A Study on Issues In SMEs Financing

CHAPTER : 1
INTRODUCTION
The small and medium enterprises (SMEs) have been accepted as the engine of economic
growth and for promoting equitable development in all over the world. Let there be any
category of countries (developed, developing and under developed), the existence of SMEs is
inevitable. The major advantage of the sector is its pivotal role through its contribution in
industrial output, exports and majority in Employment generation at low capital cost. The
labour intensity of the SME sector is much higher than that of the large enterprises.
In India, the SMEs contribution is highly remarkable in the overall industrial economy of the
country. In recent years the SME sector has consistently registered higher growth rate
compared to the overall industrial sector. With its agility and dynamism, the sector has shown
admirable innovativeness and adaptability to survive the recent economic downturn and
recession.
Small and Medium Enterprises (SMEs) have played a significant role world over in the
economic development of various countries. Over a period of time, it has been proved that
SMEs are dynamic, innovative and most importantly, the employer of first resort to millions
of people in the country. The sector is a breeding ground for entrepreneurship. The
importance of SME sector is well-recognized world over owing to its significant contribution
in achieving various socio-economic objectives, such as employment generation, contribution
to national output and exports, fostering new entrepreneurship and to provide depth to the
industrial base of the economy.
Small and medium-sized enterprises (SMEs) are the backbone of all economies and are a key
source of economic growth, dynamism and flexibility in advanced industrialized countries, as
well as in emerging and developing economies. SMEs constitute the dominant form of
business organization, accounting for over 95% and up to 99% of enterprises depending on
the country. They are responsible for between 60-70% net job creations in Developing
countries. Small businesses are particularly important for bringing innovative products or
techniques to the market. Microsoft may be a software giant today, but it started off in typical
SME fashion, as a dream developed by a young student with the help of family and friends.
Only when Bill Gates and his colleagues had a saleable product were they able to take it to
the marketplace and look for investment from more traditional sources. SMEs are vital for
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A Study on Issues In SMEs Financing

economic growth and development in both industrialized and developing countries, by

playing a key role in creating new jobs. Financing is necessary to help them set up and
expand their operations, develop new products, and invest in new staff or production
facilities. Many small businesses start out as an idea from one or two people, who invest their
own money and probably turn to family and friends for financial help in return for a share in
the business. But if they are successful, there comes a time for all developing SMEs when
they need new investment to expand or innovate further. That is where they often run into
problems, because they find it much harder than larger businesses to obtain financing from
banks, capital markets or other suppliers of credit

Common Characteristics of SMEs

(a) Born out of individual initiatives & skills
SME startups tend to evolve along a single entrepreneur or a small group of entrepreneurs; in
many cases, leveraging on a skill set. There are other SMEs being setup purely as a means of
earning livelihood. These includes many trading and retail establishments while most
countries continue SMEs to manufacturing services, others adopt a broader definition and
include retailing as well.

(b) Greater operational flexibility

The direct involvement of owner(s), coupled with flat hierarchical structures and less number
of people ensure that there is greater operational flexibility. Decision making such as changes
in price mix or product mix in response to market conditions is faster.
(c) Low cost of production
SMEs have lower overheads. This translates to lower cost of production, least up to limited
volumes.
(d) High propensity to adopt technology
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Traditionally SMEs have shown a propensity of being able to adopt and internalize the
technology being used by them.
(e) High capacity to innovate export:
SMEs skill in innovation, improvisation and reverse engineering are legendary. By being able
to meet niche requirements, they are also able to capture export markets where volumes are
not huge.
(f) High employment orientation:
SMEs are usually the prime drives of jobs, in some cases creating up to 80%. Jobs SMEs tend
to be labour intensive per se and are able to generate more jobs for every unit of investment,
compared to their bigger counterparts. After agriculture, small and medium enterprising
sector is the largest employment provider.

Key challenges faced by SME sector:

The sector has exhibited consistent growth over the last few years, but it has done so in a
constrained environment often resulting in insufficient resource utilization and producing
way is less than its real potential.
Poor infrastructure and inadequate market linkages are key factors that have constrained
growth of the sector. The lack of adequate and timely access to finance has been the biggest
challenge. The financing needs of the sector depend on the size of operation, industry,
customer segment and stage of development. Financial institutions have limited their
exposure to the sector due to a higher risk perception and limited access of SMEs to
immovable collateral. Then there problems related to obsolete technology, inefficient
processes, procurement, resource planning, lack of access to global markets so on and so
forth.
IMPORTANCE OF SME SECTOR IN INDIA:
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The development of small and medium enterprises (SME) sector is on the priority of
government agenda. As per the results-framework document(RFD) for ministry of Micro,
small and medium enterprises, the mission of the government is to promote growth and
development of globally competitive micro, small and medium enterprises, including khadi,
village and coir industries, in cooperation with concerned ministries/departments, state
governments and other stakeholders by providing support to endeavour to achieve a
cumulative growth of 40%-50% in the number of registered enterprises by the end of 12 th
plan and enhance this sectors contribution to GDP from the present 8% to 10% by the end of
12th plan.
The role of small and medium enterprises (SMEs) in the economic and social development of
the country is well established. As per the report of the working group on small and medium
enterprises (SMEs) Growth for 12th five year plan(2012-2017), the sector accounts 45% of
the manufacturing output and 40% of the total exports of the country.
The sector provides employment to about 69 million persons through 26 million enterprises
throughout the country. Over 6000 products ranging from traditional to high-tech items are
being manufactured by the SMEs in the country.
The labour to capital ratio in SMEs and the Development of SMEs in five years plan:
First five year plan (1951-1956)
In the first five year plan, the government of India allotted a sum of 43 crores for village and
small-scale industries out of the total outlay of 1,960crores. Out of this a sum of 5.2crores
was earmarked for small scale industry. Accepting the recommendations of the international
planning team under the auspices of ford foundation , the Government of India set up the
central small industries organisation as a nodal agency for the development of small-scale
sector and the small industries board as an advisory body and to provide industrial extention
service through a network of small industries service institute in 1954-55. In the same year,
the national small industries corporation was established to supply machinery on hire
purchase basis to small entrepreneurs and also to market their products. The small scale
industries board adopted the idea of industrial Estate programme as tool for promotion of
small industry. The first industrial estate was set up at Rajkot in 1955.
Second five year plan (1956-1961)

