Improving bso services and sme performance through cleaner production
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Improving bso services and sme performance through cleaner production
- 1. Improving BSO Services and SME Performance Through Cleaner Production [SPEAKERS NAMES] [DATE]
- 2. Module 8: Financing Cleaner Production 8.1: Understanding loan approval at commercial banks
- 3. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 3 Possible funding channels for CP Commercial Banks Company Shareholders (equity offering) Partners/ owners Leasing companies; equipment vendors Government-subsidized credit • Environmental revolving loan funds • Development banks & credit schemes • Ex/Im finance guarantee schemes International Development Assistance Internal sources Commercial sources Public/ODA sources Cash Credit cooperatives/ reserves unions Customer firms
- 4. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 4 Our focus: commercial banks ! Difficulties in accessing commercial credit are one of the largest challenges involved in implementing CP capital investments, particularly for SMEs. Many development organizations engaging in SME support projects and SMEs themselves have little experience in dealing with commercial banks ! ?
- 5. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 5 Background: Commercial Banks Commercial Banks: Acquire funds by receiving money from savers: savings accounts, deposit accounts, etc. Provide funds to borrowers through term loans, lines of credit, bonds, etc The interest payments on loans are used to pay interest to depositors & are a primary source of profit for the bank To be profitable/sound, commercial banks focus on: maximising their returns & minimising the risks they accept
- 6. ! Therefore: Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 6 their principal expertise is evaluating borrower credit-worthiness. . . not the performance of CP investments!
- 7. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 7 Commercial bank financing instruments For SMEs, commercial banks offer two main types of financing instruments: Term Loans Lines of Credit Issued for a specific project/purpose Specific amount and term (months or years) Interest rate will reflect risk & may be fixed over time or variable Can usually be used for any purpose Approved up to a credit limit. The customer can use any amount up to the limit. Higher interest rates than term loans. Interest is charged only on credit actually used. 1 2
- 8. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 8 Commercial bank loan procedures Commercial banks’ loan procedures have 4 basic stages Application Review Award Paying back, with interest applicant prepares proposal and submits to bank failure 1 2 3 Bank evaluates application and sets or negotiates conditions 4 We will examine at each stage in more detail
- 9. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 9 Commercial bank loan procedures Application a. Before applying to any particular bank, research and review potential funding sources b. Have initial informal discussions with bank loan officer c. Fill out bank’s loan application form; obtain all necessary data d. Submit the loan application and supporting documents to bank. Application 1 Establishing a personal relationship with the bank/loan officer is very important! !
- 10. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 10 Commercial bank loan procedures Application review and loan award Review Award 2 3 Review Negotiate terms* More information requested Commitment letter & term sheet Loan agreement signed Funds received Agreement on terms? YES NO *Terms include, e.g. interest rate, repayment period & collateral Review and award involve the following steps: Application
- 11. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 11 Commercial bank loan procedures What is the basis of the bank’s review? The bank’s review of the application is focused on two distinct aspects of risk: economic viability of the specific project the financial/economic status of the enterprise as a whole Often more important!
- 12. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 12 Basis of Review #1 Economic viability of the project How does the bank assess the economic viability of the project? ? NPV is the mostly commonly used overall indicator. HOWEVER, the bank will calculate multiple values for NPV using different assumptions regarding the performance of the project E.g. what is the effect on NPV of different sales, savings, schedules?
- 13. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 13 Basis of Review #2 Company financial and economic status How does the bank assess the enterprise’s financial and economic status? ? The bank assesses 3 Key factors: LIQUIDITY Is there cash on hand to pay day-to day operating expenses? SOLVENCY Does the company have the ability to repay outstanding long-term debt? Prospects for future PROFITABILITY and its implications for both liquidity and solvency over the expected term of the loan.
