Small and Medium Business Enterprises - Essay Example

SMALL AND MEDIUM BUSINESS ENTERPRISES by SMALL AND MEDIUM BUSINESS ENTERPRISES Introduction Small scale and medium businesses are often an independent kind of businesses which have less than 600 employees. They are significant to the US economy and represent about 96% of all the employment firms. They employ close to 50% of the private segment sector. In addition, they have created about 66% of jobs in the past. Further, the small and medium businesses contribute to the competitiveness of an economy by a process of economic renewal (Rathakrishnan, L. 2010). They usually create, eliminate and finally they reorganize economic sectors. Small and medium scale Business (SMB) is very crucial for the development of any economy. The important role of SMBs is evident when the economies of the developing nations are considered. SMBs contribute greatly to the gross domestic product in a country, entrepreneurial skill development, generation of employment and innovation to many developing economies. In light of this, the paper will critically analyze the various sources of financing for small and medium scale businesses Due to the good impact of SMBs in the economy of a country, support schemes and programs have been put forth in institutions by some of the developed and developing countries so as to support them (Prasad, C. 2004). This support includes offering loans, expert counseling on the types of credit so as to avoid credit risk, advice and legal assistance on exports by the government of the United States of America through small business administration. For instance, in the late 80s the Nigerian Government established the Entrepreneur Development Programme through the National Directorate of Employment, the objective of this policy was to reduce unemployment level through providing an opportunity for individuals to acquire entrepreneur skills. Further they would be able to secure loans for themselves so that they can start their own small and medium scale enterprises (Dinesh, 2003). Another case was in Mexico whereby the Mexican Development Fund was established so as to provide an arrangement of finance to aid agricultural activities. Despite such efforts, investigations reveal that the SMBs are still facing major challenges. Some of the SMBs cannot easily access funds thus posing a major threat to their existence in terms of growth and survival. Ekpenyong and Nyong (1992) states that in some countries like Ghana for example, financial schemes have been launched. They include Micro-finance, venture capitalist trust, and small loan centers among others. Others are export development, Investment Funds and Business Advisory fund. These institutions have been created by individuals, public and private firms. Despite availability of such support schemes, the SMBs still continue to face challenges of access to funds. Thus, lack of access to financing is a major obstacle to entry in entrepreneur ventures as the SMBs cannot afford the initial capital required to start a business (Soundarapandian, 2009). If this obscurity of access to finance continues, the SMBs may find some difficulty to start, or expand and they may just decide to go out of business. Otherwise, if they want to continue with the business they will have to seek other alternatives for financing their activities such as getting help from savings and loan companies. Importance of SMBs and access to credit In many economies, the SMBs have generated positive effects such as creation of jobs, innovation, growth in gross domestic product, boosting of creativity and contribution to the revenue generated by the exports in a country. The SMBs are more advantageous than the big enterprises since the SMBs are able endure even in adverse economic situations. In SMBs there are individuals who are technically skilled, thus making the SMBs to be labor intensive than big firms. This enables the SMBs to have a lower capital cost. The SMBs are also important due to the fact that they are easier to create job opportunities since if an individual’s skills prove to be efficient, and then he or she is good to start a small or medium scale enterprise. In addition, since they SMBs are labor intensive, they are likely to be successful in urban centers and rural areas, where they will play a part in distribution of economic activity and more so help in slowing own the migration of individuals from rural areas to urban areas (Prasad, C. 2004). The major problem that Small and Medium Business face is access to finances. Lack of enough financial resources restricts SMBs from developing or engaging in development activities. This makes the SMBs not to engage in other important activities such as investment and expansion. A study by World Bank showed that 90% of SMBs were restricted from engaging in investment activities due to lack of credit facilities (Jones & Haven-Tang, 2005). The part played by finance is a major element to ensure that SMBs access funds. Most SMBs do not have access to adequate and appropriate kinds of credit and equity facilities (Kapoor, Mugwara & Chidavaenzi, 1997). Thus, formal financial institutions have resorted to structured products so as to serve the needs of large corporations and not neglect the needs of SMBs financial requirements. Sources of Finance for Small and Medium Scale Businesses SMBs depend mostly on personal savings of the owners and at times the business profits for their financial requirements. They mostly have very little or no access to external credit facilities. The traditional financial institutions viewed SMBs as risky businesses and with a high rate of credit default compared to the large firms. Due to this reason, the financial needs of small business are normally overlooked and thus they are not considered in the lending policy formulated by the banks (Ojo, 2004). Therefore, most of the SMBs are not given access to financial help by the traditional financial institutions. This forces the SMBs to turn to other alternative sources of financing. Some of the sources of finance available for the SMBs are discussed below. Friends and family Family and friends are a vital source of finance for the SMBs. This is a significant source of finance especially for the poor who cannot access financial services in the less developed countries. It is, therefore, necessary for the Small and Medium scale business as they contribute a lot to the economic development. A report which was lately conducted reveals that financial institutions have yet to tap into a potential global market for the SMBs financing about 6 trillion. Money