SMEs and Banks Where is the Disconnect – Need for Financial Inclusion

What is an SME within the Nigerian Context? The Central Bank of Nigeria (CBN) define SMEs as enterprises with asset base (excluding land) of between N5 million to N500 million and labour force of between 11 and 300.  

These enterprises according to the CBN definition have the following key features; an asset base of between N5 million to N500 million and staff strength of between 11 and 300 employees.

However, even this definition by the country’s primary financial sector regulator is fraught with limitations that ensure financial exclusion. Why should an SME be qualified by asset base and number of employees? 

What happens to SMEs that do not fit into this garb? Do we find another name for them?  Well most financial institutions have done just that, you hear of MSMEs these days, Micro, Small and Medium Scale Enterprises. The Micro denotes companies that do not fall within the CBN’s standard definition of SMEs.

I on the other hand prefer to qualify companies as SMEs using the following features:

• Have a relatively small share of its market;
• Are not a subset or part of a large enterprise;
• Serve as seed-bed for indigenous entrepreneurship;
• Promote indigenous technological know-how;
• Use mainly local resources, thus have little or no foreign exchange requirements;
• Cater mostly for the needs of low income earners; and
• Adapt easily to customer’s needs.

What then are the forms of funding available to most SMEs?  Funds available fit largely into the following categories:

• Equity Capital – Owner’s equity, equity from family and friends, venture capitals and private equity firms;
• Quasi Equity – Esusu, suppliers credits, customer’s advances and government intervention funds; and
• Debt Capital – Loans from commercial banks, microfinance banks, finance houses and loan sharks.

I will focus on debt capital and we will be examining why the financial exclusion for most SMEs with regards to accessing bank loans and advances.

What forms of funding are available to SMEs in financial institutions? Financial institutions channel funds to SMEs in form of:

Short term funds/Working capital finance – these are facilities with tenors of a year or less and include the following:

•       Overdraft facilities - these are flexible, short-term facilities which is used by small businesses to meet current financing needs e.g. buying input materials in manufacturing concerns.
•       Trade advances – are particularly suitable for small retail businesses in assisting them stock up goods and products.
•       Trade facilities - is tailored to meet the financial requirements of enterprises with need to  import raw materials or input products for their manufacturing processes.

Long term finance – these are facilities with typical tenors of between 2-5 years, examples are:

•      Term loans - These are non-revolving facilities with tenors beyond a year final maturity extending beyond one year, normally packaged to finance capital projects or a customer’s expansion programme.
•       Equipment lease finance - Leasing is a creative financing option that can be a valuable additional source of medium term finance suitable for SMEs. It’s a contract between equipment owner (Lessor) and user (Lessee), title resides with Lessor till the last installment is made by the Lessee.  Equipment lease finance is particularly suitable for small and medium manufacturing concerns and agriculture enterprises.

What then do SMEs need to do in order to access these forms of debt financing? To access these funds SMEs are required to:

1.        Operate a legal and duly registered business;
2.        Open enterprise accounts and operate same for a period of time usually between 3-   6  months;
3.        In addition, they need to provide the following:

•       Bankable business plans;
•       Historical financials and management accounts; and
•       Adequate security as required by the lending institution.

Why do we then have the gap in funding or this seeming financial exclusion? Significant numbers of SMEs do not have access to formal sector funding i.e. funding from financial institutions. Banks have always perceived SME lending as high risk due to the following factors:

• The informal nature of SMEs i.e. no clear organisational and operational structure;
• Inability of these enterprises to prepare/provide bankable business plans;
• Poor record keeping i.e. no accounting or business information;
• Lack of security required for conventional collateral based bank lending; and
• Discriminatory cultural practices which hinder transparency.

If  “MSMEs remain the backbone of the development of any economy and the driving force of national growth” as stated by the Minister of Industry, Trade and Investment; Mr. Olusegun Aganga, then something needs to be done on a national scale, a decisive policy/ programme of action to encourage lending to SMEs.

Financial institutions also need to create products that can best meet the needs of this core segment of our economy. It is worth noting that this is already happening, a lot of commercial banks are churning out products that are created specifically for these niche market.

