional opportunities for investment that
support your mission (e.g. farm, vendor, or community venture). All should be evaluated carefully.

Conclusion
Cash management is critical to the success of your co-op. We have discussed ways to evaluate the
liquidity needs and capital structure of your co-op, as well as some of the options for managing
your cash. Running a successful co-op requires expertise in so many areas that it is critical that
you consult with experienced advisors when the stakes are high and knowledge of the options may
not be readily available on staff or with your board.

CREDIT MANAGEMENT

Credit Management for

Cooperatives
Credit Coop Business: PINOY Style

• Member puts in share capital because he intends to borrow.

• Share capital as source of funds.
• Acquisition of land and building not regulated.
• External credit is used to fill up the gap of low repayment and
weak internal capital mobilization.
• Interest rates on loans not reasonably designed to meet cop’s
income needs.
• Lending policy is not clear.
10/19/15

• Loan limit is based on capital share.

merlene quiba flores. panabo city

What is credit?

• Latin base “credo” meaning faith or trust.

• The ability of the debtor to obtain goods or
services without an actual tender of
payment.
• The transmittal of economic value now, on
faith in return for an expected equivalent
economic value in the future- (J. Allen
10/19/15 Walker)

Purpose of Credit
• Productive purposes - to finance production
activities of it’s member-borrower. (crop
prod’n. livestock prod’n. & breeding)
• Providential purposes – Intended for nonproductive purposes but
provides for the
emergency and providential needs.
(health/medical
services, educational)

Credit terms
• Short term – the borrower must pay the loan
within one year or less.
• Medium or intermediate term – Loans payable
in one year up to five years.

• Long term – loan payable for more than five

years. merlene quiba flores. panabo city

Credit repayment schemes

• Amortized loans – the principal and interest (fixed
principal + interest payments)will be paid regularly
weekly, monthly, etc.
• Single payment loans – principal and interest will be
paid at one time and in full on the last day of the
loan term.
• Discounted interest – automatic deduction of the full
amount of interest from the total loan, principal is
either paid in lump sum or installment during the
loan
term.

Why do we give credit?

• Because borrower had
signed documents,
promising to pay at
designated amount and
time.

What are the elements of credit?

• Trust or confidence
• Risks
• Period or term of payment

What are the basis of credit?

• Character
• Capital
• Capacity
• Condition
• Collateral
• (Connection)

Basic considerations in granting

loans

• Borrower’s background - done through

credit & background investigation with
focus on the following factors: character,
capacity, collateral, capital, conditions

Basic considerations in granting

loans
• Co-maker’s background – equally important
to be investigated. Some basic factors to
consider are:
- Status of the co-maker: a co-maker must
have good credit standing with the coop.
- Capacity to guarantee loans: a co-maker
must have sufficient assets.
• Thoroughly evaluate co-maker’s capacity to guarantee loans.

Important lending
processes/transactions
• Loan Analysis/credit Initiation

• Disbursements and documentation

• Collections/credit administration

• Monitoring and reporting/remedial management

merlene quiba flores. panabo city

Loan Analysis/credit Initiation

• The first step in credit
process.
• Credit and background
investigation is done.
• Written CIBI report
should be complete and
updated every six
months.
• Evaluation and
analysis of loan
applications.
• Evaluation of
credit/project
proposals.
• Credit committee
validation.
• Loan approval

Disbursements and documentation

• Necessary documents
supporting transactions
are complete.

• Documents that
provide basis for loan
grant:

• Loan agreements signed.

-Loan proposal

• Loan release-in
accordance with
disbursement procedures.

-Loan agreement

-Promissory note

-Collateral/securities
documents
merlene quiba flores. panabo city

Collections/credit administration
• After loan release- coop
to administer close
monitoring of the
borrower.

• Formulation &
installation of
Innovative collection
scheme.

• Installation and
maintenance of credit
files.
• Loan Supervision

Monitoring and reporting/remedial

management
• Coop institutes remedial
measures to minimize
loss & restore weak
credits.
• Major activities:
- Remedial measures
-Monitoring the
implementation of
remedial measures.

- Problem identification
and recognition
10/19/15

merlene quiba flores. panabo city

Functions of key staff in credit

management
• Board of Directors
-has over all
responsibility of
maintaining safe
productive lending
operations.

10/19/15

• Loan
approval,formulation
of policies.

merlene quiba flores. panabo city

Functions of key staff in credit

management
• CRECOM – critical
unit responsible for
protecting the quality
of coop loan portfolio.
• Evaluate, approve,
recommend for
approval.
• Recommend remedial
actions to the manager.
10/19/15

merlene quiba flores. panabo city

Functions of key staff in credit

management
• MANAGER –
responsible for the
day to day
management of the
coop operations.
• Organize and assign
responsibilities to key
management staff.
10/19/15

merlene quiba flores. panabo city

Functions of key staff in credit

management
• LOAN OFFICER –
responsible for
undertaking the
details of credit
operations.

10/19/15

• Promotes coop
services, analyzes and
recommends for loan
approval, maintains
merlene quiba flores. panabo city credit files.

Preventing Delinquent Loans

• Continuous orientation and education of
members
• Installation of credit management systems
prior to credit delivery
• Conduct of hones-to-goodness CIBI
• Close monitoring of loans/establish
relationship with the borrower
• Provision for insurance
quiba flores. panabo city
• Loan approvalsmerlene
and releases

10/19/15
The CREDIT FILES (Importance)
• Provide Crecom, Manger and key
management staff with critical info
regarding the borrower.
• Reference in support of the extension of
credit to borrowers.
• Ensure smooth turn-over of functions.
• Professionalize lending operations in
accordance with formal banking procedures
10/19/15 and practices.merlene quiba flores. panabo city

The CREDIT FILES (Contents)

• Record of coop’s past experience with
the borrower,
• Credit facility proposal
• Background information
• Credit investigation report
• Titles on properties offered as collateral
• Project inspection reports
• Promissory notes

10/19/15

• Other relevant information such as

business permits, registration
merlene quiba
flores. panabo city
documents

LOAN SUPERVISION
• Monitor progress of the project
implementation that will enable the coop to
determine potential problem/s arising from
such accounts.
• Ensure that the terms and conditions of the
loans are being complied with.
10/19/15

merlene quiba flores. panabo city

LOAN SUPERVISION
• Develop a credit relationship with memberborrower to bridge the
information gap for
future credit decisions.
• Ensure prompt payment at maturity of the
principal, accrued interest and other charges
or expenses associated with the transaction.
10/19/15

merlene quiba flores. panabo city

LOAN SUPERVISION
• Ensure that the mechanism to generate
available management options in improving
collection of loan accounts includes legal
deposition and execution of alternative plan
of action including restructuring and
refinancing in some cases.

10/19/15

merlene quiba flores. panabo city

MEASURING LOAN
PORTFOLIO
LOAN PORTFOLIO – largest asset
in a cooperative

10/19/15

merlene quiba flores. panabo city

Importance of portfolio
management
• Enables financial institution to
continue to provide a needed
service
• Critical to the survival of a credit
union
10/19/15

merlene quiba flores. panabo city

There is always RISK in

lending money

10/19/15
merlene quiba flores. panabo city

3 critical challenges of Loan

Portfolio Management
1.

Measure and monitor the amount of risk

in the portfolio

2. Understand the way the quality of the

portfolio affects the institution’s

INCOME

3. Find ways to manage the credit

10/19/15

operations to minimize risk of the

portfolio
merlene quiba flores. panabo city

The LOAN PORTFOLIO

• Principal – makes up the loan portfolio;

part of the cooperative’s asset

• Interest – contributes to the cooperative’s

income and cash flow
10/19/15

merlene quiba flores. panabo city

3 measures to describe
quality of loan portfolio
• DELINQUENCY
• REPAYMENT

10/19/15

• LOAN LOSS PROVISIONS

merlene quiba flores. panabo city

LOANS:
The Lifeblood of Credit Cooperatives
• Loan delinquency – one of the most common
and most serious problems a coop may have.
• Weakens the operations of the cooperative.
• Slows down the delivery of services to
cooperative members.

10/19/15

merlene quiba flores. panabo city

How to make Coop Members

responsible borrowers
• Proper education through PMES.
• Should have a basic knowledge about the
cooperative principles.
• Should have adequate information about the
products and services of the cooperative.
• Should have thorough information about the
duties & responsibilities of a cooperative
member.
10/19/15

merlene quiba flores. panabo city

High, Rising or Uncontrolled Delinquency

“ One of the most common

problem that can quickly
destroy a cooperative if
management does not
locate the cause &
remedy the problem”
10/19/15

merlene quiba flores. panabo city

Delinquency definitions
• If a members fails to pay the loan as promised or as per
agreement
• Any type of loan which is not paid when due
Delinquent by installment
Delinquent by maturity
Portfolio at risk
o Mode of repayments and due dates
o Amount of installment
10/19/15

o Term of maturity

merlene quiba flores. panabo city

How to monitor & measure delinquency

• Aging of accounts
• Loan status monitor (LSM) –
attached to the individual loan
ledger (ILL)
10/19/15

merlene quiba flores. panabo city

Aids in Monitoring Delinquency

• Number & Amount of Delinquent loans
by age
• Number of delinquent loans by purpose
• Number & amount of delinquent loans by
economic activity & sex
• Number of delinquent loans by amount
10/19/15

merlene quiba flores. panabo city

Causes of DELINQUENCY
• Personal Problems
• Financial Management
Difficulties
• Unexpected circumstances
• Cooperative Shortcomings
• Policies & Procedures
10/19/15

merlene quiba flores. panabo city

Causes of Loan Delinquency

• Organizational (Internal Factors)
Laxity in screening/recruiting possible
members
Poor/Inefficient processing of loan
applications by cooperative staff/officers
Poor monitoring, recording and reporting
system
Weak collection system and procedures
10/19/15

merlene quiba flores. panabo city

Causes of Loan Delinquency

• Organizational (Internal Factors)
Irrelevant, Un-disseminated and unwritten
Lending policies & guidelines
Poor staff services
Poor leadership example/bad management
Officers’ poor attitude toward training

10/19/15

merlene quiba flores. panabo city

Causes of Loan Delinquency

• Personal (Member factors)
– Inadequate paying capacity
– Mis-use of funds
– Misunderstanding of the
coop’s objectives

10/19/15

merlene quiba flores. panabo city

Causes of Loan Delinquency

• Personal (Member factors)
– The borrower cannot be contacted
– Lack of technical skills in
business
– Poor savings habit

10/19/15

merlene quiba flores. panabo city

Effects of delinquency
• Demoralization among cooperative
members
• Resignation of staff & Officers
• Loss or dormancy leading to bankruptcy
• Coop’s role in the community ends
• Loss of goodwill in the cooperative
movement
10/19/15

merlene quiba flores. panabo city

Costs of Delinquency
• Delinquency plays a critical role in
cooperative’s cost, structure, income and
financial situation.
• Delinquent loans imply postponed interest
income from loans with payments past due.
• Delays in income can have serious,
detrimental effects on the cooperative’s cash
flow and self sufficiency.
10/19/15

merlene quiba flores. panabo city

Costs of Delinquency
• Delinquency slows down the rotation of the
loan portfolio.
• Allowing members to miss payments even
though they eventually repay, allows the
institution to lose vital income needed to
cover the costs.
10/19/15

merlene quiba flores. panabo city

Costs of Delinquency
• De-capitalize the portfolio
• Decrease the cooperative assets
• Provisions for defaults have direct
effects on the cooperative’s income
and assets
10/19/15

merlene quiba flores. panabo city

Calculating Cost of Default Considering Variable Costs
Intial Loan Amount
Interest (15% flat)
Loan Term (weeks)
Weekly Repayment of Principal
Weekly Repayment of Interest
Total Weekly Repayment
Payments Received
Payments Lost

75,000.00
25

15
10

Lost Interest Income

Lost Principal
Total Lost Interest and Principal
Expected Revenue earned (75,000 loans for 25 weeks)
Cost per Loan
Net Revenue per Loan

Number of Loans Required to Earn Lost Principal

( taking into account variable costs of disbursing and managing loans)

7,500.00

Loans of 75,000

Lost Principal/Net Revenue per 75,000 loan

Number of Loans Required to Earn Lost Interest and Principal

10/19/15

( taking into account variable costs of disbursing and managing loans)

merlene quiba flores. panabo city

Lost Interest and Principal/Net Revenue per Loan

Loans of 75,000
Calculating Cost of Default Considering Variable Costs
Intial Loan Amount
Interest (15% flat)
Loan Term (weeks)
Weekly Repayment of Principal
Weekly Repayment of Interest
Total Weekly Repayment
Payments Received
Payments Lost

75,000.00
25

none
25

Lost Interest Income

Lost Principal
Total Lost Interest and Principal
Expected Revenue earned (75,000 loans for 25 weeks)
Cost per Loan
Net Revenue per Loan

Number of Loans Required to Earn Lost Principal

( taking into account variable costs of disbursing and managing loans)

7,500.00

Loans of 75,000

Lost Principal/Net Revenue per 75,000 loan

Number of Loans Required to Earn Lost Interest and Principal

10/19/15

( taking into account variable costs of disbursing and managing loans)

merlene quiba flores. panabo city

Lost Interest and Principal/Net Revenue per Loan

Loans of 75,000

Preventive & Curative Measures for

Delinquency
• Prevention
– Formulation, Review and Improvement
of Lending Policies and Guidelines
– Proper Implementation of upgraded
Lending policies & guidelines
– Setting up/improving the loan
monitoring & collection system
10/19/15

merlene quiba flores. panabo city

Preventive & Curative Measures for

Delinquency
• Prevention
– Incentive & reward system for nondelinquent borrowers
– Training & Education for coop
members
10/19/15

merlene quiba flores. panabo city

Preventive & Curative Measures for

Delinquency
• Curative
– Off-setting member’s share & savings
– Applying the obligation of co-makers
– Accepting payments in kind
– House calls on delinquent borrowers
– Condonation of penalties
– Authorizing collection agents
– Legal action

10/19/15

merlene quiba flores. panabo city

Methods for Delinquency Control

• Coop image and Philosophy – “dole-out”
mentality of the members.
• Methodology /Credit process– not clear lending
and collection policies.
• Information systems / Internal Management –
Information not clear; data not updated.

10/19/15

merlene quiba flores. panabo city

Coop image and Philosophy

• Members should understand that in accepting
loan, they agree to a financial contract.
• Coop should create an institutional repayment
culture.
• Culture should start at coop level.

10/19/15

merlene quiba flores. panabo city

Methodology / Credit Process

• Accepted loan analysis and evaluation
methods.
• Design incentives for members who pay loans
on time.
• Immediate follow-up after one day missed
payments.

