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Sanderson Abel
Evidence from across the globe acknowledge that SMEs play a significant role in economic development.

Examples include: SMEs in the People’s Republic of China and India accounted for more than 40 percent of total export values, followed by 26 percent in Thailand, 19 percent in the Republic of Korea, and 16 percent in Indonesia.

In Africa, Tanzania is one country that has successfully supported SME development. The nation has identified the capabilities of its citizens and promoted and facilitated the economic activities. As a result the nation is successfully run by SMEs. This has had the effect of improving the standard of living and income distribution in Tanzania.

The financial services sector and other stakeholders should embrace new innovations so that new economic structures where SMEs are the new engine for growth are adequately funded through innovative financing mechanisms, products and systems. Adequate policy attention should go to the development of hybrid tools and equity instruments to strengthen SMEs’ capital structure and boost investment in innovative start-ups and high-growth SMEs. Diversification away from reliance on bank funding is desirable, it is important that policy makers mitigate the risk that firms are merely turning to other under-developed and costly forms of financing due to an inability to access bank credit.

Financing SMEs requires stakeholders to be innovative in the sourcing of finances. Innovative financing should ensure the availability of stable financing. These financing resources must be predictable over the time frame required by the sector players so as to make planning possible. The potential sources of financing should include; internal funds or retained earnings, borrowing from commercial banks, loans from family and friends, money lenders or other informal sources, trade credit from suppliers, pre-funding from customers, leasing arrangements, finance from non-bank financial institutions and venture capital financing, among others.

What does innovative

financing entail?

Successful and sustainable innovative financing mechanisms require that the SMEs should be well organised because resources have a tendency to follow order and formal structures. Tobacco farming sector in Zimbabwe is a good example where stop order system has positively impacted the subsector in terms of increased funding opportunities.

With properly organised structures, the players in the SMEs sector are also able to borrow as a group rather than as individuals by using accumulated resources in savings as collateral. Under this arrangement, the resources of the group can act as the guarantor of the members.

Properly organised SMEs should also be able to utilise the advantage of strength of numbers and use that collective ability to develop bankable proposals which should be used to attract debt finance. Under this arrangement, the SMEs sector is able to approach institutional investors such as insurance and pension funds as venture partners. This organised framework would assist potential institutional investors or funders to view the organisation as a single entity rather than as various fragmented institutions.

SMEs should also think around using the value chain finance mechanism which involves the flow of funds to and among the various stakeholders within a value chain. The value chain actors for those providing support services include input suppliers, producers, intermediaries and retailers. The model can be implemented through backward linkages with suppliers which refers to the extent to which components; materials, and services are sourced from SMEs, since this can create new market opportunities for local SMEs

SMEs should also look at further diversifying their funding sources by pursuing external financing inclusive of equity or bond markets. The only discouraging factor is the current operating environment which is unattractive. In many countries equity trading platforms are better developed than bond markets. In general, specific trading platforms for SME stocks usually target medium-sized firms but not micro firms, due to minimum size requirements. These trading platforms have a greater growth potential in countries where the financial market infrastructure is better developed and the proportion of medium-sized enterprises is higher. There is need for the Government and the ZSE to fast track the setting up of the alternative stock exchange for the small to medium enterprises.

What are the alternative

funding mechanisms?

Lease financing is one sources of medium and long-term financing which can be used by SMEs where the owner of an asset gives another person, the right to use that asset against periodical payments which are usually made through the bank. The owner of the asset is known as lessor and the user is called lessee. Under lease financing, lessee is given the right to use the asset but the ownership lies with the lessor and at the end of the lease contract, the asset is returned to the lessor or an option is given to the lessee either to purchase the asset or to renew the lease agreement.

Purchase order financing is a short-term commercial finance option that provides capital to pay suppliers upfront for verified purchase orders. Businesses avoid depleting cash reserves or declining an order because of cash flow challenges. It allows companies to accept unusually large orders and adjust the loan basis up/down quickly to meet needs. If order volume drops, there’s no long-term commitment so they can stop using it at any time.

Invoice discounting is a form of short-term borrowing often used to improve a company’s working capital. Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid.

To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral.

Factoring is a financial transaction whereby a business sells its invoices to a third party (called a factor) at a discount. Factoring and invoice discounting are two services that finance providers traditionally supply.

Success factors for financing SMEs

There are a number of initiatives that can ensure sustainable financing of the SMEs. Most of the initiatives below are meant to incentivise banking institutions to provide sustainable financing. The Government should therefore:

Implement with support of all stakeholders public policies aimed at championing SMEs’ financial literacy and awareness. These initiatives will enhance the understanding of the broad range of available financial instruments and changes in legislation and programmes.

Promote financial inclusion for SMEs and ease access to formal financial services, including informal firms. In this regard, policy should aim to maximise the number of SMEs which have access to and use mainstream financial services and products.

Develop frameworks that encourage area and cluster financing. A cluster is a geographic concentration of companies and institutions in a particular industry, sector or region. A cluster results in interconnectedness and interdependence of firms and therefore enables each member to enjoy external economies of scale.

 Sanderson Abel is an economist. He writes in his capacity as senior economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on [email protected] or on numbers 04-744686 and 0772463008.