- 14. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 14 Barriers to Commercial Bank Finance for SMEs Small size of SME CP Projects Means that the bank’s administrative costs are very high compared to the profit it can make on the loan High perceived risk of lending to SMEs Insufficient accounting and business documentation (poor record-keeping) Limited banking track record (no history of obtaining and successfully repaying loans) Lack of security (collateral) For SMEs, access to CP finance is constrained by:
- 15. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 15 It is true that some barriers to commercial bank loans and (other CP financing) cannot be addressed by the SME alone ! BUT SOME BARRIERS CAN BE ADDRESSED
- 16. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 16 What can SMEs do to address these barriers? Understand banks’ decision criteria and analyse CP projects in these terms Improve record-keeping and management systems (utilize BDS services if available) Identify banks that do have SME lending programs; request an informational interview with a loan officer before applying
- 17. Module 8: Financing Cleaner Production 8.2: General trends in CP financing in developing areas
- 18. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 18 “Friendly trends” in commercial banking We have now discussed many barriers to financing CP projects at SMEs HOWEVER, THERE IS GOOD NEWS. Some current trends in commercial banking are “friendly” to CP financing: Increasing similarity among financial institutions Expanded commercial bank activity in developing countries Increasing interest in sustainable banking
- 19. Increasing similarity among financial institutions Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 19 Traditionally, different types of FIs specialized narrowly in their own areas. This is still true to some extent, but becoming less so. Many FI’s are expanding their product-ranges into others’ areas for borrowers, result is a wider range of potential sources of finance Be prepared to approach several different FIs of different types to raise finance on attractive terms !
- 20. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 20 Sustainable Banking FI’s are becoming more aware of their environmental responsibilities in lending. This emerging trend is focused in developing countries Thus, at many international banks, we see a shift. . . Passive with respect to environmental issues. Resist responsibility for environmental impacts of projects they finance Reject financing of environmentally damaging projects. Recognize business & social benefits of environmental investments From traditional passive attitudes. . . . . .to “sustainable banking”
- 21. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 21 Policy & development approaches to overcome finance barriers Business development service providers can work with SMEs, particularly to improve record-keeping FIs, to demonstrate that CP investments pay Special financing facilities for SMEs and for CP investments Civil Society & business associations: Lobby Government for supportive policies
- 22. Module 8: Financing Cleaner Production 8.3: SME Financing in XXX.
- 23. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 23 This presentation to be developed specifically for the host country context
- 24. Module 8: Financing Cleaner Production 8.4: Participants’ experiences in financing projects.
- 25. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 25 Group Exercise: Analyzing past funding experiences You will identify one or more past funding experiences to CHARACTERIZE and ANALYZE, answering the questions on the following slides. See exercise instructions in sourcebook
- 26. GROUP EXERCISE Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 26 Past funding experiences Analyze your funding experience by addressing the following questions: ? The basics: What was the project? ? The financing search: Which sources of finance were considered? Which sources were then approached? ? The application: What information was required to make the application? Could you provide this information? AND
- 27. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 27 Past funding experiences GROUP EXERCISE ? The review: What were the funder’s criteria for approving or rejecting the application? Were these clear? Did any problems arise during the review process? ? The outcome; terms and conditions: Was financing obtained? What were key terms and conditions? ! Lessons learned: What do you think is the reason for your success/failure? What did you do right? What would you do differently? What advice can you offer from this experience? Do you still have unanswered questions from this experience?
- 28. Past funding experiences GROUP EXERCISE Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 28 GROUP PRESENTATIONS.
- 29. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 29 Some lessons learned by participants in past courses PROBLEM Solutions that worked ! Project profitability is poor Re-evaluate profitability using total cost principles ! management is unable or unwilling to issue more shares or to raise debt Lease capital equipment rather than purchase it. ! the firm does not have contacts with commercial banks Make contacts through the chamber of commerce, BDS provider, accounting firm
- 30. Some lessons learned by participants in past courses Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 30 General Advice Rejection from one FI indicates little. Search widely for alternative sources of finance. The larger the number of possibilities you consider, the more likely you are to obtain financing... and on better terms If you are rejected, apply again when the national economic situation improves/ credit is loosened. Seek advice from experts and from contacts in other firms
- 31. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 31 ? Do we agree with these lessons learned? What lessons learned can we add? ? Are these lessons fully relevant to CP financing? ?