10/19/15

merlene quiba flores. panabo city

Information systems / Internal

Management
• Up to date information for field workers.
• Regular review and analysis of the loan
portfolio.
• Planning geographic routes to maximize
collection.
• Follow-up.
• Fast loan processing.
10/19/15

merlene quiba flores. panabo city

Identifying the cause of rising
delinquency
• When were the delinquent loans granted?
• Were a majority of the delinquent loans
granted by the credit committee or one
particular loan officer?
• Have there been any employee changes that
would affect the quality of loan underwriting
or collection efforts?
10/19/15

merlene quiba flores. panabo city

• Are the loan officers or credit committee

adequately trained to grant quality loans?
• Do the delinquent borrowers have anything in
common? Are they related? Do they live in the
same area? Do they work together? Do they
have similar occupations?
• Have the loan underwriting standards
decreased as of late in order to increase loans
outstanding?
10/19/15

merlene quiba flores. panabo city

Continuation…
• Do the loan officers or credit committee
effectively analyze the borrower’s ability to
repay the loan granted?
• Are the loan and collection policies &
procedures adequate?
• When do collection efforts begin once a loan
becomes delinquent? Is this quick enough?
10/19/15

merlene quiba flores. panabo city

Continuation…
• Are collection efforts effective?
• Is the collection department adequately staffed
and focused to meet the challenges of high or
increasing delinquency?
• Has anyone manipulated the delinquency
information in the past to hide delinquency?
• Has there been a major event that is beyond
the cooperative’s control?
10/19/15

merlene quiba flores. panabo city

There is always RISK in

lending money

10/19/15

merlene quiba flores. panabo city

Delinquency the most

important test of
institutional strength of a
cooperatives.
10/19/15

merlene quiba flores. panabo city

Problem Resolutions for High

Delinquency

10/19/15

merlene quiba flores. panabo city

Workshop
•

10/19/15

Using the result of the fishbone analysis,

develop possible solutions for the identified
causes of delinquency

merlene quiba flores. panabo city

Problem Resolution
• Management &
Officers should
ensure that
delinquency is
correctly
calculated &
disclosed
10/19/15

merlene quiba flores. panabo city

Problem Resolution
• Management should ensure that the
delinquency report is useful.
• Employees working with delinquent loans
should perform a review of each loan to
determine their collectivity.
• All charged-off loans and loans that are in
need of legal action should be given to lawyers
or collection agencies.
10/19/15

merlene quiba flores. panabo city

Problem Resolution
• All charged-off loans and loans that are in
need of legal action should be given to lawyers
or collection agencies.
• Management should ensure that interest on
loans is not accrued when loans become
delinquent.

10/19/15

merlene quiba flores. panabo city

Problem Resolution
• Management should determine that the
allowance for loan loss account is adequate for
all potential losses.
• The use of loan extension and refinances
should be strictly limited.
• If loan underwriting appears to be the source
of problem, the credit policies and procedures
should be revised.
10/19/15
merlene quiba flores. panabo city

Problem Resolution
• If delinquency is high or increasing due to the
actions of one specific employee, that
individual should be “terminated”, removed
from the position or placed in another position
or adequately trained.
• Loan application forms should be reviewed so
as to collect necessary information.
10/19/15

merlene quiba flores. panabo city

Problem Resolution
• If loan collection practices appear to be at
fault, the policies and procedures should be
reviewed.
• In the cooperatives, collection activity is an
afterthought and the collection work is given
to an employee who has some extra time.

10/19/15

merlene quiba flores. panabo city

Loan Analysis & Evaluation

10/19/15

merlene quiba flores. panabo city

CREDIT EVALUATIONS

– Key to Credit Union Success

Bigger financial risk in credit union operations lies in
loans
Credit union financial strength come from profits
generated by the loan portfolio
Profitability of the loan portfolio is high when
delinquency is low.
The best place to stop bad loans is in credit
evaluations- before they happen!
10/19/15

merlene quiba flores. panabo city

How does the cooperative

determine the borrower’s
capacity to pay?

10/19/15

Every decision to lend money is a

judgment about whether a person
will repay the loan or not. That
judgment is based on the analysis of
the data that cooperative has about
the borrower.
merlene quiba flores. panabo city

Tools in Determining
Creditworthiness..
• Additional sources for credit information:
 Credit Union files - to check the member’s
various accounts, frequency of loan application,
previous loan decisions, repayment records
 Employer’s files - to verify the member’s length
of employment,salary & loans from the
company
 Personal knowledge - to reinforce information
obtained from other sources
10/19/15

merlene quiba flores. panabo city

Tools in Determining
Creditworthiness...
LOAN APPLICATION -when

evaluating the loan application,

one should consider the following:
 length of residence of applicant

 amount of loan

 employment of the applicant and

the employment length

 purpose of loan
 collateral offered, if any, the value
and its condition
(CU employee should do a physical
inspection)
 total monthly obligations of
applicant

 monthly income of the applicant

(stable and sufficient)
 credit and savings history at
credit union
 personal and credit references

 number of dependents
10/19/15

merlene quiba flores. panabo city

Tools in Determining
Creditworthiness...
• LOAN INTERVIEW -should be conducted for any loan that poses a
risk to the credit union’s capital. It is helpful to:
 Elaborate information in the application--know the borrower
 Provide credit counseling about the wise use of credit-- borrowing
your
neighbor’s money, not donor funds.
 Determine the reliability of the applicant according to their personal
history
and references
 Establish a personal relationship-- make them understand that this is
also
their credit union
 Sell other credit union services and educate the member about the
CU’s
philosophy--use this personal time wisely--IMPRESS THE BORROWER.
10/19/15

merlene quiba flores. panabo city

Tools in Determining
Creditworthiness...
• LOAN WORK-UP SHEETS - This worksheet

brings all the most important information

together and helps the credit committee or
the loan officer make a timely and effective
credit decisions. Useful elements include:
• Verified income and debts
• Verified value and condition of collateral
10/19/15

merlene quiba flores. panabo city

Tools in Determining
Creditworthiness...
• COLLATERAL INSPECTION FORM - This form is used by credit
union personnel to document the condition of the collateral. Important
information includes:
 Description of the collateral offered
 Identification or serial number
 What is the value of equipment included with collateral
 Over-all condition of the collateral
 Estimated value
 Any noticeable damage
 Can collateral be legally possessed?
10/19/15

 If possessed, can it be easily sold?

merlene quiba flores. panabo city

Tools in Determining
Creditworthiness...
• OTHER DOCUMENTS NEEDED:
 Written verification of income
 Savings and credit history at the credit union
 Collateral agreement
 Proof of insurance on collateral
 Appraisal (in addition to the physical inspection for
specific cases)
 All of the same information for the co-makers/co-signors .
10/19/15

merlene quiba flores. panabo city

CREDIT ANALYSIS
• Credit analysis is not
examining facts
separately but
establishing a
relationship between
all the components
that affect
CRECOM’s
decisions.
10/19/15

merlene quiba flores. panabo city

Purposes of Credit Analysis



Credit analysis is for

evaluation of
information about the
member


To determine the
credit worthiness, so
that sound loan
decisions can be made


To avoid bad loans

(delinquent loans)

10/19/15

merlene quiba flores. panabo city

Components of Credit Analysis

• Loan application

• Loan interview

• Verifications

• These components
should:
 Reveal member’s identity
 Show stability, capacity
to repay and credit
history
 Be consistent

• Credit Score

10/19/15

• Credit Profile

 Should be evaluated
thoroughly and
objectively
merlene quiba flores. panabo city

Tools for determining

creditworthiness
∞ The five C’s of credit:
• CAPACITY TO PAY
• CHARACTER
• CAPITAL
• CONDITION
• COLLATERAL

∞ Loan Application
∞ Loan Interview
10/19/15

merlene quiba flores. panabo city

How Does the Credit Union

Determine the Borrower’s
Capacity to Pay?
Using the 5C’s of CREDIT
capital

character
capacity

conditions
10/19/15
collateral

merlene quiba flores. panabo city

What is Capacity Based

Lending?
• Is a non-traditional lending
practice in the cooperatives that
gives loans based on the capacity
of the members to pay.

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Security first
- members’ savings
- cooperatives
Loan Quality first
before quantity

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Evaluation of
risk
- set the limit of
manageable risk

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Grant loans to
members with
good standing &
capacity to pay

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Thorough
credit
investigation

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Loan is a
privilege rather
than a right
inherent to
membership

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• No loan will be
extended to
member with
delinquent
account

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Balance
between risk,
diversification
and
profitability

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Limiting loan
exposures to
certain
geographical
area

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• Collateral for
commercial,
real estate and
agricultural
loans

10/19/15

merlene quiba flores. panabo city

What are the Principles of CBL?

• 70% financing
for viable
project
• 30% member
participation
10/19/15

merlene quiba flores. panabo city

5 Cs of Credit
• Capacity – This refers
to the memberborrower’s proven
capability to repay the
loan on the agreed
terms

10/19/15

merlene quiba flores. panabo city

5 Cs of Credit
• Character
- integrity, credibility,
trustworthiness of the
member-borrower and or
the co-borrower

10/19/15

merlene quiba flores. panabo city

5 Cs of Credit
3

Capital
regular, consistent amount
of savings or
contributions to the buildup of financial, material
resources
10/19/15

merlene quiba flores. panabo city

5 Cs of Credit
Collateral
Real, personal and deposit
certificates that can be
offered as security to the
loans
10/19/15

merlene quiba flores. panabo city

5 Cs of Credit
5

Condition
External factors affecting the socioeconomic
condition of the loan and the borrower

10/19/15

merlene quiba flores. panabo city

Collections

10/19/15

merlene quiba flores. panabo city

Collection …..a big challenge

Between effectiveness ,
relationship, social involvement ,
and education
10/19/15

merlene quiba flores. panabo city

Because cooperative must

• Be efficient …
• Other time ..coops must create relationship
• Other time ….it needs social involvement
• Other time……coops must do education with the
members
• The problem is that coops cannot be all of that ….at the
same time so coops must choose what to do and when
….
10/19/15

merlene quiba flores. panabo city

Be efficient ….why ???
• Because the cooperative invest money in collection
and wants to recuperate the money of the borrowers
for the depositors
• A collector paid Php 7,000 pesos a month plus fringe
benefits plus motorcycle could cost up to Php 10,000
pesos a month
• How much revenue will a cooperative need to cover
the investment on a collector ?
10/19/15

merlene quiba flores. panabo city

How much per day ??

• So 10,000 pesos per month divided by a rate
of interest of :
– 2% means 500,000 or more than 25,000 a day
– 1% means 1,000,000 or more than 50,000 a day

• Assuming: visiting 20 persons per day means

that collectors should collect between 1,250 to
2,500 per borrower
10/19/15

merlene quiba flores. panabo city

So it is important to plan your intervention

to become efficient ….
• How to plan :
– Have the list of the borrowers to visit during the week and
the amount to collect
– Select with the loan monitoring officer the ones to prioritise
based on amount to collect and the capacity to collect
– Organise your collection for the day based on the route ,
your constraints and the planning of the rest of the week
( Pay day,remittances from OWF)
– Review your day ( done ,not done ,posponed )
– Rescheduled the ones
not done
merlene quiba flores. panabo city

10/19/15

How to organise and do your day ?

• While planning look at :
– Logical schedule route A to B …W
– Identify the borrowers that MUST be done ….and your
constraints ( Appointments from promises )
– Respect your word : Will come back ..you come back exactly
as you promised .
– Have time ( five minutes ) to review what has been done and
reorganize what you have to do for the rest of the day
– Open your mind on opportunities ……to collect
– BE DISCIPLINED….
merlene quiba flores. panabo city

10/19/15

How to do collection …
• Be polite ..
• Be firm ….
• Be Strict
• Be listening ….without agreeing
• If you do not get money ….get a date and hour …and go back
on due time
• Be respectful
• Leave your heart at home ….and your problems at ….the office
….

10/19/15

merlene quiba flores. panabo city

Relationship and social involvement

• Purely professional relationship otherwise you lose
your credibility ….
• Friendship must be avoided when you want to collect
…Ask someone else to do your friends and relatives
• You can help sometimes in exceptional circumstances
but you have a job to do ….do not forget that …and
cannot be involved everywhere .
10/19/15

merlene quiba flores. panabo city

Education of the borrowers

…start …
• With their payment on a disciplined way
• And continue with a non delinquent account
with the primary
• And the respect for the job of collection (not
escape neither hide when they hear you
around ) only criminals hide themself not
members. Are your borrowers criminal?
10/19/15

merlene quiba flores. panabo city

COLLECTION
STRATEGIES

10/19/15

merlene quiba flores. panabo city

(Effective Collection
Strategies)

Why do we need to collect

loans?
#
o
f

d
a
y
s

10/19/15

merlene quiba flores. panabo city

How Can Collectors

Improve Collection?

• Using the Basic Tools:

10/19/15


Acceptable policies and
procedures

Know some habits and

characteristics of the
borrowers

Timely management
information system

merlene quiba flores. panabo city

The Solid Collection

Program

• Written Collection Policies and Procedures-

implemented and administered by the management

and staff, reviewed (and updated) at least annually

• Timely Management Information System

(MIS)-delinquency reports made available to

Management, Collection Staff and Board at ALL

times; used as basis in identifying corrective
actions

10/19/15

merlene quiba flores. panabo city

The Solid Collection

Program
• Use of different collection strategies and
tools
• Recognition of loan losses, providing for
loan losses, charge-off and continued
collection activities after charge-off
10/19/15

merlene quiba flores. panabo city

Monitoring Collections

(Establishing A Collection System)

“A load made well, is a loan half collected”

10/19/15

merlene quiba flores. panabo city

How & When to establish a collection

system

• Recognition
• Follow-up
• Collection records
10/19/15

merlene quiba flores. panabo city

The Basics of Collection

• There must be an automatic
daily system to locate
delinquent accounts.
• There must be regular
charge-off or a referral
process for accounts the
collector cannot get action
on.
• Collection work is selling.
10/19/15

merlene quiba flores. panabo city

Account Classification
• In general, cooperatives should classify their
delinquent accounts according to age.
• The most past due an account is, the less likely
the cooperative is to receive payments.
10/19/15

merlene quiba flores. panabo city

Written Collection Work

• It consist of any written

communications between the
cooperative and the member
regarding missed payments.

10/19/15

merlene quiba flores. panabo city

Keys to a successful lending

program
• Develop a long term banking relationship with
your members
• Base loan decisions on repayment capacity
• Obtain non-traditional loan security
• Use the “graduation” principle
• Develop a relationship with the client
• Closely monitor loan repayments
10/19/15

merlene quiba flores. panabo city

Tools & Technique in Effective Loan

Supervision
• Conduct a site inspection.
• Project inspection/visit.
• Problem recognition.
• Officers familiarity with the borrowers.
• Be proactive in dealing with the borrowers.
• Proper documentation
10/19/15

merlene quiba flores. panabo city

Ways of Collecting Accounts

• Offer the borrower a clear choice of
action
• Get a reasonably short repayment
program
• Look for vulnerable areas of target for
collection effort
• Give the borrower a good reason to
weigh things clearly
10/19/15

merlene quiba flores. panabo city

Ways of Collecting Accounts

• Plan and exert psychological collection efforts.
• When drastic or legal action is finally decided
upon to enforce collection, proceed fast
because borrowers generally does things
damaging or unfavorable to the lender’s
interest.

