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CHAPTER 5. THE PROBLEM OF LACK OF KNOWLEDGE IN LOAN SEEKING: BUSINESS PLANS


5.1 Role and definition of a business plan

A financial institution, whether it is a commercial bank, a state agency or a private investor, will lend money to a business only if it is convinced that it is a viable proposition. The burden of proof that the proposal is economically feasible weighs on the entrepreneur. An essential part of doing so is the production of a concise but detailed business plan, capable of convincing a potential investor or lender that the proposed venture is economically sound. Failure to produce adequate business plans was identified in Volume 1 as an important reason why entrepreneurs in sub-Saharan Africa have not been very successful in raising capital for proposed aquaculture ventures.

A business plan is a detailed written document that addresses all the major aspects of the enterprise. A major reason for preparing a business plan is for it to serve as a guide for the business, providing a set of clearly articulated goals against which the performance of the business can be measured. Committing plans for a business to writing forces the entrepreneur to consider all factors which might affect the viability of the business.

The business plan, used as a tool for raising capital, should anticipate questions anyone considering risking money in a business may ask. It offers to the entrepreneur an opportunity to make the best possible case for the company, the output and the personnel available for implementing the plan. It should describe, therefore, in a structured format, with a logical flow of information, the business, its operating environment, its short and long term goals and how it proposes to achieve these goals. It should demonstrate that the entrepreneur has thought through the development of the business in terms of products, management, finances, markets and competition (Pinson and Jinnett, 1999).

In addition to its importance as the principal means of convincing a financial institution of the viability of the proposed business and serving as a guide for the entrepreneur, preparation of a business plan has the beneficial impact of forcing the entrepreneur to identify more clearly his/her ideas and goals as well as the steps that need to be taken to achieve the identified goals. The entrepreneur will develop a better understanding of the intended business as well as the industry as a whole. A business plan can play a vital role in helping to avoid mistakes or recognize hidden opportunities.

5.2 Essential elements of a business plan for a commercial aquaculture venture

The business plan has such a pivotal role as the principal written statement of the viability of the proposed business that great care should be taken to produce a document that is attractive, clearly written, factual, comprehensive and concise. It should demonstrate that all factors that could influence the success of the business have been carefully considered and assessed. Thus, any weakness in the proposal should also be identified and discussed and not glossed over. Factual information should underpin the estimates of revenues; the costs and any assumptions that are made should also be explicitly identified and justified. The essential elements of a business plan designed to persuade a financial institution of the viability of a proposed commercial aquaculture venture are discussed in this section. Unless otherwise specified, they are adapted from Pinson and Jinnett (1999), Engle and Stone (1997) and Kay (1986).

A business plan for a commercial aquaculture venture includes two main parts. The first part contains the title page, table of contents and an executive summary. The second part consists of the main body. The precise contents of any individual business plan will depend on the characteristics of the business and on the circumstances of each individual enterprise. Most business plans follow a well-tried and tested structure that may be applied to the establishment of a business in commercial aquaculture. It is important to keep in mind that there may be particular factors that have an important bearing on a particular proposed business. These might not fall neatly into the structure described below, but might require consideration in the business plan for a commercial aquaculture proposal.

5.2.1 Title page, table of contents and executive summary

A title page, a table of contents and an executive summary should precede the main body of the business plan. The title page is a separate page with the title of the business, the date and the name and contact details of the company or individual proposing the plan.

The table of contents is prepared when the main body is complete. It outlines the main points discussed in the plan. Use a page numbering system for the business plan that makes it easy for the potential lender to easily find the information sought when using the table of contents.

Like the table of contents, the executive summary is prepared when the main body of the plan is completed. It summarizes the content of the business plan. The executive summary should be very carefully prepared as it might be used by the bank to select business plans that it believes deserve closer examination. If the executive summary is not well prepared, the business plan could be rejected at this point without further examination by the bank.

5.2.2 The main body

The main body of an aquaculture business plan may be broadly divided into three sections: the anatomy of the proposed aquaculture business, a marketing plan and financial documents.

5.2.2.1 Anatomy of the proposed aquaculture business

The anatomy of a business plan gives a description of the proposed aquaculture venture, details of the site and the production system. It also gives details of the legal structure of the business and its management capacity. The anatomy of the business plan should also show evidence of the financial history of the borrower.