SMEs on their own part need to work on being taken seriously, as I stated in my previous blog, there is need to have a business plan/plan of action which addresses the issues around operations, structure and even funding. It’s time to get our acts together and stop treating our business ventures as hobbies. 

How to Write a Simple Business Plan for Small and Medium Scale Enterprises (SMEs)

I have been working with SMEs for over 10 years now in making these businesses bankable. However, a critical place to start that often seems left out by most entrepreneurs with ideas, concepts and visions is coming up with a written plan on how to actualize their dreams. Realizing the ideas, concept, visions often begins with penning down the idea with adequate consideration for country, industry and market risks as well as financing outlets.

Why is it important to have a business plan? I have come across people who start their own businesses with their own funds or funds from families and friends and the first thought in their minds are to put these monies into use without marshaling out a plan.

I liken starting a business to going out to war and I always ask these entrepreneurs a simple question; "if you were a general about to go into battle in a known territory or an unknown territory (i.e. a familiar or unacquainted business terrain) will you not have a detailed strategy/plan of action? The answer I often get is; "Yes of Course" I should have a plan of action. Then if that is the case with a battle, we should also treat a new business venture as such, have a business plan i.e. plan of action or strategies.

So how then should an entrepreneur go about writing a simple business plan? Below are three (3) steps which will facilitate the process:

1.  Determine why you need a business plan; reasons could include all or some of the following:

•              To evaluate initial start-up costs.
•               To establish the viability of a business endeavor.
•          To define your products, services and customers and assess competitors.
•               To map out the business model, the goals and the strategy used to achieve them.
•           To communicate to others (banks, investors, partners, etc.) the business idea.

2.    Once the purpose of a business plan has been determined, commence write-up by following this well established outline:

•         Introduction:

o   Introduce yourself. Tell the readers who you are, your background, education, professional experience, your successes to date.

o   Introduce your enterprise and the business concept briefly.

•         Macroeconomic Overview:

o   A brief review of the country, economic trends and as well as outlook to support growth/development of the business idea.

•        Industry & Market Review:

o   An in-depth review of the industry the business will be operating in, regulatory overview (if any) that would determine permissible activities and outlook.

o   An overview of the market which will involve a description of target customers and understanding of demand size. Explanation of your product or service. What does it do for the customer? Does it have any unique features or aspects? How is it produced? Back up your argument with evidence from your experience, reports and market research.

•         Business and Operating Model: This section will address marketing, pricing, advertising and operating strategies; i.e.  

o   Describe any unique selling points or advantages you have and why will your customers buy from your business?

o   Are you providing better value, guarantees, superior quality, reduced risk, or better location?

o   How much money your customers will pay for each of the products or services you will provide.

o   Describe any up-selling or cross-selling opportunities and how many times a customer will buy from you in a typical year.  

o   In addition, this section will break down the company’s organizational structure and human resources to support and deploy the strategies discussed above.

o   Again, use any market research or other evidence you can bring to support your argument.

•        Financial Appraisal/Viability:

o   Explain how many products you can produce or how much service you can provide in a typical year and back this up with whatever supporting evidence you have.

o   Examine how much each unit of product costs to produce. If your business is a service business, describe how much it costs to provide the service. Don't forget overhead expenses, such as payment for utilities and salaries.

o   Detail how much start-up investment the business will require and what you require it for. Explain why your business is viable and what evidence you have to support this claim.

o   This will require some market research to demonstrate that there is a viable market for your product or service.

•         Executive Summary:  Though written last, appears at the beginning of a business plan.

o   It is read first and in most cases will determine if the business plan will be given further consideration. It should not be more than a one or two pager as it is a summary.

3.      Print the business plan and commence use immediately by deploying it to:

•         Evaluate and benchmark initial start-up costs to ensure no overruns;
•         Establish the viability of  the business before commencing operations;
•         Define products, services and customers as well as assessing competitors;
•         Map out the business model, the goals and the strategy used to achieve them; and
•         Engage banks, investors, partners, etc. when prospecting for initial or additional capital.