FINANCING AGRI-BUSINESSES

 

Basic tip to secure business finance.

#Planning; a business plan is one of the basic necessity to secure business finance. A detailed business plan containing a cash budget translates operating plans into shillings. Cash budget enables the entrepreneur to estimate their financial needs and guides the lender to decide on whether to finance the business. Cash budget enables the banker to obtain answer to crucial questions such as; How much money? How will you spend/utilize the money? How soon will you pay back?

According to research poor management is cited as the main reason why most business fail as well as inadequate financing a close second in Uganda. Whether starting/ expanding a business adequate investment capital is essential.

Types of financing.

There are two types of financing;

1. Equity financing 

2. Debt financing, when looking for finance, the business "debt to equity ratio" - the relation between the amount of money borrowed and that invested by the owner is highly considered. The more money invested by the owner the easier it is to attract financing.

Equity financing 

Involves giving up a portion of the ownership of your business in exchange for money received from equity investors. An investor becomes a joint partner, if the business fail the entrepreneur is generally not obligated to pay back on the other hand, the equity investor shares financial success with financial gains exceeding the original investment.

Advantages of equity financing.

1. Ready available in large amounts than debt financing.

2. Entrepreneur doesn't have to pay back the investor Incase of business failure.

3. Investor can provide expertise and key contacts.

Disadvantages of equity financing 

1. Investor may demand a say in running the business.

2. Requires additional time to manage investors expectations.

3. Entrepreneur gives up sole ownership of the business and it's profits.

Sources of equity financing.

Venture capitalists, friends, relatives, employees, non-professional investors.

Debt financing

Debt financing is money that the entrepreneur will pay back usually with interest over a set period in accordance with specific terms.

Advantages of debt financing 

1. Easier to get than equity financing.

2. Wide range of options available in line banks, credit, family, government financing programs, friends.

3. Allow the entrepreneur to retain control of business.

Disadvantages of debt financing.

1. Collateral in most cases is needed. 

2. Amount borrowed is usually limited.

3. Incase of business failure, the entrepreneur still may have to pay back in accordance to set terms.

Sources of debt financing 

Government financing programs, banks, savings, loans, commercial financial companies. 

Family members, friends and former associates are potential source especially when the capital required is small.

MSMEs financing issues in Uganda.

Micro, Small and Medium Enterprises have been under serviced by banks and other financial institutions, attributed by a number of factors, including;

1. High lending rates.

2. Existence of alternative risk-free investment opportunities for banks such as Treasury bill at the Bank of Uganda.

3. Extremely strict approach that the bank use to scrutinize project proposal and customers before granting them loans.

4. High costs associated with lending MSMEs.

Reasons why banks may fail to lend MSMEs.

Uganda Micro, small and medium enterprises (MSMEs) have the potential to grow and compete in the global economy with banks playing the most important role.  Instead of MSMEs relying on banks they tend to rely on informal financial sources. This is because banks prefer selected customers such as government, large enterprises thus crowding out MSMEs.

From a commercial banks' point of view lending to MSMEs involves high transaction costs due to;

1. Cumbersome administrative procedures.

2. Small amounts which require large amounts of time/efforts.

3. Lack of understanding of MSMEs needs.

4. Unrealistic MSMEs business plan.

5. Poor financial information, worsened by unrealistic accounting.

Lack of credible financial information increases transaction cost of banks/ even worse hence making it impossible to evaluate the chances of getting their money back. It is commonly stated by bankers that most MSMEs even in the formal economy do only tax accounting and usually under- declare sales/ profits.

Problem faced by credit institutions in offering financial services to MSMEs 

1. Weak inter-bank collaboration.

2. Banks' inadequate capacity to appraise the creditworthiness of MSMEs.

3. Lack of established information network to track defaulters such as credit reference bureau.

4. Banks risk-averse behaviors; preferences for investing in Treasury bills.

5. Limited range of financial instruments and many lending conditions.

6. Limited branch network.

Problem faced by MSMEs in accessing financial services from credit institutions.

1. Lack of collateral required by banks

2. Low level of technical and management skills.

3. Low rates of return on capital.

4. Inadequate compiled financial records and accounts, especially audited accounts.

5. Limited knowledge of financial and business opportunities.

6. Risky business activities such as agriculture.

7. Lack professionalism.

8. Lack of market outlet due to poor quality and non standard products.

9. Poor linkages with large-scale enterprise.

Solutions for banks to improve lending?

1. Understand the dynamics of MSMEs.

2. Design new approaches for reaching out to MSMEs.

3. Design appropriate product packages for MSMEs.

4. Provide appropriate training to their staff to respond to MSMEs needs.

5. Explore the possibility of formal linkages with micro-financing institutions and mobile networks and use them to increase the outreach.

Solutions for MSMEs to secure bank credit.

1. Understand what borrowing from bank is all about.

2. Present themselves as viable businesses.

3. Prepare credible project proposal.

4. Keep financial accounts.

Solutions for government and Bank of Uganda to improve lending and borrowing.

1. Create an enabling policy, legal and regulatory environment.

2. Facilitate development of various financing market "any place/system that provides buyers and sellers means to trade financial instruments" including bonds, equities, international currencies, derivatives. Financial markets facilitates interaction between those who need capital with those need capital with those who have capital to invest.

3. Create a framework for providing public financial information.

4. Address issues of market failure through capacity building of MSMEs.

Difficulties in accessing financing from formal sources in Uganda.

1. High cost of financing.

Commercial banks average lending rates have been 23 per cent for the past three years.

2. Poor information sharing between banks and MSMEs.

Inadequate information increases the cost of borrowing and constrains access to the required credit. Banks usually don't supply all the required information to the small borrowers except lending rates, other fees are not mentioned. When these are added up the cost of borrowing escalates on the other hand, small borrowers share partial information required by the banks hence constraining their own access to credit.

3. Limited sources of long-term finance.

Uganda's financial sector is dominated by commercial banks with limited number of development banks. As a result MSMEs use the more readily available short term financing packages for medium to long term investment hence reducing business profitability and constraining business ability to pay back with in the set period.

4. Lack of acceptable collateral.

Most international banks don't accept collateral outside a 5 Kilometer radius of the city centre hence hindering access of credit by most MSMEs even in urban areas. 

In conclusion.

Banks need to develop more innovative ways of lending MSMEs more profitably, whereas MSMEs must strive to make themselves more attractive to banks by improving their record keeping, financial management and adapting modern techniques of doing business.