A cooperative is a business that is owned and controlled by the individuals who use its services. While this definition captures the fundamental difference between cooperatives and other types of businesses, it does not encompass all the variations and complexities of cooperatives. In a cooperative, the owners are also the users; they are the members.
Key operating principles of cooperatives include:
- Service at Cost: The primary purpose of a cooperative is to provide services to its member-owners at the lowest possible cost rather than generating profits for investors. However, the cooperative must still generate enough income to cover operating expenses and meet ongoing capital needs.
- Financial Obligation and Benefits Proportional to Use: Benefits are distributed according to usage rather than the amount invested. In some cases, the amount invested determines the return one gets. Members are obligated to provide financing in relation to the usage that generates these benefits.
- Democratic Control: The Rochdale pioneers established their cooperative through the principle of one member, one vote, embodying the concept of democratic control. While our political democracy allows for representative or proportional voting, some cooperatives apply proportional voting based on member usage.
- Limited Return on Equity Capital: The main value of the cooperative to its owners lies in its services. Limiting the return on equity capital helps ensure that benefits are distributed based on usage, particularly in the USA.
Important practices in cooperatives include:
- Continuing Member Education: It is essential to keep owners informed about the cooperative’s operations for two primary reasons:
- The principle of democratic control, exercised through majority rule, requires that all members are well-informed to facilitate enlightened decision-making.
- Since cooperatives are less prevalent than other types of businesses, they often receive less attention in business and economic education, necessitating that each cooperative serve as an educational institution for its members.
- Operations on a Sound Financial Basis: A cooperative should be treated as a business and must have the flexibility to adapt to changing market conditions.
- Cooperation Among Cooperatives: Cooperatives need to collaborate to minimize member production input costs and efficiently market member products to meet customer demands.
What Are Patronage Refunds?
A patronage refund reflects the unique relationship between a cooperative and its owners, illustrating how a cooperative operates. Patronage refunds are directly related to the key principles and important practices of cooperatives, as well as the mutual responsibilities between the cooperative and its members.
The goal of a cooperative is to provide services to its member users at the lowest possible cost rather than seeking profit for investors. However, this service-at-cost approach does not imply that the cooperative operates without regard to expenses daily for at least two reasons:
- It cannot determine its exact costs on a daily basis.
- As a participant in the private enterprise system, the prices it pays for purchases and receives for sales fluctuate with market conditions.
Once a year, a formal accounting is conducted to assess the cooperative’s income and expenses. The income remaining after deducting all expenses (net margin) is distributed proportionately to members based on their patronage or share of investment. The surplus income generated from members’ usage of the cooperative’s services is then refunded to them. This refund is referred to as a patronage refund.
The patronage refund is a key operating principle in cooperatives, reflecting that ownership benefits are generally proportional to usage. This refund serves as a crucial source of financing for cooperatives. Members typically choose to retain a portion of their refund within the cooperative to support its financial stability. The retained portion is allocated to the member’s equity account and can be paid out at a future date.
The unique purpose of a cooperative places the responsibility of financing the business on its member-users. Benefits are closely linked to usage and do not enhance the value of shares of stock or other equity capital. As a result, the reasons that motivate individuals to invest in the stock of other corporations do not apply to cooperative stock. Therefore, cooperative members must provide the majority of its equity capital, either through direct investments or through retained patronage allocations.
The cooperative has a responsibility to create a financing and ownership transfer plan that is fair to each member while adhering to cooperative principles. As members engage with the cooperative, they take on the fundamental responsibility of providing capital based on their usage. When patronage ceases, so does the financing responsibility. If the cooperative does not adopt a systematic approach to redeeming equities, a growing amount of capital may end up with inactive members. This situation can lead to decreased member participation in the cooperative’s activities and present conflicting objectives.
Financing the cooperative through the reinvestment of patronage refunds is a clear and straightforward way for members to fulfill their obligation to finance according to usage. Equity redemption helps ensure that the cooperative’s ownership remains in the hands of current users.
