UNIT 9: Financing Agricultural Enterprises

Success Criteria

• Identify sources of finance for agricultural production.
• Identify conditions and terms for borrowing.
• Differentiate base interest rate and effective interest rate.
• Calculate the cost of borrowing.

Professional Summary: Financing Agricultural Enterprises

Access to finance is crucial for agricultural production, serving as capital for operations and payment for services.

Sources of Finance:

• Informal: Relatives or friends, personal savings, personal investments, money lenders, village banks.
• Formal: Financial institutions, money and capital markets.

Types of Credit by Repayment Period:

• Short-term: Repaid within 1 year.
• Medium-term: Repaid within 2-5 years.
• Long-term: Repaid within 5-15 years.

Types of Credit by Security Demanded:

• Soft Loans: Require little to no collateral.
• Hard Loans: Require security or collateral (an asset the lender can seize if the loan is not repaid).

Conditions and Terms for Borrowing:

Borrowers must:

• Demonstrate ability to repay the loan with interest.
• Provide security or collateral (for hard loans).
• Accept the lender’s stipulated conditions.

Interest Rates:

• Base Interest Rate (Coupon Rate/Benchmark): The stated, minimum interest rate on a loan or bond. It represents the monetary price lenders receive from borrowers for the use of their money. For example, a 5% base rate means $5 interest for every $100 borrowed.
• Effective Interest Rate: The actual interest rate accrued, taking into account the effect of compounding more than once per year. It reflects the true annual cost of borrowing. For example, a 6% annual rate compounded semi-annually results in an effective rate of 6.09% (as shown by interest accumulating on previous interest).

Calculating the Cost of Borrowing:

The cost of borrowing includes the principal loan amount plus all accumulated interest and other charges.

• Example Calculation:
  • Money Borrowed = K80,000.00
  • Interest Rate = 20%
  • Interest = K80,000.00 * 20% = K16,000.00
  • Total Loan (Principal + Interest) = K80,000.00 + K16,000.00 = K96,000.00

Additional Loan Costs:

• Inflation: The general increase in prices of goods and services, which can reduce the purchasing power of the borrowed money and affect repayment value.
• Paperwork Service Fee: Additional charges incurred for loan processing and administrative costs.