AgriTech 313: Agribusiness Finance and Project Development

AgriTech 313: Agribusiness Finance and Project Development - Chapter I: Preliminaries

Introduction to Business

• Definition: An organized effort of individuals to produce and sell goods and services to satisfy the needs of society.

Business Objectives

• To earn profit:
  • Funds are invested to achieve a sufficient return on investment (ROI).
  • Goods and services are priced with a sufficient markup to cover operating expenses, financing charges, income taxes, and desired net profit.
• To increase its own value as an economic entity:
  • Growth: Measured by an increase in appreciating assets, improved production capacity, increased sales volume, and increased owner's equity.
  • Stability: The company's resilience to economic fluctuations and its ability to continue operations despite anticipated risks.
    • Primarily measured by the relative amount of owner's equity.
    • Measures include: debt-to-equity ratio, equity-to-debt ratio, and the number of times a company earns an amount equal to its total fixed charges.
    • Greater owner's equity generally indicates more company stability.
• To improve the quality of life in the community:
  • Refers to the business's social responsibility and its contribution beyond pecuniary means, improving the economy and environment.

Definition of Business Finance (Mejorada 2016)

• The art and science of managing a business's financial resources.
• Concerned with the allocation, procurement, and efficient utilization of financial resources to achieve predetermined objectives related to growth, stability, profitability, and liquidity.
• Involves determining fund requirements, making funds available at the least cost, and ensuring funds are used as planned to optimize operations and increase the business's value.

Importance of Business Finance

• Working Capital Management and Smooth Operations: Ensures sufficient funds for daily operations (e.g., buying materials, paying wages) to maintain efficiency and enable growth.
• Strategic Planning and Business Growth: Proper financial management helps identify capital needs for growth, evaluate investments, and forecast finances for sustainable expansion.
• Risk Management and Financial Stability: Good financial practices help identify risks, ensure liquidity during uncertainties, prepare for unexpected expenses, maintain discipline, manage cash flow, and secure long-term stability.

Major Objectives of Finance Functions

• To properly allocate and utilize financial resources.
• To raise money needed to support business operations.
• To make the business profitable.

Vital Functions of Business Finance (Pineda 2018)

• Financial planning, including forecasting cash receipts and disbursements, and preparing cash flow statements.
• Raising funds through equity capital (e.g., issuance of shares) or fixed interest capital (e.g., borrowing funds).
• Use, allocation, and administration of financial resources.
• Creation of financial controls, such as budgets and financial policies.

The Core of Business Finance (Cinco 2014)

• Sources of Funds (Sources of Assets):
  • Ownership Resources
  • Creditorship Resources
• Uses of Funds (Management of Assets):
  • Management of Circulating Assets
  • Management of Fixed Assets

Sources of Funds

Ownership Resources

• Description: Includes funds contributed by the agro-entrepreneur (owner's equity) or shareholders (equity capital) alongside profits retained in the business.
  • Considered permanent capital, invested as long as the business exists, and is not refundable like loans.
  • Owners typically retain control over management and decision-making.
  • Considered 'risk capital' as it's exposed to business uncertainties.
• Examples:
  • Initial capital: Funds invested by the farmer or agribusiness owner to start or expand production (e.g., purchasing seeds, fertilizers, machinery).
  • Retained earnings or retained profits: Profits reinvested in the farm or agribusiness instead of being withdrawn for personal use.
  • Internal Free Reserves: A portion of retained earnings that are unallocated or unrestricted, allowing the agribusiness to use them freely without legal or policy constraints.
  • Membership shares in agricultural cooperatives: Farmers pool resources by buying shares to finance collective activities like bulk purchasing of inputs or shared equipment.

Creditorship Resources

• Description: Funds obtained from external sources as loans or credit.
  • Borrowed capital is usually raised for a fixed period and must be repaid with interest.
  • Creditors do not have ownership rights or control over the business.
  • Considered a safer form of capital for lenders as they receive fixed interest payments regardless of business performance.
• Examples:
  • Short-term loans: Loans with a maturity period of less than one year, typically used for working capital needs such as purchasing seeds, fertilizers, and paying seasonal labor.
    • Example: Agricultural Production Credit Program (APCP) by DAR for crop production credit at 8.5 \% p.a., rural bank seasonal loans.
  • Long-term loans: Loans with repayment periods longer than one year, used for investments in fixed assets like farm machinery, irrigation systems, or land development.
    • Example: Development Bank of the Philippines (DBP) AgriNegosyo Loan Program, Land Bank of the Philippines (LBP) term loans for farm machinery.
  • Debentures: Debt instruments issued by companies to raise funds from the public or institutional investors, usually secured by the company's assets and with fixed interest rates.
    • Example: Large agribusiness listed on the Philippine Stock Exchange (PSE) issuing debentures.
  • Trade Credits: Short-term credit extended by suppliers, allowing agro-enterprises to buy inputs (like seeds, fertilizers, or equipment) on credit and pay later, easing cash flow constraints during the production cycle.
    • Example: Fertilizer or seed suppliers giving 30-60 day credit terms to farmers.
  • Public Deposits: Deposits mobilized by financial institutions to fund loans.
    • Example: Deposits accepted by rural banks and cooperatives used to fund agri-loans.