- 32. Improving MSME Performance through Cleaner Production. Module 8: Financing CP. Visit www.encapafrica.org. 32 Point for discussions
Hinweis der Redaktion
- These are, broadly, the main sources of finance which are usually available to firms for project finance. The firm’s business environment is the main determinant of which sources are most relevant. Internal funds can be generated by retained profits or capital supplied by the owner(s) of the firm. There may be several external private-sector sources, including other firms with whom the firm does business, who may be prepared to help with finance in order to protect their own interests. These may be suppliers of capital equipment, or finance companies associated with them (which could be through leasing arrangements), or suppliers and customers in the firm’s normal day-to-day business. Finally, the government can be a important supplier of capital to finance projects [mention any topical examples of current local programs]. Different institutions will weight differently the various criteria for making a loan. For example, a commercial bank will probably put highest importance on their assessment of the firm’s ability to pay interest and eventually to repay the loan (i.e. the bank’s risk of the firm defaulting), and on the return they earn on the loan (the interest which they charge). A development bank may be prepared to accept higher risk and a lower return provided that the project meets some specified economic development criteria. Note that credit unions are intermediate between “commercial” and “internal” sources, as only members can borrow from credit unions.
- A commercial bank provides a kind of marketplace within which, indirectly, savers who wish to invest their money safely but still earn a return on it can transfer it to borrowers who wish to raise finance, e.g. for company projects. The bank is rewarded for providing this service through the profit margin that it realises between:- - the low rate of interest that it pays to savers - the higher rate that it charges to borrowers In principle this could be achieved by the savers lending their money directly to borrowers. This would avoid the costs of operating the bank, and the bank’s profit margin. However banks add value to the process in several ways:- - scale: they can combine several small savings accounts and deposits into a larger sum, sufficient to finance a company project - duration: they are able to raise money from savers on short-term terms, so that savers retain liquidity, but make advances to borrowers on long-term terms - location: by raising money from areas or countries where savers exceed borrowers and transferring it to areas/countries where the opposite is the case - developing expertise in assessing risks by specialising in this skill Banks’ key concern is risk - if they consider that a particular company is more risky than the average, they may:- - add a risk premium to their lending rate and increase the cost of the loan to the company - insist on restrictions on the loan, for example to require security such as a mortgage on some of the company’s assets, to provide collateral If their assessment of risk is too high, they may refuse a loan altogether. Banks therefore become expert in assessing the risks of companies, and any possible extra risk posed by a proposed new project. Companies can increase their chances of success in loan applications by providing assurance to banks that they represent only low risks. In economies where several banks compete with each other, the rates charged will tend to be lower since the banks have to compete with each other for borrowers (as well as for savers), though a basic minimum will be set by the base rate set by the government or the central bank. Banks may differ in their evaluations of risk and their readiness to accept greater risk in return for charging a higher interest rate, so companies should be ready to approach several banks to find the best offer available.
- These are the two main ways that banks provide finance to small and medium-sized companies, i.e. the banks’ “products”. A term loan is for a specific period, and must be fully repaid by the end of the period. This may be either a single amount at the end, or (more usually) in instalments over the period of the loan. The interest rate is set when the loan is agreed, either at a definite rate throughout the period of the loan, or variable on a pre-defined basis such as in relation to the national base rates set by government or the central bank. Lines of credit (or “overdrafts”) are facilities by which companies can “draw down” as much as they need, up to a set limit, and pay for only what they use. The interest rate is usually higher than for term loans. Although they may be guaranteed for a set period, they can often be repayable on demand by the bank, so are not suitable for companies who wish to finance large-scale projects that require capital for a long period. Generally, term loans are likely to be more suitable to finance investment in fixed assets, whereas lines of credit are suitable for financing investments in short-term working capital (inventories, debtors etc.) which may fluctuate seasonally over time.