10/19/15

merlene quiba flores. panabo city

Considerations in Loan Restructuring

• Require a reasonable amount of payment to be
assured of the borrower’s sincerity and
commitment.
• Validate sources of payments.
• Obtain written plan for the borrower.
• Make the borrower understand that lack of
amicable settlement will mean legal action by
the cooperative.
10/19/15

merlene quiba flores. panabo city

• Condonation of penalties as “incentive”.

CONCLUSIONS
• It is a fact that loan delinquency is a major
problem to many lending institutions in the
Philippines including cooperatives. The causes
of loan delinquency maybe due to unsystematized and passive
collection of loan
repayments and members’ misunderstanding
on their role as cooperative members.
10/19/15

merlene quiba flores. panabo city

CONCLUSIONS
• To deal with delinquency, the cooperative
should have a clear collection and lending
policies as part of financial management.
These policies should be properly
implemented and reviewed. This is the best
way to prevent delinquency to happen.
However, the strictness of such policies should
not hamper the good relationship that exist
between the officers/staff and the members.
10/19/15

merlene quiba flores. panabo city

“Credit is like a
flame; use,
value, nurture,
and manage it
well.”
10/19/15

merlene quiba flores. panabo city

Collection Process

10/19/15

merlene quiba flores. panabo city

Collection Procedures
• Collection Starts on the First day of after
a non-payment of amortization.
• Reminder letter should be sent within 15
days of delinquency.
• A Demand letter shall be sent if no action
is made with reminder letter.
10/19/15

merlene quiba flores. panabo city

A-1 Client Call/Visit
• Speak pleasantly and clearly
• Proper grooming
• Greetings
• Update of loan account/borrower
• Get reasons for non-payment
10/19/15

merlene quiba flores. panabo city

A-1 Client Call/Visit

• Know how he can make payment
• Date & place of payment
• RECAP
• DON’T FORGET TO
FOLLOW-UP
10/19/15

merlene quiba flores. panabo city

A-2 COLLECTION STRATEGY

AND TACTICS
STRATEGY – a plan of action
developed to achieve a goal or
objective.
TACTIC – the behavioral
maneuvering one undertakes to
carry out the strategy.
10/19/15

merlene quiba flores. panabo city

A-3 Application of
Payment
1. Miscellaneous Advances
(insurance, mortgage, legal)
2. Penalty
3. Interest
4. Principal
10/19/15

merlene quiba flores. panabo city

A-4 Debt Recovery Courses of

Action (non-legal)
• Extension/rollover of loan
• Restructuring
• Charge-off
• Collect from co-maker
• Sale of mortgage property
• Sale of other properties
10/19/15

merlene quiba flores. panabo city

• Sale of business

A-5 Remedies Used in Litigation

• Foreclosure – process by w/c a
mortgage acquires an absolute title
to the property upon which he had
previously a lien or encumbrance.

10/19/15

merlene quiba flores. panabo city

A-5 Remedies Used in Litigation

• Dacion en pago – a juridical concept
whereby a debtor pays off his
obligation to the creditor by the
conveyance of the ownership of his
property as an accepted equivalent of
performance payment (payment in
kind).
10/19/15

merlene quiba flores. panabo city

A-5 Remedies Used in Litigation

• Replevin – a provisional remedy
which may be availed of whenever the
complaint in an action prays for the
recovery of the possession of personal
property (bond).

10/19/15
merlene quiba flores. panabo city

A-5 Remedies Used in Litigation

• Attachment – a provisional remedy by
which property of the defendant is
taken into custody of the law as a
security for the satisfaction of any
judgement w/c the plaintiff may
recover.
10/19/15

merlene quiba flores. panabo city

A-5 Remedies Used in Litigation

• Garnishment – a warning to a person
in whose hands the effects of another
are attached, not to pay the money or
deliver the property of the defendant
in his hands to him, but to appear &
answer the plaintiff’s suit.
10/19/15

merlene quiba flores. panabo city

A-5 Remedies Used in Litigation

• Writ of execution – a judicial order
to enforce payment, satisfaction or
performance of a final judgment
against the defeated party in a case.
Valid only for 60 days.

10/19/15

merlene quiba flores. panabo city

RECEIVABLES MANAGEMENT
INVENTORY MANAGEMENT- Skip to main content
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Share:
Working Capital Management of Cooperatives Among State Universities
and Colleges in Caraga
Proceedings Journal of Education, Psychology and Social Science
Research

4 Pages
Posted: 16 Mar 2018
Hasmenia N. Lasque
Surigao del Sur State University

Date Written: August 30, 2016

Abstract
This research assessed the level of effectiveness of Working Capital
Management among State Universities and Colleges in Caraga, in
terms of cash management, receivable management and inventory
management. The two types of respondents such as the cooperative
management officers and members answered the questions about the
real facts relating to existing condition of the different cooperatives in
Caraga. The cooperatives in Caraga region had greatly handled their
respective cooperative in terms of cash management, receivable
management, inventory management specifically, in general aspect
receiving, raw materials–store room, work-in process and finished
goods inventory. It has a higher survival rate in terms of start-up
capital. As democratic nature, members has a common bond of
interest, they work together for the betterment of the members and for
the sustenance of the cooperative as a whole. It also enables us to
know the financial management as to working capital because it plays
an important role to the business. In foreign countries they consider
cooperative as successful enterprise to engage with, Since they believe
that ample working capital sustained a business. In order to improve
working capital management practices, it is essential for the finance
manager to adopt a proper approach of working capital decision
making to drive their respective firms towards success. In addition,
managerial improvement, cultural factors be considered, proposed best
practices should be formulated based on the actual practices of the
different cooperative among State Universities and Colleges in Caraga.

Keywords: working capital, cooperatives, cash management, receivable

management and inventory management

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SUMMARY
PART TWO - FINANCING

Chapter 6 - Debt Management

TYPES OF DEBT- Previous Page Table of Contents Next Page

3. How can cooperative activities be financed?

A. Directly from members
B. From cooperative business surpluses
C. From outsiders
The gearing ratio
Which kind of funds are best?
Legal framework and support
The greater the amount of capital held by the cooperative, the greater
its ability to purchase more efficient technology, invest in staff training
and education and make other improvements to the running of the
business.

Capital for the operation and improvement of the cooperative business

can come from three main sources:

a directly from members themselves

b from retained surpluses generated by the cooperative business
c from outsiders.

A. Directly from members

Members help finance the operations and growth of the cooperative
through:

· one-time or annual membership fees

· member contributions with no individual ownership attached, such as
service fees.
· member share capital
· individual member deposits with the cooperative which may be used
for business
· deferred payment to members for part or all of their produce
delivered to the cooperative
Member share capital represents individual member commitment to
the cooperative form of business. It also identifies the individual
member’s financial stake. It is withdrawn only when the member leaves
the cooperative. Some other forms of member contributions, usually
related to patronage, are more variable but once given cannot be
withdrawn and hence are a particularly useful form of cooperative
capital.
B. From cooperative business surpluses
Funds created through the retention of cooperative business surpluses
that are not directly allocated to members are another important
source of cooperative capital. This is a long term source of funds since
most cooperatives’ rules allow these funds to be distributed only when
a cooperative is liquidated. Unlike loans, or individual member
deposits, the cooperative does not have to pay interest to use these
funds. Of course, retaining such funds by the cooperative also
represents a cost to the individual members who otherwise would have
had that portion of the surplus allocated to them. Members willingly
accept this cost when the benefits it creates for them are clear and
worthwhile.

This source of funds from retained surpluses is often called

“institutional capital” and represents the collectively-owned wealth of
the cooperative.

C. From outsiders
In addition to institutional capital and member capital, cooperatives
often make use of external sources of funds to run their operations or
to finance investments. These non-member sources of funds may
include cooperative or commercial banks, suppliers, government or
donor agencies. External funding may be provided in different ways:

· as a grant
· as a short-term loan
· as a long-term loan
· as trade credit offered by a supplier.
Commercial providers of funds, such as banks, generally provide credit
or loans that are legally secured by collateral (pledged assets of the
cooperative). They are motivated by profit and seek to minimise risk.
Non-commercial providers, such as governments or donors, generally
provide credit on more generous terms at below market rates of
interest or provide grants. Their motivations may be social, political or
economic - often a mixture of all three.
The gearing ratio
The more assets the cooperative owns and has fully paid for -
buildings, equipment, stock and financial reserves - the more others
are willing to lend additional funds. Also, the greater the amount of the
cooperative’s institutional plus member capital, the higher the amount
that can safely be borrowed from outside sources. Financial leverage,
or gearing, is expressed by a percentage ratio which gives an
indication of the amount of risk involved in borrowing funds. The higher
the gearing ratio, the higher the risk the cooperative runs in losing
their assets in the event of inability to repay a loan.

The gearing ratio relates the amount of externally borrowed capital to

the total capital employed by the cooperative (institutional and
member capital plus funds borrowed).

Gearing

funds borrowed ÷ (institutional and member capital plus funds

borrowed) × 100
For example, a cooperative might have $900 of assets that it has fully
paid for If it borrows $900 from a bank, it would have a high gearing
ratio (50%)2. If on the other hand, the cooperative borrows only $100,
the low gearing ratio of 0% indicates a much lower level of risk3.

2 i.e. gearing ratio = 900 ÷ (900 + 900) × 100 = 50%

3 i.e. gearing ratio = 100 ÷ (100 + 900) × 100 = 10%
The gearing ratio and hence the level of risk involved in borrowing a
given amount will vary according to the type of business a cooperative
conducts. A consumer organization with a high level of turnover but
relatively low investment in fixed assets (such as buildings and
machinery), may be able to safely take on relatively high short term
debt in proportion to its total assets. The same gearing ratio would
represent a higher level of risk for an agro-processing society with
relatively large investment in fixed assets.
Institutional and member capital are lower risk than outsider funding
since they are provided by the members and hence the assets of the
cooperative are less at risk. In most situations, therefore, they are often
a preferred form of funding. Institutional capital, in addition, is the
cheapest form of capital since generally no interest needs to be paid.

Which kind of funds are best?

Institutional and member capital are the lowest risk, safest forms of
funding and hence should be the first choice in most cases. However
these types of funding are sometimes not enough, or are not available
at the time when they are needed. Funds may, for example be needed
to cover running costs until a harvest is sold. In this case, a short term
loan from an outside source may be taken and repaid after the harvest.
In other cases, funds may be required for a longer period. This may be
the case when the cooperative decides that the purchase of a new
piece of equipment is economically justified. The group may then
decide to obtain a long term loan.

In all cases, borrowing from non-members, such as banks and

suppliers, is a good strategy only when the returns from such
borrowing are larger than the cost of borrowing.

The type and source of capital is important because they determine the
terms and conditions attached. For example, share capital which can
generally be withdrawn by the member-owner only upon leaving the
cooperative, is a relatively stable and long-term source of funds. The
cost of share capital is low because of the cooperative practice of
making low (or in some cases no) payments to the members based on
their share holdings. It is also low risk since no collateral is required to
secure the funds.

Commercial loans from banks are higher cost as interest has to be paid
on them. They are also higher risk since cooperative assets used as
collateral may be forfeited to the lender in the event of inability to
repay the loan and interest.

Equipment suppliers may also effectively provide a loan to a

cooperative by allowing payments to be spread over a period. Again,
the lender may be protected against risk through cooperative assets
pledged as collateral.

Short term seasonal loans from a bank to finance the purchase of a

harvest by a marketing society for example, have to be repaid within a
few months of the harvest. These funds are also generally relatively
expensive. However as this example suggests, such short term loans
can be very useful for a cooperative.

Legal framework and support

Many of the regulations governing the operation of cooperatives were
established before the recent changes in the world economy
mentioned in the introduction (declining donor support, globalization of
markets and increasing privatisation) began to take effect. Some of the
regulations are still appropriate, others less so.

Many laws and regulations, for example, tend to restrict cooperatives in

their business activities. For example:

· a specified percentage of the sales revenue of the cooperative may

have to be returned to members within a specified short period of time,
regardless of the financial condition of the cooperative.
· payouts of patronage refunds may have to equal a specified minimum
percentage of the surplus, regardless of the wishes of members.

· a certain portion of the surplus may have to be placed in reserve with

a government authority or an apex cooperative organization, or
dedicated to community improvement such as maintenance of parks or
roads, regardless of alternatives that would otherwise be available and
possibly of greater use to members.
· some cooperatives may be required to deliver their produce to
government agencies at prices that are not attractive, or to sell
government-rationed goods at mark-ups that are not remunerative.

Financial support and privileges for cooperatives are decreasing and

cooperatives are obliged to operate in competition with conventional
businesses. Without the former associated privileges, many of the
above regulations put cooperatives at a competitive disadvantage in
the market place.

Many current business laws and regulations are however also

appropriate and benefit cooperatives, such as those:

· that guarantee that business contracts will be enforced.

· that permit land and property to be confiscated on non-repayment of
loans and hence allow them to be used as collateral.

· that promote greater transparency in business transactions, and

· that require accounts to be periodically audited.

A review of government laws and regulations governing agricultural

cooperative businesses is needed in many countries to enable farmer
cooperatives to successfully participate in increasingly competitive
markets.
Support organizations such as the Plunkett Foundation in the UK and
international bodies such as the International Labour Office and the
International Cooperative Alliance in Geneva, Switzerland, and the Food
and Agriculture Organization in Rome, can provide guidance to
movements and governments willing to encourage cooperatives
through regulatory reform.

Previous Page Top of Page Next Page

CREDIT-RATING AGENCIES- On credit ratings of consumer credit

cooperatives and credit institutions

For the purpose of Bank of Russia Ordinance No. 3916-U, dated 28

December 2015, ‘On the Procedure for Calculating the Financial Ratios
of Consumer Credit Cooperatives and Their Numerical Values’ the Bank
of Russia Board of Directors decided to establish:

The minimum international credit rating, assigned to the second-tier

consumer credit cooperative by at least one of the rating agencies S&P
Global Ratings, Fitch Ratings and Moody`s Investors Service, no lower
than the sovereign rating of the Russian Federation decreased by five
notches, but no lower than B in the classification of S&P Global Ratings
and Fitch Ratings, and no lower than В3 in the classification of Moody`s
Investors Service, or the national credit rating no lower than ruBBB+ in
the classification of S&P Global Ratings, no lower than BBB(rus) in the
classification of Fitch Ratings, no lower than А (I) in the classification of
JSC Expert RA, no lower than BB+ (RU) in the classification of JSC ACRA,
in case of lending to the second-tier consumer credit cooperative for
the purpose of paragraph 4 of Sub-clause 1.12 of Clause 1 of the
Ordinance;

The minimum international credit rating, assigned to the credit

institution by at least one of the rating agencies S&P Global Ratings,
Fitch Ratings and Moody`s Investors Service, no lower than the
sovereign rating of the Russian Federation decreased by five notches,
but no lower than B in the classification of S&P Global Ratings and Fitch
Ratings, and no lower than В3 in the classification of Moody`s Investors
Service, or the national credit rating no lower than ruBBB+ in the
classification of S&P Global Ratings, no lower than BBB(rus) in the
classification of Fitch Ratings, no lower than А (I) in the classification of
JSC Expert RA, no lower than BB+ (RU) in the classification of JSC ACRA,
in case of placing funds on the bank accounts with the credit institution
for the purpose of Sub-clause 1.13 of Clause 1 and Sub-clause 2.11 of
Clause 2 of the Ordinance.