Uses of Funds - Management of Assets

• Focuses on how the agribusiness uses its funds to manage assets for operations and growth.

Circulating Assets

• Definition: Current assets that are used up, sold, or converted to cash within a short period (usually a year).
• Examples:
  • Inventory of seeds, fertilizers, pesticides needed for crop production.
  • Cash or cash equivalents available for daily expenses such as labor wages or transport.
  • Accounts receivable from buyers of farm produce.
  • Short-term investments to manage temporary liquidity.

Fixed Assets

• Definition: Long-term assets used for production over several years.
• Examples:
  • Farm machinery and equipment like tractors, harvesters.
  • Buildings and farm structures such as storage warehouses, greenhouses.
  • Irrigation facilities installed to support crop production.
  • Land cultivated or utilized for agribusiness operations.

Factors to Consider in Raising Additional Capital

1. Cost of raising capital: The total expense incurred to secure capital, such as interest rates on loans or dividends on equity.
2. Compulsory periodical cash payment for the use of capital: Scheduled payments like monthly loan amortizations or dividends.
   • For short-term loans, regular repayment schedules can strain cash flow, particularly in seasonal farming where income is not continuous.
   • Understanding the timing and amount of these payments helps avoid liquidity problems.
3. Period for the use of capital: The length of time the capital will be borrowed or invested.
   • Short-term loans are typical for seasonal needs (e.g., buying inputs).
   • Long-term loans suit infrastructure or equipment investments.
4. Control to be sacrificed: Raising capital through equity (bringing in partners or investors) may reduce sole control of the farm or business.
   • For cooperative members, selling additional shares dilutes ownership but provides capital without repayment obligations.
5. Restrictions on managerial freedom: Certain financing may come with covenants or conditions that limit decision-making.
   • For example, loans from government programs or banks might require periodic reporting, restrictions on asset sales, or approval for strategic moves.
6. Collateral security-pledge / mortgages: Most credit facilities require security to mitigate lender risk.
   • Common collateral in Philippine agribusiness includes land titles, farm equipment, or future crop yields.
7. Convenience in securing funds: The ease and speed of obtaining capital affect opportunity and planning.
   • Some government loans or cooperative credits may be easier to access due to lower documentation and community-based support.

Basic Terminologies Related to Business Finance

1. Agricultural Finance: The economic study of borrowing funds by farmers, the organization and operation of farm lending agencies, and society's interest in credit for agriculture (Murray, 1953).
2. Agribusiness Finance: The study and application of financial management principles to agriculture-related business operations, including sources and uses of capital, loan management, risk, and profitability analysis.
3. Short-Term Credit: Loans given for periods ranging from 6 to 18 months, primarily to meet cultivation expenses such as seeds, fertilizer, and labor wages.
4. Medium-Term Credit: Loans for 2 to 5 years, used for purchasing farm machinery, equipment, and carrying out minor farm improvements.
5. Long-Term Credit: Loans for over 5 years, often against a mortgage of property, used for major development projects like irrigation or tractor purchase.
6. Farm Mortgage Credit: Loans secured by a mortgage on farmland used as collateral.
7. Collateral Credit: Loans secured against agricultural assets like crops, livestock, or warehouse receipts.
8. Production Credit: Credit to finance seasonal agricultural operations such as planting and harvesting.
9. Marketing Credit: Credit to support marketing activities and improve crop sales and prices.
10. Consumption Credit: Loans to meet household and family expenses of the farm operator.
11. Lender (Creditor): An institution or individual that provides credit or loans to the borrower, e.g., banks, cooperatives, or moneylenders.
12. Borrower (Lendee/Debtor): A farm operator or agribusiness entity that receives credit and is obligated to repay under agreed terms.
13. Credit: A sum of money lent on trust to be paid back later, often with interest (from Latin "Credo" meaning "I believe").
14. Unsecured Loan: Credit granted based solely on trust without any collateral.
15. Secured Loan: A loan backed by collateral, such as property or farm assets.
16. Interest Rate: The charge on borrowed funds expressed as a percentage of the principal.
17. Creditworthiness: The assessment of a borrower's ability to repay a loan based on financial status and reliability.