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In the second five year plan, an outlay of 175crores was envisaged for cottage and small-scale
industry. But of this, 56 crores were allotted to small-scale industry. It was the second five
year plan that really initiated the development process in the field of small-scale industry. The
industrial policy resolution 1956, gave adequate policy support for accelerating the process of
development, during the period, the government stores purchase programme was introduced
by the government of India to provide an assured market for the product of small-scale
industry. In addition, certain products were reserved for exclusive purchase from small-scale
sector in 1956-57.
THIRD FIVE YEAR PLAN (1961-1966)
In the third five year plan, 264crores were earmarked for the promotion of village and smallscale sector and 113.06crores were set apart exclusively for the small scale industry. During
the plan period, the credit guarantee scheme was introduced in 1960, to encourage the banks
to meet the credit requirement of small scale industry. The setting up of industrial
development bank of India in 1964 led to the flow of the funds to small-scale sector. During
the annual plan (1966-67 to 1968-69), a sum of 53.48crores was allotted for the development
of small scale industry. The government of India reserved certain goods manufactured
exclusively for small-scale sector to protect them against the competition from large
industries.
FOURTH FIVE YEAR PLAN (1969-1974)
The fourth five year plan provided an outlay of 243crores for village and small-scale
industries and 221.74 crores for modern small-scale industry. The fourth five year plan
envisaged widening the range of products in small-scale sector, encouraging dispersal of
small units and promoting exports from small-scale sector. During the plan period in 1969,
fourteen major banks were nationalised and the banks included the small-scale industry in the
priority sector for financial assistance. In 1970, the government of India formulated a variety
of promotional measures to boost export from small-scale sector. In order to intensify the
activities for the development of new entrepreneurs, a separate division called entrepreneurs
development division was set up by the small industries Development organisation. In 1971,
the Government of India introduced the central investment subsidy and announced income
tax concessions in 1973, to stimulate investment in backward regions. The interest subsidy
scheme was implemented in 1973, for the benefit of engineering and technocrats.
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FIFTH FIVE YEAR PLAN (1974-1979)

In the fifth five year plan, a sum of 2930crores was earmarked for the development of village
and small industries. Of this, 221.74crores were allotted to modern small-scale sector. The
fifth plan emphasised regional dispersal, application of modern technology and provision of
incentives to establish electronic industries. The main thrust of Industrial policy statement
1977, was on effective promotion of cottage and small industries widely dispersed in rural
areas and small towns. It was decided that whatever can be produced by cottage and small
industries must only be so produced. The list of industries which were reserved for small
scale sector was significantly expanded. It was proposed to pay special attention to units in
tiny sector. The setting up of District Industries Centre in 1978 has been a hallmark in the
development of small-scale industry. The District industries centre offers various services to
the small-scale sector under one roof at the district level.
SIXTH FIVE YEAR PLAN (1980-1985)
The sixth five year plan allocated a sum of 616.10crores for small-scale sector. During the
plan period, the Government of India took efforts to build buffer stock of raw materials to
ensure supply of critical inputs in time. Facilities were provided for import of components,
raw materials and machinery under Open General License.
SEVENTH FIVE YEAR PLAN (1985-1990)
The seventh five year plan has allotted an outlay of 1,120.15crores for small scale sector. The
Government of India, in May 1986, launched the small industries Development fund with
2500crores. The fund under the Industrial Development Bank of India, provides assistance
for the development, expansion, diversification and also rehabilitation of small units.
EIGHT FIVE YEAR PLAN (1992-1997)
The eight five year plan dealt with beneficial consequences of the seventh plan and
reaffirmed that new opportunities would be generated in small-scale sector so that weaker
sections of the society as a whole would be able to draw the benefits of this sector by direct
participation and widespread employment generation.
A new policy for small and tiny enterprises was announced by the Government on 6 th August
1991. The policy promises to meet 100% credit demand of small and tiny industries. The
emphasis would be shifted from providing cheap credit to adequate flow of credit on a
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normative basis. To enhance the supply of risk capital to SSI sector, a Limited partnership Act
was proposed to introduced. To avoid delayed payment by the large units, factoring services
through SIDBI was proposed. In addition, suitable legislation to ensure prompt payment has
also been proposed in the policy. A new scheme of Integrated Infrastructure Development for
small scale industries was introduced to promote linkage between agriculture and industry.
NINTH FIVE YEAR PLAN (1997-2002):
During the ninth plan, various initiatives were taken to strengthen the small industrial units
through technology up gradation, modernisation, enabling and encouraging them to enhance
quality through introduction of modern management practices, providing marketing and other
key inputs, increasing the availability of credit/loans from financial institutions and banks
against materials supplied etc.
Fifty integrated infrastructure Development centres (IDCs) were set up during the eight plan
for infrastructure facilities of small industrial units developed in backward and rural areas,
out of which 22 have been approved. The Government has taken financial assistance of Rs.
75,000 per small industrial unit is being provided to acquire ISO 9000 or an equivalent
quality certification. The credit provided to the small industrial sector by the public sector
banks stood at Rs 31,542 crore by march 1997. The cumulative disbursement by the state
financial corporations amounted to Rs 12,704 crore up to March 1996. The proposed outlay
for ninth plan was Rs. 3,330crores, but the actual expenditure was Rs. 2855.00 crores for the
development of village and small industrial units. By the end of March 2002, there were over
3.4 million small industrial units in the country accounting for more than 40% of the Gross
output in the manufacturing sector and 35% of the total exports of the country. They provided
employment to 19.2 million persons.

