3 R’S

OF CREDIT

EXERCISE 1: Return from Investment

A farmer want to install a pump set to create additional area under irrigation. The cost of installation
of pump set is Rs. 10,000. The operation and maintenance cost of pump is Rs 5000. Other information
is given below:
Particulars
1. Paddy production under rain-fed condition 30 qt/ha
2. Paddy production under irrigated condition 50 qt/ha
3. Market price of paddy Rs 1500/qt
4. Total input costs Rs 15000.00
5. Operation and maintenance cost of pump Rs 5000.00

Based on these information find out the return from Investment.

Solution
Item Existing plan Alternate plan with credit
Gross income 30 x 1500 = 45,000.00 50 x 1500 = 75,000.00
Working Expenses 15,000.00 (15000 + 5000) = 20,000.00
Net Cash income (45000-15000)=30,000.00 (75000-20000)= 55,000.00
Incremental benefit (55,000 – 30,000) = 20,000.00
Result: The alternative plan would give additional gross income of Rs 30,000 and incremental net
cash income of Rs 20,000. The loan amount is Rs 10,000, which lower than the incremental benefit.
Hence, credit proposal is a sound proposal.

EXERCISE 2: Repayment Capacity (Self-liquidating loan)

Mr. Shivam wants to apply chemical fertilizer in the paddy crop. The cost of fertilizer is Rs 10,000
and he wants to borrow this amount from primary agricultural credit society (PACS) and he applied
for crop loan. Now official of PACS wants to find out repayment capacity of Mr. Shivam before
sanctioning crop loan. Other information of Mr. Shivam’s is given below:

Particulars
1. Paddy production without fertilizer 30.0 qt/ha
2. Paddy production with fertilizer 50.0 qt/ha
3. Market price of paddy Rs 1500/qt
4. Total input costs Rs15,000.00
5. Family living expenses Rs 5000.00
Solution
Repayment Capacity = Gross Income – (Family living expenses + working expenses + Taxes + other
loan due)

Item Existing plan Alternate plan with credit

1. Gross income 30 x 1500 = 45,000.00 50 x 1500 = 75,000.00
2. Inputs expenses 15,000.00 15,000.00
3. Family living expenses 5,000.00 5,000.00
4. Total expenses (2+3) (15,000+5,000) = 20,000.00 (15,000+5,000) = 20,000.00
Repayment Capacity (45,000-20,000) = 25,000.00 (75,000-20,000) = 55000.00

Result: The repayment capacity of Mr. Shivam has increased from Rs 25,000 to 55,000. The amount
of loan is only Rs 10,000. It can therefore, be considered a sound credit proposal.

EXERCISE 3: Risk Bearing Ability

A farmer want to install a pump set to create additional area under irrigation. The cost of installation
of pump set is Rs. 20,000 and repayment is to be made in ten instalments of Rs 2500 each (including
interest). The operation and maintenance of pump set is Rs 5000. The reduction in crop yield was
estimated to be 10% from normal paddy yield. Other information is given below:

Particulars
1. Paddy production under irrigated condition 50 qt/ha
2. Variability in crop production 10%
3. Market price of paddy Rs 1500/qt
4. Total input costs Rs 10000.00
5. Operation and maintenance cost of pump Rs 5000.00
6. Family living expenses Rs 5000.00
7. Other loans due Rs 1000.00
Based on this information, find out the risk bearing ability of the farmer.

Solution

Item Existing Plan Alternate plan with risk

1. Gross income (50 x 1500) = 75,000.00 (50 x .90) = 45 x 1500 = 67500.00
2. Working expenses 10000+5000 = 15,000.00 10000+5000= 15,000.00
3. Family living expenses 5,000.00 5,000.00
4. Other loans due 1,000.00 1,000.00
4. Total expenses (15000+5000+1000) = 21,000.00 (15000+5000+1000) = 21,000.00
Repayment Capacity (75,000 - 21,000) = 54,000.00 (67,500 – 21,000) = 46,500.00

Result: After accounting for the probable risk, the repayment capacity of farmer was reduced from Rs
54,000 to Rs 46,500, which was sufficient to repay the loan instalment of Rs 2500. The test of risk
bearing ability, thus justified the soundness of credit proposal.
EXERCISE 4: Balance Sheet

The balance sheet is analysed with the help of a number of financial ratio measures so as to know the exact
financial (solvency) position and stability of the farm business. The test ratios are current capital ratio,
intermediate/working ratio, net capital ratio, quick ratio or acid test ratio, current liabilities ratio, debt-equity
ratio and equity-value ratio are used to analyse the balance sheet.

