Department of Management Studies

Assignment on:
Chapter – 5: Finance and accounting in agribusiness

Submitted To:
Md. Mosharraf Hossain
Assistant Professor
Dept. of Management Studies
Comilla University

Submitted by:
Group: 05
SL. NO Name ID No Remarks
1 Rahima Akter 11805021
2 Md. Billal Hossain 11805022
3 Mazharul Islam (Group 11805023
leader)
4 Abdullah Al Omar Faruk 11805024
5 Eftekhar Ahmed 11805025
6 Ajoy Dhar 11805026
7 Nadiya Rahman 11805027
8 Md. Redoy Hossain 11805028
9 Mohammad Efteker 11805029
Hossain
10 Md. Abdur Rahman 11805030
11 Sultan Al Nahian 11805061

Submission Date: August 03, 2022

Table of Contents
Financial needs assessment.........................................................................................................................3
Income and assets................................................................................................................................3
Expenses and liabilities........................................................................................................................3
Short- and long-term goals..................................................................................................................3
Reasons for increasing financial resources..................................................................................................3
Sources of Finance......................................................................................................................................4
Investment by owners..............................................................................................................................4
Borrowing................................................................................................................................................4
Short-term loans..................................................................................................................................4
Intermediate-term loans.......................................................................................................................5
Long-term loans...................................................................................................................................5
Equity capital.......................................................................................................................................6
Funds generated by profits and retained in the business..........................................................................6
Equity capital.......................................................................................................................................6
Common stock.....................................................................................................................................7
Other internal financings.....................................................................................................................7
External sources of financing......................................................................................................................7
Trade credit..........................................................................................................................................7
Commercial banks...............................................................................................................................7
Insurance companies............................................................................................................................8
Commercial finance.............................................................................................................................8
Cooperative borrowing........................................................................................................................8
Types of loans.........................................................................................................................................9
Accounts Receivable Loans.................................................................................................................9
Warehouse receipts..............................................................................................................................9
Promissory note...................................................................................................................................9
Leasing and renting.............................................................................................................................9
Capital lease......................................................................................................................................10
Cost of finance..........................................................................................................................................10
Repayment terms...............................................................................................................................10
Interest rates and taxes.......................................................................................................................11

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Financial needs assessment
A financial needs assessment (FNA) is an overview of a firm’s current and future financial
situation. It considers assets, such as wealth and income, set off against liabilities, such as debt
and dependents. By creating a financial need analysis, a firm can get a complete overview of its
financial situation and how it relates to its long- and short-term goals.

A financial needs analysis includes:

Income and assets

How much does the company make each month? What kind of wealth does it have, including
securities and other investments? In a nutshell, how much does it earn, and how much does it
have?

Expenses and liabilities

What is its monthly budget? How much does it spend each month, and on what? At the same
time, what are its debts? How much does it have going out the door in debt payments and other
bills? Finally, who are its dependents? Is it taking care of family members or anyone who
represents a monthly commitment?

Short- and long-term goals

What financial goals does it have? How much money will it need to achieve them, and when
would it like to reach them?

Reasons for increasing financial resources

The ultimate reason for increasing the financial resources of an agribusiness is to increase its
revenues and profits by generating additional business. Extra funds are used for general
purposes, to increase liquidity or the cash position, or for expansion and growth. An agribusiness
requires working capital in the form of cash. The principal source of money must be the revenue
generated by the business itself. Still, in short-term situations, additional cash may be required to
meet the day-to-day obligations of the company. As a rule, many agribusinesses find it advisable
to keep on hand enough money to equal 20 to 25 percent of the number of their current
liabilities. The most important use for additional financial resources is for expansion. Expansion

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can require either a short- or long-term commitment of funds. The short-term development
involves such factors as increased labor, inventories, and accounts receivable. Long-run
expansion encourages more ambitious projects, such as purchasing new equipment, buildings,
and land. The objective of increasing the capital of an agribusiness is to increase its sales volume
and revenues, and consequently its profit, through the intelligent application of increased assets.

Sources of Finance
There are three sources from which the manager may raise funds needed to operate an
agribusiness:

 Investment by owners

 Borrowing

 Funds generated by profits and retained in the business.

Investment by owners
In most medium-to-large businesses, the primary source of funds;l (over 50 percent) is the
owner’s equity in the firm (also called “owned capital”). The larger the company, the more it
depends on the owner’s equity as a source of funds. One primary reason for this is that larger
companies usually enjoy access to public offerings for their stock or equity and possess the
ability to attract investors, a situation that smaller companies do not share. Whatever the kind or
size of a business, its ability to generate profits will ultimately determine the number of funds
made available for its use.