TENTH FIVE YEAR PLAN (2002-2007)

A study Group under the chairmanship of Dr. S.P. Gupta submitted a report on the problem of
small industrial sector in july 2000. After inter ministerial consultations, the prime minister
announced a number of new policy initiatives on 30 August 2000.

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Enhancement of excise duty exemption limit for small industrial units from Rs. 50 lakh to Rs.
100 lakhs. Increase in composite loan limit to Rs. 25 lakh. Coverage of loans up to Rs. 25
lakh under the credit Guarantee Fund Scheme Increase in project cost limit under the
National Equity Fund Scheme to Rs. 50 lakh. Credit linked capital subsidy at 12% of the cost
of technological up gradation of small Industrial units. The service and business related small
industrial units with a maximum investment limit of Rs. 10 lakh would also be covered under
priority lending Enhancement of investment limit of Rs. 500 lakh for hi-tech and export
oriented sectors technology Bank would be set up for small industrial sector by strengthening
the existing technology Bureau for small Enterprises(TBSE) of SIDBI. One time capital grant
of 50% to small industry associations for setting up international level testing laboratories for
small industrial units. Preference to be given to tiny units while organising buyer seller meets,
vendor development programmes and exhibitions Conduct of third Census on small
industries Integrated Infrastructure Development centres (IIDC) Scheme extended to all
areas.
During the Tenth Five Year Plan 58 IIDCs have been approved and central grant of Rs. 38.83
crores has been released up to February 2001. An additional 50 centres are proposed to be
taken up during the Tenth Plan period.
The Tenth Plan has been expected to increase the production of these small industrial units to
Rs. 14,01,939 crores help them provide employment to 23.7 million persons, and export
goods worth Rs. 1,26,000 crores by 2006-2007. Out of the total plan outlay of Rs. 15,25,639
crores as on 2002-07. The proposed outlay for the development of village and small industrial
units was Rs. 3,499 crores. The sector is targeted to grow at 12% per annum during the Tenth
plan.
ELEVENTH FIVE YEAR PLAN (2007-2012)
The 11th plan was aimed at raising the rate of growth of the industrial sector to 10% and
manufacturing growth to 12% per annum. Continuing commitment to priority lending for
MSMEs remains an essential feature of development banking. The 11th plan ensures that the
policies are sufficiently flexible to support the development of micro finance. In the 11 th plan,
the strategy for manufacturing proposed by the National Manufacturing Competitive Council
(NMCC), which includes the following initiatives, should be operationalised.

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State Governments should take steps to create an investor friendly climate, providing a single
window clearance of applications for establishment of industrial units. Labour-intensive mass
manufacturing based on relatively lower skill levels provides an opportunity to expand
employment in the industrial sector. The policy of progressive de-reservation of industries for
small scale, production has reduced the list of reserved industries from about 800 to 239. This
policy should continue in the 11th plan at an accelerated pace, industrial licencing should be
progressively eliminated. Equally important is the need to amend the companies Act, 1956.
The existing incentive programmes such those available for the north-east, J&K, Himachal
Pradesh and Uttarakhand need to reviewed with a view to assessing their impact on
industrialisation in these areas.
The industrial growth strategy would be incomplete if it does not recognise the critical role
and the special needs of the micro, small and medium enterprises (MSMEs). One of the
important tasks of the 11th plan would be to review the position regarding the availability of
timely and adequate credit (both term loan and working capital) to small and medium
enterprises from commercial banks and other financial institutions and suggest measures to
eliminate the shortcomings that are noticed.
TWELTH FIVE YEAR PLAN (2012-17)
Planning Commission constituted the present Working Group on Micro, Small & Medium
Enterprises (MSMEs) Growth for the 12 th Five Year Plan (2012-17) with 46 members
representing various Ministries/Offices of Government of India, representatives of selected
State Governments and Industry Associations, NGOs etc. in May, 2011. The terms of
reference of the Group were to carry forward recommendations of Prime Ministers Task
Force and suggest specific action plan and milestones to be achieved within 12th Plan period.
Further, the terms of reference of the Group also mandated suggestions to address problems
of un-organised Sector and proposals for devising programmes/schemes to facilitate overall
growth of the MSME sector.