A farmer want to take loan from cooperative bank. Farmer approached cooperative bank with balance sheet
prepared as on June 31, 2023. The balance sheet of the farmer is given below:
Assets Amount Liabilities Amount
A. Current A. Current
1. Cash in hand 10,000 1. Crop loan 8000
2. Savings in bank 8,000 2. Cost of cultivation (excluding loan) 6,000
3. Value of grains ready for disposal 38,500 3. Other loan due 5,000
4. Livestock products 60,000 4. Cost of maintenance of cattle 3,600
5. Fruits, vegetables ready for sale 8,000 5. Cost in poultry enterprises 25,000
6. Value of bond and share 2,000 6. Annual instalments 19,000
B. Intermediate B. Intermediate
1. Dairy cattle 10,000 1. Livestock loan 8,000
2. Bullocks 9,000 2. Machinery loan 15,000
3. Poultry birds 15,000 3. Unsecured loan 10,000
4. Machinery and equipment 15,000
5. Tractor 1,75,000
C. Long-term C. Long-term
1. Land 6,00,000 1. Tractor loan 1,20,000
2. Farm building 25,000 2. Orchard loan 35,000
Now, bank agricultural officer want to know success of farming of the farmer before landing loan to farmer.
For the purpose of this he want to find out [1] current ratio; [2] Intermediate ratio; [3] Long-term Ratio; [4]
Net capital ratio; [5] Acid-test Ratio; [6] Current liability Ratio; [7] Debt-equity Ratio (Leverage ratio); and [8]
Equity-value Ratio.
Solution

Assets Amount Liabilities Amount

A. Current A. Current
1. Cash in hand 10,000 1. Crop loan 8000
2. Savings in bank 8,000 2. Cost of cultivation (excluding 6,000
loan)
3. Value of grains ready for disposal 38,500 3. Other loan due 5,000
4. Livestock products 60,000 4. Cost of maintenance of cattle 3,600
5. Fruits, vegetables ready for sale 8,000 5. Cost in poultry enterprises 25,000
6. Value of bond and share to be 2,000 6. Annual instalments 19,000
realised in same year
Sub-Total 1,26,500 Sub-Total 66,600
B. Intermediate B. Intermediate
1. Dairy cattle 10,000 1. Livestock loan 8,000
2. Bullocks 9,000 2. Machinery loan 15,000
3. Poultry birds 15,000 3. Unsecured loan 10,000
4. Machinery and equipment 15,000
5. Tractor 1,75,000
Sub-Total 2,24,000 Sub-Total 33,000
C. Long-term C. Long-term
1. Land 6,00,000 1. Tractor loan 1,20,000
2. Farm building 25,000 2. Orchard loan 35,000
Sub-Total 6,25,000 Sub-Total 1,55,000
Total Assets (A+B+C) 9,75,000 Total Liabilities (A+B+C) 2,54,600
Net worth (9,75,000 – 2,54,600) 7,20,900
Total Liability + net worth 9,75,000

Test Ratio

A. Current Ratio = Current assets /Current liabilities

= 1,26,500 / 66,600
= 1.90

Current ratio indicates the capacity of the farmer to meet immediate financial obligations (liquidity). As farmer
will be able to meet his immediate financial obligations.

B. Intermediate Ratio = (Total current + intermediate Assets)/ (Total current + intermediate Liabilities)
= (1,26,500 + 2,24,000) / (66,600 + 33,000)
= 3,50,500 / 99,600
= 3.52

This indicate the liquidity position of the farm business over an intermediate period of time. Since the ratio is
more than one it shows a healthy sign of the business. The farmer will be able to meet his intermediate
obligations.

C. Log-term ratio = Log-term asset / long-term liabilities

= 2,24,000 / 33,000
= 6.788
 Long-term ratio indicates the capacity of the farmer to meet long-term financial obligations. As farmer will be
able to meet out his long-term financial obligations.

D. Net Capital Ratio = Total assets / Total liabilities

= 9,75,500 / 2,54,600
= 3.83
Net capital ratio indicates the long-term liquidity position and also the overall solvency position of the famer
borrower. As the ratio is more than one and larger, it indicates a very healthy position of the farm.

E. Acid test Ratio or Quick Ratio = (Cash receipt + Account receivable + Marketable securities (bonds,
shares etc) available in more than one year) / Total current liabilities

= 1,26,500 / 66,600
= 1.90

This reflects adequacy of cash and income surpluses to cover all current liabilities during the period of one or two
years. If there is no difference in income position of a farmer within that period, current ratio and acid test ratio
reflect the same position.

F. Current liabilities ratio = Current liabilities / Owner’s equity (Net worth)

= 66,600 / 7,20,900
= 0.09
This ratio indicates the farmer’s immediate financial obligations against the net worth. A ratio less than one
indicate a healthy performance of the farm business and over the years the ratio should become smaller and
smaller to reflect a consistently good performance.