A. Description of the proposed venture

The organization of the proposed business should be described and its business history given by highlighting any experience which may have some relevance to the proposed aquaculture venture. A brief outline of the aquaculture venture should be given, indicating the scale on which it is expected to operate.

B. Description of the site

The suitability of the site can affect fixed costs, such as those of construction, and operating costs, such as those associated with the availability and quality of the water. A description of the proposed site for the aquaculture operations should be provided. The soil characteristics should be provided, together with evidence that it is suitable for the construction of ponds to be used to grow the species. It should be stated whether the water is fresh, brackish or seawater and whether it is available in sufficient quantity and at a temperature suitable for growing the species selected for the venture. The location of the proposed site in relation to feed and seed supplies, processing facilities, and extension and laboratory services should be clearly stated as these too affect the likelihood of success for the business. These facilities are often lacking or are inadequate in sub-Saharan Africa; if they are planned for the area, this should be stated.

C. Description of the production system

There should be a thorough discussion of the proposed production system by providing information on the species that will be cultivated. The availability of seeds, the intended stocking rates, the anticipated feed rates and any aeration strategy need to be clearly presented. Care should be taken to ensure consistency so that the intended feed rate is consistent with the stocking rate, which, in turn, is consistent with intensity of aeration. The methods of harvesting should be discussed as this too has a bearing on the capital investment requirements of the enterprise. Any potential production problems should be discussed so the lender knows that you are aware of possible problems and their implications for cash flow and debt repayment.

D. Discussion of the legal structure of the enterprise

The legal status of the enterprise should be stated. State whether the enterprise is a sole proprietorship, a partnership or a company. Any legal documentation relating to its status as a sole proprietorship, partnership or company should be provided in the supporting documents section at the end of the business plan. If a change in the legal status of the enterprise is foreseen, give details of what the change might be and under what circumstances it might take place.

E. Discussion of the management capacity

The lender will want to know who will be entrusted with each task required and what competence they have to make the enterprise a success. The lender will be looking to see whether both management and technical ability are available to implement the proposed business plan. An outline of the management skill and operational capacity to run an aquaculture farm needs to be provided for key personnel. This should include experience in raising the species being considered for culture and should give factual information on acreage managed, stocking and feeding rates and the yields achieved. Any shortfalls in personnel capacity should not be glossed over; rather, an explanation should be given as to how the shortfall will be addressed and what the financing implications are for doing so. An organizational chart is a useful means of showing visually the management structure, the key areas of responsibility and the relationship between them.

F. Financial history of the borrower

The financial history of the borrower is needed to establish that the borrower can be relied upon to repay the debt. Some banks require that financial statements for the previous three years should be provided.

5.2.2.2 The marketing plan

Before writing this section of the business plan, research is required into the market potential of the species that will be raised. The detailed results of this research will need to be presented clearly and concisely in this section of the business plan. The project will only succeed if there is adequate demand for the product and a farm-gate unit price that exceeds unit production costs (Ridler and Hishamunda, 2001).

Apart from examining existing demand and the historical prices paid, the potential for increased demand in the target market should be explored. Careful consideration of the price elasticity of demand for the species raised needs to be considered. That is, the extent to which demand for the particular species will increase in response to a marginal decrease in price following an increase in supply will need to be investigated and reported. As discussed in Volume 1 of this report, if demand for the product is price elastic, then by increasing supply, there will be a minor fall in the price, but demand is likely to increase substantially. If, however, demand is price inelastic, then the same increase in supply is likely to result in a substantial fall in price with only a relatively small increase in demand for the product. Thus if demand is price elastic, the farm incomes can be expected to increase if production is increased, whereas, if demand is price inelastic, an increase in supply will reduce farm revenues.

Similarly, if incomes are rising in the target market, the question needs to be considered as to whether demand for the output of the proposed aquaculture venture is likely to increase as people find themselves with higher disposable incomes. In other words, income elasticity of demand for the proposed species needs to be evaluated.

The extent of market acceptance of aquaculture produces in general, and for the particular, species in particular is important to consider. In some places, there might be market resistance to particular species, which may call for a public education program that highlights the advantages of consuming these species[20], thereby increasing their demand. The per caput consumption of fish in Namibia was increased from about 4 kg to 9 kg during the 1990s as a result of a government campaign to increase the consumption of fish in Namibia. The market needs also to be evaluated in terms of expected population growth in the target market. Together with advertising, population growth is one of the major shifters of demand.

