3. How can cooperative activities be financed?

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 It is withdrawn only when the member leaves the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patronage, are more variable but once given cannot be withdrawn and hence are a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).

Gearing

=

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.