Glossary of Terms for Financial Statements Balance Sheet A Balance Sheet is a summary (or snapshot) of an organization’s financial position at a specific point in time; therefore it is static. It presents the institution’s stock of assets (such as cash, loan portfolio, investments or fixed assets), liabilities (such as loans or accounts payable), and equity capital (net worth, or difference between assets and liabilities). All amounts are cumulative since the organization began. On a Balance Sheet, Assets equal Liabilities plus Equity. Why is it called a “Balance” Sheet? What elements must balance on a Balance Sheet? All assets of the organization are funded either by outside parties (liabilities) or by investors, including donors or other interested parties (equity or net worth). The total amount of assets therefore must equal the funding sources. The tow sides of the Balance Sheet are two views of the same resources of the organization: the organization’s assets on one side and the funding sources for those assets on the other. ASSETS Assets represent what is owned to it. They are those items in which an organization has invested its funds for the purpose of generating future income. On the Balance Sheet, assets are always equal to the sum of liabilities plus equity. Assets are divided in order of liquidity into short-term or current assets and long-term term assets including fixed assets. Current assets Cash and marketable securities, accounts receivable, and inventories that in the normal course of business will be tuned into cash within a year. Cash and due from banks All balances available to the organization on a demand basic such as cash, and funds on deposit in non-interest bearing accounts. Reserves in central bank Funds held on deposit at the central bank as required by some bank superintendencies; the amount is generally determined as a percentage of assets or liabilities held by the MFI. Cash reserves are applicable only to regulated financial institutions. Total or Gross loan Portfolio outstanding (could be further defined in short-term and long-term net portfolio outstanding) Assets composed of the total amount of loans remaining to be paid at a point in time, that is, the total amount owed to an institution by its borrowers. It includes loans outstanding that are current, with no late payments or defaults, and the total amount of loans outstanding that have an amount past due. Past due is typically defined as when a payment is one day late. Net loans outstanding or Net Loan portfolio outstanding (could be further defined in short-term and long-term net portfolio outstanding) All loans disbursed and not yet repaid or written off, minus the loan loss reserve. Te net loans outstanding figure reflects only the principal and does not include interest expected to be received. Loan loss reserve Amount set aside to recognize probable future loan losses on the loan portfolio so that the true value of the loan portfolio so that the true value of the loan portfolio is fairly stated. To create or increase the loan loss reserve, a loan loss expense (referred to as the loan loss provision) is recorded on the Income Statement as an expensed. The amount of loan loss provision is then recorded on the Balance Sheet as the negative asset – loan loss reserve. The negative asset reduces the net outstanding loan portfolio Actual loan losses, or write-offs, affect the Balance Sheet only (and not the Income Statement) as a reduction of the loan loss reserve and the total loan portfolio. Other short-term or current assets Items that do not appear in the foregoing, such as: • Accrued interest – interest that has come due and is recorded but has not yet been received (not recommended by CGAP for loan interest) • Accounts receivable – amounts owed to the MFI for services already rendered or products already delivered. • Prepaid expenses – for example, rent or insurance premiums paid in advance for the upcoming period Long-term financial assets Investments not intended as a ready source of cash, such as stocks, bonds, promissory notes, and land that will be held for more than on year or one cycle. Fixed assets Includes property, plant, and equipment; they represent assets that are not readily redeemable for cash. Examples are land, buildings, machinery, equipment, furniture, automobiles. • Cost – property and equipment (fixed assets) are recorded at accost or current market value at acquisition. • Accumulated depreciation – an annual, noncash expense that is determined by estimating the useful life of each asset. Depreciation represents a decrease in the value of property and equipment to account for the portion of their useful life that is used up during each accounting period. Annual depreciation is recorded on the income statement as an expense that increases the accumulated depreciation on the balance sheet by the same amount. Like the loan loss reserve, accumulated depreciation is a negative asset. • Net fixed assets – the cost or recorded market value of property and equipment less accumulated depreciation. Liabilities represent what is owed by the MFI to others either in the form of a loan that has been extended to it or obligations for the MFI to provide goods and services in the future. Compulsory savings deposits Voluntary savings