Financing SMEs: Challenges and strategies

All enterprises, large or small and medium-sized, need financing from start-up business to supply of finished products or services to the consumers. Small and medium-sized enterprises (SMEs) play a vital role in employment generation, economic growth and development in developed and developing economies alike. SMEs are epitomised as 'engines of growth' by economists.
Some developing countries face enormous problems in financing enterprises, especially the SMEs. Economic, financial and political factors always stand as a stumbling block on the way of developing and financing SMEs.  Various research institutions have identified some common barriers being faced by SMEs in developing countries that hinder survival, growth and innovation. Most failures of SMEs are due to multiple factors such as under-capitalisation, short-term liquidity problems, insufficient working capital, insufficient start-up capital and weak financial management.
ECONOMIC IMPORTANCE: The SMEs-- firms with fewer than 500 employees--are the backbone of the US economy. These make up 99 per cent of all firms, employ over 50 per cent of private sector employees and generate 65 per cent of net new private sector jobs. These units account for over half of US non-farm GDP and represent 98 per cent of all its exports and 34 per cent of its export revenue. SMEs play a significant role in all economies and are the key generators of employment and income, and drivers of innovation and growth.
In the OECD countries, SMEs employ more than half of the labour force in the private sector. In the European Union, they account for over 99 per cent of all enterprises. Furthermore, 91 per cent of these enterprises are micro-firms with less than 10 workers. Given their importance in all economies, these firms are indispensable for economic recovery.
There exists strong evidence that SME expansion boosts employment more than the larger ones because these are more labour- intensive. In Pakistan, the SME sector contributes 30 per cent towards the country's GDP and provides 90 per cent of jobs, accounts for 35 per cent of the value addition in the manufacturing industry and generates 25 per cent of manufacturing sector export earnings.
Indian SMEs consist of approximately 45 million units. All these produce more than 6,000 products from traditional to high-tech items, employ 101 million people, account for 40 per cent of the country's exports and contributes 9 per cent to the country's GDP.
In Arab region, SME sector consists of more than 90 per cent of all firms outside the agriculture. According to statistics, these units constitute more than 95 per cent of all non-agricultural private enterprises in Egypt and account for nearly three-quarters of new employment generation. For Kuwait, this sector constitutes approximately 90 per cent of the private workforce and imports an estimated 45 per cent of the labour force. In Lebanon, more than 95 per cent of the total SME enterprises contributes about 90 per cent of the jobs. In the UAE, SMEs account for 94.3 per cent of the economic projects in the country and employ about 62 per cent of the workforce and contribute around 75 per cent of the GDP of the state. In addition, they account for 96 per cent of the GDP in Yemen and about 77 per cent, 59 per cent, 25 per cent in Algeria, Palestine and Saudi Arabia respectively.
CHALLENGES: Challenges encountered by the SMEs in the developing economies have been escalating due to the worldwide financial and economic crises. In addition to financing constraints, the SMEs face major challenges such as lack of technical and skilled workers, lack of modern equipment, lack of qualified and professional entrepreneurs, lack of technologies, designs, patterns, infrastructure and shortage of energy in developing countries. The unresolved challenges dissuade the SMEs from entering the competitive markets in the world and to compete with large enterprises. The other challenges confronted by the SMEs are political and economic instability, inadequate policy support from the governments, political disintegration and corruption in the developing countries.
By far, the biggest problem being encountered by the sector is unavailability of adequate financing facilities. A recently- conducted World Business Environment Survey covering 4,000 firms in 54 countries found that SMEs cited inadequate access to finance as their primary constraint to growth. Banks find it risky to extend credit facilities to them. It is relatively easy to lend to large corporates where economies of scale, collaterals and creditworthiness parameters favour such types of lending. As the small businesses cannot offer adequate collateral, banks are unable to determine whether the borrower possesses technical, managerial and marketing skills that will allow him to generate adequate cash flows and repay the loan in time. The process of financial intermediation breaks down for the SME borrowers' credibility.
Every enterprise is financed either through debt or equity or a combination of both. Both types of financing are usually sourced from either the informal finance sector (IFS) or the formal finance sector. The commercial and development banks in the formal sector are the most popular source of finance for the units. The informal sector, which consists of borrowing from friends, relatives and cooperatives, is an important source of SME financing. Another source of enterprise financing is through personal savings, commercial and micro-finance banks.
Roughly 4.5 billion people living in developing countries and emerging economies do not have access to financial services such as credit, savings and insurance. Formal financial intermediaries, such as commercial banks, usually refuse to serve poor households and micro-enterprises because of the high cost of small transactions, lack of traditional collateral, lack of basic requirements for financing and geographic isolation. By doing so, these institutions ignore the enormous potential in talents and entrepreneurship of this area of business activities. Providing access to financial services will stimulate independence and self-development of households and micro-entrepreneurs. This will help not only to improve poor people's economic condition but also to provide a way to maintain or improve their quality of life in the face of uncertainty.
Moreover, gaining access to financial services is a critical step in connecting the poor to a broader economic life and in building  confidence among them to play a role in the larger community.
By increasing access to services for the poor segments of the society, the financial sector can play an important role in alleviating poverty in developing countries. To accomplish sustainable economic growth in these countries, the focus should be on the whole range of economic activities, including SMEs which are important drivers of a country's economic development. They have the ability to create goods, innovations and employment which can take the economy to a higher level. It is essential that these enterprises have access to financial services, meeting their needs with easy and favourable terms in order to continue and expand their businesses.
SMES IN BANGLADESH: Bangladesh is one of the most populated countries in the 21st century with 161 million people. Unemployment has become a serious problem like many other countries around the world. It is a common agenda of all political leaders, economists, entrepreneurs and professionals to create jobs for thousands of graduates coming every year out of the universities. SMEs can play as a catalyst in creating new jobs like other developed economies. When the GDP growth is slowed, inflation is rising and exports are weakened, these small and medium-sized units are considered as one of the significant ingredients for fostering economic development, sustainable growth and poverty reduction in a developing country like Bangladesh.
SMEs in Bangladesh account for about 45 per cent of manufacturing value added, 80 per cent of industrial employment, 90 per cent of total industrial units, and employ about 25 per cent of the total labour force. Their total contribution to export earnings varies between 75 per cent and 80 per cent. According to the ADB, there are about 6.0 million SMEs and micro enterprises in Bangladesh, which contribute around 25 per cent of the GDP. About 60 to 65 per cent of SMEs are located outside the metropolitan areas of Dhaka and Chittagong. These units have easy access to labour in the non-urban areas, where business environment is better than in congested urban centres and business costs are also low.
Unfortunately, these small industries face inadequate and inefficient infrastructure, inappropriate policies and actions of the government, lack of effective implementation of policies, inefficient development institutions, inadequate financial assistance and absence of specialised financial institutions. In addition, high interest rates charged by micro-credit institutions and commercial banks and problems concerning labour, entrepreneurship, technology and market are common barriers to development of SMEs in Bangladesh. Proper planning and implementation, policy supports, easy access to financing sources, low financing costs and infrastructure development are indispensable for bringing about a change in socio-politico-economic situation in the country. The SMEs offer great hope for overall national development of Bangladesh.
The writer a CFO of a private
group of industries  
[email protected]