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A Study on Issues In SMEs Financing

CHAPTER : 2
RESEARCH DESIGN

2.1 TITLE OF THE STUDY:

A study on The issues in SME financing.
2.2 STATEMENT OF THE PROBLEM
Despite the role of SMEs in the Indian economy, the financial constraints they face in
their operations are daunting and this has had a negative impact on their development and
also limited their potential to drive the national economy as expected. This is worrying for a
developing economy without the requisite infrastructure and technology to attract big
businesses in large numbers.
Most SMEs in the country lack the capacity in terms of qualified personnel to manage their
activities. As a result, they are unable to publish the same quality of financial information as
those big firms and as such are not able to provide audited financial statement, which is one
of the essential requirements in accessing credit worthiness from the financial institution.
This is buttressed by the statement that privately held firms do not publish the same quantity
or quality of financial information that publicly held firms are required to produce. As a
result, information on their financial condition, earnings and earnings prospect may be
incomplete or inaccurate. Faced with this type of uncertainty, a lender may deny credit,
sometimes to the firms that are credit worthy but unable to report their results.
Another issue has to do with the inadequate capital base of most SMEs in the country to meet
the collateral requirement by the banks before credit is given out. In the situation where some
SMEs are able to provide collateral, they often end up being inadequate for the amount they
needed to embark on their projects as SMEs assets- backed collateral are usually rated at
carcass value to ensure that the loan is realistically covered in the case of default due to the
uncertainty surrounding the survival and growth of SMEs.
These are some of the factors already acknowledged by some researchers as blocking most
SMEs in accessing credit from the financial institution in the country. Hence a detailed
research in this direction is necessary.

A Study on Issues In SMEs Financing

2.3 NEED AND RELEVANCE OF THE STUDY

SMEs are the 2nd largest employment providers in the Indian economy after agriculture.
According to reports of working group on SME growth for 12 th five year plan (2012-2017),
the SME sector now contributes 45% of the manufacturing output and 40% of total exports of
the country. It has created an employment opportunity for 69 million workers and Financing
to small and medium enterprises(SMEs) is a subject of great interest for researchers and is an
important issue for policy makers around the globe. But these SMEs dont get the necessary
finance hence often depend on local money lenders for their financial needs. Hence a study
in this direction is necessary to come out with proper solution for the issues.
2.1 OBJECTIVES OF THE STUDY
SME is Gen-Next engine of economic development and it is answer to realize 12 th plan with
special reference to generate employment and export of the country. Also this sector has huge
potential of banks finance for sustainable growth, the instant research project issues in SME
financing hence aims
1. To examine & analyse the status of credit flow to SME sector against the set
benchmark under SME policy guidelines.
2. To understand the criteria referred by financial institutions while lending SMEs
3. To identify major issues in SME financing. Why SMEs are not bankable!
4. To analyse responses sought from entrepreneurs and bank officials in regard to the
problems being faced and related issues in SME finance and ascertain viability of
SMEs.
5. To suggest measures to overcome the constraints.
4 .LIMITATION
1. While administering the questionnaires, sometime it happens that respondents either
hesitate to respond questions or dont get enough time to interact and provide
distorted data that fail to draw realistic findings.
2. Poor responses from certain corners of the country as compared to other parts of the
nation are also one of constraints.
3. Time constraints was the biggest limitation.
complete the report.

4. METHODOLOGY
TYPE OF RESEARCH-

Only four weeks was available to

A Study on Issues In SMEs Financing

DATA USED
The data for this study were gathered through the use of primary and secondary data sources.
The primary data source for this study involved the use of questionnaire. The questionnaires
were distributed to SME operators and/or owners for first hand information for processing
towards answering the research questions. The questionnaire was divided into three sections.
Section A, concentrated on the bio data of the respondent firms such as:
Age of the firm
Form of ownership
Nature of the firm
Number of employees of the firm
Average monthly turnover of the firm
These helped us in identifying the type of SME we were dealing with, whether or not they
were Micro, Small or medium enterprise.
Section B of the questionnaire consisted of various questions geared towards answering the
objective of the study. These questions looked at the constraints faced by SMEs when
accessing credit, other financing options available to these SMEs and how cheap the cost of
finance is in the opinion of these SMEs among others.
The final section also looked at the future of these SMEs, whether or not they plan to remain
a going concern in the foreseeable future through the expansion of their business to other
regions of India when assisted financially.
The secondary data were obtained from reviewing journals and literature relevant to the
subject matter of this research. Newspaper source and official policy documents of
government of Ghana with relevance to the subject were also consulted. The electronic search
site: www.google.com was employed extensively for up-to-date materials on the topic.
The primary data formed the crux of this study because it afforded the opportunity in
obtaining at first hand, relevant relevant responses.
SAMPLE SIZE
Sample Size of SMEs that classified SMEs into:

A Study on Issues In SMEs Financing

Micro enterprise (1 to 9 workers)

Small enterprise (10 to 29 workers)
Medium enterprise (30 to 140 workers)
A sample size of the 80 participants was targeted for responses. 80 questionnaires were
distributed to these SMEs out of which we received responses from 68 respondents. This
represented about 85% of the response rate which we deemed to be impressive for this study.

