A range of profitability ratios will clearly indicate how successful a microfinance institution is financially. Measuring and monitoring key ratios will support the management decision making that a microfinance institution needs to sustain that success as it grows.
Microfinance institutions need to understand how profitable or financially sustainable they are in order to effectively manage their services to their clients. Good financial performance is an indicator of a structurally investable microfinance institution which is attractive to impact investors and donors.
1. Portfolio Yield
This metric demonstrates the MFI’s ability to generate cash from interest, fees and commissions based upon the average loan book. A declining trend in the yield might indicate a change in product mix, a change in loan pricing or an issue with increasing arrears.
2. Net Interest Margin
This ratio shows the net of interest income less interest expense over the average earning assets. This yield measures the margin after paying for funds and a declining trend will mean less profit to cover operating expenses and loan losses.
3. Return on Average Assets
This ratio demonstrates how the MFI is managing its assets. A positive RoA indicates how mature the MFI has become.
4. Return on Average Equity
This metric is a good measure of profitability and a mature MFI should generate positive RoE by building equity through retained earnings.
5. Financial Expense Ratio
This ratio provides a measure of the financial expense an MFI incurs to fund its loan portfolio.
6. Impairment Expense Ratio
This ratio shows credit related losses or write-offs in the loan portfolio. Delinquency and provision policies can affect this ratio.
7. Operating Expense Ratio
This measure shows the cost of delivering loans to the average loan portfolio. A declining trend may indicate a more efficient organisation or an increasing average loan size.
Whilst financial performance is important to microfinance institutions it is often only one half of a dual bottom line. To find out how MFI's can balance the dual bottom lines of financial and social performance, download our guide.