Financing SME Essay Example for Free

Financing SME EssayThe definition of Sm tout ensemble Medium scale Enterprises (SMEs) varies from country to country. The classification send away be base on the firms assets, number of employees, or annual strainover on with the loan amount. Central Bank of Sri Lanka defines SMEs as enterprises with less than Rs. 600 million turnover per annum and with a maximum moving- experience show of Rs. 200 million in the main to be classified as a SME for Basel II Capital adequateness calculation and utilization of funds accumulated in the Investment Fund Account in Banks. whatsoever the definition, and tendernessless of the size of the economy, the growth of SMEs through with(predicate) with(predicate)out the region is crucial to growth of respective economies. Because, SMEs play a critical and master(prenominal) role in providing job opportunities, enhancing the quality of human resources, maximizing the use of topical anaesthetic resources, saving foreign exchange, nurturi ng a culture of entrepreneurship, fostering creativity and opening up new byplay opportunities etc. Most corporate organizations in Sri Lanka or elsewhere are the establishments receiveed as SMEs in its former(a) stages.Classic examples from our own country may be Nawaloka Group, Access International, Softlogic Group of companies. In close to literature, it is mentioned that gateway to financial support has been recognized as a major impediment for m both SMEs and its growth, whereas corporate dividing line entities defy the advantage over the SMEs in doing so primarily as a result of their formalization. However, according to Juliet Mckee and Kimball Dietrich (2003), most common problems for SMEs are the neediness of access to market discipline and technology, the kickoff quality of human resources and the privation of access to capital.Despite efforts by financial institutions and public-sector bodies to close funding gaps, SMEs continue to experience uncorrectabley in obtaining risk capital. These funding gaps relate to firm size, risk, knowledge, and flexibility. The bring onment literature focus a darling plenty of attention on issues faced by SMEs in accessing finance. Traditionally, the focus is on obstructions created by financial institutions, mainly by commercial strands or on imperfections in the broader institutional environment.However, SMEs also make decisions about financial backing and display attitudes that have an main(prenominal) bearing on financing decisions. Therefore, constraints may also appear on the demand side of the financing market. Objective of this article is to discuss the key challenges and issues for bankers pertaining to SME lending, of which, part of them are internal in SMEs and for others bankers are responsible. 1. Issues of SMEs 1. 1 Lack of financial literacy or weak financial literacyIn the literature, lack of financial literacy is designated as randomnessal asymmetries where SMEs typically posse s privileged information on their commercial enterprise that cannot be easily accessed or cannot be accessed at all by lenders or outsiders. Reasons for this may vary and also have distinct perspectives. SMEs are mainly driven by entrepreneurs who have advertd in their own ways to likely SMEs. As a result of hard ways of education, they either had no metre to devote further development or do not believe in l forming.This is evident from the assent applications that are submitted to banks for financing. This eventually leads to low levels of financial literacy among entrepreneurs. monetary literacy is the ability to generalise how money works in the world how someone manages to earn or make it, how that person manages it, how he/she invests it (turn it into to a greater extent) and how that person donates it to help others. More specifically, it refers to the set of skills and knowledge that allows an individual to make informed and effective decisions with all of their fi nancial resource.Though many SME owners are threatening in developing task models and working out the profitability of products and service, understanding about the macro picture of the SMEs overall financial standing in terms of profit and loss account, balance sheet and hard interchange offices is week. As a result, they some generation opt to resort to outsiders or merely depend on themselves in preparation of financial information which may or may not reflect the actual picture of the SMEs. Because of this impediment, banks have no choice, but to depend on collateral for SME financing.At the backdrop cash shine lending is encouraged, financial institutions are struggling to realise the SMEs sustainable bankability. This is recognized as the main obstacle for banks and financial institutions in financing SMEs. One of the options to counter this impediment is the concept of Para accountant. A Para accountant is an external consultant who uses finance, economics, risk manag ement and technology skills to help organizations prepare and accounting financial and tax statements according to accounting principles and regulatory requirements.A Para accountant also may review a firms internal controls, processes and procedures to ensure that such controls are adequate. A Para accountant may work on a clients site or remotely. They are not necessarily qualified accountants, however, capacity be an option. Bankers prime objective in this endeavor is to develop reliable sources of information so that they could project the sustainable cash flows of the business.With this objective banks could train their recognize appraisal officers as Para Accountants, who will interacts with prospective SMEs and develop a set of financial information while strengthening the banking kind over a period of era. 1. 