SME Finance

Sabine Spohn , Asian Development Bank/PSDI Pacific Microfinance Week, Nadi, Fiji, 21-25 October 2013

Agenda
1. 2. 3. 4. What is SME Finance? How should we do it? Excursion: Collateral SE Loan Products
a. b. c. Marketing Applicant Screening Credit Appraisal

What is SME finance? How should we do it?

There is no typical SME...

Source: IPC GmbH

The SME Finance 'Gap'

Banks
Corporates

SME Finance Gap

Large Enterprises Medium Enterprises Small Enterprises

MFIs

Micro-Enterprises

Three approaches to fill the SME Finance Gap

Bank
Upscaling Downscaling

Investors
Greenfielding

MFI

MFIs usually work their way up the ladder, starting with Small Enterprise (SE) finance
Family-owned and managed enterprises More or less formal, but poor financial records Private and business affairs not clearly separated Labor-intensive, low productivity Lack management and financial skills Many non-financial challenges: power supply, taxation, corruption, red tape, transport, staff skills, succession...

One third of start-ups fail within three years!

Good reasons for MFIs to get into SE finance

Grow with your clients (client graduation) Virgin market Larger loans, reasonable profit margins Diversification of the loan portfolio Good for reputation Availability of external support (cheap funding, credit guarantee scheme, TA, etc.)

However, there are also drawbacks...

Up-front expenses
market research, product development, MIS, HRD, etc.

Higher operational expenses per client

more time used for loan appraisal and client monitoring

Liquidity constraints
longer loan durations, larger loan amounts, grace periods

Higher risks
limited collateral/enforcement options, lack of audited financial records, concentration risk, loan loss provisions, lack of credit bureau information

Various approaches in SE lending

Group approach (suits group-based MFIs) Individual approach (suits clients better) Relationship lending (costly but effective) Credit scoring (for advanced lenders)

Collateral based lending (sometimes challenging in developing countries)

Excursion: collateral

Using Movable Collateral

Works in all industries and with many types of movable property:
Agriculture: livestock/crops as collateral for seeds or a tractor loan Manufacturing: tools, existing equipment as collateral for new equipment purchases Grocery store: the inventory on the shelves as collateral for a loan Wholesalers: accounts receivable as collateral for a loan

ADBs Support to lenders

Provide an easier way to use movable property as collateral for loans How the reform process works?
Legislative changes that provide for an efficient framework Implementation of on-line collateral registry to assist lenders in evaluating borrowers 100% predictable results in the case of default

Sample Client Registry Page: Tonga

How the reform really works

Business case example: restaurant expansion
Owner needs a loan, visits lender Lender willing give $$$, but demands collateral Restaurant
No land ownership Does own kitchen equipment, chairs, etc.

Restaurant owner can pledge movable assets as collateral and keep those assets working while paying off loan Lender registers security interest (collateral) online If owner fails to pay loan, lender can seize the collateral and sell it to pay off the loan

SE loan products

Typical products in SME Banking

PURPOSE
Cashflow Management

PRODUCT
Working Capital Loan, Money Transfer Services, Check Account, Overdraft/ Credit Line, Credit card, Trade Finance, Factoring, Savings Account Savings Account, Insurances, Guarantees/ Letter of Credit, Term Loans, Leasing, Term Deposits Investment Advice and Investment Products Short and long term Deposit Accounts, Insurance, Credit Card, Housing Loan

Business Protection & Expansion

Profit Enhancement Private Life

Example: Working Capital Loan for Trade and Service Businesses

Product Flyer
We help you to manage your business cashflow Loan repayment schedule that fits your cashflow Multi-purpose: buy stock, buy or repair equipment, vehicle or building We accept movable assets as collateral Bronze, Silver and Gold Membership Card Max. loan sizes and duration: 5,000 USD / 1 Year; 10,000 USD / 2 years; 30,000 USD / 3 years Interest rate: 15-20% p.a. (on actual loan balance) Loan decision within 5 working days

Direct Product Marketing

Existing Clients Recommended Clients Mobile Marketing Unit Marketing Events
(fairs, exhibitions)

Visit Potential New Clients

Product Presentations
(e.g. for business associations)

Target desired market segment

Fictional Case:
Applicant runs a Fast Food Restaurant (VFC)

Loan amount request: 5000 USD

Loan purpose: stock purchase

Loan Application
Eligibility Criteria (esp. financial track record and business experience) Loan request reasonable? (purpose, amount, duration, own contribution) Income sources for loan repayment (business and household) Acid Test: 50% of average monthly net cashflow to cover loan repayment

Screen out hopeless cases

Criteria
Does the applicant have a good financial track record? Does the applicant have good business experience? Is the loan request reasonable? Household income sources

SCORE CARD
Yes (regular savings and loans) = 10 Yes (regular savings only) = 7 Irregular savings but no loan repayment problems = 5 Loan repayment problems in the past = 0 More than 5 years without business problems = 10 More than 5 years but minor business problems = 8 3-5 years without problems = 5 Less than 3 years = 0 Yes = 10 Minor inconsistencies = 8 Several inconsistencies = 5 No own contribution to investment = 0 More than 3 sources = 10 3 sources = 8 2 sources = 5 Only from business = 0

RESULT

10 10

8 5

Acid test

Positive = 10 Negative = 0

10

Application Scoring Results for VFC

RESULT RESPONSE
50-40 POINTS Continue with loan application processing 39 - 20 POINTS Discuss with Senior LO whether to continue BELOW 20 POINTS Inform client that he/she is not eligible for a loan at this stage.