A Study on Issues In SMEs Financing

CHAPTER -3
DATA ANALYSIS AND INTERPRETATION
The contribution of SME s is presented in Table-1. It shows that they have been playing a
significant role in employment generation and contribute significantly towards the Indian
GDP.

The major sources of funds for MSMEs are his personal savings, credit cards, loans from
friends and family and loans against property (Smith and Smith, 2000). If the MSMEs
finances with equity, the money is fully lost in the case of insolvency (Mamis and Hyatt
(1997). On the other hand if MSMEs finances with debt fulfilling legal requirements can be
difficult (Stefan, 2003).

A Study on Issues In SMEs Financing

TABLE 2

SME Finance Gap

Firms

Small

Medium

Large

Very large

% with bank loans

20

40

52

55

M. Hallward-Dreimeier and D. Stewart, 2005.

Micro, Small & Medium Enterprises, Ministry, Government of India, 2013.

TABLE 4

Units in the SSI and Tiny

Sector

Type of Units

Registered

Unregistered

Total Units Surveyed

750,102

96,431

SSI Units

492,804 (100.0%)

34,658 (100.0%)

Tiny Units within SSI

482,200 (97.8%)

34,620 (99.0%)

Micro, Small & Medium Enterprises, Ministry, Government of India, 2013.

TABLE 5 Major Sources of External Finance
Size
Informal
Banks
External
equity
Micro
14.4
9.5
3.2

Long-term
credit
8.9

No external
finance
64.0

Small

9.4

17.6

3.0

15.4

54.6

Medium

4.6

25.2

2.8

16.6

50.8

Large

3.6

29.5

4.1

17.0

45.9

Very large

2.7

31.5

2.9

14.7

48.1

Source: Cull, et. al., 2012

A Study on Issues In SMEs Financing

Role of Small and Medium Enterprises in India

The most commonly used definitions MSMEs relate to either size of employment and/or
quantum of capital investment /fixed assets. In India the criteria for classification has been
shown in table given below.
Investment Limits for Micro, Small and Medium
TABLE 6
Category
Micro Enterprises
Small Enterprises
Medium Enterprises

Enterprises
Investment (Plant & Machinery)
Less than 2.5
Less than 50
Less than 100

Service
Less than 1
Less than 20
Less than 50

PRODUCTS OF MSEs
22%

36%

12%
6%

6%

8%

10%

Food Products

Chemical & Chemical products

Basic Metal Industry

Metal Products

Electrical & Machinery Parts

Rubber & Plastic Products

Others

A descriptive statistics was found to be an ideal analysis technique and subsequently used in
ascertaining the difficulties that SMEs faced in accessing bank loans. Aided by the tabulation
of data extracted from a closeended questions surveyed, it was easier to understand the
issues identified by the respondents.

A Study on Issues In SMEs Financing

Also to help answer the question whether or not SMEs have challenges in accessing credit in
India as contained in the objectives in chapter one, the below hypothesis were formulated and
tested using test of proportion:
Ho: Not more than 50% of SMEs face challenges when accessing credit
H1: More than 50% of SMEs face challenges accessing credit
These could also be expressed statistically to be:
Ho: P = 0.5
H1: P > 0.5
Where P = the proportion of respondents who face major challenges in accessing credit in
Ghana.
n = sample size, hence n=68 and X being the number of respondents facing difficulty in
accessing credit
Level of significance:
Let = 0.05
Test Statistics:
Z = X np
(npq)
Where z follows the standard normal distribution N (0, 1)
Null distribution:
X follows B (68, 1/2) and since np = n (1-p) = 68 x 0.5 > 5, we can approximate the binomial
to the normal distribution
Decision Rule:
If the computed p value is less than the level of the significance = 0.05 we reject Ho
otherwise we fail to reject Ho
ie p* = P(X x/ Ho)
Computation
Given that n = 68, x = 50 and p = 0.5

A Study on Issues In SMEs Financing

Our P value can be calculated as:

P* = P( x 50)
By approximating the binomial to the normal distribution, we had
P* = P Z 50 68*0.5 / (68*0.5*0.
(n = 50 has been reduce to 49.5 due to continuity correction)

This implies,
P* = P (Z 3.759) = 1 P(Z 3.759)
=1 0.9999 (read from the Standard Normal Table)
=0.00
Decision:
Since the P value ( p* = 0.00) < the level of significance, we reject Ho
Conclusion:
The small P* value of 0.00 which is far less than the level of significance gives us enough
evidence to conclude that more than 50% of SMEs face challenges accessing credit.

