Poverty is widespread in developing countries especially in the countryside where agriculture is the lifeblood of rural households. From agriculture sector they earn their livings and feed their families. These small poor households contribute to a major portion of the population and labor force. Despite of their significant role and valuable contribution to the economy and society, they usually spend a miserable life. Usually they remain in debt all over their lives. Rural households get inputs and credit from input dealers and local informal lenders with the promise to pay at the time of harvest of the crop. In return, the input dealers and money lenders charges very high interest rates. Easy and uninterrupted access to the inputs and credit can bring positive impact on their economic conditions but there is problem of limited or no access to resources. Farmers are poor and have no access to the commercial banks because commercial banks ask for the collateral. This way, farmers are compelled to seek financial help from input suppliers, commission agents or local money lenders at very high cost, causing negative impact on welfare. With the help of microfinance these poor households may have access to credit and subsequently to the resources and can get rid of poverty. This dissertation takes into account the different development activities related to the microfinance participation of small rural households. We estimated the impact of microfinance on the lives of rural households. The results explain the determinants of participation in microfinance programs and impact of microfinance participation on welfare indicators like per head expenditure, poverty gap and severity of poverty and crop production like fertilizer use, yield and net returns. Results indicate that there is positive relationship between microfinance participation and welfare of the rural households in Punjab province of Pakistan. From the results of this study we conclude that microfinance is a poverty combating tool.