deposits Compulsory client savings that have been deposited in the MFI that the MFI must return, generally when the loan has been repaid or when the client leaves the MFI. Forced savings may or may not incur an interest cost for the MFI. Client savings that have been deposited voluntarily with the MFI that the MFI must return. Although a liability for MFI, voluntary savings are different from borrowed funds because there is no due date or amortization schedule. Voluntary savings generally incur an interest cost for the MFI. If interest is not paid out to the client, it is sometimes accrued and increases the liability of the MFI to the client. Amounts deposited with the MFI for a specified period of time. The rate of interest paid generally increases as the length of the deposit increases. Time deposits (short-term or long-term) Commercial borrowings (short-term or long-term) Outstanding amount that the MFI owes a bank or other lender for which it is paying a market rate of interest. The loans could be short-term or long-term. Long-term debt is that portion which is due in over one year’s time. Outstanding amount that the MFI owes to a lender (typically from a donor or government) for which it is paying the lender a rate of interest below the rate the MFI could have obtained from commercial sources. Concessional borrowing (also called subsidized or soft loan) (short-term and long-term) Other short-term liabilities and accounts payables Restricted or deferred revenue (shortterm or long-term) Outstanding amounts that the organization owes to a bank, other lenders or other organization (such as past due rent) that are due within one year or less. Also includes accrued expenses and unearned/deferred income. Funds received but restricted for use in future years or for specific activities are classified as a liability on the Balance Sheet because they must be returned to the funding organization if the specified programs are not carried out. Restricted funds are not recorded as earned until the service or product that they are funding is delivered. When the organization receives restricted funds, it incurs an obligation (liability) to provide the services described in the grant agreement. As the organization provides the services (such as loans to microentrepreneurs in a certain region), it incurs expenses. Deferred revenue is then recognized as grant revenue and used to cover those expenses. Other long-term liabilities Outstanding amounts that the organization owes to a bank, other lenders, or other organizations that are due more than one year form the date of the financial statements. EQUITY Equity is also referred to as capital or net worth. Unlike liabilities, the equity of an organization does not have to be repaid. It therefore represents the value or “net worth” of the MFI. Equity is equal to the amount of assets less liabilities. It represents the link between the balance sheet and the income statement flows into the equity section of the balance sheet at the end of each period. Paid in capital from shareholders Amount of funds contributed by shareholders to the MFI. Donated equity Accumulated amount of donations received by the MFI. Retained earnings Amount of profit (or loss) accumulated in previous years since the formation of the organization. Other capital accounts other specific fund or reserves such as nonrefundable contributions from clients and/or statutory reserves required by law. Should also include the difference between nonoperational income and expenses. INCOME STATEMENT The Income Statement is also known as the Profit and Loss Statement. It is a summary of the income, expense and net profit or loss (the difference between income and expenses) for a period of time – say, January 1 to December 31 2002. INCOME In accounting terms, revenue refers to money earned by the organization for goods sold and services rendered during a given period. When an organization renders services to its clients. It usually received income in the form of cash or an account receivable. Main income for MFIs is interest revenue on loans. OPERATING INCOME Operating Income is produced by an institution’s core business. For a microfinance organization operating income includes interest earned on loans to clients; fees earned on loans to clients; interest earned on funds on deposit with a bank, and so forth. Financial revenue from loan portfolio a) Interest income from loans b) Fee income from loans Amount received from clients for borrowing money from the MFI for a specified period of time. The interest rate is stated as a percentage of the loan amount. Interest received refers to the interest that the borrowers owes the MFI but has not yet paid. Note: The principal amount of the loan repaid is not included in income. Only the Balance Sheet accounts are affected by the principal portion of a loan repayment; that is, total loan portfolio decreases and cash increases. The only time the Income Statement is affected by the principal portion of a loan is when a loan which has been written off is repaid. Amount charged to clients for (services associated with) loans disbursed by the MFI, usually in addition to the Interest charged. They may be stated as a percentage of the loan amount or a flat amount. These fees or service charges are often