lenders Money lenders are just another source available for the SMBs. Money lenders are a form of micro-finance and they are usually an important source of funds needed for emergency and short-term finance after family and friends. They help SMBs and the entire population that cannot access financial services from the commercial financing facilities. In the 1970s, money lending became a part time activity conducted by traders and other people with liquid money than a profession conducted full time. The money lenders usually have terms and conditions that should be adhered to by the lenders (L & Urata, 2002). These sources are necessary if money is needed for short term finance needs. The borrower usually pays interest which is higher than that of banks. The terms and the mode of payment of the interest rate and principle is usually agreed and documented, and a witness or observer is involved for future references when need arises. However, the dependence on money lenders has recently reduced due to the emergence of credit union facilities, clubs, saving and loan companies which have facilitated lending of money to be licensed. Of late, the money lenders do not have licenses and they do not carry out their activities full time, thus the ordinance has stopped being that important. Trade credit Trade credit is a major source of finance to the SMBs. It is usually given out for short term requirements. However, trade credit has some effects. For example, when using it, borrowers usually avoid problems like information asymmetry and high transaction cost. This finally results in high interest rates and rationing of credit. However, trade credit results to lower transaction costs which lead to liquidation of every person’s commercial exchange compared with credit from other financial institutions for instance banks. Thus trade credit is the best way for the SMBs to deal with market imperfections such as information asymmetry (Patra, Misra & Lall, 2006). Venture Capitalist These are firms which help in the initial period or start up of high growth SMBs, in order to gain a small portion of the business. Therefore, the venture capitalist provides a source of funds for the SMBs. Nevertheless, the firms in which they invest have to decide as it is a kind of risk that they will be undertaking if they allow to be financed. Business Angels Business Angels are an informal market for direct finance. Angels are wealthy persons who are selective in nature and they have long experience in business. They usually invest directly in high growth investments such as SMBs of which they have no relationship with. This kind of investment is based on equity contracts that are purely common stock. Generally business Angels are individuals; however they can also conduct their investment in groups. There are varied reasons why business Angels are the best option for the SMBs. In the first instance, Business Angels are usually very active and cooperative when a small business enterprise starts. They help the small business close up the equity gap by helping them form a bridge between internal financing sources and outside investors. Secondly, they have a lower rate of rejection while having a more effective kind of capital with longer exit horizons. Business Angels moreover adapt to the requirements of the SMBs with ease. For instance, in Germany, Business Angels are ranked as the best source of funds for the SMBs. As compared to venture capitalists; Business Angels like to support the SMBs in their localities (Patra, G., Misra, P., & Lall, G., 2006). Non-Bank Financial Institutions Financial institutions are usually different from the banks simply because of their regulatory difference. The activities of non-bank financial institutions have lately gained popularity due to the introduction of new regulatory policy frameworks. The non-bank financial institutions include savings and loan companies, credit unions, pension funds, finance houses, investment trust companies, finance companies, insurance companies, mortgage houses and leasing (Islam, 1997). Non-bank financial institutions play the best role in financing the SMBs. This is because they facilitate the availability of finances to the SMBs especially in rural areas. Moreover, their procedure for the loan application is shorter compared to the commercial banks. In addition, the non-bank financial institutions provide longer maturity periods for borrowed fund; this makes it very favorable for the SMBs. Government Support and Schemes SMBs have and are continuing to enable development of economies in many countries. For this reason, various government agencies have decided to support the SMBs. For instance in Ghana, the National Board for Small Scale industries (NBSSI), Business Assistance Funds, Ghana Investment Funds, GRATIS Foundation, Rural enterprise Project(REP) and Microfinance and Small Loan Centre have been established. Due to the fact that SMBs have recorded a major success in the economic development and have actually promoted greater investment because they are offered support by the government (Bhalla, 1991). Non-Governmental and community Based organization The NGOs can facilitate the development of SMBs (Aryeetey, 1994). They usually collaborate with RMFIs through the introduction of internationally tested methodologies. These methodologies are based on group solidarity methods and have benefited from linkages. They are based on some kind of locations. For instance, occupation, friendship, family ties, and gender among others. The NGOs are making financial services available to SMBs, especially in the rural areas where commercial banks are scarce. However, the NGOs are localized and they depend on donation facilities. In addition, the NGOs are usually meant for multipurpose such as they are welfare oriented agencies. Worldwide credit crisis impact on small business finance Since the beginning of the financial depression in 2007 up to 2010, the world is experiencing a credit crisis (Organization For Economic Co-Operation And Development, 2000). This has had a negative impact on the SMBs. For example, there is a major decrease in the value of the real estates, high default rates on loans and high shut out. This makes it hard for the business to obtain credit facilities and loans for growth and expansion. Therefore, the credit crisis has made managers to resort to making decisions which reduce costs, but maintain the same operational level. The following are some of the impacts of the credit crisis; Lack of cash flow There is an inadequate cash flow in business operations due to the credit crisis. This