Redefining small and medium enterprises

The Bangladesh economy has undoubtedly passed through a considerable transformation over the last few decades from an agricultural base to an industrial thrust. Now the economy needs to intensify its industry-based activities. In order to achieve Vision 2021, we also need to shift to a knowledge-based economy.  
Small and medium-sized enterprises (SMEs) are called the engine of an economy. These provide jobs, create entrepreneurial spirit and innovation and are thus crucial for fostering competitiveness. However, these enterprises are often confronted with market imperfections.
SMEs frequently have difficulties in obtaining capital or credit, particularly in the early start-up phase. Their restricted resources may also reduce their access to new technologies or innovation. Therefore, support for SMEs is one of the country's priorities for economic growth, job creation and economic and social cohesion. The Bangladesh Bank (BB) plays dual role i.e regulatory and development, in promoting the SMEs in Bangladesh.
Most academicians and economic policy-makers claim SMEs as the backbone and at the same time we often see statement that 'there appears to be no universally accepted definition of SMEs'. Both these claims are true. At one level, the issue of SME definition comes down to eligibility for special support. National governments, multilateral and bilateral development institutions, and NGOs support SME development with a varied menu of interventions, including pumping billions of dollars in special credit lines and loan guarantees, firm level business development services and technical assistance, and fiscal incentives.
The presumed intention of the SME policy in Bangladesh is to provide this assistance to enterprises that need them most and are able to use assistance in order to help grow further under adverse conditions for the good of our economy. Most of the large companies in Bangladesh as well as global institutions like Microsoft, Apple, Ford Motor Company and Federal Express began in a small way. Therefore, definition of SME is a very vital policy issue for the economy.
CURRENT DEFINITION: The government agencies such as the Bangladesh Bureau of Statistics (BBS), the Ministry of Industries and the Bangladesh Bank provided varying definitions of large, medium, small, micro and cottage industries in the past. Past industrial policies from 1973 to 2005, the Industrial Policy 2010, the SME Policy Strategy 2005 and the Bangladesh Bank SME Credit Policies and Programmes 2010 are sources of such definitions.
However, SME definition formulated by the Ministry of Industry vide its Industrial Policy 2010 is now being followed by all concerned because of its legal status. The BB on the basis of the Industrial Policy 2010 circulated SME definition for compliance of all banks, FIs and their SME clients. All cottage, micro, small and medium enterprises, falling under manufacturing, service and trade under a circular on SME definition will come under purview of SME financing. The definitions of SME vide BB circular no. 01/2011 dated June 19, 2011 is as follows:
The new circular gives emphasis on the following:
* Cottage and micro enterprises have been brought under purview of banks and FIs' financing along with small and medium enterprises.
n As success of manufacturing depends on trading of products, trade has been included in the definition of SME issued by the BB.
Generally, there is no accepted worldwide definition of SMEs. However, in Bangladesh the above definition is used which is mainly based on head count or value of fixed asset excluding land and factory building. There are two parts of the above definition. One is measurement indicators like value of fixed assets or number of persons employed and the other is threshold level of each indicator like 100-250 persons.
LIMITATIONS: When we talk about definition, it seems meaningful if we could define SMEs by their functional and behavioural attributes. Given the impracticability of quantifying such attributes for a large number of companies or firms, reasonable proxy measurements used worldwide are as follows: employees (head count), assets (size) and turnover (size).
First of all, the very important indicator turnover is missing. Why turnover is important is discussed in the later part of the write-up. Secondly, it is not clear which indicator or threshold is compulsory. Thirdly, it is to be found whether both indicators are qualifying indicators.  Fourthly, there is no linkage with loan limit. Fifthly, what's about group or linked enterprises? Sixthly, what will happen if SME Unit goes above a particular threshold for a point of time and revert back say for example by next 13 months? In that case, will it lose its SME status between the periods?
THREE MEASUREMENT INDICATORS: Defining SMEs by the number of employees suggests, may be incorrectly that the larger an enterprise is, the more employees it will have, and that to grow, it must take on more employees. This latter notion would certainly not be welcome by many analysts worldwide.
Many publications argue that cross-country studies and multi-country policies that use numbers of employees to define SMEs run the risk of classifying businesses by their inefficiency or their lack of value addition. Despite almost all the definitions used worldwide number of employment is used as a measurement indicator for defining SMEs. However, definition of employed persons needs to be clarified such as officers, full time labourers, part-time labourers, 'consultants' or 'students'.
