Small and Medium Enterprises (SMEs) play a major role in most economies, particularly in developing countries. SMEs account for the majority of businesses worldwide and are important contributors to job creation and global economic development. They represent about 90% of businesses and more than 50% of employment worldwide. Formal SMEs contribute up to 40% of national income (GDP) in emerging economies. These numbers are significantly higher when informal SMEs are included.
According to our estimates, 600 million jobs will be needed by 2030 to absorb the growing global workforce, which makes SME development a high priority for many governments around the world. In emerging markets, most formal jobs are generated by SMEs, which create 7 out of 10 jobs. However, access to finance is a key constraint to SME growth, it is the second most cited obstacle facing SMEs to grow their businesses in emerging markets and developing countries.
SMEs are less likely to be able to obtain bank loans than large firms; instead, they rely on internal funds, or cash from friends and family, to launch and initially run their enterprises.
The International Finance Corporation (IFC) estimates that 65 million firms, or 40% of formal micro, small and medium enterprises (MSMEs) in developing countries, have an unmet financing need of $5.2 trillion every year, which is equivalent to 1.4 times the current level of the global MSME lending. It is against this back drop that this article seeks to explore some simple ways that SMEs can secure working capital to support their business needs.
Invoice Financing:Invoice financing, also known as accounts receivable financing, is an effective way for SMEs to access working capital. This method involves selling outstanding invoices to a financial institution at a discount. The SME receives immediate funds, typically a percentage of the invoice value, which can be used to meet immediate cash flow requirements. Once the customer pays the invoice, the financial institution pays the remaining balance, minus a fee. This option allows SMEs to unlock the cash tied up in unpaid invoices and maintain a steady cash flow.
Business Line of Credit:A business line of credit is a flexible funding option that provides SMEs with access to a predetermined amount of capital. Similar to a credit card, SMEs can withdraw funds as needed, up to the approved limit. Interest is only charged on the amount borrowed, making it a cost-effective solution for managing short-term cash flow gaps. Business lines of credit can be obtained from banks, online lenders, or alternative financing companies, and are often secured by collateral or based on the business’s creditworthiness.
Crowdfunding:Crowdfunding has gained popularity as a way for SMEs to raise working capital. Through online platforms, businesses can pitch their ideas or products to a wide audience, who can then contribute funds to support the venture. This method allows SMEs to tap into a larger pool of investors and customers, while also generating buzz and brand awareness. However, it is important to note that successful crowdfunding campaigns require careful planning, a compelling pitch, and a well-defined target audience.
Supplier Financing:Negotiating favorable payment terms with suppliers can help SMEs manage their working capital effectively. By extending payment terms, businesses can delay cash outflows, providing them with additional time to generate revenue from their products or services. This approach can be especially beneficial for SMEs that have strong relationships with their suppliers and a proven track record of timely payments. It is important to communicate openly with suppliers and negotiate terms that align with the business’s cash flow needs.
Government Grants and Programs:Many governments offer grants, loans, and programs specifically designed to support SMEs. These initiatives can provide access to working capital, financing for expansion, or funding for research and development. SMEs should explore local, regional, and national programs that cater to their industry or business needs. Applying for these grants and programs often requires careful planning, documentation, and meeting specific eligibility criteria. However, the potential benefits can be significant and can provide a much-needed boost to working capital.
Securing working capital is a critical aspect of running a successful SME. While the process may seem daunting, there are several simple ways for SMEs to access the funds they need. Whether through invoice financing, business lines of credit, crowdfunding, supplier financing, or government grants, SMEs have various options to explore. It is important for SMEs to carefully assess their business needs, evaluate the available options, and choose the most suitable method to secure working capital and fuel their growth.