The data collection for this study was done basically through the usage of questionnaire. We
targeted a population of 20 SMEs and distributed the questionnaires among them. Out of the
20 questionnaires circulated, 18 were returned representing about 90% of response rate,
which we deemed impressive considering the short time given to these respondents. A higher
response rate would have been preferred, but there were many reasons for the percentage
achieved. Two of the most crucial reasons were:
Some of the SMEs were reluctant in answering the questions because they thought the
information they will provide will one way or the other fall in the hands of the tax authorities

A Study on Issues In SMEs Financing

despite the assurance given in writing that all information given would be treated
confidentially.
Others also complained about the time given them to provide answers to the questions.
According to them, it was too short and as a result their inability to complete answering the
questions

Table I
Frequency Distribution of Forms of Participant SMEs
Form

Frequency

Percentages (%)

Cumulative (%)

Private Ltd Company

11

57

57

Public Ltd Company

57

Partnership

66

Sole Proprietorship

26

93

Family Owned Business

100

100

Others
Source: Research questionnaire

As can be seen from table I, the bulk of the respondents SMEs are registered as Private
Limited Liability Companies. They accounted for 11 out of 18 respondents, representing
61%. None of the respondents were Public Limited Liability Company. 3 respondents,
representing 18% were Sole Proprietorship with 2 being Partnership represents 11%. The
remaining 10% of the respondents SMEs were registered as family owned businesses.
Table II.
Frequency Distribution of Nature/ Kind of Participant SME

Nature

Frequency

Percentages(%)

Cummulative (%)

Retail Trading

47

47

Export

22

69

Manufacturing

12

81

A Study on Issues In SMEs Financing

Services

15

96

Real Estate industries

100

Farming

100

Others

100

It is a general knowledge that SMEs cut across the various sector of an economy, hence the
68% responses received were fairly spread across a wide range of the Indian economy with
the most concentration centered in the retail trading sector. This sector alone accounted for
47% of the total responses as can be seen from table II. The export sector accounted for 15,
representing 22%, Services, 10 or 15%, Manufacturing 8 or 12% and the Real Estate
industries accounting for 3 or 4%. For all intent and purposes, apart from the Agricultural
sector, all the key sectors of the economy were captured in the sample.

4.3 SMEs Constraints

SMEs known all over the world are faced with lots of challenges in their operations and this
was not different from the responses received from our target respondents. SMEs operators
who took part in the study were however asked to rank the major constraint they face in
operating and growing their businesses. Lack/inadequate access to finance (bank loans) were
considered to be a major constraint as it recorded 75%. This means that among all the
problems faced by SMEs in their operation ranging from competition, high utility tariffs,
infrastructure among others, the participant SMEs saw the lack of credit facilities as the
major constraint. This assertion was also confirmed from the test run in the data analysis
subsection in chapter three, where P value (p* = 0.00) < the level of significance, which is =
0.05. Table (IV) below shows the various challenges faced by SMEs in India.

Table IV.

A Study on Issues In SMEs Financing

Major Constraint to the growth of SME

The above shows participants rankings of the major problems facing the growth of their
businesses in order on importance. 50 or 74% of the participant ranked lack of finance as the
major constraints to the growth of their business followed by high utility tariffs, which
recorded 15%. Competition and infrastructure were ranked as the 3rd major constraint to the
growth of SMEs with just 3% thinking that taxes also constrained their growth.
This result reinforces the theory by Cuevas et al (1993) where they indicated that access to
bank credit by SMEs has been an issue and continues to be raised by numerous studies as a
major constraint to growth, which was also supported by Aryeetey et al. (1993) that from the
view point of private sector, problems related to finance dominate all other constraints to
business expansion. These go to also indicate that finance for SMEs particularly in India is
still a major problem even though the number of banks operating in the country has increased
tremendously since 1993 when Aryeetey et al. came out with their studies. With a total
number of banks and number of non-bank financial institutions operating in the country one
expects that access to credit by these SMEs will greatly improve as competition becomes
keen. But the expectation has not been met since the results confirm the numerous theories
that lack of access to credit/bank loans remains a key constraint that needs attention to
resolve to enhance SMEs growth.
This notion was also in line with Schiffer and Weder (1991), who found that small firms tend
to experience more difficulties than medium-sized firms, which also experience more
difficulties than large firms.

A Study on Issues In SMEs Financing

4.4 Factors Contributing to SMEs Constraints

The inability of SMEs in India to readily have access to credit from the countrys financial
institutions (banks) can be attributed to a lot of factors. Schiffer and Weder (1991), attributed
this factors to the perceived high risk nature of these SMEs, small portfolios of these
businesses and the high transaction cost that banks go through in performing credit appraisal
on them before granting credit to these SMEs. Berger and Udell (2006) in finding out factors
contributing to the challenges in financing SMEs attributed some of the causes to the type of
lending infrastructure of nations. For them, it affects the feasibility and profitability of using
the different lending technologies in SME financing.
Before revealing what this study came out with, the study first tested the possibilities of these
SMEs being denied credit from the countrys banks. That can be referenced from the result
below:

Table V
Total Number of Participant SMEs granted or denied access to Credit
Frequency

A Study on Issues In SMEs Financing

Frequency

25%
Granted Credit
Denied Credit

75%

The above pie chart shows a number of participant SMEs who in one way or the other has
been granted or denied access to credit from financial institutions. From the chart above, 75%
of the total respondents say they have been denied access to credit, whilst 25% of them
responded No to the same question.
Out of the 18 respondents sampled, 60% of them attributed their lack of access to bank loans
or credit to their inability to provide the required security or collateral for the loans or credit
being requested for and in situations where they are able to provide, it ends up to be
inadequate, which accentuate the opinion of Binks et al., 1992. For them, they attributed this
factor to the inability of the SMEs to provide collateral and in some cases where they do, they
are inadequate and also the SMEs asset-backed collateral are usually rated at carcass value
thereby making it difficult for these SMEs to get access to the credit they want.
The result collated from the survey in table (VI) below shows the frequencies of various
factors hindering SMEs in securing loans for their businesses.

