CASHFLOW analysis and corporate transparency are among the key things that banks look at before giving credit to a Small and Medium Enterprise (SME).
So small firms should improve in these areas if they want to obtain bank finance more readily, says Tony Lythgoe of the International Finance Corporation (IFC) - a member of the World Bank Group.
He told BT: 'Transparency is one of the key issues often lacking in the SMEs. And corporate governance is a major issue for some bankers when it comes to SMEs.'
According to Mr Lythgoe, financial reports in a lot of regional markets do not paint a complete picture of corporate health, and annual reports are often not indicative of future performance.
'So a SME that wants to be more transparent has to think of auditing standards - not just unaudited financial statements - and develop business plans that bankers understand and can relate to,' he said. 'Because if you are looking at the financial statements and the cashflow from last year, they may not be able to demonstrate based on last year's cashflow that you can service the debt.'
Key items that SME bankers typically look for include cashflow and a strong business proposition, he said. 'They want to see not only historically that you have sufficient cashflow, but that going forward you have efficient working capital and sufficient cashflow to service the debt.'
SMEs are often poor in this regard for two reasons, he believes. 'They tend to be over-ambitious. They don't factor in some of the risks. And one thing they almost always get wrong is the timing. So the cashflow often lags six to 12 months behind projections.'
Such delays often result from bureaucracy in emerging markets, and it is critical that SMEs account for this so that the viability of their investments is not jeopardised, he said.
Beyond that, bankers also look for a sound business proposition that makes sense. Questions that need to be addressed are: Does the company have a market? Who are the competitors in that market? Is there a niche for the particular project? And is it going to generate cashflow?
'If the proposition involves trading overseas, banks will need more information on the suppliers,' Mr Lythgoe said. Companies might also wish to account for factors such as currency and country risks.
Biggest challenge
He reckons that the biggest challenge for bankers is understanding SMEs and their needs. And 'the biggest change I have seen in the last three years is those banks that take the SME sector seriously, they are doing a lot more segmentation. So they are breaking it down into small businesses, middle-market businesses and larger businesses, because the servicing requirements, types of products and delivery channels are different in each segment'.
Banks also have to factor in the life cycle of SMEs. 'Some of them are in growth mode, some of them are in start-up mode, some of them in transition from the small to medium stage,' he said. 'So there are different types of SMEs across that size spectrum, and it influences the types of products and services and funding requirements.'
A second challenge in SME banking is reducing information asymmetry in the sector. 'So the development of credit bureau services is very important,' according to Mr Lythgoe. 'For SMEs that are serious about doing business, it is important they have a credit rating, a credit file that demonstrates to others that they have successfully managed credit previously.'
Having a good credit rating also reduces the cost of borrowing and makes it easier for an SME to access funds, he said. 'One of the things IFC is doing in the region is help develop services similar to those available in Singapore in some of these emerging markets. We are currently working in Vietnam to develop a credit bureau, very much like the Credit Bureau of Singapore.'
Mr Lythgoe also touched on the current uncertain economic environment, but noted that SMEs are generally more resilient than large corporations in times of slowdown as 'typically the smaller company is more geared up to either change production or go in a different direction than larger organisations'.
Also, he believes that Asia has not been hit by the US credit crunch yet, even though SMEs here could see slower business in the next 12-18 months.
To cushion the impact of higher energy prices and business costs, Mr Lythgoe advises small companies here to boost efficiency to offset rising overheads.
Beyond that, he notes that a number of the larger SMEs have outsourced production to low-cost centres, except that there are issues with quality control in the longer term.
This article was first published in The Business Times on Jun 3, 2008