Assuming everything else remains constant, if the demand for the species is income elastic, the increase in the disposable income of consumers in the target market will lead to higher quantity demanded, and thus, to higher revenues. Similarly, a fall in disposable income will result in a relatively important decline in quantity demanded, thereby reducing farm revenues.

If, however, the demand for the species raised is income inelastic, a substantial fall in disposable income will result in proportionately lower fall in quantity demanded, which in turn, will not significantly affect the farm revenues, other things being equal.

The primary market might be local or an export market. If the site and other physical conditions lend themselves to production of species suitable for export, the requirements of the export market need to be explored. In addition to the above, there could be additional costs involved in meeting the food safety and quality measures required by the export market, such as the HACCP (hazard analysis critical control point) system. Such systems can be costly to establish but have become a requirement for exporting into these markets.

Thus, the marketing plan would include identification of markets, the distance between them and the business site and the related transportation costs, their accessibility, the frequency and the scheduling of deliveries, the volume and size requirements of the market as well as historical prices paid.

5.2.2.3 Financial documents

Supporting documentation, which backs up the statements made in the three main parts of the business plan, should be presented in an additional section at the end of the business plan and cited, where appropriate, in the main body of the plan.

The purpose of the borrowed capital influences the nature of the financial documentation that completes a business plan. The borrowed capital can be used to finance a new aquaculture business; it can also be raised for an existing business. In the first instance, pro-forma statements, which are projections generated from available data on prices and costs must be produced to support the loan application. If additional capital needs to be raised for an existing business, then the historical financial statements will be used in lieu of pro-forma statements.

Historical statements are easier to produce than pro-format statements. Thus, to complete this section, it is assumed that the capital is being raised for financing the start-up of a new aquaculture business. The following documents will be needed for this part of the business plan.

A. Estimate of required financing

In this section, the borrower will make a summary of financial needs and loan funds dispersal statement. The summary of financial needs is a statement of what types of capital funds are being sought and how much will be needed. If working capital is needed to bridge a start up period, this should be differentiated from capital needed for establishing fixed assets such as ponds or buildings. In the first case, the repayment period would be expected to be over the next full working cycle while in the second, business profits would be expected to increase sufficiently to repay the loan with interest over a period of several years.

The loan funds dispersal statement should briefly explain to the lender how the borrower intends to use the loan sought. If the capital is needed, for example, to build a pond, an estimate of the cost of doing so should be given with a breakdown of how that figure is obtained. If capital is needed for the purchase of equipment, its purchase price should be given together with a brief explanation of why it is needed and what impact it is expected to have on production.

B. Pro-forma financial statements

Accurate, well-prepared income statements and balance sheets are needed to document the income level of the business and its current financial position. Lenders can learn much about a business from these records, and financial progress over time can be as important as the current financial position. Both factors reflect the applicant’s management ability, business profitability, growth, and repayment capacity. Complete and detailed records included with a loan application will do much to ensure a favourable response (Kay, 1986).

A series of pro forma financial statements need to be generated using, as far as possible, verified, accurate data. Financial statements required by banks generally consist of income statement, balance sheet or net worth statement and cash flow statement.

B1. Pro-forma income statement

Income statement summarises the financial transactions that occurred over a certain time period. Thus, it contains costs, gross revenues and net returns over the chosen period, which is generally a year. Its purpose is to assess if the business is profitable.

Costs refer to total expenses incurred in the business. They are the sum of the variable and fixed costs. Variable costs will include all operating costs and will include such items as feed, seed, fuel, electricity, water, chemicals, labour costs and opportunity cost of own capital. The fixed costs include an estimate of depreciation, general overhead expenses, taxes and interest paid. The gross revenues are obtained by multiplying output by the price per unit of output. Net returns represent the difference between the gross revenues and total costs. Positive net returns indicate that the business is profitable.

A pro-forma income statement should be produced for the aquaculture proposal. The principal purpose of the pro forma income statement is to compute the expected profit for a given period. The statement itemizes the revenues that are expected to come in and the expenses that are anticipated.

