ACCOUNT OFFICER’SBASIC TRAINING

Cash Flow Review TechniquesCash Flow Review Techniques

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ObjectivesObjectives

At the end of this session, Account Officers will be able to –1. Review the Cash Flow and test the accuracy and

consistency of data using the five Cash Flow Review Technique tools.

2. Make the adjustments to Cash Flow computations, if needed, to ensure that information contained in the report is accurate and consistent with industry and business standards.

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v Most information on the business is based on “memory” rather than actual financial records

v High possibility of biased information from the loan applicant - overstated income and understated expenses.

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The income and expense data supplied by the client can be checked for consistency by reviewing:(1) Price mark-up or Profit margin

(2)  Average Inventory

(3) Total Monthly Income from Business and Other Sources

(4)  Total Monthly Household Expenses

(5)  Net Monthly Income

Price Mark-up/Gross Profit Margin Analysis

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Price Mark-up/Gross Profit Margin

Price mark-up or gross profit margin is computed using the formula:

Sales - 1 x 100

Cost of Purchases

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Price Mark-up/Gross Profit Margin

vThe computed price mark-up or profit margin should not exceed the maximum standard rate set by the MFU for each type of enterprise

For example:

-15-20 % price mark-up for sari-sari stores,

-25% for other retail shops,

-50% for carenderias and food processing activities

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Price Mark-up/Gross Profit Margin

vIf the computed mark-up exceeds the standard rate, the reported sales or income should be adjusted by using any acceptable rate and applying this on the cost of purchases.

vBetween using the reported sales or income and the cost of merchandise purchases, the latter would be easier to verify.

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Example: If a sari-sari store owner claims that his weekly sales is P20,000 and his weekly purchases is P15,000, his average price mark-up will be: (P20,000 / P15,000) – 1 x 100 = 33.3%

If the normal price mark-up for sari-sari stores in the area is only within the range of 10-20%, the reported sales is too high.

Adjust sales by assuming that the average mark-up, say, is only 15%. A more realistic weekly sales level, therefore, can be computed, as follows:  P15,000 x 1.15 = P17,250

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Estimating the Average Price Mark-Up

The average price mark-up can also be estimated by comparing the buying and selling prices of, at least, the five (5) fastest selling items in the shop, through the formula:

Total Sales - 1 x 100 Total Purchases

Where: Total Sales = Selling price x Quantity of each item Total Purchases = Buying price x Quantity of each item

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Example:

Average Current Buying Selling Total Total Price stock Price Price Sales Purchases

Mark-Up Item A 100 units 10.00 12.00 12,000 10,000Item B 50 units 30.00 33.00 1,650 1,500Item C 70 units 20.00 23.00 1,610 1,400Item D 30 units 50.00 60.00 1,800 1,500Item E 60 units 15.00 18.00 1,080 900 ______ Total 18,140 15,300 ?

18,140 -1 x 100 = 18.6% 15,300

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Exercise:Question: Is there anything wrong with these data?

Type of Business: Sari-sari storeDaily sales: 1,500Weekly Purchases: 9,000

Analysis:

Weekly equivalent of daily sales = 1,500 x 7 days = 10,500

Weekly Purchases = 9,000

Price mark-up = (10,500/9,000) - 1 x 100 = (1.167 - 1) x 100 = 16.7% Conclusion: This price mark-up is acceptable

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Exercise:

Analysis:

Question: Is there anything wrong with these data?

Type of Business: Sari-sari storeDaily sales: 1,500Weekly Purchases: 9,000Merchandise Inventory (AO’s estimate): 1,000

Merchandise Inventory: 1,000Daily Sales: 1,500Derived Cost of Purchase: (1,500/1.15) = 1,304 which means that the ending inventory cannot support even one day of salesConclusion: Data on sales & purchases are doubtful

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What to do --

• Check sales receipts or records, if any; or

• Check receipts or records of purchases, if any; or

• Verify level of regular purchases with client’s suppliers; or

• Estimate a more realistic level of sales and purchases based on the client’s average inventory level

Average Inventory Analysis

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Average Inventory

Average inventory, is the total value of stocks usually maintained by the business. Small retail shops usually maintain an inventory equal to 2-4 weeks of regular daily or weekly sales.