G. Debt-equity ratio (Leverage ratio) = Total debt / Owner’s equity (Net worth)
= 2,54,600 / 7,20,900
= 0.35

This presents the capacity of the farmer to meet the long-term commitments. Also it throw light on the extent of
indebtedness in the farm business or conversely the amount of capital raised by the farmer in running the farm
business. A consistently falling ratio indicates a very heartening performance of farming and the ability of the
farmer to reduce dependency on borrowings.

H. Equity-value ratio = Owner’s equity (Net worth)/ Value of Assets

= 7,20,900 / 9,75,500
= 0.74

The ratio highlights the productivity gained by the farmer in relation to the assets he has. The improvement in the
ratio over the years makes it crystal clear regarding the increased strength in the financial structure of the farm
business. This ratio has a direct bearing on the type of assets one has. Managerial competence of the farmer is an
essential in raising the productivity of the assets.
Exercise 5: Pay-back Period

Mr. Shivam has Rs 30,000 excess money and he want to invest it either in pomegranate
orchard or mango orchard. The annual cash flow from the pomegranate and mango orchard is Rs 4000
and Rs 5000 per year respectively and productive life of the orchard is 10 years.

Table 1: Calculation of Payback Period

Initial investment = Rs 30,000
Year Cash flow (in Rs) Year Cash flow (in Rs)
Pomegranate orchard Mango orchard Pomegranate orchard Mango orchard
0 -30,000 -30,000 6 5,000 4,000
1 5,000 4,000 7 5,000 4,000
2 5,000 4,000 8 5,000 4,000
3 5,000 4,000 9 5,000 4,000
4 5,000 4,000 10 5,000 4,000
5 5,000 4,000

Based on above information estimate the Pay-back period.

Solution
I
Payback period =
E

P is the payback period of the project in year; I is the investment of the project in
Where,
rupees and E is the annual net cash revenue in rupees.
Rs 30000
Pomegranate orchard= =5 year
Rs 6000
Rs 30000
Mango orchard= =6 year
Rs 5000
Exercise 6: To estimate the Net Present Worth (NPW), B-C Ratio and Internal Rate of Return
(IRR)

A farmer wants to invest in apple orchard. The capital cost of the apple orchard is Rs 100000.
The productive life of the apple orchard is 10 years. Farmer also needs to invest some money during
the subsequent period as input cost and other expenses. Farmer starts getting income from second year
and onward. The discounting rate is 12% and 25%. The other information is given below:

Year Cost of inputs and Gross Year Cost of inputs and Gross Income
other expenses (Rs) Income (Rs) other expenses (Rs) (Rs)
1 100000.00 - 6 11000.00 45000.00
2 5000.00 25000.00 7 11500.00 50000.00
3 7000.00 30000.00 8 12000.00 55000.00
4 9000.00 35000.00 9 12500.00 60000.00
5 10000.00 40000.00 10 13000.00 65000.00
 Based on the above information estimate the [a] Net Present Worth, [b] B-C Ratio and [3] Internal
Rate of Return

Solution
Year Cost of Gross Net Estimation of Lower Higher NPW Present Present NPW NPW
inputs & Income Income discounting Dis. Dis. @ (Rs) Worth of worth of Lower Higher
other (Rs) (Rs) factor Factor 25% Cost (Rs) Gross discounting discounting
expense @ Income rate rate
s (Rs) 12% (Rs)
[1] [2] [3] [4] = [5] [6] [7] [8] = [9] [10] [11] [12]
[3] - [2] [5] [6] [4] x [6] [2] x [6] [3] x [6] [4] x [6] [4] x [7]
1 100000 0.00 -100000 (1/{1+(12/100)}1 0.893 0.800 -89285.7 89300.00 0.00 -89300.00 -80000.00
2 5000 25000 20000 (1/{1+(12/100)}2 0.797 0.640 15943.88 3985.00 19925.00 15940.00 12800.00
3 7000 30000 23000 (1/{1+(12/100)}3 0.712 0.512 16370.95 4984.00 21360.00 16376.00 11776.00
4 9000 35000 26000 (1/{1+(12/100)}4 0.636 0.410 16523.47 5724.00 22260.00 16536.00 10649.60
5 10000 40000 30000 (1/{1+(12/100)}5 0.567 0.328 17022.81 5670.00 22680.00 17010.00 9830.40
6 11000 45000 34000 (1/{1+(12/100)}6 0.507 0.262 17225.46 5577.00 22815.00 17238.00 8912.90
7 11500 50000 38500 (1/{1+(12/100)}7 0.452 0.210 17415.44 5198.00 22600.00 17402.00 8074.04
8 12000 55000 43000 (1/{1+(12/100)}8 0.404 0.168 17366.98 4848.00 22220.00 17372.00 7214.20
9 12500 60000 47500 (1/{1+(12/100)}9 0.361 0.134 17128.98 4512.50 21660.00 17147.50 6375.34
10 13000 65000 52000 (1/{1+(12/100)}10 0.322 0.107 16742.61 4186.00 20930.00 16744.00 5583.46
Total 191000 405000 214000 62454.85 133984.50 196450.00 62465.50 1215.93

