Project Financing to the SME Sector

Project Financing to the SME Sector:

Project Financing to the SME Sector By N.Thanesh Credit Workshop RHO-Jaffna

What is SME?:

What is SME? Small medium enterprises are the businesses who have the capability of Value Addition Value Creation Change in Value design Employment Creation

How to identify SME?:

How to identify SME? Annual turnover of the enterprise (Below 300Mn) Total Number of Employees(4-29 Small enterprises 30-150 medium enterprises) Total Value of Assets(3 Mn-19 Mn small Enterprises 20-70 Mn Medium enterprises)

Why We should Promote SME Sector?:

Why We should Promote SME Sector? Creation of Employment Use of local Raw materials Foreign exchange earnings Import substitution & Innovation Poverty alleviation Regional Development

Challenges Ahead:

Challenges Ahead Should transform our mind set from security oriented lending towards cash flow based lending Lack of proper financial records Lack of collateral as they are in the early stages of the development Lack of risk capital Leverage is too high as the owners wealth is minimum

To whom we can cater?:

To whom we can cater? Lending to new projects For the expansion of existing projects To increase the productivity of the existing projects Important features to be noted!! Maximum loan amount is 60 Mn minimum is 0.5 Mn Can be given as Investment loan or as Permanent WC loan

Investment loan:

Investment loan Investment loans can be extended to Maximum tenor of 10 years(+2 year grace period)

Mind the following:

Mind the following Structure the loan with adequate grace period to enable the business to start the operation If the project is already Started grace period not required. Structure the loan according the economic life span of the machinery

Important additional Documents Should be supported:

Important additional Documents Should be supported Buildings Plant & machinery BOQ Copies of invoices Contractors Acknowledgement Performa invoices Inspection report confirming the LC /Bill of Lading Effective utilization of funds Quotation from at least 3 vendors

Loans for Permanent WC requirement:

Loans for Permanent WC requirement Maximum tenor is 3 years following documents should be filed Bills & receipts Inspection report affirming effective fund utilization

Note that!!!!!! :

Note that!!!!!! Must be a registered business Comply environmental and legal guidelines Foster correct labour practices

PART II :

PART II Practical Aspects of Projected oriented lending

What to be analyzed?:

What to be analyzed? Market analysis Technical analysis Financial Analysis Environmental Analysis Management Analysis

Market Analysis:

Market Analysis Check the followings Is there any cheap import substitute Past trend Export Viability End use Supply and competitors Pricing Lifecycle of the Product Distribution Channels

Technical Analysis:

Technical Analysis Technical Arrangements Size of the plant Procurement Location Availability of raw materials and workforce Schedule of project implementation Environmental Impacts

Financial Appraisal :

Financial Appraisal Capital Cost Sources of finance Financial Projection BEP NPV &IRR (well above market interest rate) Calculation of WC ( Will be Discussed in detail at the end of the session)

Economic Appraisal and social Cost benefit analysis.:

Economic Appraisal and social Cost benefit analysis. Creation of employment opportunities Capital Labour Ratio Value Addition Foreign Exchange Earnings & Savings

Financial Appraisal-Some Deeper Look:

Financial Appraisal-Some Deeper Look Profitablity Ratios GP Ratio NP Ratio ROE ROCE EPS P/E Ratio Liquidity Ratios Current Ratio Acid Test Ratio Leverage Ratios Debt Equity DSCR

For your Knowledge-Current Srilankan SME Profiles:

For your Knowledge-Current Srilankan SME Profiles Turnover Growth 14% GP margin 30% ROI 21% AVG Stock days 31 Debtors Collection period 34 Creditors Payment period 40 Current ratio 2:3 Debt/Equity Ratio 0.64

Financial Propositions :

Financial Propositions Correct financial information's should be obtained to evaluate actual requirements Over financing as well as Under financing can lead to high risk exposure. Bankers should extend Credit Plus Services and Foster good practices. Educate good Financial habits -Arranged Short term facilities instead of adhoc TOD

Understanding Balance Sheet:

Understanding Balance Sheet B/S Net worth LTL STL Fixed Assets Current Assets

Slide 22:

Good business is depend on sizes of the above boxes,It Reveals How cleverly the portfolio is being managed as well as financial Strength of the organization Management efficiency is portrayed from the picture of B/S If the external Borrowing in the Form of LTL /STL increases net worth as well as risk capital shrinks .