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Average Inventory

vThe AO should compare the reported average inventory with the total value of the stocks of the shop when he/she visits the business during the CI/BI.

vIf the discrepancy between the total value of the observed inventory and that of the reported inventory is large, the AO should verify reason for discrepancy from the client.

vIf the client cannot provide adequate explanation for the discrepancy, the AO should use whichever amount is lower to represent the applicant’ average business inventory.

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Average Inventory

•For trading-related activities, such as retail shops, the ending inventory should be compared with the average inventory. The ending inventory should always be equal to, or greater than, the average inventory.

• If the ending inventory is lower than the average inventory, the COST OF SALES should be adjusted downwards using the difference between the average inventory and the ending inventory.

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Adjusting SALES

Steps Formula

1 Cost of Sales Reported Sales(1 + Normal Price Mark-up)

2 Adjusted Cost of Sales

Cost of SalesPlus : Ending Inventory minusMinus : Average Inventory

3 Adjusted SALES Adjusted Cost of SalesMultiply by : (1 + Normal Price Mark-up)

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Example

Type of Business: Sari-sari storeDaily Sales: P 1,500Total Weekly Purchases: P 9,000Merchandise Inventory (AO’s estimate): P 1,000Average Inventory (Client’s estimate): P 5,000

Analysis

Step 1:COST OF SALES = P1,500 x 7days (1 + 0.167) = 8,997Step 2:ADJUSTED COST = 8,997 + (1,000 - 5,000) OF SALES 4,997

This means that the cost of sales of P9,000 should be reduced to P4,997.

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Step 3:Adjusted Sales = Adjusted Cost of Sales x (1 + Normal price mark-up)

Adjusted Sales = 4,997 x (1 + 0.167)= 4,997 x 1.167= 5,831

This means that the reported sales of P1,500 per day or P10,500

per week should be reduced to only P5,831 per week, or P833 per day.

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These adjustments are necessary in order to make the average inventory consistent with the average sales and purchases of the business, as shown in the table below. These adjustments are necessary in order to make the average inventory consistent with the average sales and purchases of the business, as shown in the table below.

Before AfterAdjustments Adjustments

Average Inventory, Beginning 5,000* 5,000Add: Purchases 9,000 4,997Less: Cost of Sales 9,000 4,997Equals: Average Inventory, Ending 1,000** (?) 5,000

*As claimed by the client** As estimated by the AO

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NOTE : Do the average inventory NOTE : Do the average inventory analysis only if the total value of the analysis only if the total value of the inventory is substantially lower than inventory is substantially lower than the total cost of purchases reported by the total cost of purchases reported by the client. the client.

However, if the difference between the However, if the difference between the observed inventory and the cost of observed inventory and the cost of purchases is not large, the price mark-purchases is not large, the price mark-up or gross profit margin analysis up or gross profit margin analysis would suffice.would suffice.

Analysis of Total Monthly Business and Household

Income

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Total Monthly Income from Business and Other Sources

Item Daily Weekly Semi-Monthly

Monthly MONTHLY TOTALS

Net Income from Business:

Total Business Income

Business Expenses:

Total Business Expense

NET BUSINESS INCOME

Total Other Household Income

TOTAL BUSINESS & HOUSEHOLD INCOME

Analyze data here

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Total Monthly Income from Business and Other Sources

vThis income represents the regular monthly income of the household before household expenses.

vIt is, thus, comparable to the monthly salaries received by the AOs (or other employees), in the sense that both are incomes before household expenses.

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Total Monthly Income from Business and Other Sources

vThe AO can verify whether the estimated total monthly household income of the applicant, as shown in the cash flow, is consistent with the living condition of the applicant and his family when he/she visit the borrower’s house during the CI/BI.

vThe AO may compare the applicant’s house and living condition with that of his own, or those of other persons whom he/she knows belong to the same income bracket as that of the applicant.

