Financing Small and Medium Enterprises

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Name: Neal Date: 11 Oct, 2010

Financing Small and Medium Enterprises


Cash is like the blood in human body for all companies. So, the problem of financing is one of the most important issues in company operations. Appropriate and healthy sources of capital is the primary issue for an enterprise, especially for the SMEs. As policy, the reasons for their ideas, and SMEs’ own flaw, so that the financing channels for SMEs is relatively narrow, a shortage of funds has become a major bottleneck for the development of SMEs. This paper is trying to explore into the financing problems that SMEs face and provide some feasible sources of finance which can ease the cash flow pressures for SMEs.

SME’s can be defined as having three main characteristics:

• Companies are not quoted on a stock exchange – they are “unquoted”

• Ownership of the business is typically restricted to a few individuals. Often this is a family connection between the shareholders

• Many SME’s are the means by which individuals (or small groups) effectively achieve self-employment

When an SME is not growing significantly, financing may not be a major problem. However, the financing problem becomes very important when a company is growing rapidly, for example when contemplating investment in capital equipment or an acquisition.

Few growing companies are able to finance their expansion plans from cash flow alone. They will therefore need to consider raising finance from other external sources. In addition, managers who are looking to buy-in to a business or buy-out a business from its owners, may not have the resources to acquire the company. They will need to raise finance to achieve their objectives.

Sources of finance for SME’s

There are a number of potential sources of finance to meet the needs of small and growing businesses:

• Existing shareholders and directors funds (“owner financing”)

• Overdraft financing
• Trade credit
• Equity finance
• Factoring and invoice discounting
• Hire purchase and leasing
• Merchant banks (medium to longer term loans)

Overdraft financing is provided when businesses make payments from their business current account exceeding the available cash balance. An overdraft facility enables businesses to obtain short-term funding - although in theory the amount loaned is repayable on demand by the bank.

There are several important factors to consider when assessing the appropriateness of an overdraft as a source of funding for SME's:

- The amount borrowed should not exceed the agreed limit ("facility"). The amount of the facility made available is a matter for negotiation with the bank;

- Interest is charged on the amount overdrawn - at a rate that is above the Bank Base Rate. The bank may also charge an overdraft facility fee;

- Overdrafts are generally meant to cover short-term financing requirements - they are not generally meant to provide a permanent source of finance

- Depending on the size of the overdraft facility, the bank may require the SME to provide some security - for example by securing the overdraft against tangible fixed assets, or against personal guarantees provided by the directors

The amount of an overdraft at any one time will depend on the cash flows of the business, the timing of receipts and payments, seasonal trends in the sales and so on.

For the past few years, apart from traditional financing as said above, a new form of financing was known as Trade financing. It’s a popular method in order to solve the cash flow in the international trade. The trend is reflected partly in the growth in factoring volume. Trade finance gives you access to additional working capital and can help your business grow by funding the gap between the purchase and sale of a product or service. Trade finance terms are usually flexible and cost- effective, complementing existing banking relationships.

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