2 Entrepreneurs knowledge about building a prospective banking relationship A banking relationship is about much more than just selecting a bank to handle a compa nys bank accounts. If the relationship is managed well, it can help a company to thrive. SMEs that use more than one bank will need to manage multiple banking relationships.A company will first have a business account (or several) at a retail bank (or banks) for all day-to-day financial transactions. Whether it is retail, SME or corporate, the banks should have a team of business banking advisers on hand, to advise and course a company. Its important to ensure continuity banks usually offer a contact with a designated person and in turn brook to deal with the same person or persons from the company. A good banking relationship depends not barely on personal rapport, but also by having a solid understanding of the company and its financial unavoidably.Over time, a banking adviser should build up a good understanding of the companys preferred ways of doing business and incorporate that into how their banking requirements are handled. There are many advantages having a sound bankin g relationship for SMEs. The bank is more likely to offer loans and other lines of reference work, potentially at preferential evaluate of interest, if the bank advisers feel there is a good relationship with the company. The banks advice can be tailored for the companys needs and personal style, rather than given generically.In times of crisis, a company having its banks support will be crucial. Even if a company is a text-book case of insolvency, strong personal rapport with a company representative means that the bank is more likely to offer leeway if it knows that directors are doing their utmost to keep the company going. Failure to develop a strong relationship, however, means that the SME is likely to miss out on good advice and, crucially, support in times of hard-foughty. However, unfortunately, many SMEs are not on the right track to understand the importance of having a good banking relationship.Given that no sound financial information are available, at least, SMEs sh ould try to go for a healthy customer relationship with the financial institution to entice financial needs, especially in difficult periods. It is both Bankers and SMEs responsibility of developing a prospective banking relationship over a period of time without compromising risk capital. More than the creed facilities, credit plus would be reasonably appropriate to start such a relationship and then move into advanced levels of relationships along with credit facilities. 1. 3 Financial discipline of entrepreneursAs Henry Ford correctly cited, Wealth does not come accidently. You have to platform for it. Ones discipline explains the right behavior and ability to set about decisions without emotions. Hence, financial discipline is all about right financial decisions. In order to be financially discipline one should understand concepts of accounting and financial management in SME business. Accounting in general is all about stick around down keeping and developing summary fin ancial reports. Most commonly available financial reports or information are the profit and loss account, balance sheet and the cash flow statement.Unless SMEs keep records of their daily activities, it is difficult to develop financial statements with regard to their businesses. With no financial statements, SMEs will everlastingly struggle in make financial decisions. More often, there is no clear distinction between the business finance and the cash in hand of the proprietor. Therefore, it is critical that the lender examines carefully borrowers all commitments, i. e. , those related directly to the business and those associated with the proprietors private life and assets. Lack of Business Planning is a result of weakfinancial indiscipline in SMEs where enthronisation decisions, working capital decisions, even pricing decisions are based on the entrepreneurs set than on facts. The lack of proper financial discipline results in incorrect business decisions, which hampers th e sustainability of the SMEs. MacRobert (2002), in his SME manual of arms explains why SME borrowers are unalike to commercial and corporate borrowers. One of the common reasons is unskilled/ untrained principals. umteen SME principals in the Asia-Pacific region are self-starters, often with limited formal education, and minimal training in business management skills.That is not to say that they are incompetent, but that they often lack the capacity to research information on ways to strengthen their businesses, and, indeed, to be aware that such resources even exists. Role of the bankers in this regard is to educate the importance of financial discipline through strong banking relationships. Bankers are one of the key sources, to go SMEs to believe in financial discipline. Bank officers should take the initiatives in this endeavor to educate the SME owners. Role of the organisation is also a key imperative in developing required conducive environment through institutional and p olicy frameworks.Some universities in Sri Lanka have already started dedicated departments to teach courses related entrepreneurship. (Example University of Sri Jayewardenepura and University of Colombo) and It is important to note that Business studies is part of the GCE A/L curriculum. Recent budget proposals in 2011, 2012 and 2013 has given nice support to encourage SMEs and SME financing and one of the very useful proposals was to direct government banks to set up dedicated SME Branches not only to facilitate SMEs with well access to finance, but also to educate SME owners and to guide and direct them to right places and people.However, strengthening the institutional framework to develop business development support services is also an imperative. 