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V. Ways of financing economic activities

V. Ways of financing economic activities

5.1 Money and credit

In a market economy, money is the medium of exchange. It serves as a measure of values and prices and is a means of preserving purchasing power (savings).

Money enables us to resolve the problems posed by the barter system. In fact, without money, there would be no economic progress. Every good can be converted into money, which is accepted as payment for goods and services in every country and between countries. Modern economies are said to be monetized.

Types of money: Since replacing the barter system money has evolved from shells to banknotes. We have paper money (fiduciary currency) i.e. banknotes, and other negotiable instruments such as cheques.

Money and the banks: So that money can circulate between those who need it to run their activities and those who have enough to save, it is traded by the banks and private lenders. The banks use the savers' deposits to provide credit or loans to their clients (we will see how they do this later).

5.2 Production costs

As we saw in Chapter 2, goods and services have a price or value, e.g. one kilo of merchandise costs x francs, and transport costs y francs per ton per kilometre. For vegetable growers to know how much it will cost to produce one kilo of carrots, they will have to know what they will spend on seeds, fertilizer, pesticides, water and labour. In order to obtain the selling price of one kilo of carrots on the market, other costs such as packaging, storage, processing and transport will have to be added to the production cost.

It is essential to estimate production and other costs accurately when establishing a provisional operating account, as this enables us to fix the selling price of the merchandise or commodity and to compare its competitively and cost-effectiveness.

In order to meet production and other costs, individuals or groups involved in economic activities need funding. They should carefully determine how much funding is needed and then set about finding it. There are two possibilities: they may use their own funds, or seek an external source.

5.3 Using one's own funds or self-financing

We speak of self-financing when activities are financed with the promoters' own funds. In the case of cooperatives these funds will come from the authorized capital and reserve funds; in the case of individuals, from their savings.

Nowadays it is difficult to cover all one's needs with one's own funds. All undertakings, whether big or small, rural or urban, often require credit in addition to one's own funds. It is increasingly common for economic systems to be based on credit.

5.4 Credit and credit mechanisms

When the promoter of an activity has no funds of his/her own (or not enough), he/she applies to an external funding agency to obtain credit (a loan) to carry out his/her activities.

5.4.1 What does "granting credit to someone" mean?

To grant credit to someone is to trust that person and to take a risk in handing over a sum of money or goods, on the undertaking that the sum of money or goods will be repaid by a certain date plus an additional amount (of money or goods), called interest.

Credit is therefore based on trust (from the Latin credere meaning to trust) between two parties. It must be repaid by a date agreed by the two parties, plus interest. This need for repayment differentiates credit from subsidies, which are not repaid.

5.4.2 Sources and forms of credit

Savings are the source of credit. To save is to "set aside" resources, either passively hoarding them, or actively investing them, for use at a later date. As these savings may be used to provide credit, credit is linked to savings.

Credit may be distributed in several ways:

Access to bank or project credit has become a necessary prerequisite for income-generating activities.

5.4.3 Interest rates. terms of credit

Interest rates (or the rent charged on the money borrowed) are expressed as a percentage of the capital over a period of time (usually annually). Interest is intended to cover the lender's risks.

The time that the lender (the person providing the money) allows the borrower (the person receiving the money) to repay the loan is called the terms of the loan. Thus, based on the time (period) allowed, we have:

The term of a loan is therefore usually based on the expected lifespan of the activity for which the loan has been requested, and the repayment time on the time it takes for that activity to begin producing a return. For instance, inputs are used in a single season, ploughs may be used for between one and five years, fruit trees need five years to become profitable, and a building lasts more than five years...

5.4.4 Repayment guarantees and other credit features

In addition to rates of interest, a lender requires repayment guarantees from his/her client in order to minimize risks. These guarantees may be real (tangible) (e.g. the mortgage on a building), or moral (e.g. the joint guarantee and several guarantees of cooperative group members). Other factors are:

5.4.5 How to obtain a loan from a project bank?

The first requirement is, of course, to be already involved in or have plans to set up an income-generating activity. The next step is to prepare a loan application containing the information needed by the lender to examine the activity or project put forward by the applicant. A lender usually requires details on:

(1) The applicant: full identification plus, for group applicants, other essential details such as the group's history, composition, statutes and regulations;

(2) The presentation: purpose, justification, description of activities, history and evolution, context, etc.

(3) Market study for the proposed activity

(4) Applicant's financial/economic situation

(5) Technical analysis of the proposed activity

(6) Financial review of the proposed activity

(7) Lender guarantees

The estimated operating account is an essential component of the credit application file and should be as accurate and realistic as possible.

The complete credit application is forwarded to the lender who will review it and probably ask for additional information before deciding whether or not to grant the loan.

If the credit application is approved, the two parties will sign a financing agreement which will bind them until the loan is fully repaid, as we saw above.

5.4.6 Using credit wisely

(1) Is a loan necessary? This is a question that should be asked in order to prevent systematically resorting to credit, a step which can draw the borrower into a vicious circle and end up "sinking" him/her. Credit is expensive, and should therefore only ever be used to top up one's own resources, and for really profitable activities.

It may not always be credit that one needs to improve activities, but better organization and management, better training or a complete reorganization of his/her activity. Credit should alleviate the borrowers' financial burden so that they need not resort to credit in future.

(2) Immediate investment. It should be borne in mind that interest starts "piling up" as soon as the credit has been released. Loans must therefore not be allowed to lie "dormant, they should immediately be invested in the operation for which they were obtained.

(3) See that the repayment dates coincide with the dates at which revenue can be expected to come in, so as to avoid late repayment.

(4) Repay loans on time. A loan agreement is a mark of trust between lender and borrower. A betrayal of trust will damage future relations between the two parties. Always repay loans. Make that a point of honour.

In the event of early repayment (prior to the agreed repayment date) do not forget to claim the surplus interest that the lender would have obtained. Of course, the lender may return this automatically.

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