CREDIT ANALYSIS
4RS, 5CS AND 7PS OF CREDIT, REPAYMENT PLANS
The principles of farm finance are stated as ‘three Cs’, viz,
1) Character
2) Capacity, and
3) Capital.
The application of these principles facilitate largely the lending agencies, in the sense
that the character of the borrower is a dominant factor for consideration before a lending agency
decides to advance loan. Although the farm more net income, create good finance extended to
a farmer may yield repaying capacity and buildup risk bearing ability he will not repay the loan
unless he has good character. The second principle deals with the capacity of the borrower who
not only produce more but also has to repay the loan in time. The third principle is intended to
safeguard the interest of the lending agency. When the first two intangible assets prove
inadequate during distress periods, the third, asset or capital will come to the rescue of the
lending agency.
The principles of farm credit can also be stated as ‘three Rs'. They are:
i) Returns from the proposed investment,
ii) Repaying capacity
iii) Risk-bearing ability of the borrower
To find out the feasibility of a project or a scheme or a farm plan, these principles can
the applied as economic feasibility tests.
i) Returns
The economic viability of a project indicates whether the proposed project is likely to
contribute reasonable returns on the investment which in turn will lead to economic
development of the farmer.
The economic viability can be measured by
1) Net Present Worth (NPW)
2) Benefit-Cost Ratio (BCR)
3) Internal Rate of Return (IRR)
1. Net Present Worth
The NPW of the project can be estimated using formula as given below:
n
Bn − Cn
NPW = ∑t =1 (1 + i ) n
, Where,
Bn = Benefits in n'th Year.
Cn = Costs in n'th Year.
n = life span of the proect
i = interest or discount rate.
If the NPW of a project is positive, then it is considered that the project is economically feasible.
2. Benefit-Cost Ratio (BCR)
The BCR can be calculated using the following formula:
n
Bn
∑
t =1 (1 + r ) n
BCR = n
Cn
∑
t =1 (1 + r ) n
To compute the NPW and BCR, the opportunity cost of capital (normal/market lending rate) may
be used as a discount rate. If the BCR is greater than 1, then it is worth wile to invest on the
project.
n
Bn − Cn
IRR = r ∑t =1 (i + r ) n
=0
IRR is that rate of discount which makes the present worth of benefits and costs equal or the net
present worth of cash flow equal to zero. If IRR is greater than the opportunity cost of capital,
the project is feasible.
ii) Repaying capacity
The repayment of loan depends on the amount of surplus income available with the farm
household after providing some amount for the family expenses and pre-existing liabilities,
besides keeping a margin for the risk factor. As the farming family is likely to get income from
the farm business as well as from off-farm activities, the repaying capacity of the borrower
should be judged by taking into account their total income.
The concept of repaying capacity can be expressed symbolically as:
Rc = ( (Y2-rf) + (Y 1 -rf) + Y) - ( (X 2 -X 1 ) + Fe+OL)) ≥ I+i
Where,
Rc = Repaying capacity
Y = Income from other sources.
Fe = Family expenses
4RS, 5CS AND 7PS OF CREDIT, REPAYMENT PLANS
The principles of farm finance are stated as ‘three Cs’, viz,
1) Character
2) Capacity, and
3) Capital.
The application of these principles facilitate largely the lending agencies, in the sense
that the character of the borrower is a dominant factor for consideration before a lending agency
decides to advance loan. Although the farm more net income, create good finance extended to
a farmer may yield repaying capacity and buildup risk bearing ability he will not repay the loan
unless he has good character. The second principle deals with the capacity of the borrower who
not only produce more but also has to repay the loan in time. The third principle is intended to
safeguard the interest of the lending agency. When the first two intangible assets prove
inadequate during distress periods, the third, asset or capital will come to the rescue of the
lending agency.
The principles of farm credit can also be stated as ‘three Rs'. They are:
i) Returns from the proposed investment,
ii) Repaying capacity
iii) Risk-bearing ability of the borrower
To find out the feasibility of a project or a scheme or a farm plan, these principles can
the applied as economic feasibility tests.
i) Returns
The economic viability of a project indicates whether the proposed project is likely to
contribute reasonable returns on the investment which in turn will lead to economic
development of the farmer.
The economic viability can be measured by
1) Net Present Worth (NPW)
2) Benefit-Cost Ratio (BCR)
3) Internal Rate of Return (IRR)
1. Net Present Worth
The NPW of the project can be estimated using formula as given below:
n
Bn − Cn
NPW = ∑t =1 (1 + i ) n
, Where,
Bn = Benefits in n'th Year.
Cn = Costs in n'th Year.
n = life span of the proect
i = interest or discount rate.
If the NPW of a project is positive, then it is considered that the project is economically feasible.
2. Benefit-Cost Ratio (BCR)
The BCR can be calculated using the following formula:
n
Bn
∑
t =1 (1 + r ) n
BCR = n
Cn
∑
t =1 (1 + r ) n
To compute the NPW and BCR, the opportunity cost of capital (normal/market lending rate) may
be used as a discount rate. If the BCR is greater than 1, then it is worth wile to invest on the
project.
n
Bn − Cn
IRR = r ∑t =1 (i + r ) n
=0
IRR is that rate of discount which makes the present worth of benefits and costs equal or the net
present worth of cash flow equal to zero. If IRR is greater than the opportunity cost of capital,
the project is feasible.
ii) Repaying capacity
The repayment of loan depends on the amount of surplus income available with the farm
household after providing some amount for the family expenses and pre-existing liabilities,
besides keeping a margin for the risk factor. As the farming family is likely to get income from
the farm business as well as from off-farm activities, the repaying capacity of the borrower
should be judged by taking into account their total income.
The concept of repaying capacity can be expressed symbolically as:
Rc = ( (Y2-rf) + (Y 1 -rf) + Y) - ( (X 2 -X 1 ) + Fe+OL)) ≥ I+i
Where,
Rc = Repaying capacity
Y = Income from other sources.
Fe = Family expenses