Borrowing
There are four types of capital:

 Short-term loans: one year or less

 Intermediate-term loans: one to five years
 Long-term loans: more than five years
 Equity capital: no due date

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Short-term loans
Short-term loans are generally defined as loans for one year or less, used whenever the
requirement for additional funds is temporary. Some of these funds would also be needed to
support accounts receivable as inventory is sold to customers. An essential characteristic of
short-term loans is that they are usually self-liquidating; that is, they often start a chain reaction
process that results in their repayment:

Loan => inventories => receivables => cash =>repay loan

While short-term loans may be made on an unsecured basis to firms that are well established,
there is often a requirement for collateral or for the loan to be secured by some of the firm’s
assets. Unable to meet the payment. Short-term loans may be regular-term loans with a specific
amount due at a specified time or revolving or line of credit loans. Managers who anticipate a
need for short-term funds often apply for a line of credit in advance of their needs. A line of
credit is a commitment by the lender to make a certain sum of money available to the firm,
usually for one year and at a specified interest rate, at whatever time the firm needs the loan.
Usually, the loan must be repaid during the operating year of the firm.

Intermediate-term loans
Intermediate-term loans are typically used to provide capital for one to five years. Such a loan is
almost always amortized; that is, the process in which the amount of a loan is reduced by equal,
periodic (i.e., monthly, quarterly, annual, etc.) loan payments. These payments include both
interest and principal. The purpose of the intermediate-term loan is to provide the agribusiness
with a source of capital that will allow growth or modernization without forcing the owners to
surrender control of the business. These loans allow for additional working capital, which can be
used to increase revenues and sales; the funds generated by the increased revenues will, in turn,
help to retire the loan.

Long-term loans
In general, long-term loans have a duration of more than five years. The time distinctions among
these loans are somewhat arbitrary, and there is some overlap in the functions of intermediate-
and long-term loans, depending on the philosophies and policies of lender and borrower. But the
real difference between intermediate- and long-term loans usually rests with the planned use of

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the funds and the long-term prospects for the firm’s existence and solvency. The purpose of the
long-term loan is most often for real estate, that is, for land and buildings. Long-term loans are
nearly always amortized over the loan period and secured by a mortgage or claim on a specific
fixed asset.

Equity capital
If the agribusiness is not in a solid financial position or cannot meet the stiff collateral
requirements set by lenders, it may have to turn to equity capital to meet its long-term needs.
Equity capital can be used for the same purpose as borrowed funds, but there is a significant
difference: equity capital does not have to be repaid. It becomes a permanent part of the capital
of the business. Equity capital is secured either by reinvesting profits from the company or
finding investors willing to invest additional funding in the industry. Lenders pay particular
attention to equity when making long-term loan commitments, and they may insist that a more
significant percentage of the owner’s money be invested in the capital of the agribusiness than
the lenders. This is particularly true of new businesses, where risks are more difficult to
calculate. For various reasons, some owners do not wish to increase their equity, but it may be
the only prudent way of securing long-term capital funds.

Funds generated by profits and retained in the business

One of the most important sources of capital is the money obtained from retained earnings. Some
managers fail to understand the importance and role of retained earnings fully. It is not that a
manager lacks awareness of these funds, but because they have not used the financial tools and
techniques previously described, they have no idea how to use retained earnings to the fullest
extent.

Equity capital
Equity capital represents funds the firm obtains through retaining the profits it has made, through
the investment of more money by the owners, or by taking into the additional business people
willing to risk their funds. This may be the only alternative for securing capital funds in some
small or new businesses. The venture capitalist, a specialized financing organization, provides
equity capital for new and high-potential enterprises. Some owners are not anxious to sell equity
to other people. These owners feel that the loss of complete control over the business is not

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worth the additional capital. Such owners should be aware that borrowing funds may place far
more restraints on their power than sharing ownership. And if an owner defaults or is slow in
paying a term loan, they can completely lose control of the management of the business.

Common stock
Preferred stock is the stock to which a corporation shows preference. In the event of the
corporation’s liquidation, the owners of preferred stock would be repaid before holders of
common stock. Most preferred stock also has a definite actual dividend rate, which means it
would pay a percentage (say 6 percent) of the face or issue value annually. Sometimes
corporations will reserve the right to defer this dividend until a later date should the corporation
have financial difficulties. In exchange for its preferred nature in the event of liquidation, most
preferred stock does not carry rights or control in the management affairs of the corporation.