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Total Monthly Income from Business and Other Sources

NOTE : If the estimated total monthly NOTE : If the estimated total monthly business & household income is not business & household income is not consistent with the living condition of consistent with the living condition of the household, the AO must revise the household, the AO must revise the cash flow. Loan applicants tend to the cash flow. Loan applicants tend to overstate their incomes.overstate their incomes.

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Example

Total Monthly Income from Business & Other Household Sources: P25,000

Analysis

Compare the P25,000 total monthly income (before HH expenses) with the following items:•No. of HH members 4 •Household appliances None•House construction materials Temporary

Conclusion: The income data is doubtful. A household with only 4 HH members and receiving a monthly “salary” of P25,000 normally would be owning at least some small HH assets, or is residing in a house made of more durable materials. AO should further verify the discrepancy between the reported HH income & the observed living condition of the HH.

Analysis of the Total Monthly Household Expenses

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Total Monthly Household Expenses

Item Daily Weekly Semi-Monthly

Monthly MONTHLY TOTALS

Other Household Income

Remittances

Total Other Household Income

Total Business & Household Income

Household Expenses

Food

Education & School Allowance

Utilities (Light & Water)

Sub-Total

Miscellaneous (10%)

Total Household Expenses Analyze data here

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Total Monthly Household Expenses

vThe total monthly household expense should be compared with the size of the household and the ages of household members.

vThe AO should be familiar with the major expenditure items of households in his/her area of assignment and the most common level of expenditures for each item.

vFor greater conservatism, add at least 10% to the total household expenses as miscellaneous expenses.

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Example

Total Monthly Household Expenses: P2,000

Analysis

Compare the P2,000 total monthly expenses with the following items:•Type of client’s business Sari-sari store •No. of HH members 5 •Ages of HH members (children) 1 HS, 1 college, 1

grade school•Community where client is residing Urban

Conclusion: The expense data appear too small for the household described above. AO should gather more information on the applicant’s HH expenditures and adjust these, if necessary.

Analysis of Net Monthly Household Income

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Net Monthly Household Net Monthly Household IncomeIncome• Compute for this data using the Monthly Totals column in the

Cash Flow• Formula:

Total Other Household Incomeless : Total Household Expenseequals :NET HOUSEHOLD INCOME

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Net Monthly Household Income

vThe Net Monthly Household Income also represents the monthly savings of the household or the size of its investment funds.  vThis amount should be checked against the relevant items in the applicant’s balance sheet --i.e. savings deposit, cash on hand, real properties, other household assets, and other investments.

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vIf the amount appears large compared with the amount the applicant intends to borrow, verify from the client the reason why he/she still intends to borrow.

vIf the applicant cannot provide an adequate explanation for the apparent discrepancy, the AO should review the cash flow and make the necessary adjustments in the applicant’s income and expense data.

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Example

Total Net Monthly HH Income: P10,000

Analysis

Compare the P10,000 net monthly income with the following items:•Savings/cash in bank None •Cash on hand P500•Real properties None•Household appliances P10,000•Business assets P10,000•Total Assets P40,000

Conclusion: The income data is doubtful. It is not clear where the P10,000 net monthly income or “savings” is kept or invested by the applicant. AO should further verify the applicant’s income and expense data.

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Example

Total Net Monthly HH Income: P3,000

Analysis

Compare the P3,000 net monthly income with the following items:•Savings/cash in bank None •Cash on hand P500•Real properties P300,000•Household appliances P100,000•Business assets P10,000•Total Assets P500,000•Total liabilities None

Conclusion: The income data is doubtful. Monthly net income is too small compared with the HH’s assets. This HH most likely had acquired all these assets from borrowings. AOs should further verify the liabilities of the HH.

Analysis of Monthly Household Income Structure

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Monthly Household Income Structure

•This refers to the ratio of the NET BUSINESS INCOME to the TOTAL BUSINESS & HH INCOME The ratio is computed as follows:

Net Business Income x 100Total Business & HH Income

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•Net Income from Business should be at least 80% of the total household income.