A Study on Issues In SMEs Financing

Table VI
Frequency Distribution of Factors that Hinders Participants SMEs Access to Credit
Factors
Default on Previous Loan
No Security/ collateral
Small Equity base
Lack of experience Management
others

Frequency
1
10
4
2
1

Percentages(%)
3
60
22
10
4

Ranking
5
1
2
3
4

60% representing 10 of the total respondents of 68 ranked lack of collateral as the major
factor preventing them from accessing loans from the financial institutions. 4 or 22% ranked
small equity base as factor affecting their access to credit. Lack of experience management
was the opinion of 2 or 10% of the respondents with 4% thinking that other factors such as
the inability to provide audited financial statement are preventing them from accessing credit
with 3% relating their inability to access credit to default on previous loan.
Again apart from the collateral issues and other factors as indicated above, which makes it
very difficult for SMEs to access the maximum amount needed for various expansion
projects, the interest rates charges on the loan facilities by the various banks are outrageous
and also unattractive for most SMEs to access these credits. Almost all the respondents
expressed an opinion on the level of interest rates charged by financial institutions on
facilities received, to be extremely high whiles others also say the rates are just high. Table
(VII) shows the figures:

Table VII

A Study on Issues In SMEs Financing

Frequency Distribution of the Level of Interest rates on Loans

Measure

Frequency

Percentages(%)

Cummulative (%)

Extremely High

12

71

71

High

26

97

Acceptable

100

Low

100

The above table shows the opinion of respondents on the level of interest rates charges on
loans from the bank and non-bank financial institutions. 12 out of the 18 responses received
from participants saw the interest rates on loans to be extremely high. This represented 71%
of the total responses. 5 or 26% of the total respondent think the rates are high with just 3%
saying the rates are manageable.
One significant thing is that among the respondents, none saw the interest rates charged on
loans by the financial institutions to be low. The extremely high interest rate group numbering
about 12 out of the total respondents of 18 pays interest between 31% and 40% per annum.
26% of the respondents, which indicated that the rates charged by the financial institution are
high, also pay interest of 21% to 30% per annum, with just 3%, which we will term the
fortunate ones servicing their loans at an interest of less than 20% per annum. This makes
their businesses unprofitable as the profits made are eroded by the huge finance cost.
This high interest rate demanded from the SME sector by the banks is due to the high risk
nature of this sector, resulting from the high default rates associated with SMEs financing.
The high default was also linked by the respondent SMEs to the delay in receiving payments
for their goods and services rendered. This was revealed in the answers given in one of the
questions, which sort to find out the causes of high default on the part of SMEs in honouring
their loan obligation. One shocking revelation was that about 85% of the total respondents
linked the problem to delays in receipts of debtors payments. These delays, affect their cash
flow considerably making it difficult for them to meet their loans repayment dates leading to
them bearing extra cost in financing loan contracted in respect of additional fees to the
already high interest charge on the loans facility
4.5Alternative Sources of SMEs Financing

A Study on Issues In SMEs Financing

Boom et al.(1983) like most writers on the subject of SME financing, described two basic
type of financing namely debt and equity, which were further classified by Hisrich and Peters
(1995) also into two sources internal and external.
Since finance is the major constraints to SMEs development and growth, various sources
ought to be explored by these SMEs to run their businesses. It came to the fore through the
survey that most of these SMEs depend on mostly on external sources such as the banks, nonbank financial institution, families and friends and also personal savings the only internal
source as alternative source of financing for their businesses. Table (VIII) below shows these
sources.
Table VIII
Distribution of SMEs Major Sources of Funding
Source

Frequency

Percentages(%)

Cummulative (%)

Bank loans

17

25

25

Personal Savings

28

Retained Profit

32

Trade Credit

32

Families/ Friends

12

44

NonBank financial Institution

38

56

100

100

others

A Study on Issues In SMEs Financing

Among the various sources in Table VI, which is also presented in the graph, 56% out of the
total respondents ranked their major sources of funding from the Non-Bank Financial
Institutions followed by 25% getting their financing from bank loans. The third ranked
sources of funding for SMEs operation are from families and friend with 12% and the fourth
being retained profit with 3%. Personal savings was ranked the fifth with trade credit not
resorted to as a source.
This goes to show that the SMEs operating in India are skewed more towards the external
source of funding, which is not also easy to access thereby inhibiting their growth. From the
above the only internal source of funding is just from their personal savings none of the other
internally generated options of funding are being exploited. These internal sources include
operational and investment profits, sales of assets, extended payment terms, reduction in
working capital and proper management of accounts receivable, which are less expensive and
also reliable.
The kind of banks operating in the country have limited interest in funding the SMEs sector
most especially those seeking funds as start up capital for their businesses because of the risk
associated with new businesses where it is known that 8 out of 10 new businesses fail within
the first three years (Mason, M.K, 2011). The limited interest of banks to finance start up
businesses is also supported by the data in table (IX)
Table IX
Frequency Distribution of Sources of Funds for Start-up Businesses
Sources

Frequency

Percentages(%)

Cummulative (%)

Personal savings

25

37

37

Bank Credit

12

49

Friends and Relatives

31

46

94

Others

100

The above table shows the distribution of SMEs sources of funding in establishing their
businesses. It is clear from the table that 37% and 46% of the funds are generated from
personal savings and relatives and friend respectively with 12% of SMEs start-ups getting
their finances from the banks. The reaming 6% get their funds from other sources.
This makes it extremely difficult for the SME sector to pursue growth thereby hindering their
growth just to stay afloat. In spite of these challenges there is a strong desire among these
SMEs to pursue the agenda of growth when the question was asked as to whether or not they

A Study on Issues In SMEs Financing

would like to expand their business to other cities within the country should their financing
needs be met. 60% of the respondents showed interest in that direction as indicated in Table
(X).