Working Capital Management:

Working Capital Management

Understanding Working Capital:

Understanding Working Capital From Customers’ point of View The amount of cash the organisation needs to operate/run the business From Accounting point of view Working capital = Current Assets - Current Liabilities From Banks’ perspective It is the Net Working Assets of a client’s business

Measuring Working Capital:

Measuring Working Capital Current Assets – Current Liabilities Current Assets – Inventory/stock, Receivable from Debtors, Short Term Investments, Cash & Bank balances etc. Current Liabilities – Creditors, Expenses Payable, Tax Payable, Short Term Loans, Bank Overdraft, etc.

Net Working Assets (NWA):

Net Working Assets (NWA) Bank is concerned only at the Net Working Assets of the organisation when it comes to any facilities for working capital financing NWA = Stocks + Debtors – Trade Creditors Financing decision on NWA depends on working capital cycle of the customer

Working Capital Cycle (WCC):

Working Capital Cycle (WCC) WCC shows the length of time between the organisation paying cash for material/goods and the inflow of cash from sale of goods Bought Material Issued for Production Completed Production Sold on Credit Collected the cash Paid Cash to Supplier 01 Apr 10 Apr 20 Apr 24 Apr 01 May 30 May

Calculation of WCC:

Calculation of WCC Raw material stock holding period - 10 days Work-in-progress period - 14 days Finished inventory holding period - 06 days Debtors’ collection period - 30 days Total period of Operating Cycle - 60 days Less: Creditors Settlement Period - 20 days Working Capital Cycle - 40 days

Formulae for WCC Components 1/3:

Formulae for WCC Components 1/3 Raw material stock holding period Work-in-progress (WIP) holding period Average Stock Average cost of materials consumed X 360 Average WIP Stock Average cost of Production X 360

Formulae for WCC Components 2/3:

Formulae for WCC Components 2/3 Finished goods holding period Debtors collection period Average Debtors Receivable Average Credit Sales X 360 Average Finished Stock Average cost of Sales X 360

Formulae for WCC Components 3/3:

Formulae for WCC Components 3/3 Creditors settlement period Average Creditors Payable Average Credit Purchases X 360

Maximum Level of Net Working Assets Financing:

Maximum Level of Net Working Assets Financing Calculate the Projected Net Working Assets Raw material stock + WIP + Finished inventory + Trade debtors –Trade Creditors Deduct the amounts already used to finance the NWA Existing Long Term Financing Facilities from Other Bank

Ways of Net Working Assets Financing:

Ways of Net Working Assets Financing Trade finance facilities Export Loans Import Loans Bill Discounting Pledged Loans Packing Credit Short term loans

Importance of Financing “Correct” Amount – 1/2:

Importance of Financing “Correct” Amount – 1/2 Should not lend too little or too much for working capital Consequences of too little financing Frequent requests from customers Strained relationship with the customer Difficulty for customers in planning their business Liquidity problem for customer Loss of business to other banks

Importance of Financing “Correct” Amount – 2/2:

Importance of Financing “Correct” Amount – 2/2 Consequences of Too Much financing Possible diversion of funds by organisation Hiding real financial problems Low profitability Unnecessary bank’s exposure towards the organisation

Is Overdraft a mode of Working Capital Financing?:

Is Overdraft a mode of Working Capital Financing? Most abused facility by customers High risk for bank managers Not Supported by specific purpose and repayment plans Better minimize the Overdraft as a mode of working capital financing Bank O/D is general purpose financing only

Measuring Working Capital Stability:

Measuring Working Capital Stability Current Asset Ratio Current asset ratio should be around 1.5 – 2.0 Liquid Asset Ratio / Acid Test Liquid asset ratio should be around 0.8 – 1.0 Current Assets Current Liabilites Current Assets - Inventory Current Liabilites

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Thankyou