SME SHort Notes on 'Asset based financing'

A specialized method of providing structured working capital and term loans that are secured by accounts receivable, inventory, machinery, equipment and/or real estate. This type of funding is great for startup companies, refinancing existing loans, financing growth, mergers and acquisitions, and management buy-outs (MBOs) and buy-ins (MBIs).  An example of asset-based finance would be purchase order financing; this may be attractive to a company that has stretched its credit limits with vendors and has reached its lending capacity at the bank. 

The inability to finance raw materials to fill all orders would leave a company operating under capacity. The asset-based lender finances the purchase of the raw material, and the purchase orders are then assigned to the lender. After the orders are filled, payment is made to the lender, and the lender then deducts its cost and fees and remits the balance to the company. The disadvantage of this type of financing, however, is the high interest typically charged - which can be as high as prime plus 10%. In the simplest meaning, asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a mortgage is an example of an asset-backed loan. More commonly however, the phrase is used to describe lending to business and large corporations using assets not normally used in other loans. 

Typically, these loans are tied to inventory, accounts receivable, machinery and equipment. This type of lending is usually done when the normal routes of raising funds, such as the capital markets (selling bonds to investors) or normal unsecured or mortgage secured bank lending is not possible. This is usually because the company was unable to raise capital in the normal marketplace or needs more immediate capital for project financing needs (such as inventory purchases, mergers, acquisitions and debt purchasing). It is usually accompanied by higher interest rates, and can be very lucrative for the parent company. For example, the bank Wells Fargo made more money from asset-based lending business than it did the rest of its corporate business (both lending and fee based services). Many financial services companies now use asset-based lending package of structured and leveraged financial services. Most banks, both national investment banks (Goldman Sachs, RBC) and conglomerates (i.e. Citigroup, Wells Fargo), along with regional banks, offer these services to corporate clients.

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What is the purpose of the cash flow statement?

The purpose of the cash flow statement or statement of cash flows is to provide information about a company’s gross receipts and gross payments for a specified period of time. The gross receipts and gross payments will be reported in the cash flow statement according to one of the following classifications: operating activities, investing activities, and financing activities. The net change from these three classifications should equal the change in a company’s cash and cash equivalents during the reporting period. 

For instance, the cash flow statement for the calendar year 2010 will report the causes of the change in a company’s cash and cash equivalents between its balance sheets of December 31, 2009 and December 31, 2010. In addition to the cash amounts being reported as operating, investing, and financing activities, the cash flow statement must disclose other information, including the amount of interest paid, the amount of income taxes paid, and any significant investing and financing activities which did not require the use of cash. The statement of cash flows is to be distributed along with a company’s income statement and balance sheet.

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What are the assumption of of BEP analysis?

The Break-even Analysis depends on three key assumptions:

Average per-unit sales price (per-unit revenue):
This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue $1 and enter your costs as a percent of a dollar.
Average per-unit cost:
This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of revenue or unit of service delivered, to deliver that service. 

Monthly fixed costs:
Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses). This will give you a better insight on financial realities. If averaging and estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimate—it will be a rough estimate, but it will provide a useful input for a conservative Break-even Analysis.

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Eligibility for equity support from the Equity and Entrepreneurship Fund Unit (EEF)

1.    The project will have to be a new one and belong to either of the sectors viz., software industry or food processing and agro-based industry.

2.    The sponsors/entrepreneurs applying for EEF support will have to be a private limited company registered under the Companies Act, 1994 and established old companies can also apply for EEF support by setting-up a subsidiary new private limited company. But in case of a software company registered on or after 01 January, 1997 will be treated as a new company.
3.    The total project cost ( including net working capital ) of the proposed project will have to be of minimum 0.50 (half) core for both IT and agro-based industries and that of the maximum is Taka 5.00 Crore for IT& Taka 10.00 Crore for agro –based industries . Project proposal with bank loan is not allowed for agro –based industries but allowed for IT industries.

4.    The project shall have to be viable technically & financially .It should be environment friendly. Importance shall be given on the appraisal of the entrepreneurship such as educational qualification in the relevant discipline, knowledge in the technology/ process operating such project, track records in financial conduct specially with Banks/FI. In case of ratio analysis the project has to offer minimum IRR (Internal Rate of Return) of 15%, Return on equity (ROE) of 15% Debt service coverage Ratio 1.50:1 Current ratio 1.50:1 and Fixed asset coverage ratio 1.50: 1 and SWOT analysis should have to be acceptable.4. The project shall have to be viable technically & financially .It should be environment friendly. Importance shall be given on the appraisal of the entrepreneurship such as educational qualification in the relevant discipline, knowledge in the technology/ process operating such project, track records in financial conduct specially with Banks/FI. In case of ratio analysis the project has to offer minimum IRR (Internal Rate of Return) of 15%, Return on equity (ROE) of 15% Debt service coverage Ratio 1.50:1 Current ratio 1.50:1 and Fixed asset coverage ratio 1.50: 1 and SWOT analysis should have to be acceptable.