The expected gross revenues can be estimated by multiplying the expected output by the expected price per unit of output. Expected net returns or profit is calculated by subtracting the estimated total costs from the estimated gross revenues from the proposed venture. Positive expected net returns would indicate that the proposed project is profitable. The structure of the pro-forma income statement is illustrated in Table 5.

B2. Pro-forma balance sheet or net worth statement

In addition to analysing the profitability of the business by using income statements, the lender will want to know the financial position and the strength of the proposed aquaculture project. For this, they will want to see a balance sheet for the proposed project.

The balance sheet or net worth statement is a systematic listing of the value of all assets (anything owned) and liabilities (anything owed). It serves to measure the financial strength and position of a business at a given time. The financial strength and position of a business, including an aquaculture venture, can be measured in terms of its solvency, liquidity and net worth.

Table 8. Pro-forma income statement

Category

Unit

Unit price

Quantity

Total

1. Gross revenues

Kg or number

a

b

a x b

2. Variable costs

Feed

Seed

Fuel

Electricity

Water

Labour

Chemicals

Harvesting

Miscellaneous

Opportunity cost of own capital

Total variable costs





3. Income above variable costs




(1-2)

4. Fixed costs

Depreciation

Interest on borrowed capital

Taxes

Insurance

Overhead expenses

Other fixed expenses

Total fixed costs





5. Total costs




(2+4)

6. Net returns




(1-5) or (3-4)

There are several ways to evaluate the solvency, liquidity and the net worth of a business. One of these is through financial ratios[21], which include the net capital ratio, the debt to equity ratio, the current ratio and the working capital ratio. All ratios are calculated by using the information contained in the balance sheet statement.

The net capital ratio measures the overall financial strength and solvency of the business. It represents the ratio of total assets over total liabilities. If the net capital ratio is less than 1, then the business is insolvent or technically bankrupt. This is because, should the business be liquidated and the assets sold, the cash generated from the sale of the assets would not be enough to cover all liabilities. An acceptable net capital ratio depends on the nature of the business and the type of the assets in the balance sheet. However, a net capital ratio of 2 is considered safe (Kay, 1986).

The debt/equity ratio, also called the leverage ratio, is another measure of solvency. It represents the ratio of total liabilities over owner’s equity. The smaller the value, the stronger the financial position of the business. A debt/equity ratio of 1 is equivalent to a net capital ratio of 2. This implies that a debt/equity ratio of 1 is safe but a lower figure is better and safer.

The current ratio or the ratio of current assets over current liabilities, measures the business liquidity or its ability to generate cash required to meet its cash needs in the next year without seriously disrupting its operations. A current ratio of 1 is barely acceptable; a current ratio of less than 1 means that the business has a liquidity problem; a ratio greater than 1 is safe as it indicates that the business is liquid.

The working capital ratio measures both the solvency and the liquidity of the business but over several years. It is calculated by dividing the sum of the current and intermediate assets by the sum of the current and intermediate liabilities. A working capital ratio greater than 1 is safe.

The structure of a pro-forma balance sheet, which shows the assets and liabilities of the proposed business at a particular time period is presented in Table 9. In addition to the ratios discussed above, it contains the “net worth”, which is another good measure of the solvency of a business. The net worth is obtained by substracting the value of all liabilities from the value of all assets. If this difference is positive, the business is solvent; otherwise, it is insolvent or bankrupt.

An important feature of a balance sheet or net worth statement is the equality between the total assets and the sum of total liabilities and net worth. Hence, the name “balance sheet” (Kay, 1986).

Table 9. Structure of a pro forma balance sheet

1. Current Assets


4. Current Liabilities


Fish Inventory



Accounts payable


Cash (on hand and in banks)