For the purpose of this decision a rating notch means its gradation
expressed through figures, letters and symbols (‘+’, ‘-’, ‘A’, ‘В’, ‘С’, 1,
2, 3, I, II, III).

Section V of Minutes No. 14 of the meeting of the Bank of Russia Board

of Directors of 26 May 2016 shall be deemed invalid (information notice
of 31 May 2016 published on the Bank of Russia website ‘On credit
ratings of consumer credit cooperatives and credit institutions’).

This decision is to become effective since it is published on the Bank of

Russia website.

25 January 2017
The reference to the Press Service is mandatory if you intend to use
this material

Credit Ratings
The Co-operative Bank has a contractual relationship with Moody's Investors Service (Moody's)
and Fitch Ratings for the provision of rating information. These agencies evaluate the ability of
the Bank to meet its obligations for the timely payment of financial commitments. Members of the
Bank's management meet these agencies at least once a year to share with them the Bank's latest
financial results and business plans.

Summary Ratings for The Co-operative Bank plc:

Ratings Fitch Moody's

Long Term B (Rating Outlook Stable) Caa1 (Rating Outlook Stable)
Short Term B
Not prime

ACCOUNTING FOR DEBT--- Our vision for this accounting best practices
series is to examine fundamental financial tools and best practices for
co-ops that promote overall financial health and the ability to improve.
In previous articles, we reviewed best practices for the balance sheet
(Cooperative Grocer Nov.–Dec. 2011), the income statement Jan.–Feb.
2012), and internal controls (March–April 2012).

This final installment covers cash management. Understanding cash

flow keeps the doors of your co-op open and is essential if you want to
build your co-op's future. It can answer the question: "If the income
statement says we are making money, why don't we have any cash?"

Note: Please don't guess! A qualified accountant or experienced co-op

consultant can be an important resource for you in analyzing your cash
management practices and needs.

Cash management is big

Cash management is multifaceted in that it involves every aspect of
your co-op's organization and requires you to understand and develop
sources of cash, know how cash is generated by your business, learn
how to structure debt capital, and, in a crisis, how to generate cash in a
hurry. Together your balance sheet, income statement, and cash flow
statement are a map that you can use to understand how to be
successful and make money and profit for your members.
How does your cash flow?
It is not unusual to have a circumstance where the co-op has a cash
shortage at the same time as its income statement shows a positive
net income. How can this be? A cash flow statement (see template,
page 22) narrates the story of where cash came from and where it was
spent. It summarizes all cash received or paid out by the co-op within a
specified period of time.

In business, cash is generally invested to support the increase of non-

cash assets such as inventory or fixed assets or to decrease liabilities
such as payables or principal payments on long-term debt. Note:
interest payments on your debt are expensed as "other expenses" on
your income statement.)

Usually there are only two entries from your income statement that
appear on a cash flow statement. They are net income (positive or
negative) and depreciation and amortization (a non-cash expense). All
other items are reflections of changes made to your balance sheet over
the time period specified.

Always know your cash needs

Grocery operations require a significant amount of cash to operate
smoothly. To avoid cash shortages, a co-op general manager (GM)
needs to assess how much cash is needed at any given time. It is a
best practice for GMs to know their co-op's cash needs well enough to
anticipate and plan for cash shortfalls.

Co-ops that are managing their cash closely must develop a budgeting
process that allows them to anticipate cash shortfalls. A best practice is
a weekly cash budget that should then be monitored against the actual
bank balances. Doing this ensures that you know that there is enough
cash available to keep the doors open.

Evaluating sources of cash

Once you know your cash needs, you can put together a long- and
short-term plan for generating cash in advance of running out. If you
can anticipate your needs well enough in advance, equity or debt
issuance are good options. Shorter-term, useful strategies for
generating cash quickly include slowing cash outflows through delaying
payment of invoices and reducing inventory.

Following the opening of one expanded co-op, the GM sat down to

reconcile the sources and uses budget with the actual project costs and
calculated that when it opened they had about $200,000 remaining in
the project budget to sustain them until operations were generating
enough cash to cover costs. This was more available cash than they
had anticipated because their construction costs had come in under
budget. Since opening, however, gross sales had leveled off to a
weekly average of $55,000 instead of the $65,000 budgeted in the
proformas. Additionally, labor expenses were higher than budgeted,
and monthly inventories showed that the gross margin was too low.
Though gross sales, margin, and labor had been steadily improving, the
amount of cash they were spending to cover initial losses following the
opening (their "burn rate") was averaging $10,000/week. It was during
week eight that the GM conducted this analysis, which indicated that
the co-op had about 12 weeks to get operations to a "cash-neutral"
position (burn rate of zero dollars), or they would need to get an
infusion of cash. While dollars were coming in as planned through
additional member loans and new member equity, clearly that wasn't
going to be enough. A plan was needed to secure additional cash, as
well as to improve operational performance more quickly. He calculated
that they would likely need an additional $100,000 to bridge them to a
cash-neutral position.

Banking relationships
Good cash management includes establishing and maintaining a good
relationship with the banking institution that holds your cash. Many co-
ops have been able to obtain needed capital at critical moments based
on their rapport with lenders and others.

Two important notes: One, do not underestimate the value of your

business to a bank. Having the high volume of transactions, large cash
balances, and the need for loans and other banking services makes
your co-op attractive to a bank. Two, when evaluating a bank, make
sure that you will have the ability to review bank transactions online.
This is critical for cash management and is also important in allowing
for the segregation of duties for internal control over cash.

Line of credit
Having a line of credit available is a best practice and is important to
be able to cover any temporary shortfalls without causing disruption to
your operations. It is especially important to have arranged this well in
advance of your need since it will be difficult to negotiate one if you are
in the midst of cash flow issues. These lines of credit typically have
requirements to pay them off annually, so you should not plan to use
them for long periods of time. In our co-op expansion story above, if a
line of credit for $100,000 had been established as a part of their
expansion plan, they could have used it to bridge their cash gap,
effectively "buying" more time to steady their operations and develop
other capital if needed to ensure cash flow.

Accounts payable management

When cash flow is tight, slowing payment of accounts payable and
other liabilities can help immediately. Some things must be paid on
time, such as taxes, especially payroll taxes, and invoices with early
payment discounts or late payment penalties. Keeping communications
open with vendors is critical to avoiding disruptions in delivery or
sudden COD requirements.

Reviewing your accounts payable list may generate additional ideas

that you can include in your cash plan strategy. Are there stakeholders
in your co-op that may be willing and are positioned to assist you in
your plan to bridge a cash gap? Banks, landlords, vendors, members,
your community, and local government and businesses all have a
vested interest in your co-op's continued success. Having a good plan
is key in being able to engage them properly.

Inventory management
One of the largest assets on your balance sheet is inventory. There are
a few different ways to generate cash quickly from your inventory.

Extend your terms. If you can defer payment of vendor invoices by

extending your invoice terms from, say, 10 days to 21 days, your cash
should go up by the average dollar amount of 11 days' worth of
invoices. In essence, your vendor becomes a partner in financing your
inventory.

Since it is such a large asset, reducing inventory can be another

way of generating cash quickly. This is generally accomplished by
carefully decreasing the amount of back stock that you keep on hand
without causing unnecessary out of stocks. A ratio you can use over
time to monitor progress is inventory days (aka days of inventory),
which is the average number of days that inventory is owned by the
store before it is sold. The greater the number, the longer the inventory
sits in the backroom or on the shelf before it is sold.

If your back stock is already lean, you could consider intensifying your
category management efforts for ways to generate cash, but this would
likely take longer.

A new wellness manager was hired in one co-op, and after six months
the store manager discovered that wellness department inventory had
gradually increased by $50,000. The GM was furious, but upon
reflection recognized that the department manager was new to
management and did not have proper training, plus there were no
policies in place to prevent such a mishap.

Capital structure and debt management

In general, every business needs to understand its own capital
structure and how it can be managed to optimize return on investment
for your members. You can evaluate it by looking at your debt-to-equity
ratio, which shows the ratio between capital invested by the owners
and the funds provided by lenders and other creditors, i.e., how much
of your business is financed through debt and how much is financed
through equity. Note: A best practice is to annually review your debt
and interest terms for opportunities that optimize your debt structure
to meet your cash needs.

In conversation recently one GM was questioned by her peers about

the interest rate their co-op was paying on their primary loan.
Prompted to analyze it, they found that with little work and no cash
they could easily refinance this source of capital, resulting in lower
monthly payments and savings to the co-op of over $10,000 in reduced
interest expense over the life of the loan.

Good capital structure does not mean that your co-op has no debt. It
means that you are managing the risks and benefits of available capital
and optimizing member benefit. Any time the debt-to-equity ratio is
less than 1:1, there will almost always be a large cash balance. Is there
a way for you to invest excess working capital in your growth, your
future, and/or your mission? How much can you invest without putting
your current co-op business at risk? These are only some of the
important questions you will want to ask yourself. Engaging with your
peers and experts can assist you in detecting and answering questions
that facilitate your understanding of risk so that you can protect and
leverage your co-op's assets with more confidence.

Members have a role in investing in their co-op's future. Developing

ways for them to invest in the co-op can build less-expensive sources
of capital for the co-op. It can also contribute to co-op profitability by
decreasing the amount of interest paid through higher loan rates. And
it can deliver interest to co-op members instead of outside lenders.
Larger net profits for the co-op can deliver larger patronage dividends
to members in good years.

In years when the board of directors declares a patronage dividend, it

is important to know your working capital needs before you declare
what portion will be delivered to member owners in cash. An analysis
of paying taxes or paying patronage dividends often shows the
advantage of paying patronage dividends, especially if only a portion is
paid out in cash. The maximum a co-op can retain is 80 percent. This
serves to reward members who shop at the co-op, and it builds your
balance sheet (member equity) while reducing your tax obligation.
Designing the patronage dividend cash portion so that it can be
redeemed as a store coupon can also help to keep more of the cash
portion in the co-op.

Got cash? How can you leverage it well?

Many co-ops maintain very high cash balances. Cash levels should be
reviewed regularly to determine that the co-op is fully leveraging this
asset. Since current interest rates on short-term deposits are low, the
use of sweep accounts and transfers to money market accounts or
certificates of deposit will yield very little income.

Investing your excess cash in debt repayment, a co-op loan fund or

local community development organization, or another co-op project
may be a way for the co-op to achieve its mission. Since all co-ops
benefit from a stronger co-op community, the use of excess cash to
support other co-ops has multiple benefits. We caution co-ops to
conduct a rigorous evaluation of the risks and benefits before making
direct investments. In general, investing in areas associated with your
core expertise is less risky, but we know that there are additional
opportunities for investment that support your mission (e.g. farm,
vendor, or community venture). All should be evaluated carefully.

Conclusion
Cash management is critical to the success of your co-op. We have
discussed ways to evaluate the liquidity needs and capital structure of
your co-op, as well as some of the options for managing your cash.
Running a successful co-op requires expertise in so many areas that it
is critical that you consult with experienced advisors when the stakes
are high and knowledge of the options may not be readily available on
staff or with your board.

DEBT-RELATED CONTROLS----SMALL BUSINESS ENTREPRENEURSHIP

Financial Cooperative
REVIEWED BY INVESTOPEDIA STAFF Updated Dec 16, 2017
DEFINITION of Financial Cooperative
A financial cooperative is a financial institution that is owned and
operated by its members. The goal of a financial cooperative is to act
on behalf of a unified group as a traditional banking service. These
institutions attempt to differentiate themselves by offering above-
average service along with competitive rates in the areas of insurance,
lending and investment dealings.

BREAKING DOWN Financial Cooperative

Credit unions are the most popular form of financial cooperative
because they are owned and operated by their members. These
financial institutions often pay higher-than-average interest rates and
are only accessible to those that have accounts.

The size of financial cooperatives can vary from only a handful of

branches to being widespread with thousands of locations. Many
financial cooperatives offer products and services that are comparable
to those offered by the major diversified banks.

How Financial Cooperatives Are Structured

Financial cooperatives have open membership, and unlike banks, they
may be focused on seeing to the financial wellness of their members,
rather than turning a profit. Control of the cooperative takes a
democratic form with each member getting one vote. Their individual
financial standing is not relevant, and they do not hold different layers
of control based on ownership of shares.

The members of a cooperative, while being owners, are also

customers. The size the cooperative is based on the number of
members who participate. As more members join, the financial
cooperative has more resources to offer financial products, reduced
fees, lower interest rates on loans, and higher yields on savings. Credit
unions, in particular, offer ATMs and collectively may have more of
these devices in place than large banks.

In addition to the financial products and services the cooperative

offers, they can also be sources of financial education for its members
and others. The services that cooperatives make available might
include retirement planning and understanding of how credit works.

The history of financial cooperatives stretches back to rural

cooperatives that formed to offer credit and financial services to
farmers. Consumer cooperatives may also be established to make a
variety of products and services available to members, such as
healthcare, housing, grocery, and insurance. Housing cooperatives, for
instance, can be made up of apartment complexes that the members
reside in and buy ownership into.

The scope of cooperatives can vary from small, local operations to

large cooperatives that operate across numerous states. A financial
cooperative may form a board of directors to provide leadership and
structure to the organization.

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DEBT-RELATED POLICIES---pdf of by laws of multipurpose cooperative

DEBT-RELATED PROCEDURES-ETTOP NEWS
Opinion
Debt recovery laws a must for co-operatives
May 15, 2013, 05.00 AM IST

Guj HC recently ruled that a notification issued by the Central

Government to extend the SARFAESI Act to co-operative banks is illegal
and ultravires.
By: MR Umarji, Chief Adviser-Legal,IBA
The Gujarat High Court recently ruled that a notification issued by the
Central Government to extend the SARFAESI Act to co-operative banks
is illegal and ultravires the powers of the centre.
ADVERTISEMENT

The High Court granted the plea of about 70 defaulting borrowers of

cooperative banks to the effect that such lenders cannot exercise
recovery powers under the SARFAESI Act. With regard to the validity of
the Recovery of Debts due to Banks and Financial Institutions Act
(RDDB Act), 1993 ,the Supreme Court has already held that the
provisions of the said Act are not applicable to co-operative banks.
The basis of this decision is that the RDDB Act is applicable to a
banking company as defined in section 5(c) of the Banking Regulation
Act (BR Act),1949. The definition under the BR Act is not intended to
include a co-operative bank.
While extending the provisions of the BR Act to co-operative banks,
through an amendment in 1965, cooperative banks were separately
defined. The apex court made a distinction between banking
undertaken by co-operative banks and commercial banks and observed
that: “The distinction between peoples’ co-operative banks serving
their members and corporate banks doing commercial transactions is
fundamental to constitutional dispensation and understanding
cooperative banking generally and in the context of co-operative
banking not coming under the ambit of the Banking Regulation
Act,1949. Thus, even if co-operatives are involved in the activity of
banking, which involves lending and borrowing, this is purely incidental
to their main co-operative activity, which is a function in the public
domain.”
ADVERTISEMENT
The Supreme Court also noted that co-operative banks have
comprehensive, self-contained and less-expensive remedies before
them under the State co-operative societies laws. The apex court
further held that the field of co-operative societies cannot be said to
have been covered by Parliament by reference to List I, Entry 45 that is
banking.
Co-operative banks constituted under the Co-operative Societies Acts,
enacted by the respective States, would be covered by List II entry 32
of the State list. Hence the RDDB Act is not applicable to co-operative
banks.The Gujarat High Court judgment holding that the SARFAESI Act
is not applicable to co-operative banks is based on the above ruling of
the Supreme Court.
Section 5(b) of the BR Act, defines ‘banking’ as accepting, for the
purpose of lending or investment, deposits of money from the public,
repayable on demand or withdrawable by cheque ,draft, order or
otherwise. In the applicability of this definition, no change is made by
section 56 of the BR Act which specifies modifications of the provisions
of the Act for co-operative banks. The co-operative banks can,
therefore, accept public deposits.