•If Other Household Income is more than 20% of the Total Business & HH Income, the AO should gather proof of this income (e.g. pay slip of spouse’s salary).

•If Other HH Income is more than 50% of the Total Business & HH Income – that is, most of the HH income come from outside the client’s business, offer the client other loan products of the banks (e.g. salary loan)

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Example

Net Business Income 10,000Other HH Income (Spouse’s salary) 4,000Total Business & HH Income 14,000

Analysis

Net Business Income 71.4%Other HH Income (Spouse’s salary) 29.6%Total Business & HH Income 100.0%

Recommendation: AO should present proof of the spouse’s salary (pay slip)

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Example

Net Business Income 4,000Other HH Income (Spouse’s salary) 10,000Total Business & HH Income 14,000

Analysis

Net Business Income 29.6%Other HH Income (Spouse’s salary) 71.4%Total Business & HH Income 100.0%

Recommendation: Client’s spouse should be offered a salary loan instead.

Cash Flow Paradox

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The Puzzle --

•Even without any improvement in the client’s cash flow, and using the same loan term and Adjusted Repayment Capacity Rate (ARCR), a client can still be given a bigger loan amount by moving the repayment schedule from daily to weekly.

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Example

MONTHLYDAILY WEEKLY MONTHLY TOTAL

NET BUSINESS & HH INCOME 300 0 0

Debt Capacity AnalysisEquivalent of DAILY Net Income 300 2,100Equivalent of WEEKLY Net Income 0Equivalent of MONTHLY Net Income 0Amount Available for Debt Service 300 2,100Adjusted Debt Capacity Rate (35%) 105 735Maximum Loan Amount (13 weeks % 2.5%) 6,349 8,888

By just moving the amortization schedule from daily to weekly, the loan amount can be increased from P6,349 to P8,888 - or an increase of about 40%. How is this possible?

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Solving the Puzzle --

•In the daily loan amortization schedule, the loan amount is computed using 65 collection days. In the weekly loan amortization schedule, however, the loan amount is computed using 13 weeks, or 91 days.

•To avoid committing this error, the number of days to be used in computing the loan amount for loans paid either daily or weekly should be the same.

•If loans with daily payments are computed using 65 days, loans with weekly payments should also be computed using 5 collection days a week.

•In the daily loan amortization schedule, the loan amount is computed using 65 collection days. In the weekly loan amortization schedule, however, the loan amount is computed using 13 weeks, or 91 days.

•To avoid committing this error, the number of days to be used in computing the loan amount for loans paid either daily or weekly should be the same.

•If loans with daily payments are computed using 65 days, loans with weekly payments should also be computed using 5 collection days a week.

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Example

MONTHLYDAILY WEEKLY MONTHLY TOTAL

NET BUSINESS & HH INCOME 300 0 0

Debt Capacity AnalysisEquivalent of DAILY Net Income 1.500*Equivalent of WEEKLY Net Income 0Equivalent of MONTHLY Net Income 0Amount Available for Debt Service 1,500Adjusted Debt Capacity Rate (35%) 525Maximum Loan Amount (13 weeks % 2.5%) 6,349

1500 = 300 x 5 days

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SUMMARY --SUMMARY --

•The secret in analyzing the cash flow is in the MONTHLY TOTALS. Without the Monthly Totals, it is difficult to compare and analyze the various items in the cash flow.

•There are a lot of information in the CIBI report that can be used in validating the data reported in the cash flow. Do not limit cash flow analysis by looking only at the figures in the cash flow. Also, compare the cash flow figures with other sections of the CIBI report.

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Individual Case AnalysisIndividual Case Analysis

• You may have the participants prepare the Cash flow for Jenni’s Bakery and apply Cash Flow Review techniques to checking for validity/accuracy of the data.

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Lending to Microenterprises without analyzing the cash flow …

… is like playing darts blind-folded. Determining how much loan the bank should give to a client is left to CHANCECHANCE.

Thank you!