Financial Management and Accounting Policies

“Financial management is concerned with the acquisition, financing and management of assets with some overall goal in mind.[1]”

From its definition it is evident that financial management, with its three inter-related sub-functions, is a critical management issue for all MFIs.  Accounting refers to the recording, classification and summarising of economic events resulting in the consolidation of information and presentation of financial statements that can then be used for decision-making purposes.  Accounting is guided by certain universal principles though accounting practices are open to interpretation even while seemingly adhering to these principles.  The sound use of policies and disclosure of financial information is the key to all financial management decisions.  Poor accounting practices lead to inaccurate financial statements and, in turn, financial management decisions become sub-optimal. 

Therefore, the prime functional area of financial management and accounting practices are investment, financing, asset management and accounting policies. 

4.4.1    Current Status of MFIs on Financial Management and Accounting Practices

As discussed in earlier sections, the information from M-CRIL’s database in Table 4.5 again shows a somewhat better performance on financial management and accounting systems for Indian MFIs registered as companies though there are still MFI companies with relatively poor quality of such management as well.

Table 4.6

Quality of Financial Management & Accounts of Indian MFIs

Source: M-CRIL Database

It is clear that the MFIs registered as societies and trusts due to their non-profit orientation have a long way to go in improving their financial management and accounting practices.  While the legal form does not guarantee a better performance on any parameter, it is apparent, as discussed earlier, that it is some of the better managed MFIs that transform and register as NBFCs and Section 25 companies – though this is not invariably so. 

4.4.2    Best Practices and emerging trends in Financial Management and Accounting

Good practice in financial management and accounting provides financial benefits, long-term direction and stability to the operations of microfinance institutions.  Clear accounting policies contribute to disclosure and transparency in terms of reporting financial performance and providing an accurate reflection of the financial position of the MFI.  The key aspects of good practice in financial management and accounting are set out in Table 4.6.

Table 4.6

Good Practice in Financial Management and Accounting

Source: M-CRIL, 2003. “Improving Microfinance Practice”

Financial management and accounting are inter-related and key functional areas for all institutions engaged in financial intermediation.  With a greater scale of operations, increased reliance on commercial funds that provides a platform for attaining high levels of outreach, financial management is now attracting the requisite degree of attention.  The trend to commercialisation is also leading to greater recognition of the need for sound accounting practices.

With the scaling up of operations the following trends can be observed in financial management practices 

·        Separately dedicated professional staff and department for financial management; 

·        Cash management is fast becoming an important aspect of financial management in microfinance.  Clear cash transfer procedures, specific cash holding limits and emphasis on the optimal utilisation of excess cash are becoming the norm in most progressive MFIs.

·        Cheque based disbursement and repayment: Some MFIs have now moved towards a cheque-based system of loan disbursement and repayment.  Apart from enhancing cash control, this reduces the delays in encashing cheques and allows for the speedy transfer of cash.

·        Accounting: Documented accounting practices with increasing emphasis on disclosure. 

4.4.3    Requirements with respect to various legal forms

Regulations for societies and trusts do not provide any guidelines for financial management and accounting policies specific to the microfinance business.  The emphasis in these regulations is largely on the annual accounts and financial reporting in prescribed formats.  NBFC regulations, as discussed in Sections 2 & 3 provide various guidelines on prudential norms, accounting practices and reserve requirements (in the case of deposit taking NBFCs) asset-liability management and reporting formats. Cooperative Banks, like NBFCs are subject to RBI regulations and are supervised by NABARD along with their state cooperative departments.  Such banks need to follow the specified norms on disclosure, reserve maintenance and prudential norms.  However, these standards are not applicable to legal forms like cooperatives, mutually aided saving and credit cooperatives.  While MFIs established as societies and trusts are able to get away with relatively ineffective accounting practices, this is not so easy for NBFCs and cooperative banks since these are subject to scrutiny by supervisors and regulators. 

4.5       Internal Audit and Control

The Basel Committee on Banking Supervision defines internal control[2] as “a process, effected by an entity's board of directors/trustees, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories

ð     Verify the efficiency and effectiveness of operations

ð     Assure the reliability and completeness of financial and management information, and

ð     Comply with applicable laws and regulations”

This definition reflects certain fundamental concepts

§         Internal control is a process.  It is a means to an end, not an end in itself.

§         Internal control is effected by people.  It is not policy manuals and forms, but people at every level of an organization.

§         Internal control can be expected to provide reasonable assurance and increased probability, not absolute assurance, to an entity's management and board.

Internal control is comprised of the following five inter-related components:

·        Control Environment:  The core of any organization is its people - their individual attributes, including integrity, ethical values and competence largely determine the environment in which they operate.

·        Risk Assessment:  Establishment of mechanisms to identify, analyze and manage related business and operating risks.

·        Control Activities:  Establishment and implementation of control policies and procedures to help ensure that the actions identified by management as necessary to address risks and obtain the specified goals are effectively carried out.

·        Information and Communication:  Surrounding these activities are information and communication systems. These enable the organization to capture and exchange the information needed to conduct, manage and control the MFI’s operations.

·        Monitoring: The entire process must be monitored, and modifications made as necessary. In this way, the system can react dynamically, changing as conditions warrant.

4.5.1    Current Status of MFIs on Internal audit and control

As in the earlier sub-sections, there is some indication here also that companies perform better, albeit because it is the better MFIs that have transformed into the more professional legal forms (Table 4.7). The lack of professionalism among MFIs registered as societies and trusts continues here. This results in a significant number of such MFIs having ineffective internal audit and control systems. 

Table 4.8

Assessment of Internal Control Systems of Indian MFIs

Performance	Trusts/Societies	Cooperative/ MACTS	NBFCs/ Sec 25 Co.	Total
Excellent	0	0	1	1