The view that co-operative banking is peoples’ co-operative banking

servicing their members is erroneous, as far as deposit taking activity
is concerned. With respect to lending activity, co-operative banks
require borrowers to become their membersbut that does not change
the character of business undertaken by cooperative banks which is no
different from commercial banks.
BANKING A UNION SUBJECT
With the highest respect for the courts of law, it is submitted that
banking is a subject in the Union List and Parliament is well within its
powers to enact a law to provide that any entity undertaking banking
business shall be governed by banking laws which include laws to
regulate banks and recover defaulted loans. The enactment of the
Enforcement of Security Interest and Recovery of Debt Laws
(Amendment) Act, 2012, has modified the definition of ‘bank’ contained
in ‘SARFAESI’ Act, as well as RDDB Act, to include ‘multistate co-
operative banks’.
The Amendment Act negates the judgements of the apex court and the
Gujarat High Court as far as multi-state co-operative banks are
concerned.
In the matter of undertaking banking business, a co-operative bank
established under the State cooperative law, is as much a commercial
bank as any other lender, doing banking business with public money.
Considering the large number of borrowers of co-operative banks
objecting to recovery actions under the Central Debt Recovery Laws, it
is clear that the Central laws are effective and resulting in better
recovery for the co-operative banks.
In the interest of better management of co-operative banks, and to
protect the interest of depositors of such banks, it is necessary to
extend the Central Debt Recovery laws to cooperative banks — as has
been done for the multi-state co-operative banks — as an additional
remedy to recover defaulted loans.
It needs to be appreciated that banking is a subject in the Union list
and any person whether a corporate, or non-corporate, or any
association of persons conducting banking business has to be governed
by banking laws irrespective of the status of such a person. Debts due
to co-operative banks are no different from debts due to other banks
and the same considerations for speedy recovery of defaulted loans of
banks should apply to co-operative banks.
The Central Debt Recovery Laws, therefore, need to be extended to all
co-operative banks as has been done for multi-state co-operative
banks.
(Views expressed are personal )
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LATEST COMMENT
I totaly agree with Dr. Balakrishnan on th edebt recovery laws. I would
like to highlight the fact that most cooperatives do not abide by the
norms or directions set by the centre or the RBI or for that matter any
financial regulatory authority when it comes to providing better
oppurtunities and facilities to the public. I can easily cite one example
when cooperative banks clearly refuse one time settlement citing that
their scope of business cannot be tagged as the same as other banking
institutions. Same is in the case of providing education loans where
many cooperative banks still continue to ask for guarantors even if the
loan is under Rs 4 lakhs which is prohibited as per the directions issued
by RBI. Since all banks have to follow RBI norms and cooperative banks
do not, it clearly indicates that they do not want to be in the same
category. Then why let them exercise same powers. I can cite
numerous cases where cooperative banks have deliberately created
bad loans under political pressure to undersell properties and
businesses solely by delaying disbursements. The borrower however
genuine, will never have a clear oppurtunity to earn and repay in such
cases.It goes against public sympathy but the fact remains that
cooperative bank do lend only after being influenced and also create
NPA after influence.An influenced loan case if with a deliberate NPA by
the borrower can remain hidden in dust gathering files for ages without
seeing the daylight of recoveries.
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Co-opLaw.org
Financing
Contents [hide]

Financing a Cooperative
Outside Equity: Issues Specific To Cooperative Corporations
Alternative Ways to Raise Capital for a Cooperative
(1) Member Capital Contributions
(2) Donations
(3) Micro Loans
(4) Pre-Selling
(5) Loans with Return of Principle Only
(6) Product Discounts
(7) Bartering
Best Practices for Cooperative Owners Interested in Traditional Sources of Funding
(1) Preparation
(2) Understanding The Bank’s Perspective
(3) Pay Attention to Detail
(4) Follow-Up/Be Creative/Keep At It!
Securities Law and Cooperatives
How to Comply With Security Laws
What Is A Security?
Ways to Raise Capital Without Securities Registration
Ways to Raise Capital With Securities
California Limited Offering Exemption
California Cooperative Equity Exemption
Direct Public Offering (DPO)
Angel Investors and Venture Capital
Socially Responsible Investing or Community Investment
Crowdfunding Exemption (2012 JOBS Act)
Government Funding
Outside Investors and New Generation Cooperative Statutes
FINANCING A COOPERATIVE
Due to their unique ownership structure, cooperatives often have a difficult time finding money to
start and operate their enterprise. Traditionally, businesses look to three sources of capital:
contributions from the owners of the business (internal equity), loans (debt), and outside investors
(outside equity).

The initial source of funding for a cooperative is often capital contributions provided by the
founding members (e.g., each founding member contributes an amount as a membership share).
Membership share is a term used to refer to the contribution required for a person to become a
member of the cooperative. The initial funding provided by founding members is also known as
equity capital. Equity capital reflects the member’s ownership stake in the cooperative.

Equity capital is one of the measures by which financial institutions will gauge a business’
potential for receiving loans. Equity financing is typically received in exchange for an ownership
share in the business. By contrast, debt financing is borrowing money that the business will have
to pay back. The lender, such as a bank, does not receive an ownership share in the business.
When analyzing the creditworthiness of a business, lenders like to see that the members of the
business have invested their own money in the business first, before seeking outside funding.
Lenders are also more comfortable giving loans if they feel that a business has its own resources
to pay the loan back. Banks are not in business to lose money, so you need to convince them that
lending to your cooperative is a worthwhile investment. Thus, in the eyes of banks and other
lenders, the more equity capital the cooperative holds in the form of membership shares and other
capital contributions, the more deserving of the loan it is.

It is important to note that cooperatives come in multiple forms and have unique, and sometimes
complex accounting, tax, and financing issues. This website does not substitute for the advice of a
qualified attorney, business advisor, or financial advisor.

OUTSIDE EQUITY: ISSUES SPECIFIC TO COOPERATIVE CORPORATIONS

Outside equity is more complicated for a cooperative business than a traditional for-profit
business. First, in California, cooperatives are not permitted to have “outside” or non-member
investors. Thus these investors need to become members of the cooperative most likely as a
separate class of “investor” members. Second, cooperative businesses follow the principle that
voting rights are based on one’s membership in the cooperative, not on one’s investment of
capital. This is different from a traditional capitalist enterprise in which ownership and voting are
based on the number of shares an individual owns. In a cooperative, ownership and voting are
based on your membership. Thus, no one member should have more votes than another.

This is a problem when a cooperative tries to attract capital investors, because such investors
typically would like to have increased ownership and voting rights based on their capital
investment. They may not be familiar with the concept of cooperative ownership and may not be
interested in giving up the rights they would otherwise have in a conventional corporation.

Cooperative businesses have sought ways around these obstacles to raising capital by issuing
memberships to a separate class of “investor members” who do not work in the business. These
memberships may allow the outside investors limited additional voting protections related to
transformative events, such as mergers, acquisitions, or the dissolution of the cooperative. In
addition these shares can offer dividends, which may incentivize people to invest. However,
dividend distributions (i.e., returns that are not based on patronage) from a cooperative corporation
are often limited by statute (e.g., in California, they are limited to 15% of the capital contribution
per year). As a result of obstacles to obtaining equity capital, most cooperatives are debt financed,
as opposed to outside-equity financed.

ALTERNATIVE WAYS TO RAISE CAPITAL FOR A COOPERATIVE

Here are examples of ways to raise capital that are well suited to cooperatives:

(1) MEMBER CAPITAL CONTRIBUTIONS

If cooperative member will be participating in the management of the business, the members’
capital contributions are generally not considered a security.

(2) DONATIONS
When people give money without the expectation of receiving anything in return, they are
donating. Many entrepreneurs are using so-called crowdfunding websites such as Kickstarter.com
and Indiegogo.com to raise money for various enterprises. Entrepreneurs that solicit donations
often provide non-monetary rewards to donors.

For example, the Isla Vista Food Co-op launched Project We Own It in 2012 as an effort to
purchase its property. The National Cooperative Bank lent them $1.2 million for the purchase and
they successfully raised $200,000 for the down payment through crowdfunding.

(3) MICRO LOANS

While traditional banking loans are sometimes difficult for cooperatives to obtain, an alternative is
a micro loan. A micro loan is a small, low interest rate loan, supplied through various sources. .
Typically, the organizations that provide micro loans are socially conscious about the difficulties
that community entrepreneurs face when trying to secure financing.
Two examples of micro lenders are Kiva Zip and Working Solutions. Team Works, a cooperative
home cleaners based in San Jose, had two successful Kiva Zip campaigns in 2012. They were lent
$10,000, enough working capital to be able to provide health care for their members and expand
their membership. This article from Grassroots Economic Organizing gives a good overview of
the process they went through to find a trustee and promoting the loan. Though these loans can be
very demanding, Kiva Zip requires the first repayment within one month of disbursement, they are
zero interest and can work well for coops that have outside support.

(4) PRE-SELLING
If you’re an existing business and want to expand your business, one possible way to raise funds is
to pre-sell gift certificates. For example, you might sell a $150 gift certificate that a customer can
redeem at your business, but only charge $100 for the gift certificate. Charging less than the value
of the certificate gives the buyer an extra incentive to purchase the gift certificate.

(5) LOANS WITH RETURN OF PRINCIPLE ONLY

Return of principle only means giving back the money that the funder gave, and not offering a
return on the investment. Not offering a return means that the business will not offer anything
more than the original investment amount, such as an additional dividend, interest, or appreciation
in value. It is important to note that, in California, this is likely considered to be a security, so you
should proceed with caution and consult with a lawyer if you choose to utilize this funding
method.

(6) PRODUCT DISCOUNTS

Another way to raise capital for your business is to charge a membership fee and offer product
discounts in exchange. REI provides an interesting model for product discounts funding. REI is a
consumer cooperative that sells memberships to its customers. At the end of the year, REI
members receive a “dividend” based on the amount spent at REI during the year. This “dividend”
can then be used to shop at REI.

(7) BARTERING
One unique and often overlooked way to gain needed resources is to avoid money altogether for
certain goods or services your business needs. Bartering, or exchanging services or goods directly,
is a means of obtaining resources. If you need to raise money to pay for something such as web
design or compostable cups, consider whether you might be able to barter your goods or services
to get what you need. This is not a traditional means utilized by businesses when financing their
business; however, it can be utilized as an alternative way to obtain much needed resources for
your business. However, you should note that bartering may be subject to taxation.

BEST PRACTICES FOR COOPERATIVE OWNERS INTERESTED IN TRADITIONAL

SOURCES OF FUNDING
Thus far you have been presented with an overview of financing available for your cooperative
business and some alternative means for financing that business. You may still be interested in
attempting to secure a bank loan or other traditional financing methods. The following page
outlines best practices when approaching a bank for financing. The goal of this section is to help
you understand the difficulties that cooperatives face when approaching a lender, more
importantly, preparing you to overcome, to the best of your abilities, these challenges. Here are
some best practices:

(1) PREPARATION
Preparation is a key step in both business development and obtaining funding for your business.
Very few people can simply walk into the bank without preparation and obtain a significant loan.
To prepare for your interactions with financial institutions start by evaluating your financial
situation and the financial situation of your fellow founding co-op members. You will want to
collect documents from all founding members and evaluate personal income, credit scores, debts
etc. You will then want to decide whether it is in the best interest of your cooperative to obtain
funding individually (e.g., one member has outstanding credit and is willing to try and obtain a
loan) or collectively (e.g., you all pool your resources and sign together for a loan). You can
receive one free credit score per year at the government sponsored site
www.annualcreditreport.com, beware of credit report scams at other websites. You will want to
bring all financial documents with you when speaking to financial officers. Be sure to cast a wide
net, bringing more documents is better than bringing less. Do not neglect any information that is
less favorable to you (e.g., a bad credit score or default on loans). You need to realistically
consider the pros and cons of your financial situation, individually or as a group, and be prepared
to discuss these pros and address the cons where necessary.

(2) UNDERSTANDING THE BANK’S PERSPECTIVE

A bank is a business. They want to reduce their risk and increase their returns. It is important to
understand that bankers, loan officers, or whomever you are dealing with at a financial institution
has to follow institutionally determined standards. These standards are not all the same and some
are less difficult to overcome than others. Ultimately, a financial institution will be interested in
knowing how much money you want, what you plan on doing with it, and how you are going to
pay the money back (on time!).

(3) PAY ATTENTION TO DETAIL

Details are key! Neglecting a negative financial history or failing to point out the strengths of your
business are just two important details that might get skipped in the process of obtaining a loan. A
financial institution should not have to search for necessary and persuasive information about you
or the business. Present all the details of your unique financial circumstances to the bank clearly.
Also, being detailed and thorough will only make the process run more smoothly.

(4) FOLLOW-UP/BE CREATIVE/KEEP AT IT!

Receiving financial assistance in the form of a loan is undoubtedly a difficult and time-consuming
process; however, persistence is the key. Many small businesses face hurdles when they are just
beginning. Do not let a few undesired events get in the way of your business’ success. Be creative
when preparing for and communicating with financial institutions and potential investors.
Remember not to burn bridges and do not stop trying when one door closes.
SECURITIES LAW AND COOPERATIVES
HOW TO COMPLY WITH SECURITY LAWS
Don’t just ask for loans and investments! Make sure you follow the law. Even asking a potential
investor for money can be considered a violation of securities law, unless you’re just applying for
a regular business loan from your bank as described above. This section of the manual does not
substitute consultation with a qualified lawyer in the field of securities law. Securities law is
highly complex and failure to comply with securities regulations may lead to civil and criminal
sanctions. Consult an attorney before trying to raise money. This section of the manual will
attempt to provide you with a basic overview of securities law as it relates to finding funding for
your cooperative business.

