Most governments around the world have identified small businesses as a major catalyst for economic growth. However, small businesses cannot achieve this without some form of financial assistance.
Central Bank of Nigeria (CBN), in response has put forward several schemes that it hoped will help improve the ability of small businesses to access loans. Despite these lofty efforts small businesses can’t still access loans and with about 90% of all small business loan applications out-rightly thrown out or rejected at some stage of the application. Nairametrics spoke to some credit analysts and small businesses to understand some of the challenges impacting on the ability of small businesses to access loans.
These are some of the findings:
Lack of Business Plan
Business plans are typically the first piece of information banks want to see before considering a request for a loan. A Relationship Manager of a top Nigerian bank informed Nairametrics that even when business plans are received it often fails to clearly show how the business will generate the cash flow required to repay the loans. Rather than focus on cash flows, entrepreneurs focus more on the idea and execution. Business owners should have multiple business plans that cater to different types of financiers. A business plan might have information that is suitable for an equity investor but lack the details lenders want to see. Lenders are more risk averse unlike equity investors who are not afraid of taking risk. A business plan should thus be able to show lenders what the risks are and how the company aims to mitigate it. A good business plan a credit analyst reveals should also show what the competition is if any and how much of the market share you own. Business plans that fails to show a ready market for a product or service is more likely to fail credit risk assessment for most banks. It is more likely that a bank will give you a loan when you show them confirmed orders for your product.
Poor accounting records
Banks also complain that most small businesses seeking funding from them fail to keep a simple book of accounts. Most are so poorly run that they do not even have Balance Sheet that shows how their assets and liabilities are classified. Those who even provide accounting records do not have it properly audited suggesting that it was quickly put together perhaps for tax reasons. For businesses to be loan worthy, they should at least keep 3 years of audited financial statements that shows balance sheets, profit and loss accounts as well as cash flow statements.
Mixing personal and business cash
Small Business owners also make the fundamental mistake of not separating their personal cash and expenses from that of the business. Financial advisers cite this as the fundamental reason for keeping poor accounting records. This also leads to poor corporate governance and risk of misappropriation of cash belonging to the business. When banks see this they don’t even bother to consider the application let alone lend.
Banks also complain that most small business that even provide good business plans and sound financial statements often lack assets that can be used as a collateral for loans. Some of the assets that they provide can’t be verified, valued independently or recoverable. The Central Bank has been working on an asset registry for years now which they hope will help solve some of the issues banks and small businesses have with collateral. Till then, small businesses may have to over time, set money aside either as cash collateral or use them to acquire assets that they can use in future as collateral.
Knowing the right people
In Nigeria, having “connection” involves knowing influential people who can help you obtain loans faster and possibly at better rates. Successful small businesses inform Nairametrics that having an influential person on their board as a director helped shorten the entire loan application process by about 50%. It can even rise to 70% if your board member is also on the board of the commercial bank or microfinance banks that you have applied to. Banks value personality and integrity believing that an influential board members can use their experience to guide management of small businesses.
Poor Debt Service Coverage Ratio
A lot of businesses confuse income and cash. For banks, cash is the live wire of a business and they will want to be sure that the ratio between income and cash is as close to 1 as possible. A lot of businesses sell products and record income but have no cash to back it up due to huge trade debtors. Banks can detect this ratio by comparing the cash turnover in your bank statement to the turnover in your financial statements. This is why most banks come up with a debt service coverage ratio (DSCR) which is the ratio of cash your business can generate historically to debt repayment and interest payments. The higher your historical DSCR the easier it is to convince the bank that you can repay the loans as agreed. Nigerian banks often like to a see a DSCR of 2x. In fact, getting a loan on a DSCR of 1x or less is often indicative of a business that had no plans of repaying loans.
A small business owner informs Nairametrics that he was unable to get a loan from any bank after he defaulted from a previous loan. According to him, he had obtained a short-term loan and used it to finance a local purchase order from a government agency. Unfortunately for him, they refused to pay after a new director general assumed office. Banks these days exchange credit history with a registered credit bureau of their choice. Unbeknownst to some small businesses, banks have a credit bureau that tracks, stores and shares credit ratings of borrowers. That way a customer who defaults with Bank A cannot escape a review by Bank B. Sometimes small businesses end up getting black listed.
Credit analysts surveyed also complain about ventures that are not bankable. They argue that while some business ideas may sound good on paper, using bank loans to finance them creates more harm than good. Business owners need to recognize this when seeking funding. For example, a business requiring equity style funding either via a venture capitalist or angel investor cannot be seeking for funding from a bank. Business managers should only seek bank funding when their business is already generating positive cash flows and seeking to scale up. One analyst explains positive cash flow as cash generated from sales that is at least twice the company’s expenses. For such companies rather than sacrifice operating expenses that can drive a company to bankruptcy, they only sacrifice dividend payment by substituting it for loan repayments.
Some businesses surprisingly do not take image building very seriously. You ask a bank for a N20m loan, yet your office is a two room cubicle with little or no product on display. First impression last long and banks themselves need to be convinced not just by the business plan and numbers, they also want to see that you have what it takes to utilize the money. Like one credit analyst explained, you can’t be going to a bank for a loan driving a rickety car. Image is everything in the world of finance.