Operating loan


Supplies



Accrued interest on loans


Accounts Receivable



Accrued taxes payable





Principal payment on intermediate and long-term loans due within 12 months


Total



Total





2. Intermediate Assets


5. Intermediate liabilities


Equipment



Equipment Loan


Broodstock





Total



Total




3. Fixed (long-term) Assets


6. Long-term Liabilities


Wells



Real Estate Loan


Ponds





Land





Buildings





Total



Total




7. Total Assets = (1+2+3)


8. Total Liabilities =(4+5+6)




9. Net Worth = (7 - 8)



10. Owner’s equity = (9)



11. Net Capital Ratio = (7 ÷ 8)



12. Debt/Equity Ratio = (8 ÷ 9)



13. Current Ratio = (1 ÷ 4)



14. Working Capital Ratio = (1+2)/(4+5)



B3. Pro-forma cash flow statement

The pro-forma cash flow budget is a projected (estimated) summary of how much cash will flow into and out of a business over a given time period in the future, generally on a monthly basis. It identifies how much and when income is expected and how much and when expenses must be incurred. It includes all cash flows irrespective of the type, source or use. This implies that a cash flow statement includes monies earned on and off the farm. Its primary goal is to assist the lender to identify future borrowing needs and when they are likely to arise as well as the loan repayment capacity of the business and when it might actually be possible for loans to be repaid.

The first estimate in a pro-forma cash flow budget is the beginning cash balance, say on 1 January. A typical structure of the pro forma cash flow budget statement is presented in Table 10. It gives a monthly breakdown of expected cash inflow and outflow, but the period chosen for purposes of raising capital could also be quarterly.

Table 10 Typical structure of the pro forma cash flow budget statement


Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Total

1. Beginning cash balance














2. Cash receipts















Sales















Other revenues














3. Total cash inflow = (1+2)














4. Cash expenses
















Operating cash expenses
















Feed
















Seed
















Fuel
















Labour
















Chemicals
















Harvesting
















Repairs and maintenance
















Other operating expenses















4a. Total operating cash expenses
















Fixed cash expenses
















Interest on borrowed capital
















Tax
















Insurance
















Other fixed cash expenses















4b. Total fixed expenses















Scheduled debt payments
















Short-term:

- principal















- interest
















Intermediate:

- principal















- interest
















Long-term:

- principal















- interest















4c. Total scheduled debt payments














5. Total cash outflow = (4a+4b+4c)














6. Cash available = (3-5)















New Borrowing
















Short-term
















Intermediate
















Long-term














7. Total new borrowing














8. Ending cash balance = (6+7)















Summary of debt outstanding
















Short-term
















Intermediate
















Long-term














9. Total debt outstanding














5.3 Presentation of the business plan

When the business plan is completed, it should be neatly and logically presented in a suitable binder. The borrower should not go to excessive expense by having it typeset, printed on expensive paper and professionally bound. This could give the impression that money could be spent unwisely. A cover letter presenting the business plan and requesting the lender to consider lending the money being applied for should accompany the business plan. Always remember that the business plan is the principal means that the lender will use to judge the potential for success of the proposed enterprise and so decide whether the loan should be made or not.

Summary and conclusions

In addition to checking the factors discussed in Chapter 2 of this report, such as the applicant’s character and credit history, and the availability of adequate collateral as a guarantee of repayment of the loan, when evaluating a loan proposal, the lender will consider the business plan in great detail to ensure that the proposed business is profitable and that there is a capacity to repay the loan sought.

This chapter gave a detailed explanation of the content of the business plan for a commercial aquaculture venture. It indicated that a business plan for a commercial aquaculture venture should contain three major parts[22], of which the main body. The first section of the main body of a business plan for an aquaculture venture describes the physical, technical and legal aspects of the business, and the personnel capacity available to implement the plan. The second section presents the plans as to who the output from the proposed business is intended, how, when and how much and at what price, and what opportunities the entrepreneur envisages for the expansion of the existing market or the opening of new ones. The third major section of the business plan contains the financial statements for the proposed project. These statements were presented with proposed formats and a breakdown of the detail that a bank would need in order to make an informed assessment about how the proposed business is likely to perform. Suggestions on the presentation of the business plan to lenders are also offered.

Information presented in this chapter shall guide and assist farmers in generating the detailed financial and other information needed by lenders. It should also assist loan seekers in presenting their proposals for aquaculture projects in the form in which banks would wish to receive them.


[20] Due to several reasons, such as the colour or appearance of the fish, or the texture of its flesh.
[21] Ratios are used as they provide a standard unit of measurement. They also allow to monitor the financial position and the strength of the business over time and allow for comparison between businesses of different scale. Balance sheets of a large and small aquaculture farm can be different in monetary terms, but have the same ratio value, which would indicate the same relative degree of the financial strength (Kay, 1986).
[22] A checklist for the main elements of an aquaculture business plan is presented in Appendix A for ease of reference.

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