43 POINTS

The 5 C's of the Credit Appraisal

Character - stable and honest Capacity to repay the loan Capital sufficient to carry debt Collateral suitable as security Conditions favorable for the business

The Credit Appraisal consists of...

Site visits to collect and cross-check information Character Assessment Business Assessment Financial Assessment

Character Assessment
Reputation Family problems Honesty Loan defaults Savings pattern Conclusion:
Is the client likely to default on the loan due to character weaknesses or due to problems in his/her private life

Business Assessment
Business infrastructure Technologies used and Skills of workers Operational Management Financial Management Dependency on suppliers / buyers Competition Market outlook (demand, prices) Customer feedback

Financial Assessment

Balance Income Cashflow Sheet Statement Statement

Balance Sheet of VFC

ASSETS Current Assets: Cash on hand Bank account Savings account Receivables Stock Fixed Assets: Home Business building Furniture Kitchen Mini-Van USD LIABILITIES+EQUITY 100 250 5,500 0 1,000 45,000 100,000 10,000 20,000 5,000 Current Liabilities: Payables (suppliers) Loans Others USD 6,200 0 0

Long-term Liabilities: Loans Others

0 0

Equity

180,650

TOTAL

186,850

TOTAL

186,850

Balance Sheet Analysis

Collateral value = 35,000 USD in movable assets

Debt-to-Equity Ratio = 3% (before loan), 6% (after loan) and 17% (after loan and without immovable fixed assets) >> capital base of the business is strong Current assets/ Current liabilities = 110% >> Liqudity situation of the business is quite weak; standing with suppliers should be checked

Income Statement
Year 2012 Sales Cost of Goods Sold (COGS) Gross Profit Operating expense (staff, utilities...) EBITDA Interest USD 150,000 (50,000) 100,000 (60,000) 40,000 0

Depreciation / Amortiziation
Taxes NET INCOME

(15,000)
(5,000) 20,000

Income Statement Analysis

Sales growth >> market position Sales per Staff >> productivity Profit margin
= (Net income before taxes) / Sales = 17% compare this ratio to other fast food restaurants to assess profitability

Sensitivity to dropping sales and price changes

simulate different scenarios, e.g., 10% sales decrease results in Net Income before tax of 10,000 USD (can the family live on that?)

Cash Flow Statement (projection based on past performance)

Jan Cash Inflow Business Cash Outflow Business Cash Inflow Household Cash Outflow Household 12,000 -16,000 2,000 -1,000 Feb 12,500 -10,000 2,000 -1000 Mar 13,000 -13,000 2,000 -1000 Apr 12,000 -10,000 2,000 -1000

Cash Inflow Financing

Cash Outflow Financing NET CF Accumulated

10,000 (loan + own c.)

-6,200 (supplier) 800 800

0
-1,900 (loan) 1,600 2,400

0
-1,900 (loan) -900 1,500

0
-1,900 (loan) 1,100 2,600

Cashflow Statement Analysis

Adjustment of loan instalments to the actual repayment capacity in each month Savings potential (acccumulated net cash flow) can be used as risk buffer for unforeseen events Sensitivity to dropping sales and price changes for each month (scenario simulation)

Cross-Checks (examples)
BALANCE SHEET Assets: Cash & Bank Accounts Assets; Equity Receivables; Payables Inventory Turnover Net Income Sales; Purchases Sales Cash In; Cash Out INCOME STATEMENT CASHFLOW STATEMENT Net Cashflow

How to avoid typical pitfalls in Credit Analysis

Clients can paint a rosy picture of their businesses. If business ratios are much better than industry averages, re-check the data. Look at long-term trends in the business rather than short term results (e.g., growth of assets and equity) Conduct sensitivity analysis to assess the impact of changes in prices and sales Cashflow often paints a more realistic picture than the Income Statement Don't forget to include irregular cash flows (maintenance, replacements, private expenses, additional incomes)

Good loan officers also offer financial advice to their clients...

Separate household and business finances Save up for emergencies and lump sum payments, such as taxes and major purchases

Pay a salary to yourself and to all household members working in the business

Maintain a cashbook and follow up on accounts payable and receivable

THANK
Thank you for your participation...

Thanks for your participation.... Questions?

More information contact :

Sabine Spohn, Pacific Liaison and Coordination Office www.adb.org/plco sspohn@adb.org