charged up front. There are also penalty fees for late or partial payment and these are charged once a payment is missed. Amount of interest earned by the organization on its investments such as interest-bearing deposit accounts, term deposits, treasury bills, and so on. Income from investments EXPENSES Expenses represent the costs incurred for services used in the process of earning revenue. They are often referred to as the “cost of doing business” since they represent the cost that are necessary for the organization to generate revenue and thus remain in operation. Direct expenses for a microfinance organization include financial costs, operating expenses and loan loss provisions. FINANCIAL EXPENSES Expenses that are specific to delivery of the core business (credit and savings activities) for a specified time period. For a single-purpose MFI, all costs should be included. For multipurpose institutions, all direct costs of financial operations and an appropriate portion of the institution’s overhead should be included. Financial expenses on liabilities a) client savings Payments (interest and fees) made to clients who deposit savings in the organization (either voluntary or forced). b) borrowings Interest and fees paid to banks and other financial institutions for money that they have loaned to the MFI. Loan loss provision expense Based on the historical default rate and the current outstanding loan loss reserve, the loan loss provision is the (non-cash) amount expensed in a period to increase the loan loss reserve to an adequate level to cover probable defaults of the loan portfolio. Although the loan loss provision is a non-cash expense, it is treated as a direct expense for an MFI. OPERATING EXPENSES Expenses that are considered a subset of financial expenses. Personnel: Salaries and benefits Payments from the MFI to its staff for services rendered; usually the largest operating expense for an MFI. Administrative Expense a) Rent Payments made for lease of land and/or buildings for the purposes of loan fund management over a specified time period. b) Transportation and travel Payments for transportation, room and board, etc., of staff members working on behalf of the organization. c) Depreciation An annual, non-cash expense that is determined by estimating the useful life of each asset. Using the most common method, called straight-line depreciation, an asset with an estimated useful life of five years would have on-fifth of its purchased price reflected as an expense in each of the five years. The depreciation expense increases the accumulated depreciation account on the balance sheet (similar to the loan loss provision [expense] and the loan loss reserve [negative asset] respectively). Plus All other expenses related to the MFI’s operations, such as office materials/supplies, publications/publicity, telephone and postage, insurance, utilities, staff training, board meeting expenses, legal services/other service fees, expenses, legal service/other service fees, bank charges, repair and maintenance, courier and delivery, loss on currency conversion, taxes, etc. NET OPERATING PROFIT/LOSS OR NET INCOME FROM OPERATONS Income that is direct result of the MFI’s lending and savings activities net of the expenses directly related to these activities. NON-OPERATIONAL INCOME AND EXPENSES Income not produced by the core business (e.g., donations); expenses not incurred by the core business. CASH DONATIONS Funds donated to the MFI that year (for which the conditions, if any, have been met), to cover operating expenses, loan fund capital, and so on. OTHER NON-OPERATIONAL INCOME AND EXPENSES Other revenue earned by the MFI for services provided other than credit and savings, such as training fees, and expenses incurred in providing these services. BALANCE SHEET Assets Short Term Assets Cash and Due from banks Reserves with the Central Bank Short Term Financial Assets Net Outstanding Portfolio Gross ST Outstanding portfolio (Loan loss reserve) Accounts receivables Other short term assets Long Term Assets Long term financial assets Net fixed assets Gross fixed assets (Accumulated Depreciation) Other long term assets Liabilities and Equity Liabilities Short term liabilities Demand deposits Short term deposits Short term borrowings – commercial Short term borrowings – concessional Other Short term liabilities Long term liabilities Long term deposits Long term borrowings – commercial Long term borrowings – concessional Other long term liabilities Restricted funds Equity Paid-in capital Donated equity Reserves Retained earnings Current year Previous years Year 1 INCOME STATEMENT a Financial revenue from operations Revenue from loan portfolio Revenue from other financial assets Other Revenue related to financial services b Financial expenses from operations Interest and fees paid on borrowings Interest and fees paid on deposits Other expense related to financial services (net exchange losses) c Gross Financial income from operations (a-b) d Loan loss provision expense e Net Financial Income (c-d) f Operating expenses Personnel Expenses Administrative Expenses (including depreciation) g Operating Income (e-f) h Income not from operations i Income tax j Net Income before donations (g+h-i) k Revenue from donations l Net Income after donations (j+k)