Other internal financings

Partnerships may secure more capital by selling portions of their business to others willing to
risk their money in the industry. These others may be either general or silent partners. A general
partner assumes the same rights and liabilities as other partners, while a silent partner has
restricted rights and liabilities. An owner may lend money to the business just as any outside
creditor would if that owner does not wish to commit any additional funds on an equity basis.

External sources of financing

There is a multitude of sources of capital available to any agribusiness. Some of these sources
are used only in specific situations, while others are used more routinely. The most important
sources of financing for agribusiness will be discussed in the following sections.

Trade credit
Trade credit is one of the most neglected sources of capital available to agribusiness managers. It
is the credit advanced by suppliers and vendors of the agribusiness firm. Most suppliers and
vendors will allow credit terms if the agribusiness is creditworthy. The manager can often
negotiate for longer credit terms than are usually offered. The agribusiness manager should
ensure that suppliers and vendors are extending maximum times and that the procedure for
paying accounts payable takes every advantage of all credit terms extended.

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Commercial banks
Commercial banks are most agribusinesses' primary source of borrowed funds, except trade
credit. Commercial banks usually offer a full line of banking services, including checking
accounts, savings accounts, and loans. Banks make many kinds of loans, such as short-,
intermediate, and long-term loans, lines of credit, and particular loans. Banks also make personal
unsecured loans to owners, and many other secured loans, such as mortgages against real
property; chattel mortgages against tools and equipment; and loans against the owner’s life
insurance policies, stocks, bonds, etc. This is particularly helpful to retailers selling relatively
expensive items, such as farm implements, tractors, and combines.

Insurance companies
Insurance companies are always looking for places to invest funds they have collected from
policyholders. Most insurance companies are interested in intermediate- and long-term loans on
fixed assets, such as equipment or real estate. They prefer large loans and mortgages for
collateral. Suppose the owners or agribusiness have insurance policies with a particular
company. In that case, that company will usually lend the agribusiness amounts equal to the
policy’s cash value at favorable interest rates.

Commercial Finance
Companies Commercial finance companies are those finance companies that specialize in
business and commercial loans. They are not to be confused with personal finance companies,
which make loans to individuals. Commercial finance companies often grant loans that are
riskier than those that banks will accept, so commercial finance companies usually charge higher
interest rates than banks. Commercial finance companies may also demand considerable control
over management decisions. This is particularly true if the loan involved is high risk. Sometimes
commercial finance companies will pay off all firm debts to consolidate the firm’s indebtedness
into one loan held by the finance company. This can be of particular value if cash flow presents a
problem because payment schedules can be reconstructed within the agribusiness’s cash flow
constraints.

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Cooperative borrowing
In cooperative borrowing, the suitable patrons, who are its borrowers, own these particular
banks. The bank makes short-, intermediate, and long-term loans to its members. To receive a
loan, a cooperative must purchase an amount of membership stock that is equivalent to the
amount of money being borrowed. This stock is revolved or repurchased whenever the debt is
repaid, and the firm has funds available for that purpose. Often CoBank can offer better interest
rates than some commercial banks because it is a nonprofit organization operated exclusively for
the benefit of its members. Because they specialize in loans to cooperatives, the bank’s personnel
are often able to offer management help and guidance to member-borrowers.

Types of loans
Accounts Receivable Loans
Accounts Receivable Loans are loans in which the bank lists a business’s accounts receivable as
collateral. This may be done on either a notification or non-notification basis. Notification means
that the bank informs the debtors (customers of the agribusiness) that it wishes to collect the
money owed. The bank receives the payment from the customer and then deducts a service
charge and interest. The bank then credits the balance against the loan to the agribusiness. Under
non-notification, the agribusiness (borrower from the bank) collects the receivables and then
forwards the payments to the bank. Record keeping and interest costs are usually high, and
managerial flexibility is lost when using non-notification, so non-notify loans should be avoided.

Warehouse receipts
Warehouse receipts represent a means of using inventory as security for a loan. As inventory is
stored in the warehouse, the borrower sells the inventory to the bank and then buys back the
receipts from the bank as the product is sold. This loan is feasible only on nonperishable items,
allowing the borrower to manage with limited working capital.

Promissory note
The promissory note is a promise by the borrower to pay the lender a particular amount of
money and interest after a specified period. Promissory notes are familiar to agribusiness firms
and are used by banks, private individuals, and other creditors. Agribusiness firms may also
accept promissory messages from their customers.