is because due to recession, the customers decided to decrease the quantity of cash they used to spend to purchase things from the business. As a result, the business cash flow reduces. Therefore, the businesses have resorted to seek help from the credit lending facilities so that they can boost their cash flow. However, since lenders have imposed strict lending policies, it becomes difficult for the businesses to access credit facility (Patra, G., Misra, P., & Lall, G., 2006). Layoffs and unemployment Following the recession, the business have decided to reduce some of their employees, this is because they want to cut on their budget. Flexibility Due to credit crisis, business has become more elastic so as to keep up with the business operations until the credit crisis is over. Flexibility in business included closing some days of work and bargain with employees on modes of payment. Business property Default Businesses that had some property had to adjust their mortgage rates to be higher so as to keep up with the credit crisis period. This caused some individuals who owned the properties to default. Thus, businesses that used to lease commercial property were in trouble since landlords failed to pay mortgages while banks shut out their properties. Increased creativity The credit crisis led to businesses becoming more creative. This is because the businesses had to negotiate with their suppliers on favorable terms. Moreover, they had to tell employees to work part time until the period when things would be well. Measures Taken By Policy Makers to Reduce the Impact of the Credit Crisis The small and medium businesses suffered greatly during the financial crisis. As a response, the government took specific measures to address these problems. Besides introducing specific emergency programs, government maintained or the expanded assistance programs, government guarantee to small business increased dramatically through financial institutions. Policy measures to support debt financing There was a formulation of a credit guarantee scheme (CGSs) which was a key policy tool to address the small business finance gap while limiting the burden of public financing. This tool enabled SMBs access the financial services too. Another policy was the introduction of credit mediation schemes that became successful and continued in many countries (Hallberg, 2000). They continued to evolve into long term initiatives to support the SMBs which faced difficulties in insurance and credit markets. In addition, public financial Institutions were enacted (PFIs) which played a major role during and after the financial crisis. They addressed the short term financial gap and it also mitigated cyclical fluctuations in lending activities of financial institutions especially to the SMBs. Risk Capital and Policy Measures The crisis affected the venture capitalist severely. Consequently, policy makers decided to engage in research aimed at assessing the links between need and the early stage policy interventions, the regulatory and administrative environment and the outcomes in terms of the need and early stage investments (Moha Asri Abdullah & Mohammad Isa Bin Haji, 2000). While majority of countries have grants, loans and guarantee schemes, in place, their support increased and other support measures were availed. Regulatory and administrative framework played a greater role too. Non-Bank small business finance Due to this crisis, SMBs had to consider other sources of finance apart from traditional banks in order to expand various financial instruments available to them. There was development of other alternatives by the policy makers which included crowd funding and peer-peer funding. Securitization policies were also revised so as to favor the SMBs. New securitization was made due to the crisis which is safer, simpler, and more transparent through government regulatory and support (Iqbaszirmai & Szirmai, 2005). Conclusion The Small and Medium Business are the momentum and engine of economic development in a country. Therefore, efforts by the government, policy makers, individuals and financial institutions are imperatively required so as to develop the SMBs in the economy. This can only be done when credit facilities are made available to the SMBs. Savings and Loan Companies have continuously supported the SMBs by providing them with easy access to their credit facilities as traditional financial institutions are very cumbersome. The situation is attributed to information asymmetry, and high transaction costs and lack of collateral for lending to the SMBs. Moreover, they view SMBs as very risky compared to large businesses. However, the Loans and savings company has taken that opportunity to serve the SMBs so that they can easily have access to financial facilities. Since the SMBs are considered to have a high default rate and risky, it is therefore recommended that the SMBs should engage in group lending. On the other hand, defaulting can be reduced if credit rationing is undertaken. Moreover, the character lending should be considered where funds should only be available to individuals or the SMBs who have good records concerning their lending and repayment. In addition to these, the lending organizations should monitor the borrowers or the SMBs. Some SMBs are not aware of alternative sources of credit which is cheaply available; this is due to the fact that the SMBs have information asymmetry. They cannot access relevant information on loans in time. Therefore, it is recommended that the SMBs should be active and look for any relevant information themselves. Therefore they will have a varied choice to make concerning where to borrow and they can easily select a credit with longer maturity period and of low cost. In addition, since SMBs are regarded as unattractive ventures, there is need for them to improve their business management skill. This includes basic record keeping, market and putting proper organizational structure. The SMB should be assisted to prepare financial reports with individuals who are skilled such as auditors; this will enable the access credit facilities as the loans company usually examines the financial statements before giving loans. Finally, the SMBs should be offered support and their collateral accepted by banks and other financial institutions. They should be given credit with favorable interest rate too. Lastly, the government’s role in supporting the SMBs should be intensified. This is needed where economic conditions are unfavorable and the SMBs cannot easily access credit facilities. 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