Despite few deficiencies of the method, the asset criterion for defining business size is also used worldwide. But the threshold level varies from country to country. The deficiencies of this method are the following:
* SMEs rarely have a precise estimate of the value of their fixed assets
* Where there is inflation, local currency values for various fixed assets are likely to be understating the 'true value' of the assets, as a regular restatement of such assets is generally not required.
* The asset base of an increasing share of growth-oriented companies will be defined by rapidly depreciating assets. In these situations, the value of fixed assets can decline even as revenues and employment increase.
* Just as employment-based definitions tend not to recognise labour efficiency, asset-based definitions tend not to recognise capital efficiency.
If you ask any entrepreneur (assuming you are not a tax inspector) how big his or her business is, the response is not likely to be, "I'm having 100 employees now," or "My asset value is up to 3 million." Rather, you are more likely hear, "We had 30 million in sales last year."
If you are trying to sell a business that has recently graduated from SME to large size, you will surely not promote it on the basis of how many people it employs. Rather, as investment professionals who have actually sold such businesses will tell you, you will pitch it first on the basis of its growth in sales and market share, and only later, in more detailed negotiations, will the focus turn to multiples and net asset values.
In Bangladesh, where employment figures and profits are often seriously blurred by tax considerations, one might say that sales are the measure of all things. A definition based on turnover would seem to be both realistically measurable and meaningful.
Of the three conventional tools, measurement of business size by turnover also most closely reflects functional and behavioural attributes. If we measure something which does not reflect the typical SME, we should not be surprised if what we find as a result of analysis does not have relevance for the typical SME either. Turnover information may not always be accurate, but the magnitude of turnover is generally either available or relatively easy to extrapolate. And as we have seen, gaining information as to employment or assets is fraught with many problems.
PROPOSED DEFINITION: The European Commission has adopted the following new SME definition. It says, 'The category of micro, small and medium-sized enterprises (SMEs) is made up of enterprises which employ fewer than 250 persons and which have an annual turnover not exceeding 50 million euro, and/or an annual balance sheet total not exceeding 43 million euro." The new SME definition, which entered into force on 1 January 2005, represents a major step towards an improved business environment for SMEs and aims at promoting entrepreneurship, investment and growth.
Based on pros and cons as elaborated, it is proposed that our policymakers revisit the definition of SME according to the following three criteria: employee (staff headcount), annual turnover (size) and fixed asset (size).
Major Challenges:
* Determining turnover threshold: Once we agree to incorporate turnover in our SME definition, then the major challenge would be to determine the threshold level for each category of SME. Tom Gibson and H J van der Vaart propose a formula for defining SME in terms of annual turnover: 'An SME is a formal enterprise with annual turnover, in U.S. dollar terms, of between 10 and 1000 times the mean per capita gross national income, at purchasing power parity, of the country in which it operates." It is a matter of discussion; however, it captures the relative measures of the economy.  
* Exceeding threshold on a point of time: What happens if SME Unit goes above a particular threshold? Through a clear policy we may resolve the issue. For example, if SME exceeds the headcount or financial ceiling during the course of the reference year, this will not immediately affect the situation. SME Unit will retain the SME status with which it began the year. However, it will lose the status if it exceeds the ceiling over two consecutive accounting periods. Conversely, it will gain SME status if it were previously a big enterprise, but then fall below the ceilings for two consecutive accounting periods.
* Group or linked enterprises: We need to define autonomous enterprise, partner enterprise, linked enterprise and group enterprise.  Say for example, enterprise A is linked to enterprise B through the holding of 60 per cent but B also has two partners, enterprises C and D, which own respectively 32 per cent and 25 per cent of B.  After defining enterprises, an appropriate calculation mechanism needs to be developed to determine the size of each enterprise. If an individual proprietor has 5 separate concerns and among which 2 concerns fall under SME and remaining 3 fall under corporate, in such case what is the status of proprietor?
Objectives of Proposed Changes:
* To ensure that only those enterprises which genuinely fall under the category get the benefit of SME status
* To track the migration of one segment to another with respect to economic activity and GDP contribution
* To promote real SMEs
* To take account of different relationships between enterprises
* To include real SMEs into various public schemes and regulations i.e risk weight, rating scale, notch and methodologies are different for SMEs compared to corporate.
* To establish a clear picture of an enterprise's economic situation and to exclude those that are not genuine SMEs
* To make it easy for the stakeholders to identify SMEs
The writer is Senior Vice President & Chief Rating Officer, Credit Rating Agency of Bangladesh Limited.                The views expressed are                    solely the writer's own. [email protected]