Solution

[a] Net Present Worth (NPW) or Net Present Value (NPV)

P1 P2 P3 Pn
NPW = t1
+ t2
+ t3
+ .. .. . .. .. . ..+ t
−C
( 1+ i ) (1+i ) (1+i ) ( 1+i ) n
Where, P=Net cash flow in the year; i = discounting rate expressed in term of per cent; t = time period; and C = initial cost
of the investment.

[b] Benefit-Cost Ratio (B-C Ratio)

n
∑ B t /( 1+r )n
B−C Ratio= t=1
n
Ct
∑ ( 1+r )n B-C Ratio = Present worth of gross return/ Present worth of costs
t =1

196450 .00
B−C Ratio=
133984 . 50 B - C Ratio = 1.466

The B-C ratio was estimated to be 1.466. It means if farmer invest one rupee on a project he would get gross
income from the investment is Rs 1.466 and net income of Re 0.466.

[c] Internal Rate of Return

 ][ ][ ]
Present worth of cash flow at the

[
Difference
Lower lower discounting rate
IRR= discounting + between two ∗
discounting Absolute difference between present
rate woth of cash flow at two discounting rate
rate

IRR=[ 12 ] + [ 25−12 ] x
[ 62454.85
(62454.85−1215.93) ]
IRR=[ 12 ] + [ 13 ] x
[
62454.85
(61238.92) ]
IRR=[ 25 ] x [ 1.0199 ]
IRR = 25.50
EXERCISE 7: Income statement

Mr. Rakesh approached a cooperative bank with income statement for borrowing money. The average
capital investment of Mr. Rakesh is Rs 300,000 per year. The cooperative bank wants to know his
success of agriculture. For the purpose of this bank wants to calculate [a] operating ratio; [b] fixed
ratio; [c] gross ratio [d] capital turn-over ratio; and [e] rate of return on investment The Income
statements of Mr. Rakesh is given below:

Income Statement of Mr. Rakesh for the period 2010-11

Items Amount in Rs.
A. Cash Receipts 2010 2011

1. Return from crop 52,000 55,000

2. Revenue from milk and milk product 5,000 7,000
3. Return from poultry enterprise 12,000 15,000
4. Gifts 2,000 3,000
5. Gross cash income 7,000 8,000
6. Appreciation on the value of assets 3,000 4,000
Gross Income 81000 92,000
B. Operating Expenses
1. Hired human labour 10,500 11,000
2. Bullock labour 900 1,000
3. Machinery 1,500 2,000
4. Seeds 1,100 1,200
5. Feeds 5,000 6,000
6. Manure and Fertilizer 3,000 3,500
7. Plant protection 1,550 1,600
8. Veterinary expenses 500 700
9. Irrigation 250 300
10. Misc. 2,000 2,500
11. Interest on working capital 2,100 2,200
Total Operating Expenses 28400 32,000
C. Fixed Expenses
1. Depreciation 3,000 3,000
2. Land Revenue 200 200
3. Interest on fixed capital 3,200 3,200
4. Rental value of own land 10,000 10,000
Total Fixed Expenses 16400 16,400

1. Net cash income = (Total receipts – appreciation assets) – Operating expenses

 = (81,000 – 3000) – 28,400
= 49,600

2. Net operating income = Total receipts – Operating expenses

= 81,000 – 28,400
= 52,600
3. Net farm income = Net operating income – Total fixed cost
= 52,600 – 16,400
= 36, 200
SOLUTION FOR 2010

Operating Ratio = Total Operating Expenses ÷ Gross Income

= 28,400 ÷ 81,000
= 0.35

Fixed Ratio = Total Fixed Expenses ÷ Gross Income

= 16,400 ÷ 81,000
= 0.20

Gross Ratio = Total Expenses (Operation + Fixed) ÷ Gross Income

= 44800 ÷ 81,000
= 0.55

Capital turn over Ratio = Gross Income ÷ Average capital investment

= 81,000 ÷ 300,000
= 0.27

Rate of Return on investment = Net return to capital ÷ Average capital investment

= (Net farm income + Interest on fixed and operating) ÷
Average capital investment

= (36,200 + 2100+ 3200) ÷ 300,000

= 41,500 ÷ 300,000
= 0.138