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Leasing and renting
A lease is a contract by which the control over the right to use an asset is transferred from the
lessor (owner) to the lessee (person acquiring power) for a specified time in return for a rental
payment. Land leasing is a standard method of gaining control of a durable asset in agriculture.
A land lease is a contract that conveys control over the use rights in real property from the lessor
to the lessee without transferring the title. The contract usually specifies the property’s intended
use and payment conditions for that use. An operating lease is usually a short-term rental
arrangement (i.e., hourly, daily, weekly, monthly, etc.) in which the rental charge is calculated on
a time-of-use basis. The lessor owns the assets and performs almost all ownership functions,
including maintenance. The lessee pays the direct costs, such as fuel and labor. However, the
terms may vary and even be negotiated between the two parties.

Capital lease
A capital lease is a long-term contractual arrangement in which the lessee acquires control of an
asset in return for rental payments to the lessor. The contract usually runs for several years and
cannot be canceled. So, the lessee acquires all the benefits, risks, and costs of ownership, except
price variations of the asset, but does not have to make the usual investment of equity capital.

Cost of finance
When a business borrows money, it incurs special costs paid to the lender. One of

These are interests, but interest is not the only cost of borrowing money. Several other factors
affect the net worth of borrowed capital:

 Repayment terms and conditions

 Compensatory balances, points, and stock investments
 The income tax bracket of the firm

Repayment terms
The repayment terms and conditions directly affect the rate of interest that is paid. If a person
borrowed $100,000 for one year at the stated interest rate of 8 percent, the amount of interest
paid would be $8,000. At the end of the year, he would pay the lender$108,000. This type of
interest is called simple interest. The formula for simple interest is:

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(Amount of Interest Paid / Amount of Available Capital) × 100 =Annual Interest Rate

($8000 / $100000) × 100 = 8%

Sometimes, however, loans are discounted, which means that the interest to be paid is deducted
from the amount the lender makes available to the borrower. If this method had been used in
Doug’s case, the $8,000 interest to be paid, or 0.08 × $100,000, would have been deducted from
the loan amount, and Doug would have used only $92,000 in the capital. The discounted loan
formula is as follows:
Amount of Loan - Amount of Interest Paid = Amount of Available Capital

($100000-$8000) = 92000

At the end of the year, $100,000 would have been repaid to the lender; but because Doug used
only $92,000, the “effective” interest rate was not the stated rate. The “effective” interest rate for
a discounted loan is calculated as follows:

(Amount of Interest Paid / Amount of Available Capital) × 100=Annual Effective Interest Rate

($8000 / $92000) × 100 = 8.7%

Other restrictions
Lenders often restrict the management prerogatives of an agribusiness during the loan period.
These restrictions vary from requiring monthly and annual financial statements or other financial
information regarding inventories and accounts receivable. It accounts payable to restrictions on
expending capital funds without the lender’s approval. Often banks require that firms maintain
specific ratios during the loan period. Agribusiness managers must be sure that they can live
comfortably with these restrictions before they agree to them. Otherwise, they may find
themselves severely handicapped in decision-making and their flexibility to meet changing
conditions and capitalize on new opportunities.

Interest rates and taxes

One of the things that agribusiness managers often overlook is that they can deduct from the
business’s taxable income every dollar of interest paid because the claim is a business expense.
To know the effective cost of borrowing funds, the manager must know the after-tax interest
cost. This effect can be seen by looking at net income after taxes, before and after borrowing. For

11
example, assume Doug Davies’s company (a corporation) borrowed $100,000 at 8 percent
interest; the following tabular information is used to illustrate the impact of interest paid on the
after-tax cost of borrowing:

Before loan After loan

Net operating income $50,000 $50,000
Interest charges 0 $8,000
Net income before taxes $50,000 $42,000
Income tax (assume 25 % $12,500 $10,500
rate)
Net income after taxes $37,500 $31,500

The leverage principle

Leverage is the concept of financing through long-term debt instead of equity capital. Many
managers like to use debt as a lever against equity as much as possible to maximize the number
of assets or capital at their disposal. Several factors affect the leverage principle. First, it must be
remembered that as debt-to-equity proportion increases, lenders are likely to increase the cost of
supplying borrowed funds because of the deterioration in the solvency measures and the
resulting increase in risk. It must be understood that risks for equity holders also increase as debt
increases because they hold a last-place claim on the fi rm’s assets if the assets of the fi rm must
be liquidated to satisfy the fi rm’s debt obligations. In general, equity capital is risk capital — in
the event of financial problems, all other creditors are paid before equity owners are paid.
Leverage, or increasing the proportion of debt to equity, can be either a profitable or an
unprofitable decision.

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