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3. How can cooperative activities be financed?

A. Directly from members
B. From cooperative business surpluses
C. From outsiders
The gearing ratio
Which kind of funds are best?
Legal framework and support

The greater the amount of capital held by the cooperative, the greater its ability to purchase more efficient technology, invest in staff training and education and make other improvements to the running of the business.

Capital for the operation and improvement of the cooperative business can come from three main sources:

a directly from members themselves
b from retained surpluses generated by the cooperative business
c from outsiders.

A. Directly from members

Members help finance the operations and growth of the cooperative through:

· one-time or annual membership fees
· member contributions with no individual ownership attached, such as service fees.
· member share capital
· individual member deposits with the cooperative which may be used for business
· deferred payment to members for part or all of their produce delivered to the cooperative
Member share capital represents individual member commitment to the cooperative form of business. It also identifies the individual member’s financial stake. It is withdrawn only when the member leaves the cooperative. Some other forms of member contributions, usually related to patronage, are more variable but once given cannot be withdrawn and hence are a particularly useful form of cooperative capital.

B. From cooperative business surpluses

Funds created through the retention of cooperative business surpluses that are not directly allocated to members are another important source of cooperative capital. This is a long term source of funds since most cooperatives’ rules allow these funds to be distributed only when a cooperative is liquidated. Unlike loans, or individual member deposits, the cooperative does not have to pay interest to use these funds. Of course, retaining such funds by the cooperative also represents a cost to the individual members who otherwise would have had that portion of the surplus allocated to them. Members willingly accept this cost when the benefits it creates for them are clear and worthwhile.

This source of funds from retained surpluses is often called “institutional capital” and represents the collectively-owned wealth of the cooperative.

C. From outsiders

In addition to institutional capital and member capital, cooperatives often make use of external sources of funds to run their operations or to finance investments. These non-member sources of funds may include cooperative or commercial banks, suppliers, government or donor agencies. External funding may be provided in different ways:

· as a grant
· as a short-term loan
· as a long-term loan
· as trade credit offered by a supplier.
Commercial providers of funds, such as banks, generally provide credit or loans that are legally secured by collateral (pledged assets of the cooperative). They are motivated by profit and seek to minimise risk. Non-commercial providers, such as governments or donors, generally provide credit on more generous terms at below market rates of interest or provide grants. Their motivations may be social, political or economic - often a mixture of all three.

The gearing ratio

The more assets the cooperative owns and has fully paid for - buildings, equipment, stock and financial reserves - the more others are willing to lend additional funds. Also, the greater the amount of the cooperative’s institutional plus member capital, the higher the amount that can safely be borrowed from outside sources. Financial leverage, or gearing, is expressed by a percentage ratio which gives an indication of the amount of risk involved in borrowing funds. The higher the gearing ratio, the higher the risk the cooperative runs in losing their assets in the event of inability to repay a loan.

The gearing ratio relates the amount of externally borrowed capital to the total capital employed by the cooperative (institutional and member capital plus funds borrowed).



funds borrowed ÷ (institutional and member capital plus funds borrowed) × 100

For example, a cooperative might have $900 of assets that it has fully paid for If it borrows $900 from a bank, it would have a high gearing ratio (50%)2. If on the other hand, the cooperative borrows only $100, the low gearing ratio of 0% indicates a much lower level of risk3.

2 i.e. gearing ratio = 900 ÷ (900 + 900) × 100 = 50%
3 i.e. gearing ratio = 100 ÷ (100 + 900) × 100 = 10%
The gearing ratio and hence the level of risk involved in borrowing a given amount will vary according to the type of business a cooperative conducts. A consumer organization with a high level of turnover but relatively low investment in fixed assets (such as buildings and machinery), may be able to safely take on relatively high short term debt in proportion to its total assets. The same gearing ratio would represent a higher level of risk for an agro-processing society with relatively large investment in fixed assets.

Institutional and member capital are lower risk than outsider funding since they are provided by the members and hence the assets of the cooperative are less at risk. In most situations, therefore, they are often a preferred form of funding. Institutional capital, in addition, is the cheapest form of capital since generally no interest needs to be paid.

Which kind of funds are best?

Institutional and member capital are the lowest risk, safest forms of funding and hence should be the first choice in most cases. However these types of funding are sometimes not enough, or are not available at the time when they are needed. Funds may, for example be needed to cover running costs until a harvest is sold. In this case, a short term loan from an outside source may be taken and repaid after the harvest. In other cases, funds may be required for a longer period. This may be the case when the cooperative decides that the purchase of a new piece of equipment is economically justified. The group may then decide to obtain a long term loan.

In all cases, borrowing from non-members, such as banks and suppliers, is a good strategy only when the returns from such borrowing are larger than the cost of borrowing.

The type and source of capital is important because they determine the terms and conditions attached. For example, share capital which can generally be withdrawn by the member-owner only upon leaving the cooperative, is a relatively stable and long-term source of funds. The cost of share capital is low because of the cooperative practice of making low (or in some cases no) payments to the members based on their share holdings. It is also low risk since no collateral is required to secure the funds.

Commercial loans from banks are higher cost as interest has to be paid on them. They are also higher risk since cooperative assets used as collateral may be forfeited to the lender in the event of inability to repay the loan and interest.

Equipment suppliers may also effectively provide a loan to a cooperative by allowing payments to be spread over a period. Again, the lender may be protected against risk through cooperative assets pledged as collateral.

Short term seasonal loans from a bank to finance the purchase of a harvest by a marketing society for example, have to be repaid within a few months of the harvest. These funds are also generally relatively expensive. However as this example suggests, such short term loans can be very useful for a cooperative.

Legal framework and support

Many of the regulations governing the operation of cooperatives were established before the recent changes in the world economy mentioned in the introduction (declining donor support, globalization of markets and increasing privatisation) began to take effect. Some of the regulations are still appropriate, others less so.

Many laws and regulations, for example, tend to restrict cooperatives in their business activities. For example:

· a specified percentage of the sales revenue of the cooperative may have to be returned to members within a specified short period of time, regardless of the financial condition of the cooperative.

· payouts of patronage refunds may have to equal a specified minimum percentage of the surplus, regardless of the wishes of members.

· a certain portion of the surplus may have to be placed in reserve with a government authority or an apex cooperative organization, or dedicated to community improvement such as maintenance of parks or roads, regardless of alternatives that would otherwise be available and possibly of greater use to members.

· some cooperatives may be required to deliver their produce to government agencies at prices that are not attractive, or to sell government-rationed goods at mark-ups that are not remunerative.

Financial support and privileges for cooperatives are decreasing and cooperatives are obliged to operate in competition with conventional businesses. Without the former associated privileges, many of the above regulations put cooperatives at a competitive disadvantage in the market place.

Many current business laws and regulations are however also appropriate and benefit cooperatives, such as those:

· that guarantee that business contracts will be enforced.

· that permit land and property to be confiscated on non-repayment of loans and hence allow them to be used as collateral.

· that promote greater transparency in business transactions, and

· that require accounts to be periodically audited.

A review of government laws and regulations governing agricultural cooperative businesses is needed in many countries to enable farmer cooperatives to successfully participate in increasingly competitive markets.

Support organizations such as the Plunkett Foundation in the UK and international bodies such as the International Labour Office and the International Cooperative Alliance in Geneva, Switzerland, and the Food and Agriculture Organization in Rome, can provide guidance to movements and governments willing to encourage cooperatives through regulatory reform.

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