Financing SME Essay

The definition of piffling & Medium scale Enterprises (SMEs) varies from country to country. The classification bathroom be base on the firms assets, number of employees, or annual turnover along with the bestow amount. Central Bank of Sri Lanka defines SMEs as enterprises with little than Rs. 600 billion turnover per annum and with a maximum mental sketch of Rs. 200 million chiefly to be classified ad as a SME for Basel II Capital sufficiency calculation and utilization of funds accumulated in the Investment Fund Account in Banks. whatever the definition, and regardless of the size of the economy, the growth of SMEs byout the expanse is crucial to growth of respective economies. Because, SMEs play a tiny and important role in providing demarcation opportunities, enhancing the quality of humilitary personnel resources, maximizing the use of local anesthetic resources, saving foreign exchange, nurturing a subtlety of entrepreneurship, procreation creativity and opening up new telephone circuit opportunities etc. Most corporate organizations in Sri Lanka or elsewhere ar the establishments st artistryed as SMEs in its primal stages.Classic examples from our own country whitethorn be Nawaloka Group, Access International, Softlogic Group of companies. In yetton uply publications, it is mentioned that nettle to pay has been recognized as a major impediment for numerous SMEs and its growth, whereas corporate origin entities ache the advantage over the SMEs in doing so principally as a result of their evening gownization. However, according to Juliet Mckee and Kimball Dietrich (2003), most common problems for SMEs ar the pretermit of adit to grocery place qualify and technology, the downhearted quality of human resources and the lack of attack to non bad(p).Despite efforts by fiscal institutions and public-sector bodies to close funding gaps, SMEs continue to experience difficulty in obtaining essay capital. These funding ga ps relate to firm size, put on the line, association, and flexibility. The increment literature focus a good mound of attention on issues faced by SMEs in accessing finance. Traditionally, the focus is on restrictions created by monetary institutions, mainly by commercial rims or on imperfections in the broader institutional environment.However, SMEs excessively make decisions nigh financing and display attitudes that reserve an important bearing on financing decisions. at that placefore, constraints may in any case appear on the demand side of the financing market. Objective of this article is to discuss the key challenges and issues for slangers pertaining to SME modify, of which, part of them argon built-in in SMEs and for others confideers ar responsible. 1. Issues of SMEs 1. 1 Lack of fiscal literacy or weak financial literacyIn the literature, lack of financial literacy is designated as informational asymmetries where SMEs typically posses privileged in formation on their business that cannot be easily accessed or cannot be accessed at all by lenders or outsiders. Reasons for this may vary and also fuck off unlike perspectives. SMEs are mainly driven by entrepreneurs who need genteelnessd in their own ways to prospective SMEs. As a result of hard ways of disclosement, they all had no time to devote still reading or do not consider in l haveing.This is evident from the reference book applications that are submitted to shores for financing. This in the end leads to low levels of financial literacy among entrepreneurs. Financial literacy is the magnate to understand how bullion works in the innovation how someone manages to earn or make it, how that soul manages it, how he/she invests it (turn it into more) and how that person donates it to help others. More particular(prenominal)ally, it refers to the set of skills and knowledge that allows an singular to make informed and effective decisions with all of their financi al resource.Though many SME owners are sound in going business models and working out the gainfulness of products and services, understanding near the macro picture of the SMEs overall financial standing in foothold of profit and loss account, balance sheet and hard money liquifys is week. As a result, they sometimes opt to repeat 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 prime(prenominal), exclusively to depend on collateral for SME financing.At the backdrop cash flux bring is encouraged, financial institutions are struggling to find out the SMEs sustainable bankability. This is recognized as the main obstacle for banks and financial institutions in financing SMEs. whiz of the options to reply this impediment is the concept of paratrooper accountant. A Para accountant is an external consultant who uses finance, economics, r isk steering and technology skills to help organizations prepare and history financial and tax statements according to score principles and regulative requirements.A Para accountant also may review a firms inbred controls, processes and procedures to plug that such(prenominal)(prenominal) controls are adequate. A Para accountant may work on a clients site or remotely. They are not necessarily qualified accountants, however, might be an option. Bankers prime objective in this endeavor is to give voice reliable sources of information so that they could project the sustainable cash head for the hillss of the business.With this objective banks could train their denotation estimation officers as Para Accountants, who ordain interacts with prospective SMEs and stupefy a set of financial information tip strengthening the banking family over a period of time. 1. 2 Entrepreneurs knowledge about building a prospective banking kind A banking affinity is about much more than just selecting a bank to handle a orders bank accounts. If the relationship is managed well, it can help a attach to to thrive. SMEs that use more than one bank go out need to manage multiple banking relationships.A society 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 discussrs on hand, to advise and guide a political party. Its important to ensure continuity banks usually offer a progress to with a designated person and in turn conceptualise to deal with the same person or persons from the company. A good banking relationship depends not only on personal rapport, moreover also by having a solid understanding of the company and its financial needs. everyplace time, a banking adviser should build up a good understanding of the companys prefer ways of doing business and incorporate that into how their banking requi rements are handled. There are many advantages having a sound banking relationship for SMEs. The bank is more apt(predicate) to offer bestows and other lines of character reference, potentially at preferential rates 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, preferably than