improving bso services and sme performance through cleaner production
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Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Possible funding channels for CP
CommercialBanks
Company
Shareholders(equity offering)
Partners/owners
Leasingcompanies; equipment
vendors
Government-subsidized
credit
InternationalDevelopmentAssistance
• Environmental revolving loan funds
• Development banks & credit schemes
• Ex/Im finance guarantee schemes
Internal sourcesCommercialsources
Public/ODA sources
Cashreserves
Credit cooperatives/unions
Customerfirms
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Our focus: commercial banks
Difficulties in accessing commercial credit are one of the largest challenges involved in implementing CP capital investments, particularly for SMEs.
Many development organizations engaging in SME support projects and SMEs themselves have little experience in dealing with commercial banks
!
!?
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Background: Commercial Banks
Commercial Banks:
Acquire funds by receiving money from savers: savings accounts, deposit accounts, etc.
Provide funds to borrowers through term loans, lines of credit, bonds, etc
The interest payments on loans are used to pay interest to depositors & are a primary source of profit for the bank
To be profitable/sound, commercial banks focus on: maximising their returns & minimising the risks they accept
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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their principal expertise is evaluating borrower credit-worthiness. . . not the performance of CP investments!
! Therefore:
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Commercial bank financing instruments
For SMEs, commercial banks offer two main types of financing instruments:
Term Loans
Lines of Credit
Issued for a specific project/purpose
Specific amount and term (months or years)
Interest rate will reflect risk & may be fixed over time or variable
Can usually be used for any purpose
Approved up to a credit limit. The customer can use any amount up to the limit.
Higher interest rates than term loans. Interest is charged only on credit actually used.
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Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Commercial bank loan procedures
Commercial banks’ loan procedures
have 4 basic
stages
Application
Review
Award
Paying back, with
interest
failure
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2
3
4We will examineat each stage in
more detail
applicant prepares proposal and submits to bank
Bank evaluates application and sets or negotiates conditions
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Commercial bank loan procedures
Application
a. Before applying to any particular bank, research and review potential funding sources
b. Have initial informal discussions with bank loan officer
c. Fill out bank’s loan application form; obtain all necessary data
d. Submit the loan application and supporting documents to bank.
Application1
Establishing a personal relationship with the bank/loan officer is very
important!
!
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Commercial bank loan procedures
Application review and loan award
Review
Award
2
3
ReviewNegotiate
terms*
More information requested
Commitment letter
& term sheet
Loan agreement
signed
Funds received
Agreement on terms?
YES
NO
*Terms include, e.g. interest rate,repayment period & collateral
Review and award involve the
following steps:
Ap
plic
atio
n
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Commercial bank loan procedures
What is the basis of the bank’s review?
The bank’s review of the application is focused on two distinct aspects of risk:
economic viability of the specific project
the financial/economic status of the enterprise as a whole
Often more important!
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Basis of Review #1
Economic viability of the project
How does the bank assess the economic viability of the project??NPV is the mostly commonly used overall indicator.
HOWEVER, the bank will calculate multiple values for NPV using different assumptions regarding the performance of the project
E.g. what is the effect on NPV of different sales,
savings, schedules?
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Basis of Review #2
Company financial and economic status
How does the bank assess the enterprise’s financial and economic status??The bank assesses 3 Key factors:
LIQUIDITYIs there cash on hand to pay day-to day operating expenses?
SOLVENCYDoes the company have the ability to repay outstanding long-term debt?
Prospects for future PROFITABILITYand its implications for both liquidity and solvency over the expected term of the loan.
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Barriers to Commercial Bank Finance for SMEs
Small size of SME CP Projects Means that the bank’s
administrative costs are very high compared to the profit it can make on the loan
High perceived risk of lending to SMEs Insufficient accounting and
business documentation (poor record-keeping)
Limited banking track record (no history of obtaining and successfully repaying loans)
Lack of security (collateral)
For SMEs, access to CP
finance is constrained
by:
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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It is true thatsome barriers to commercial bank loans and (other CP financing) cannot be addressed by the SME alone
!
BUT SOME BARRIERS CAN BE ADDRESSED
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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What can SMEs do to address these barriers?
Understand banks’ decision criteria and analyse CP projects in these terms
Improve record-keeping and management systems (utilize BDS services if available)
Identify banks that do have SME lending programs; request an informational interview with a loan officer before applying
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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“Friendly trends” in commercial banking
We have now discussed many barriers to financing CP projects at SMEs
HOWEVER, THERE IS GOOD NEWS.
Some current trends in commercial banking
are “friendly” to CP financing:
Increasing similarity among financial institutions
Expanded commercial bank activity in developing countries
Increasing interest in sustainable banking
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Increasing similarity among financial institutions
Traditionally, different types of FIs specialized narrowly
in their own areas.
This is still true to some extent, but
becoming less so. Many FI’s are
expanding their product-ranges into
others’ areas
for borrowers, result is a wider range of potential sources of finance
Be prepared to approach several different FIs of different types to raise finance on attractive terms
!
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Sustainable Banking
FI’s are becoming more aware of
their environmental
responsibilities in lending. This
emerging trend is focused in developing
countries
Thus, at many international banks, we see a shift. . .
Passive with respect to environmental issues.
Resist responsibility for environmental impacts of
projects they finance
Reject financing of environmentally
damaging projects.
Recognize business & social benefits of
environmental investments
From traditional passive attitudes. . .
. . .to “sustainable banking”
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Policy & development approaches to overcome finance barriers
Business development service providers can work with SMEs, particularly to improve record-
keeping FIs, to demonstrate that CP investments
pay
Special financing facilities for SMEs and for CP investments
Civil Society & business associations: Lobby Government for supportive policies
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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This presentation to be developed specifically for the host country context
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Group Exercise: Analyzing past funding experiences
You will identify one or more past funding experiences to CHARACTERIZE and ANALYZE, answering the questions on the following slides.
See exercise instructions in sourcebook
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Past funding experiences
Analyze your funding experience by addressing the following questions:
GROUP EXERCISE
? The basics:What was the project?
? The financing search:Which sources of finance were considered?Which sources were then approached?
? The application:What information was required to make the application?Could you provide this information?
AND
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Past funding experiencesGROUP
EXERCISE
? The review:What were the funder’s criteria for approving or rejecting the application? Were these clear? Did any problems arise during the review process?
? The outcome; terms and conditions:Was financing obtained?What were key terms and conditions?
! Lessons learned:What do you think is the reason for your success/failure? What did you do right? What would you do differently? What advice can you offer from this experience?Do you still have unanswered questions from this experience?
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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GROUP PRESENTATIONS.
Past funding experiencesGROUP
EXERCISE
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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Some lessons learned by participants in past courses
PROBLEM Solutions that worked
! Project profitability is poor
Re-evaluate profitability using total cost principles
! management is unable or unwilling to issue more shares or to raise debt
Lease capital equipment rather than purchase it.
! the firm does not have contacts with commercial banks
Make contacts through the chamber of commerce, BDS provider, accounting firm
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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General Advice
Some lessons learned by participants in past courses
Rejection from one FI indicates little. Search widely for alternative sources of finance. The larger the number of possibilities you consider, the more likely you are to obtain financing... and on better terms
If you are rejected, apply again when the national economic situation improves/ credit is loosened.
Seek advice from experts and from contacts in other firms
Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org.
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? Do we agree with these lessons learned?
What lessons learned can we add??Are these lessons fully relevant to CP financing??
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