WHAT IS A SECURITY?
A security is a financial instrument representing ownership, a debt agreement, or the rights to
ownership. Examples include stocks, bonds, derivatives, and many other types of financial assets.
You create a security when you ask people to put money into your business or venture, and you
offer them a return. For example, a security could be:

Selling stock in your business

Asking people to lend money to your business
Offering a share of your business’ profits
Interests in limited liability companies
Most financing and fundraising options require compliance with securities laws. This is true when
the funders are looking for a “return” on their investment.

It is important to know what is or is not a security because when you sell or even offer to sell a
security, it needs to either: 1) be registered with the U.S. Securities and Exchange Commission
and with the state agency where you want to raise money (in California, state registration is called
“qualification”); or 2) qualify for an exemption from registration. Registration/qualification is an
expensive, time-consuming process. If possible, your business should try to find an exemption,
which is simpler and less expensive.

WAYS TO RAISE CAPITAL WITHOUT SECURITIES REGISTRATION

The seven alternative methods to funding your cooperative, mentioned above, are examples of
ways that you can raise capital without triggering securities law.

WAYS TO RAISE CAPITAL WITH SECURITIES

CALIFORNIA LIMITED OFFERING EXEMPTION
California Corporations Code Section 25102(f) offers a special securities law exemption to certain
kinds of private securities offerings, if they meet the following criteria:

First, you must be exempt from federal securities filing requirements:

Your company must be formed under California law (i.e., if you are a corporation you filed your
articles of incorporation in California, etc.)
You plan only to offer securities to California residents
Your contract with your investors includes that they will not resell the security to anyone outside
the state for nine months
Your business is very California-focused – here is a test for this:
You get at least 80% of your revenues from California
At least 80% of your assets are in California
You plan to use at least 80% of the money you raise within California
Then, you must meet the requirements for 25102(f)

You can sell your securities to up to 35 investors that are not wealthy as long as they meet one or
more of the following criteria:
The investors have a preexisting personal or business relationship with you “consisting of personal
or business contacts of a nature and duration such as would enable a reasonably prudent purchaser
to be aware of the character, business acumen, and general business and financial circumstances of
the person with whom such relationship exists.” These investors can be friends or family;
The investors have enough financial experience to protect their interests; or
The investors have experienced professional financial advisors.
You can sell an unlimited number of securities to officers and directors of the company and
accredited investors. Accredited investors are 1) people with $1 million in net worth (excluding
their home) or $200,000 in annual income, or 2) entities with more than $5 million in assets.
Your securities offering cannot be advertised to the public.
The investors must sign something saying that they are not investing for the purpose of reselling
the securities to someone else.
You have to file a simple form with the California Department of Corporations.
CALIFORNIA COOPERATIVE EQUITY EXEMPTION
Under California Corporations Code Section 25100(r), a California cooperative can raise up to
$1,000 from each member without qualifying the securities. For example, a cooperative might set
its initial capital contribution requirement at $1,000. However, any person who purchases a
security under this exemption becomes a member and must have voting rights in the cooperative.
Also, you cannot use a “promoter” to sell these securities. As with the California Limited Offering
Exemption above, you could use the federal intrastate offering exemption to satisfy the federal
securities regulations.

Note that if a cooperative member will be participating in the management of the business, the
members’ capital contributions are generally not considered a security, which means each member
can contribute more than $1,000 to the cooperative. It is primarily for non-managing cooperative
members that you would need to use the 25100(r) exemption.

Worker cooperatives in California may sell shares to community investors for up to $1,000 per
person, with minimal voting rights, and avoid securities registration. Read more about this
financing strategy here.

DIRECT PUBLIC OFFERING (DPO)

Registering a DPO is not simple and it may require assistance from a lawyer, but it’s a nice option
if you need to raise a lot of money and you want to offer shares of your business to local
community members. A DPO is a securities offering that is registered at the state level and allows
a business to publicly advertise investment opportunities to both accredited and non-accredited
investors.Unlike an initial public offering (IPO), which requires an investment bank to underwrite
the security, or the anticipated Crowdfunding exemption, which will require the online funding
portal to be registered as an intermediary, a DPO allows an entity to sell securities directly to the
public without a third party intermediary. Upon the state’s approval of your DPO plan, you can
begin offering securities directly to the public.

The formation of a cooperative waste management company called CERO in the Boston area
provides a great case study of a cooperative successfully raising money through different
financing options. They have used crowdfunding, CDFI loans and a DPO to raise the money
needed to purchase their trucks and enter into waste removal contracts. CERO hired Cutting Edge
Capital, one of the leading consultants in the field of community capital development, to help
them with launch their DPO. CERO reached its goal, raising $340,250 by early June 2015. All
investments came from Massachusetts residents and ranged from $2,500-$25,00. Cutting Edge
recently launched CuttingEdgeX, a marketplace which has provided a centralized place for
investors to find social enterprises with open DPOs.

ANGEL INVESTORS AND VENTURE CAPITAL

Finding an angel investor or venture capitalist to invest in your business can be competitive and
challenging. At the same time, angel and venture capital funds have helped to launch and grow
many successful businesses.

SOCIALLY RESPONSIBLE INVESTING OR COMMUNITY INVESTMENT

Socially responsible investment organizations have grown rapidly over the past 30 years and
continue to expand, even in the down economy. Many of them are located in the Bay Area.

CROWDFUNDING EXEMPTION (2012 JOBS ACT)

In April 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act. Among
other things, the JOBS Act includes a provision that would exempt certain small investments from
securities registration requirements. More info here. Crowdfunded investing occurs when many
members of the general public invest smaller amounts of money in a business. Instead of relying
on a small pool of wealthy “accredited” investors, crowdfunded investing allows a business to
gather support from their customers, neighbors, friends, family, and other community members,
most of whom might be non-wealthy people who otherwise want to support your business.
Although this new exemption is not specific to cooperatives, some cooperatives might consider
using this exemption at some point, after considering related issues such as how crowdfunded
investing might affect a cooperative’s governance or control by its members.Cutting Edge Capital
is also a good resource for information on crowdfunding.

GOVERNMENT FUNDING
There are also some decent government financing options, the most notable of which is the Small
Business Administration (SBA) Loan.
Most relevantly, the SBA offers the CDC/504 Loan Program
A Certified Development Company (CDC) is a private, nonprofit corporation which is set up to
contribute to economic development within its community. CDCs work with SBA and private
sector lenders to provide financing to small businesses, which accomplishes the goal of
community economic development.
Must be used for fixed-asset projects:
The purchase of land, including existing buildings;
The purchase of improvements, including grading, street improvements, utilities, parking lots and
landscaping;
The construction of new facilities or modernizing, renovating or converting existing facilities; and
The purchase of long-term machinery and equipment.
Cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing.
There is also the California Small Business Loan Guarantee.
It allows a business to not only acquire a loan it could not otherwise obtain, but to establish a
favorable credit history with a lender so that the business may obtain future financing on its own.
Eligible Applicants: Any small business as defined by the SBA (typically businesses that employ
100 people or less).
Eligible Uses: Proceeds must be used primarily in California and for any standard business
purpose beneficial to the applicant’s business, such as expansion into new facilities or purchase of
new equipment.
OUTSIDE INVESTORS AND NEW GENERATION COOPERATIVE STATUTES
The issue of “outside investors” in cooperatives is the subject of a great deal of debate.
Cooperatives must serve the interests of their members and must not subordinate member interests
to outside investors. Most cooperatives avoid taking investments from non-members to avoid the
potential for conflict between those two interests. However, it is becoming increasingly difficult
for cooperatives to rely exclusively on member capital and bank loans, since bank loans for
cooperatives are very scarce. Capital-intensive cooperatives such as agricultural processors or
restaurants may find it impossible to start up and operate without outside capital. While most
cooperative statutes permit outside investors, they do not allow outside investors to have any
voting rights and they cap their returns. This is consistent with the principles laid out in Puget
Sound Plywood, 44 T.C. 305 (1965). Unfortunately, it is very difficult to attract outside investors
without offering them any voting rights to protect their investment. Some cooperatives, like
Organic Valley and Equal Exchange, have successfully sold non-voting preferred stock have
successfully sold non-voting preferred stock, but most cooperatives would have a hard time selling
an investment like that because most investors would not feel comfortable making a large
investment unless they have some right to influence major decisions, at least.

Because of this problem, some states, including Iowa, Wyoming, Wisconsin, Minnesota, and
Tennessee, have adopted a statute called the Limited Cooperative Association (also known as
“new generation cooperatives”). (The National Conference of Commissioners on Uniform State
Laws adopted a Uniform Limited Cooperative Association Act that is the model legislation for the
new generation cooperative statute.) This is a hybrid between a traditional cooperative corporation
and an LLC. These statutes allow outside investors to have limited voting rights while still
ensuring that members retain control and majority ownership. For example, Wisconsin’s Chapter
193 authorizes the formation of Cooperative Associations. Investor-members’ voting rights may
not exceed 49 percent, but the bylaws may provide such members with the power to veto certain
unusual decisions, such as merger or dissolution. In addition, the investors’ may not receive more
than 70 percent of the profit allocations and distributions of the cooperative.

Because these cooperatives essentially are LLCs, they can elect to be taxed under Subchapter K
which has many of the same advantages as Subchapter T. It remains to be seen whether a
cooperative that has a significant amount of outside investment and that provides limited voting
rights to these investors would be deemed by the IRS as not “operating on a cooperative basis.”

Didn't find what you were looking for? Have an idea for a resource that could support
cooperatives to navigate the law? Want to support Co-opLaw.org by contributing? Please email
Ricardo S. Nuñez at ricardo@theselc.org. . . . . . . . . . . . . . . PLEASE NOTE: Specific webpages
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:)

SUMMARY

Chapter 7 - Equity Management

STOCK REGISTRATION----MEMORANDUM CIRCULAR 2015-01

Series of 2015

SUBJECT : REVISED GUIDELINES GOVERNING THE REGISTRATION OF

COOPERATIVES

Pursuant to Republic Act No. 6939, the Cooperative Development

Authority hereby adopts and promulgates the following revised
guidelines governing the registration of cooperatives.

Article I
Title

This guideline shall be known as the “Revised Guidelines Governing the

Registration of Cooperatives”.

Article II
Policy

It is the declared policy of the State to foster the creation and growth of
cooperatives as practical vehicles for promoting self-reliance and
harnessing people power towards the attainment of economic
development and social justice.

Article III
Purpose

This guideline is issued for the orderly registration of cooperatives in

compliance with the requirements as provided under RA 9520,
Implementing Rules and Regulations, and relevant administrative
issuances by CDA.

Article IV
Coverage

This shall govern the registration of all types and categories of

cooperatives intending to register as such except those cooperatives
defined under Chapters XII, XIII, XVI and XVII of R.A. 9520.

Article V
Definition of Terms

As used in this guideline, the following terms shall be defined as:

(a) Area of Business Operation – shall refer to the principal place of

business of cooperative where the cooperative conducts its business as
provided for in their articles of cooperation and by-laws.

(b) Area of Operation – shall refer to the area where the cooperative
members come from as provided for in their articles of cooperation and
by-laws.

(c) Authority – shall refer to the Cooperative Development Authority.

(d) Bond of Membership – shall refer to the condition where members

associate themselves to attain their common goals and objectives
which may either be residential, occupational, associational, and
institutional.

(e) Business Transaction – shall refer to any business activity or

livelihood engaged in by the cooperative where such cooperative
generates savings.

(f) Cooperative – shall refer to the autonomous and duly registered

association of persons, with a common of interest, who have voluntarily
joined together to achieve their social, economic, and cultural needs
and aspirations by making equitable contributions to the capital
required, patronizing their products and services and accepting a fair
share of the risks and benefits of the undertaking in accordance with
universally accepted cooperative principles.

(g) Federation – shall refer to a cooperative the members of which are

primary cooperatives doing the same line of business.

(h) Inter-regional – shall refer to the cooperative’s area of operation

covering two or more adjacent regions.

(i) Primary Cooperative –shall refer to a cooperative the members of

which are natural persons except electric cooperative, water service
cooperative and other cooperatives which the implementing rules and
regulations of RA9520 or the Authority may allow.

(j) Registration – shall refer to the operative act of the Authority

granting judicial personality to a proposed cooperative and is
evidenced by the Certificate of Registration.

(k) Secondary Cooperative – shall refer to a cooperative the members

of which are primary cooperatives.

(l) Share – shall refer to a unit of capital in primary cooperative the par
value of which is fixed at any figure not more than One Thousand Pesos
(P1,000.00) and should be divisible by one peso may be divided into
common share capital and preferred share capital.

(m) Share Capital – shall refer to the money paid or required to be paid
by the members for the conduct of the operation of the cooperative.

(n) Tertiary Cooperative – shall refer to a cooperative the members of

which are secondaries.

(o) Union – shall refer to a cooperative the members of which are

registered cooperatives and/or federations organized purposely to
represent the interest and welfare of all types of cooperatives at the
provincial, city, regional, and national levels.

Article VI
Types of Cooperatives
As defined under Section 23 of RA 9520 the types of cooperatives are,
as follows:

(a) Advocacy Cooperative – is a primary cooperative which promotes

and advocates cooperativism among its members and the public
through socially-oriented projects, education and training, research and
communication, and other similar activities to reach out to its intended
beneficiaries.

(b) Agrarian Reform Cooperative – is one organized by marginal

farmers majority of which are agrarian reform beneficiaries for the
purpose of developing an appropriate system of land tenure, land
development, land consolidation or land management in areas covered
by agrarian reform.

(c) Consumers Cooperative - is one the primary purpose of which is to

procure and distribute commodities to members and non-members.

(d) Credit Cooperative – shall refer to one that promotes and

undertakes savings and lending services among its members. It
generates a common pool of funds in order to provide financial
assistance and other realted financial services to its members for
productive and provident purposes.

(e) Dairy Cooperative – is one whose members are engaged in the

production of fresh milk which maybe processed and/or marketed as
dairy products.

(f) Education Cooperative – is one organized for the primary purpose of

owning and operating licensed educational institutions,
notwithstanding the provisions of Republic Act No. 9155, otherwise
known as the Governance of Basic Education Act of 2001.

(g) Fishermen Cooperative - is one organized by marginalized

fishermen in localities whose products are marketed either fresh or
processed products.

(h) Health Services Cooperative - is one organized for the primary

purpose of providing medical, dental, and other health services.

(i) Housing Cooperative - is one organized to assist or provide access to

housing for the benefit of its regular members who actively participate
in the savings program for housing. It is co-owned and controlled by its
members.
(j) Marketing Cooperative - is one which engages in the supply of
production inputs to members and markets their products.

(k) Multipurpose Cooperative - is one which combines two (2) or more

of the business activities of these different types of cooperatives.

(l) Producers Cooperative - is one that undertakes joint production

whether agricultural or industrial. It is formed and operated by its
members to undertake the production and processing of raw materials
or goods produced by its members into finished or processed products
for sale by the cooperative to its members and non-members. Any end
product or its derivative arising from the raw materials produced by its
members sold in the name and for the account of the cooperative shall
be deemed a product of the cooperative and its members.

(m) Service Cooperative - is one which engages in medical and dental

care, hospitalization, transportation, insurance, housing, labor, electric
light and power, communication, professional, and other services.