2. Issues with Banks SMEs are not only critical to the economy, but also to the banks profitability. Most diversified banks maintain a substantial percentage of exposure to the SMEs as a strategic investment given the multifariousn ess within the SME portfolio itself. It is always profitable, but need to properly evaluate and closely monitor the delinquencies to avoid any credit risks.It is a perception as well as a fact sometimes, that SMEs are always highly risky as explained by many banks. It may be due to several factors including, non availableness of financial information, no tax returns, no collateral, one man show, highly sensitive to economic conditions, no proper organizational structure, and many more. These are reasons given to avoid or very cautious underwriting of SME credit proposals. As a result of these reasons, credit policies of financial institutions are based on stringent credit guidelines. 2.Institutional framework with hindering process issues In the case of many developing countries, the above mentioned obstacles to SME financing are exacerbated by institutional and process factors. Most developing countries are still highly concentrate and have uncompetitive banking sectors. This rei nforces the tendency to adopt conservative lending policies. Credit policies which mainly cover the credit risk and market risk, endorse a processes which covers many elements to secure exposure, while satisfying the regulators requirements.This eventually results in a value driven Credit culture in financial institutions. harmonise to MacDonald and Timothy (2006), managements credit policy determines how much risk the bank will take and in what form. A banks credit culture refers to the fundamental principles that drive lending use and how management analyzes risk. There can be large differences in their lending philosophy. The three potentially different credit cultures are values driven, current profit driven, and market share driven.The institutional framework is reflected through the credit policy in this part of the world, the tendency is to inculcate a value driven credit culture, which has the following attributes Focus is on credit quality with strong risk management syst ems and controls Primary furiousness is on banks soundness and stability and a consistent market presence Underwriting is conservative and significant loan concentrations are not allowed.Typical outcome is lower current profits from loans with fewer loan losses It is evident with lower non- performing ratios prevailing in banks justifies that credit risk is cover with loan risk mitigation factors and discourage granting venture capital to SMEs. Eventually, SMEs need to resort to acceptable securities which hinders them from easy access to finance from financial institutions. 2. 2 Collateral syndrome (Risk avert) Strong value driven credit cultures in financial institutions always tighten the belts in covering credit risk. Unless the financial institutions develop competencies in cash flow based lending, credit officers have no choice but to cover themselves with collateral in risky SME lending. Competencies itself will not drive the business unless the risky lending is rewarded wit h challenging business targets. trade protection based lending propositions are gradually becoming unhealthy for economies as it discourages strategically important investment decisions. Government of Sri Lanka recently enacted legislations to ease the pressure on SMEs through amendment of Parate execution where normal civil procedure of debt recovery should be applied for loans below Rs. five million with security of property mortgages. 2. 3 tripping competency in building cash flow based lending propositions Strong value based credit policies encourage security oriented lending and creates knowledge gaps in credit officers. Security oriented lending does not require strict cash flow projections and credit evaluations.Developing cash flow projections is an art and requires overall knowledge about the industry, technology, external factors (external climate) and specific firms (internal climate) along with econometrics modeling to analyze the cash flows. When it comes to large proj ects, knowledge in project appraisals and risk analysis will help the credit officers to get exposed to project financing. At the backdrop of investor confidence and developing businesses in emerging economies, venturing into risky business propositions is in the agenda of the banking and financial intuitions. Financing SMEs are risky but at the same time profitable, so indeed banks need to develop how best they could mitigate the risk of these ventures. One of the options is to gradually develop a culture of SME financing with confidence through development of competencies in their credit officers.Competency development not only addresses econometric techniques of analyzing and evaluating the credit proposals, but also industry knowledge and exposure, experiences of sick industries and business units, world politics and world economics, knowledge in emerging markets and technologies, behaviors and issues of labor, understanding the entrepreneurship etc. Conclusion umteen of the li terature examine the issues of financing SMEs world over. However, there are key issues not only from the SMEs point of view, but also from the financial institutions and, governments point of views. No one can expect the SMEs to nurture in best practices all by themselves. In this regard, the role of financial intuitions is greater, when it comes to inculcate and nurture SMEs in the right directions. The issues for SME financing discussed above are the keys, but there are many others which needs further discussions.