5.    The non-resident Bangladeshis will be given preference subject to the fulfillment of the terms & conditions mentioned in the above paragraphs.

6.    Any defaulter (as defined by Bangladesh Bank) cannot apply for EEF.

7.    Where a sponsor of a project needs term-loan and /or working capital loan from any Bank/FI and also equity support form the EEF, he has to submit application to the Bank/FI concerned. The Bank/FI will have to be satisfied that the project has fulfilled all the terms and conditions required. Where the sponsors/entrepreneurs need only equity support from EEF without any bank loan a Bank/FI will be nominated as representative of EEF for appraisal of the project by Bangladesh Bank(EEF) . To nominate such Bank/FI, previous business relationship of entrepreneur with the Bank/FI will be  considered. The concerned Bank (which will also act as monitoring bank) will make thorough appraisal of the project in accordance with EEF rules and guidelines and if the bank is satisfied about the viability of the project they shall send the project proposal with specific recommendation to Bangladesh Bank. The Bank/FI may determine their project examination fee according to their existing rules. Bangladesh Bank, EEF Unit will re-examine the project appraisal and perform pre-sanction visit if necessary. Then EEF  Unit will place it with specific recommendation before the Technical Advisory Committee (TAC). TAC is a four member expert Committee under the chairmanship of the Governor of the Bangladesh Bank. This Committee is the ultimate authority to approve the projects. When a project is approved by the TAC, EEF Unit will issue a sanction letter to the concerned  entrepreneur instructing them to invest their portion of equity within a certain period of time.

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Why Bank Prefer SME Financing?

SME is becoming the driving force of the economy in our country.  Now a day’s SME is considered as the employment generating machine which is fostering economic growth and development of our country.

Ø Refinancing Facilities from Bangladesh Bank;

Ø Risk diversification to large number of borrower;

Ø Low cost of fund than other sources of fund;

Ø Flexible repayment schedule;

Ø SME financing is respectively less complicated than general  term loan.

Ø Easy to communicate with borrower;

Ø Short processing time;

Ø SME Database and Market Segmentation Reporting; and

Ø Decentralization of delegation of power.

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Discuss the existing sources & areas of SME Financing

The main sources of SME Financing are basically personal funds, family and friends, banks and NBFIs. Some refinance Schemes from different organization are also available. These are discussing below:

SME Financing by Banks & NBFI:  

An important element of SME finance is not directly provided by banks through traditional loans but rather by leasing or factoring companies. Bank loans and overdrafts are the most widespread debt financing tools for SMEs, but also those alternative sources like leasing and factoring are of high relevance. 

The EEF:  

The Government had instituted the Equity Entrepreneurship Fund (EEF) in early 2002 in an effort to make funding more widely available for agro-processing and information technology businesses in the country. 

Small Enterprise Fund (SEF): 

Small Enterprise Fund (SEF), a scheme to refinance banks and other financing institutions that lend to the SME sector create a capacity to specifically channel needed debt-finance.  Disbursements made by financial institutions and leasing companies into small-enterprises will be refinanced from the proceeds of the SEF. 

ADB Fund: 

The Small and Medium Enterprise Sector Development Program (SMESDP), which is financially assisted by The Asian Development Bank, Manila and implemented by the Ministry of Industries, Govt. of Bangladeshintroduce a fund for SME entrepreneurs by Banks & NBFI.

Other Refinance Scheme:

1. Bangladesh Bank Fund:

2. EGBMP (IDA) Fund:

3. Japan International Cooperation Agency (JICA) Fund

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SME is considered as Employment Generating Machine-Explain

SME is considered as employment Generating Machine for the following reason: 

 1.    SME sector is the largest provider of employment in most countries, especially of new jobs.

2.   SMEs tend to employ poor and low -income Workers.

3.   SMEs are sometimes the only source of employment in poor regions and rural areas.

4.   There are approximately six million SMEs in Bangladesh, which include enterprises with up to 100 workers employing a total of 31 million people – equivalent to 40 per cent of the population of Bangladesh aged 15 years and above.

5.     SME has huge Employment generation potential due to labor intensive nature of most of the SME activities. Between 1986 and 2006, the labor force grew by nearly 3 percent while employment grew by 2.6 percent. In the small enterprises, employment grew by 4.8 percent during 1978-1991 and by 5.5 percent during 1991-2001.

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