(n) Transport Cooperative - is one which includes land and sea

transportation, limited to small vessels as defined or classified under
the Philippine Maritime Laws, organized under the provisions of this
Code.

(o) Water Service Cooperative - is one organized to own, operate and

manage water systems for the provision and distribution of potable
water for its members and their households.

(p) Workers Cooperative - is one organized by workers, including the

self-employed, who are at the same time members and owners of the
enterprise. Its principal purpose is to provide employment and business
opportunities to its members and manage it in accordance with
cooperative principles.

(q) Other types – the requirements for the organization, membership,

capitalization shall be determined and prescribed by the Authority in
separate guidelines.

Article VII
Jurisdiction

All applications for registration of cooperative and amendment thereto

shall be filed and registered with the CDA Extension Office (EO) having
jurisdiction over the principal office of the proposed cooperative.

In case of secondary or tertiary cooperative that shall operate with

municipal/city, provincial, regional or inter-regional coverage shall be
registered in the CDA Extension Office where its principal office is
located.

The CDA Central Office shall register tertiary cooperatives with national
coverage and selected types of cooperatives including amendments
thereto prescribed by law, rules and circular issued by the Authority
which are forwarded by concerned Extension Office together with the
validation report.

For this purpose, tertiary cooperatives with national coverage shall

refer to a cooperative whose area of operation covers three or more
regions in Luzon, Visayas and Mindanao.

Article VIII
Primary Cooperatives

Section 1. Number of members required for Registration. Fifteen (15) or

more natural persons who are Filipino citizens, having a common bond
of interest and are residing or working in the intended area of
operations are required for registration.

Section 2. Capital Requirements.

2.1. All primary cooperatives shall be organized with share capital. The
authorized share capital of a cooperative shall be provided for in its
Articles of Cooperation. At least twenty five percent (25%) of the
authorized share capital shall be subscribed by the members and at
least twenty five percent (25%) of the subscribed share capital shall be
paid by the members prior to registration.

2.2. The paid up capitalization requirement for primary cooperatives

shall not be less than Fifteen Thousand Pesos (P15,000.00) except for
multipurpose cooperative which should have at least One Hundred
Thousand (P100,000.00) or as required by the feasibility study
whichever is higher.

2.3. In the case of Transport Cooperatives, capital requirements shall

be in accordance with Rule V Section 5 of IRR, RA9520.

Section 3. Cooperative Name and Prohibition.

3.1. The word "Cooperative" “Kooperatiba” or “Cooperativa” shall be
included in the name of the cooperative, which name shall likewise
specify the type of cooperative in accordance with Article 23 of RA
9520.

3.2. No cooperative name shall be allowed by the Authority if the

proposed name is identical or deceptively or confusingly similar to that
of any existing cooperative, contrary to public policy, moral and
existing laws.

The use of the words “development” and “integrated” in the

cooperative name shall be discouraged.

3.3. The use of “Incorporated”, “corporation”, “company”,

“incorporation”, partnership, or other similar connotation and
abbreviation shall not be allowed. In addition, the use of the word
“federation” and “union” in the name of the proposed primary
cooperative is likewise prohibited except if it is part of the registered
name of association or institution where the members of the proposed
cooperative come from.

3.4. Name shall not be written in all capital letters except if it is an

acronym. Acronym shall be written after the full name of cooperative.

Section 4. Registration Requirements. The following documents shall be

submitted to the Authority in Four (4) copies except for item (1) below:

4.1. Cooperative Name Reservation Notice (CNRN); (1 copy only)

4.2. Economic Survey;

4.3. Articles of Cooperation and the approved By-laws;

4.3.1. All original;

4.3.2. The Articles of Cooperation shall be signed by all the cooperators

on each and every page; and

4.3.3. The By-Laws shall be signed all the members on the adoption
page.

4.4. Treasurer's Affidavit;

4.5. Surety Bonds of accountable officers;

4.6. Certificate of Pre-Membership Seminar (PMES) signed by the

cooperative Interim Chairman, as validated by the Authority;

4.7. Undertaking to change name;

4.8. Undertaking to comply with the auditing and accounting standards

prescribed by the Authority;

4.9. Undertaking to comply with other requirements prescribed by the

other regulatory agency, when applicable;

4.10. Favorable endorsement/written verification/authority/pre-

feasibility study, if applicable; and

4.11. Registration fee.

Section 4.a Other Specific Requirements for each type of cooperative:

4.a.1. Multi-Purpose Cooperative

4.a.1.a. Detailed feasibility study; and

4.a.1.b Undertaking to maintain separate books of accounts for each

business activity

4.a.2. Agrarian Reform Beneficiaries Cooperative

4.a.2.a Mother CLOA in case of plantation based ARBs; and

4.a.2.b Written verification from Department of Agrarian Reform (DAR)

to the effect that the cooperative organization is needed and desired
by the beneficiaries, economically viable, at least majority of the
members are agrarian reform beneficiaries.

4.a.3. Housing Cooperatives

4.a.3.a. Copy of the Pre-Feasibility Study of the housing projects

undertaking certified as reviewed by National Housing Authority (NHA).

4.a.4. Transport Cooperatives

4.a.4.a. Certification of Cooperative Education and Transport Operation

Seminar (CETOS) by Office of Transport Cooperatives (OTC)

4.a.5. Water Service Cooperative

4.a.5.a. Proof of Land ownership

4.a.5.b. Well Drilling Data

4.a.6. Professional Service Cooperative

4.a.6.a. Undertaking to comply with the regulatory requirements

prescribed by other regulatory agency;

4.a.6.b. Favorable endorsement from the Governing Board of the

respective profession;

4.a.6.c. Tax Identification numbers of all cooperators; and

4.a.6.d. Photocopy of valid individual Professional License of all

members.

4.a.7. Labor Service Cooperative

4.a.7.a. Undertaking to comply with the regulatory requirements

prescribed by other regulatory agency;

4.a.7.b. Cooperators/Members’ Profile and

4.a.7.c. Tax Identification numbers of all cooperators;

4.a.8. Health Service Cooperative

4.a.8.a. Undertaking to comply with the regulatory requirements

prescribed by other regulatory agency;

4.a.8.b. Favorable endorsement/written certification from Concerned

health related professional regulatory Board attesting to the fact that
the concerned health related profession is not prohibited from forming
a cooperative for the purpose of engaging in the subject undertaking;

4.a.8.c. Tax Identification numbers of all cooperators; and

4.a.8.d. Detailed Feasibility Study (expressly mentioning whether the

undertaking is primary, secondary or tertiary level hospital, diagnostic
center, spa, and wellness center, home for the aged, lying in, drop-off
center, etc. and specifying the financial, technical including
architectural, plans, etc.)

4.a.9. Small Scale Mining Cooperative

4.a.9.a. Undertaking to comply with the regulatory requirements

prescribed by other regulatory agency;

4.a.7.b. Certification from Mines Geo-Science Bureau Regional Office

that the members are licensed miners if the area of business operation
is within the Peoples Small-Scale Mining Area; and

4.a.7.c. Tax Identification numbers of all cooperators.

Section 5. Submission of Documents. The documents required for

registration shall be printed in an 8.5” x 13” or 8.5” x 14” and may be
written in English or in Filipino or other local dialect with appropriate
English translation. As far as practicable, the text should use bookman
old style 12. In case of confusion in the interpretation of the provisions,
the English translation shall prevail.

Section 6. Common and Preferred Share.

6.1. The share capital of a cooperative may consist of common share

capital and preferred share capital if the latter is provided for under the
cooperatives’ articles of cooperation and by laws. Should the
cooperative wish to have common and preferred shares, statements to
that effect should appear in the Articles of Cooperation specifying the
amount of shares to be offered for common shares and for preferred
share. However, it is recommended that only the common share be
offered.

6.2. Should preferred share capital be offered, the rights and privileges
of holders of preferred shares shall be provided for in the By-laws of the
cooperative.

6.3. Preferred share capital shall not exceed Twenty Five (25%) percent
or one-fourth (1/4) of the total authorized share capital of the
cooperative.

6.4. The paid up and subscription of the common share capital

contribution should strictly adhere to the twenty-five percent (25%)
requirement based on the authorized capital share.
6.5. No member shall own more than Ten (10%) percent of the
subscribed share capital of the cooperative.

Section 7. Bond of Membership. The bond of membership is

categorized into four (4). Only one common bond or field of
membership will be adopted by the cooperative. The categories are the
following:

7.1. Residential - members working and/or actually and physically

residing in the same place.

7.2. Institutional - members consist of employees, workers and/or

officers of a particular institution.

7.3. Associational - members come from a registered and/or recognized

association, group, club, fraternity, religious group, cultural and other
similar aggrupation.

Recognized association means legitimate aggrupation of persons which

is validated to be publicly known in a particular community and is able
to present certification from applicable government entity or
substantial proof of visible activity in the community; and

7.4. Occupational - members come from same or allied profession or

actual occupation.

Section 8. Dual Membership. A prospective cooperative may include in

its by-laws a provision not allowing members of existing cooperatives
of the same type within the same area of operation to be a member of
the proposed cooperative unless they resign from the former.

Section 9. Bonding Requirements of Accountable Officers / Employees

of the Cooperative. In order to meet any contingency that may arise in
the operations of the cooperative accountable officers/employees of
cooperatives shall submit a surety bond for the faithful performance of
their functions in accordance with Articles 14(5) and (56) of the Code
and in accordance with the following sub-sections:

9.1. The following persons shall be bonded:

9.1.1. Chairperson

9.1.2. Treasurer and Cashier;

9.1.3. Manager;

9.1.4. Warehouseman;

9.1.5. Loan/deposit Collectors;

9.1.6. Signatories of checks and other financial instruments; and

9.1.7. Such other persons as may be authorized by the cooperative to

act as a custodian of funds merchandise, inventories, securities and
other assets of the cooperative.

9.2. The board of directors shall determine the adequacy of such

bonds. For this purpose, the Board of Directors shall be guided based
on the initial networth of the cooperative which shall include the paid-
up capital, the membership fees and the other assets of the
cooperative at the time of registration.

Section 10. Required Period for Approval of Registration.

10.1. An application for registration shall be finally disposed by the

Authority within the period of Sixty (60) days from the filing of
complete documentary requirements. Otherwise, the application is
deemed approved unless the cause of the delay is attributable to the
applicant.

10.2. In the case of denial by the Authority, appeal of such denial may
be sent to the Office of the President within ninety (90) days from
receipt of the notice of denial.

10.3 The failure of the Office of the President to act on the appeal
within ninety (90) days from the filing thereof shall mean the approval
of said application.

Article IX
Registration of Secondary and Tertiary cooperatives

Section 1. Requirements for Registration. The following shall be the

minimum requirements for registration:

1.1. Membership – The minimum number of members in a federation or

union pursuant to BOA instruction dated May 23, 2011 is
recommended, as follows:
Category

Federation

Union

1.1.1 Secondary
1.1.1 Tertiary

10 primary Coops
10 secondary coops

15 primary coops
15 secondary coops

1.2. Paid-up Capital – The minimum paid-up share capital for any
proposed federation/union shall be, as follows:

Category

Federation

Union

1.2.1 Secondary
1.2.2 Tertiary

Php 500,000.00
Php 5,000,000.00 or feasibility study requirement whichever is higher

Not applicable
Not applicable

However, for purposes of registration of a federation, the capital

requirement stated in the feasibility study may also be followed but in
no case shall the paid-up share capital of a federation be less than the
amounts stated above.

1.3. Area of Coverage - A federation/union may be organized at the

municipal/city, district, provincial, regional or national levels.

1.4. Business Activity – the federation can engage in any cooperative

enterprise authorized under Article 6 of RA 9520 that compliments,
augments, or supplements but does not conflict, compete with, nor
supplant the business or economic activities of its members.

1.5. Bonding Requirement – Accountable officer/s of the proposed

federation shall be covered by sufficient Surety Bond. The amount of
the bond shall depend primarily on the amount of accountabilities the
officer/s are handling as determined by the Board of Directors.

1.6. Registration Fee – The registration fee to be paid by the proposed

federation shall be one tenth (1/10) of one (1%) percent of the
authorized share capital or the amounts prescribed in the CDA
schedule of fees, whichever is higher. Payment of the registration fee
shall be collected on or before the issuance of the Certificate of
Registration.

1.7. Feasibility Study - Four (4) copies of the Feasibility Study

containing the following items shall be submitted to the Authority:

1.7.1 Organizational Structure

1.7.2 Purposes/Objectives

1.7.3 Area of Operation

1.7.4 Number of Member and Potential Members

1.7.5 Feasibility

1.7.5.1 technical aspect of federation operation

1.7.5.2 management aspect

1.7.5.3 financial aspect, 3 years projection, contribution, subsidies

1.7.5.4 shall incorporate provision specifying cooperative education

and training programs

In the case of cooperative union, feasibility study can be replaced by a

three year development plan.

1.8. Articles of Cooperation and By-laws – Four (4) copies each of the
Articles of Cooperation and the By-laws shall be submitted to the
Authority.
1.9. Treasurer’s Affidavit – A duly notarized document attached to the
Articles of Cooperation stating the total amount received from
members share capital contribution, membership fee, donations or
subsidies.

1.10. General Assembly Resolution – duly notarized resolution stating

that the general assembly has approved the membership and the exact
amount of share capital/dues to be contributed to the proposed
federation/union it wishes to be affiliated with.

1.11. Other documentary requirements:

1.11.1 BOD Resolution on authorized representative;

1.11.2 Certification of the chairperson of member primaries stating the

following:

1.11.3 Line of business activity to be engaged in;

1.11.4 Compliance/Adherence to the accounting and auditing standards

as prescribed by the authority;

1.11.2 Other documents as may be prescribed by the Authority

Section 2. Place of Registration. (a) The Extension Offices of the

Authority shall register all federations/unions. In cases where the
proposed federation/union shall operate with inter-regional coverage, it
shall be registered in the Extension Office where the principal office is
located. (b) The Central Office of the Authority shall register tertiary
cooperatives with national coverage.

Section 3. Miscellaneous. – The following policies shall be followed by

any federation/union:

a. A federation shall engage in economic activity. A union shall actively

advocate for the benefit and welfare of its members and regularly
implement plans and programs for the advancement of member's
interest.

b. No federation/union shall be registered without complying with the

minimum membership requirement stated herein.

c. Federations/Unions are prohibited from conducting audit service to

their members.
Section 4. Registration Procedures. – The procedures for registration of
cooperative federations/unions shall follow the same procedures
outlined for the registration of primary cooperatives, as approved by
the Board of Administrators.

Article X
Validation Requirement

The CDA Extension Office concerned shall ensure that proposed

cooperatives applying for registration must have complied first with the
basic requirements for the organization and registration of the
proposed cooperative by conducting the requisite validation procedure
prescribed below.

Section 1. Objective. The Authority recognizes the importance of

verification/validation as an essential pre-registration function to
ensure that the proposed cooperative applying for registration with the
Authority has met the minimum requirement of the law.