Table X
Distribution of Participants SMEs Establishing More Branches in the Major Cities in
India
Ranking

Frequency

Percentages(%)

Cummulative (%)

Strongly Agree

41

60

60

Agree

24

35

96

Not Sure

100

Disagree

100

Strongly Disagree

100

This table shows the distribution on the question relating to SMEs expanding their businesses
to the other cities of the country. 60% of the respondents strongly agreed to the statement,
meaning that all things been equal they would like to grow their business. 24 or 36% of the
same respondents also agreed to the statement with just 4% not sure as to whether they will
expand or not. One critical point is that none of the respondents disagree with the statement
of whether SMEs would like to establish more branches in the major cities of the country.

A Study on Issues In SMEs Financing

This seems to remain a dream for them as the funds to undertake such an expansion projects
are difficult to access because of the stringent criteria of the banks. The only sure way of
getting such an amount to embark on these expansions is mainly through the banks and the
listing onto the Stock Exchange, which most of the SMEs are not qualified. This leaves the
banks as the only viable source and even then because of the duration given in repayment of
loan, which is mostly up to two years (see Table XI), such facility will not be appropriate for
investing into business expansion.

Table XI
Frequency Distribution of Loan Repayment Distribution
Factors

Frequency

Percentages(%)

Cummulative (%)

Up to 1 year

49

72

72

Up to 2 years

19

28

100

Up to 3years

100

Above 3 years

100

This shows the frequency distribution of loan repayment duration by the respondents usually
received from the financial institution by which time they should have repaid the loan
amount. From the above record, 72% are given a repayment period of up to one year, whilst
28% or 19 of the total respondents of 68 indicated a repayment period of up to one year
The findings enumerated above corroborate the opinion about the difficulty that SMEs in
India faced when it comes to accessing credit (bank loan) to run their businesses. But one
interesting twist in these findings is the issue of poor management of account receivables of
these SMEs. However, we believe that with proper management of SMEs receivables, they
should have enough cash to boost their working capital to run their operations and also meet
their financial obligations.

A Study on Issues In SMEs Financing

Chapter-4.
Findings, Suggestions And Conclusion
Findings
Problems in Debt Capital
The responses of the MSMEs are shown in the table below. MSMEs face the maximum
problem due to requirement of collateral. This is followed by problems faced due to a low
chance of obtaining debt capital for business. Insufficiency of funds for business does not
pose a problem faced in raising debt capital.
Table 7: Debt Capital -Problems faced by entrepreneurs of MSMEs
Problems in Debt Capital

Average Rating

Insufficient Funds

1.66

Difficult to convince as there is a lack of trust

3.18

Cost of fund is high

3.38

Process is time consuming

3.18

Collateral/Guarantee is required

4.49

Excessive paper work

3.41

References/Assurances are required

3.51

Chances of obtaining finance are low

4.35

A Study on Issues In SMEs Financing

Chart Title

Series 3

The findings of the statistical test indicated that Entrepreneurs of MSMEs face problems in
raising debt capital and problems are faced by them does not differ age-wise, locationwiseand gender-wise. The summarized findings have been presented in table 3 given below

Conclusions
This study highlights the important role of MSMEs in the Indian economy. The problems
faced by MSMEs in raising capital are first stated in the literature survey and later vindicated
through the survey of MSMEs. The study gives the perspectives of MSMEs in the Indian
context. It shows that the maximum problem in raising debt capital is faced due to
requirement of collateral and that the chances of obtaining debt financing by MSMEs is low.
Furthermore this study shows that all entrepreneurs of MSMEs irrespective of their location,
age and gender face problems.
The findings of this study are in line with previous studies that have highlighted the relative
and absolute importance of MSMEs (Dun & Bradstreet 2008). Also previous studies such as
Cull, et. al., 2005 depicts the position of small and medium enterprises (SME); showing that
they have access to lesser bank credit than larger enterprises.
As per the data from Ministry of Micro, Small & Medium Enterprises, Government of India,
the MSMEs sector has registered a consistently higher growth rate than the
overall manufacturing sector. MSMEs constitute an important segment of Indias industrial
production with a contribution to 33% of its exports. But though MSMEs are being touted as

A Study on Issues In SMEs Financing

the priority sector within the economy, they continue to face problems pertaining to finance.
When it comes to banks, they have a very traditional way of lending to this segment against
collateral and MSMEs end up being under financed as compared to larger enterprises. In view
of the contribution of MSMEs to the Indian economy their problems in raising debt capital
should be addressed in earnest.

Chapter- 5 Learning Experience

Bibliography