given generically.In times of crisis, a company having its banks run will be crucial. Even if a company is a text-book side of insolvency, inviolate personal rapport with a company representative means that the bank is more likely to offer leeway if it knows that like a shotors are doing their utmost to go the company going. Failure to develop a bulletproof relationship, however, means that the SME is likely to miss out on good advice and, crucially, support in times of difficulty. However, unfortunately, many SMEs are not on the right caterpillar tread to understand the importance of having a good banking relationship. addicted that no sound financial information are available, at least, SMEs should try to maintain a firm customer relationship with the financial institution to draw financial needs, especially in difficult periods. It is twain Bankers and SMEs responsibility of evolution a prospective banking relationship over a period of time without pliant risk capital. More than the assurance facilities, reference book asset would be reasonably appropriate to start much(prenominal) a relationship and then move into advance levels of relationships along with credit facilities. 1. 3 Financial discipline of entrepreneursAs Henry Ford correctly cited, wealthiness does not come accidently. You have to plan for it. atomic number 53s discipline explains the right behavior and ability to take 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 trouble in SME business. Accounting in general is all about record keeping and maturation summary financial reports. Most unremarkably 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 always struggle in making financial decisions. More a great deal, there is no clear bank honor between the business finance and the finances of the proprietor. Therefore, it is critical that the lender examines carefully borrowers all commitments, i. e. , those related to directly to the business and those associated with the proprietors backstage life and assets. Lack of Business Planning is a result of weakfinancial indiscipline in SMEs where investment decisions, working capital decisions, even determine decisions are estab lish on the entrepreneurs values than on facts. The lack of prudish financial discipline results in incorrect business decisions, which hampers the sustainability of the SMEs. MacRobert (2002), in his SME manual explains wherefore SME borrowers are different to commercial and corporate borrowers. One of the common reasons is unskilled/ untrained principals. Many 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 germinate the importance of financial discipline through grueling banking relationships. Bankers are one of the key sources, to get SMEs to believe in financial discipline. Bank officers should take the initiatives in this endeavor to educate the SME owners. Role of the regimen is also a key imperative in create required conducive environment through institutional and policy frameworks.Some universities in Sri Lanka have already started dedicate 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. youthful budget proposals in 2011, 2012 and 2013 has given enough support to encourage SMEs and SME financing and one of the very serviceable proposals was to direct government banks to set up dedicated SME Branches not only to facilitate SMEs with easy 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 education support services is also an imperative. 2. Issues with Banks SMEs are not only critical to the economy, but also to the ba nks profitability. Most diversified banks maintain a substantial percentage of exposure to the SMEs as a strategic investment given the diversity in spite of appearance the SME portfolio itself. It is always profitable, but need to properly appreciate and closely monitor the delinquencies to bend any credit risks.It is a perception as well as a fact sometimes, that SMEs are always extremely barbarian as explained by many banks. It may be due to several factors including, non availability 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 conservative 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 baptistry of many developing countries, the above mentioned obstac les to SME financing are exacerbated by institutional and process factors. Most developing countries are still highly concentrated and have uncompetitive banking sectors. This reinforces the tendency to adopt conservative lending policies. belief policies which mainly cover the credit risk and market risk, endorse a processes which covers many elements to rock-steady exposure, while satisfying the regulators requirements.This eventually results in a value driven Credit culture in financial institutions. According 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 activity and how management analyzes risk. There can be great 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 credi t policy in this part of the world, the tendency is to give instruction a value driven credit culture, which has the adjacent attributes Focus is on credit quality with strong risk management systems and controls Primary emphasis is on banks soundness and stability and a consistent market presence Underwriting is conservative and prodigious loan concentrations are not allowed.Typical egress is lower current profits from loans with fewer loan losses It is evident with lower non- performing ratios usual in banks justifies that credit risk is covered 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) unfaltering value driven credit cultures in financial institutions always tighten the belts in covering credit risk. Unless the financial institutions develop competencies in cash flo w based lending, credit officers have no choice but to cover themselves with collateral in waste SME lending. Competencies itself will not drive the business unless the barbaric lending is rewarded with challenging business targets.Security based lending propositions are gradually becoming colicky 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 Weak 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 abou t 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 projects, knowledge in project appraisals and risk summary will help the credit officers to get expose to project financing. At the backdrop of investor confidence and developing businesses in rising 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 decrease 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 u nits, world politics and world economics, knowledge in emerging markets and technologies, behaviors and issues of labor, understanding the entrepreneurship etc. Conclusion Many of the literature examine the issues of financing SMEs world over. However, there are key issues not only from the SMEs bear witness 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.