Section 2. Rationale. While proposed cooperatives comply with the

documentary requirements, it has been observed that others are not
complianct with the cooperative conceptual definition on common bond
of interest, voluntariness, and willingness to undertake the business in
accord with the generally accepted cooperative principles.

Section 3. Scope. All types and categories of cooperatives shall be

subjected to verification/validation before registration. On-site
validation of the proposed cooperative’s principal office address and
gathering of relevant information including but not limited to its
adherence to the cooperative principles, concept and values carried
out by the cooperators/officers necessary in the submission of
complete validation report.

Article XI
Separability Clause

If any provision of this guideline is declared null and void or

unconstitutional, the other provisions not affected thereby shall
continue to be in force and effect.

Article XII
Automatic Review
This guideline shall be subject to automatic review three years from
effectivity thereof.

Article XIII
Repeal

All previous circulars and/or guidelines issued by the Authority which

are inconsistent with this guideline are hereby repealed or modified
accordingly.

Article XIV
Effectivity

This guideline shall take effect upon the approval of the Board of
Administrators and fifteen (15) days after filing with the Office of
National Administrative Registry (ONAR).
Approved by the Board of Administrators pursuant to Res. No. 2015-29,
S-2015 dated February 18, 2015.

For the Board of Administrators:

By:

(Sgd) EULOGIO T. CASTILLO, Ph.D.

Office-in-Charge, CDA

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CGN Spaces
Cooperative Capital and Member Equity Systems: The Heart of
Cooperatives
By Dave Gutknecht
025 November - December - 1989
This section presents material intended to help readers active in the
leadership of their cooperative to design and argue for an improved
member equity system. Four co-ops are briefly surveyed regarding
their practices in this area, along with an essay reviewing the need for
such capital and of desirable characteristics of member equity
systems.

Member equity and its multiple links to the rest of the cooperative are
worth examining closely, for this is an area in which co-ops still have
much to learn. Practices among cooperatives vary widely, and along
with examples of healthy cooperative businesses with strong and
growing member equity systems, there are many instances of neglect
of the role of member capital or of inconsistent and irrational
organizational practices.

If capital is the lifeblood of a business, a co-op's member equity system

may indicate whether that business is anemic or full of vitality. Yet
member equity usually is less evident and less promoted than other
features of the cooperative. Even where there are growing sales and a
satisfied membership, there may be a serious capital problem.
Frequently we find that members are owners in name only, with but a
token investment in the co-op. There may be little sense of identity as
owners of a business, and little attention given to whether the
cooperative is building equity.

Despite this frequently low visibility, we can see in member equity

systems the locus of several fundamental features of cooperative
business. The cooperative mission, the member's link to the co-op, the
cooperative's ability to sustain operations serving the members -- all
these are manifested in the structure and practice of member equity
systems.

Analogously, the cashier is the locus of several fundamental features of

a retail operation. Store income, the movement of inventory, essential
operating data, and customer relations all are generated or manifested
at the checkout counter.

Of course, just as store operations are more than cashier/customer

transactions, a cooperative is more than its member equity system. But
while the co-op in all its aspects always is something larger and more
complex, equity programs do compress into the co-op/member
relationship a great deal of what makes the cooperative.

Mind your mission

Take, for example, member equity and its relation to cooperative
mission. A broad but essential mission or purpose for cooperatives, I
would argue, is the redistribution of wealth (or capital) and the
democratic control of wealth. Cooperatives pool assets to support
organized services to members; members, by meeting their required
contribution toward those pooled assets, obtain and may exercise
voting privileges and patronage related privileges. The co-op is
structured to control capital by limiting interest paid on member
investments, and by distributing earnings according to the level of
patronage or production rather than according to the level of
investment. Growth in assets supports improved services and increases
the amount of cooperatively owned and controlled capital.

But how are cooperative assets to be financed? Assets needed to

establish and maintain business services must be financed in some
fashion. Recall the balance sheet equation: Assets = Liabilities +
Capital. This reminds us, as you can remind your members in
marketing an equity program, that the co-op's assets are financed
either by external (debt) capital or by internal (owner) capital. (The
debt to equity ratio -- total liabilities over total equity -- is an
expression of the relative use of these two sources of capital and a
common measure of solvency.) A challenge to the co-op leadership is
to tap into the tremendous potential that the membership has for
strengthening the owner equity side of the equation.

[continued below]

New Leaf Market

Tallahassee, Florida
Based on a conversation with general manager Carol Wilkinson:

The member equity program is two years old. We instituted it at a point

when we were nearly bankrupt and needed the capital to move
forward. With the board having thought through the proposal, most
members supported it. Of th former members, half rejoined right away,
and now we are back to the previous level -- but with many new
people.
Initially, some people seemed to have trouble understanding that the
new program called for a one time, refundable investment, and we had
to work on the best way to convey that message. Of the old members
who renewed under the new system, almost half chose to be in the
$100 or $200 investment class. Presently, the majority of members are
in the $25 class.

At the beginning of the program, because we were in such bad shape,

we didn't want the members to be concerned that we would lose their
equity through store operations. The initial investments were put into a
trust fund not available to the store until $25,000 had been built up
and the store had demonstrated viability; both goals were achieved.
The funds are being used, but remain targeted for capitalization,
primarily equipment and other fixed assets. This capital is not available
for operations, although management can borrow against it for a
specified short term basis.

Administrative notes:

Different colored cards help cashiers identify the proper discount.

The co-op's membership form asks for a beneficiary name, and the co-
op is often so designated by the new member.
The co-op avoids perpetual records of obsolete memberships through a
clause that revolves the amount to the co-op after two years of
inactivity in the member account.

Oryana Food Cooperative

Traverse City, Michigan
Based on a conversation with general manager Alan Green:

The co-op has had an equity program for about half of its 17 years. The
present three-tiered system has been in place for three years.

In the past, we used member deposits to support operations. But we no

longer do that, and by policy require otherwise. Now, store operations
must be supporterd by sales and margin on sales. We set aside
member deposits, essentially in escrow; presently it is in a money
market account. It is used only with board approval and has always
been used for capital improvements.

This has been a very good shift for us and an important one. People
feel really good about their investment in the co-op and the way it is
being handled. The member deposit system has improved our balance
sheet also. The steady inflow of member capital lets us finance more
assets with equity rather than short term liabilities.

One question the board and management and the membership will
soon have to explore is whether the capital program is sufficient to
carry us through the kinds of major projects we're looking at: The co-op
must expand and relocate its retail operation; we have committed to
doing this by the end of 1991. In addition, the co-op has a food service
division with a soy products wholesale distribution operation, and we
want to expand that. Will the present member equity program give the
co-op enough capital to leverage more from commercial sources? At
current rates, the co-op will have accumulated member deposits in
escrow of about $200,000 within two years.

The co-op leadership is aware of a need to revolve member capital. We

are considering changing the present unlimited term of annual member
deposits to one with an early return of the deposits -- but this will not
be attempted until after the above improvements have been
accomplished.

North Coast Cooperative

Eureka-Arcata, California
Based on a conversation with membership marketing director Karen
Zimbelman:

Along with the cooperative, North Coast's membership continues to

grow, and so does the number of members, now about 750, with their
$200 "fare share" fully invested. And despite a low initial requirement
for membership, the average amount invested is $72. This is double
the average investment by members five years ago.

Although North Coast is in some ways undercapitalized and is very

highly leveraged at present, we have accomplished a lot -- and
member investments have a lot to do with that: a growing and
profitable cooperative operating three full line natural foods grocery
stores and a regional distributor. The equity program also has had a
very positive impact in building the idea of the cooperative as a place
to invest.

In addition, we've found that giving dividends helps promote

understanding by everyone of the membership as an essential source
of capital for the co-op. We're showing that we would rather pay
interest to the members than to a bank. And since unlimited
investment is allowed and encouraged and earns interest, it leads to
some large investments by individual members. In the fiscal year
ending March 31, 1989, North Coast raised $78,000 in investments by
individual members.

On the down side, the North Coast member equity system is complex
and requires a sophisticated selling job. There is much
misunderstanding about the different types of shares, and one-on-one
explanation is often needed. Other drawbacks are that dividends are
paid after taxes (unlike interest expenses paid, which are deductible).
And the co-op's methods require annual filing with the California
Department of Corporations for review for possible consumer fraud --
more work for us, but actually a positive safeguard for the members as
consumers and investors.

Seward Co-op
Minneapolis, Minnesota
Based on a conversation with general manager Gail Graham:

Member reaction to the member equity program has been good.

Unfortunately, the program has suffered mainly from lack of applied
resources. We just finished our first year in an expanded store;
adjustments in operations and other needs have taken precedence. In
addition, the member coordinator position has not been adequately
filled until recently. Prior to that, there was much negative member
relations generated by inconsistent or otherwise improper practices
around the newsletter, discounts, billings, etc. Our new person is
cleaning everything up nicely. Notices are going out, and renewals and
new memberships are rolling in. Our basic handout has been rewritten,
and cashiers are being trained -- they continue to be very effective
membership recruiters. A recent survey told us that members continue
to spend more money per trip at the store than nonmembers. We
realize we very much need to build and solidify our membership base.

[continued from above]

A cooperative which promotes the role of member equity in fulfilling its

mission and requires member capital contributions is taking advantage
of a very important opportunity. As a co-op generates increasing
amounts of capital, it is in a stronger position to leverage additional
debt capital, if needed, from external sources. Prudent financial
management can magnify, through such borrowing, the impact of
member investments. At the same time, in general there is relatively
less need for debt capital, and more financial security, as owner equity
increases.

Mind your members

Member equity systems also are closely linked to the member relations
aspects of cooperative enterprise. Why join the co-op? How does one
do so? What is the purpose of the cooperative? What services and
benefits does membership offer? A successful member equity system is
inseparable from education about the cooperative, and a member
capital progam must "fit" with the rest of the business and
organizational culture of the co-op. The aim in such a system should be
nothing less than that membership be understood and supported by
most of the shoppers. Corollary to the goal of increasing the level of
member equity over time, a cooperative should strive for an increasing
level of member sales, avoiding long term major reliance on non-
members.

If customers and potential members don't understand or support a

program for member equity, something is amiss. Properly planned and
presented, member equity can be the piece linking the individual
service needs with the business resources that enable the co-op to
meet those needs. Do your members think of themselves as owners of
the business? Successful retail cooperative enterprise usually includes
a member equity system which provides the business with the
substance of ownership and provides the members with the pride and
opportunities of ownership.

Mind your store

To highlight a final way (last but far from least!) in which member
equity is integral to the cooperative: the capital infusion it provides is
needed to sustain the business over the long term. The concentration
of resources that creates the co-op also must provide for replacement
of aging fixed assets, future expansion, revolving of past investments,
and other costs that neither result from daily operations nor are
covered by the margin from operations.

In the grocery industry generally, the margin of earnings from

independent retail operations is seldom adequate for meeting long
term capital needs, and this appears to hold also for higher margin
natural foods and specialty stores. If there is pressure to meet all of a
retail's capital needs through operating profits, the results probably will
be higher prices and/or lower wages. In store operations, these two are
the most important factors that determine the income statement's
bottom line, which carries over to the owner equity section of the
balance sheet.

In addition to overreliance on net earnings as a source of capital,

another common pitfall among food co-ops should be noted: giving an
inflated return on the individual member's investment through
excessive price discounts. For example, assuming store prices are
roughly competitive with those in the rest of its market, giving a 5
percent discount on all purchases in return for $20 annually will provide
most individual shoppers with a return on their investment of more
than 200 percent!

In reducing or even eliminating the net margin from member sales,

overdiscounting encourages reliance on non-member sales and is an
obstacle to growth in total equity. Such practices also ignore the cost to
the cooperative of other, borrowed capital. And overdiscounting may
prevent the cooperative from using capital investments to do anything
more than cover operating expenses and to supplement the margin
from non-discounted sales. Certainly the co-op should look to its
members for capital, and explain to them the need for such capital --
but not pay them at a rate far greater than the co-op would pay to
another lender!

(This discussion of return to the individual member is a different matter

than the co-op's overall return on investment [ROl], a measure of
business performance calculated by dividing total equity into net
earnings; or the return on assets [ROA], calculated by dividing total
assets into net earnings. For figures and comments on ROI and ROA
ratios among co-op retails, see the Retail Operations Survey.)

Tired assets, undernourished capital?

In its effect on operations, a lack of owner equity may cause serious

difficulties, both in the short term and long term. It may result in the
cooperative having both inadequate assets and overreliance on debt
financing.

With weak or inadequate assets, you will find:

a lack of cash -- leading to loss of purchase discounts, minimal
reserves, and overdraft problems;
a lack of inventory;
an inability to maintain and invest in equipment and facilities.
As a consequence of these conditions, operations profits are diminished
or losses increases, which further depletes capital.

With overreliance on debt financing, you will find:

high accounts payable and problems with creditors;

high other liabilities, the risk of penalty charges, and higher interest
charges (debt service);
an inability to leverage additional financing when needed, particularly
when the lending institution cannot be shown that the owners are
making a significant investment themselves.
As noted earlier in discussing discounts to members, their capital
contributions should not be used to cover losses or operating expenses
in general. These expenses should be covered by operating income.
Such misuse of member capital may occur both in the case of member
fees, which to the member becomes just another expense, as well as in
situations where member equity is devalued as a result of negative
retained earnings.

Note futher that member loans to the co-op are an additional source of
capital and can be an important complement to required member
investments. But often such loans from members are misused by
covering for the absence of a member equity system. In addition to the
advantages discussed above, required member investments can be the
most stable and least costly source of capital for the cooperative. And if
the member equity program is well planned and marketed, it will also
generate additional capital through loans from some of the members.

You need Dr. Equity!

Certainly the benefits and potential problems outlined here underscore

the need for skilled management of the cooperative's finances and of
its entire operations. But even more, they should remind us of the need
for sound planning for meeting the co-op's capital needs.

In examining your co-op's member equity system, or designing a new

one, consider the following desirable characteristics of a model
program:
It's sellable.

The member equity system is easy to understand and explain. It is

neither so complex nor calls for so large an investment that it is a
serious barrier to marketing co-op membership.

It's simple. The system can be administered -- for new members,

numerous transactions, accounting, payment schedules maintained,
etc. -- without extraordinary difficulties.

It fits. Member equity requirements are appropriate for the members

and the type of co-op, and the marketing of the program is integrated
with the co-op's larger efforts in marketing, member relations and
member education.

It's legal. The equity system reflects an awareness of statutory and

regulatory limitations on raising capital for the business, and is
consistent with the co-op's articles of incorporation and bylaws.

It's effective. The member equity system provides its share of the
cooperative's capital needs: leveraging additional debt as needed;
sustaining renewal and expansion of the co-op's capital base, not using
it for operating expenses; allowing for periodic return of earlier
investments. In addition, membership in the cooperative provides
discounts and/or dividends which realistically reflect the cost of capital
and which allow for net earnings from operations to contribute toward
building capital. The member equity system is rationalized to
encourage both the co-op and the customers to continue building
member sales as well as member capital.

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EQUITY-RELATED POLICIES pdf sample policies

EQUITY-RELATED PROCEDURES---pdf cir 56