Question

You have been recently engaged as the Chief Executive Officer (CEO) of a microfinance institution (MFI). You are expected to do a presentation to the board of the directors of the MFI on the financial health and performance of the institution. You found the need to explain the relevant concepts used for the evaluation of MFIs in order to facilitate the appreciation of the issues by your audience. The content of the presentation shall form the basis of the strategic plan currently being considered. (Use the data the provided in excel in the column assigned to your index number).

You are required to:

a) Provide an assessment of the financial health and performance of the MFI using the data extracts from income statements and balance sheet of the microfinance institution (MFI) that have assigned to you.

b) Make recommendations based on your analysis which will be used for the crafting of the strategic plan for the MFI.

Answer 1

A range of profitability ratios will clearly indicate how successful a microfinance institution is financially. Measuring and monitoring key ratios will support the management decision making that a microfinance institution needs to sustain that success as it grows.

Microfinance institutions need to understand how profitable or financially sustainable they are in order to effectively manage their services to their clients. Good financial performance is an indicator of a structurally investable microfinance institution which is attractive to impact investors and donors.

1. Portfolio Yield

This metric demonstrates the MFI’s ability to generate cash from interest, fees and commissions based upon the average loan book. A declining trend in the yield might indicate a change in product mix, a change in loan pricing or an issue with increasing arrears.

2. Net Interest Margin

This ratio shows the net of interest income less interest expense over the average earning assets. This yield measures the margin after paying for funds and a declining trend will mean less profit to cover operating expenses and loan losses.

3. Return on Average Assets

This ratio demonstrates how the MFI is managing its assets. A positive RoA indicates how mature the MFI has become.

4. Return on Average Equity

This metric is a good measure of profitability and a mature MFI should generate positive RoE by building equity through retained earnings.

5. Financial Expense Ratio

This ratio provides a measure of the financial expense an MFI incurs to fund its loan portfolio.

6. Impairment Expense Ratio

This ratio shows credit related losses or write-offs in the loan portfolio. Delinquency and provision policies can affect this ratio.

7. Operating Expense Ratio

This measure shows the cost of delivering loans to the average loan portfolio. A declining trend may indicate a more efficient organisation or an increasing average loan size.