- Each bank will set its own detailed procedures by which companies can apply for finance, within this broad overall framework. This slide distinguishes between three stages in the process:- application: this is done by the company, so the speed with which this can be completed will be to some extent under the company’s own control. One source of delay can be the need to collect together all the information that the bank requires. Companies which have already set up good accounting and other information systems will be able to prepare and submit applications more quickly. Review. The bank will then evaluate the application and make a decision. The time that this will take will depend in part on how accurately and completely the company has completed the application. If there are gaps in this, the bank may have to come back to the company to request what it needs, which could cause further delays.
- These are the main steps in a typical loan application and approval process, although the details will differ between different banks, and perhaps between different types of project. [The list of steps continues onto the next slide as well]. It is valuable already to have a good working relationship with a bank, and previous personal contacts with their senior staff, in order to build up an impression of business ability and financial reliability. The first bank to approach will obviously therefore be the company’s main banker, with whom it keeps its current account. At the same time however, it is sensible to approach other banks as well, in economies where there is sufficient competition in the banking sector to make this possible. If each bank is aware that the company is considering a number of different banks, this will help to encourage them to make attractive their own offer to the company.
- To assess the financial position, the bank will want to review the economic feasibility of both:- - the specific investment project which is being proposed - the company as a whole. The latter will usually be the more important, since the liability due to the bank will be from the company as a whole, not a single project. Even if this project is unsuccessful, the bank can still demand repayment from the company’s other resources, provided the company as a whole is financially sound.
- Calculating different values of NPV for different assumptions is called sensitivity analysis.
- Assessing the viability of the company as a whole is less straightforward since there are several factors that can affect this. This slide lists the main questions about the company’s financial strength on which the bank will want to seek assurance. These are:- - liquidity - the ability to pay for its day-today operating expenses, e.g. payments to its suppliers, payments and utility bills. - solvency - the ability to repay, as they fall due, any long-term debts which are outstanding. - profitability - since if this is negative (i.e. if the company were trading at a loss) then over time this would erode its liquidity and solvency. It is what will happen to these factors in the future that matters, but this can only be estimated. Guidance on this, from what has happened in the past, may be obtained from the company’s accounts. These can be used to derive a number of indicators (or ‘ratios’) which reflect liquidity, solvency and profitability. These are also covered in Separate CP finance courses.
- This slide sets out the reasons as given by FIs as an explanation to their reluctance to lending to SMEs.
- SMEs can overcome some of these challenges by registering with local Business Development Service Providers to receive training in record keeping.
- There are a number of trends in commercial banking that may help companies wishing to raise finance for cleaner production investments. These are expanded on, in more detail, in following slides.
- There are a number of trends in commercial banking that may help companies wishing to raise finance for cleaner production investments. These are expanded on, in more detail, in following slides.
- Traditionally, different types of FI have tended to specialise in different sections of the market, and have offered distinctly different products. However, in recent years there has been a trend for companies to broaden their product ranges and to offer products that previously were offered by other types of FI. A COUPLE OF EXAMPLES HERE? For would-be company borrowers this means that there is a wider range of potential sources of finance, and companies should be ready to approach several different FIs, of different types, in order to raise finance on the most attractive terms.
- The trend to ‘sustainable banking’ is still very new, and mainly limited to banks in developed countries who wish to appeal to environmentally-conscious customers. However, it is possible that this could provide a further source of finance, on attractive terms, for companies wishing to finance cleaner production investments. This slide defines sustainable banking and refers to the landmark UNEP declaration that 118 banks have voluntarily signed, to recognise their responsibility to contribute to sustainable development and express a commitment to this. A progression can be defined, from the traditional attitude of banks to the environment, to more progressive attitudes. The traditional attitude can be described as ‘defensive’, with a reluctance to accept responsibility, and a tendency to react to possible new environmental legislation by lobbying against it. This attitude is probably still typical of a lot of the banking sector , but a number of banks are moving towards a more progressive approach [go on to next slide]. Sustainable Banking’ is an ideal, rather than something which any existing bank can be claimed to have fully achieved. This recognises that banks have a considerable potential to impact the environment, not only through their own banking operations but even more through their influence on the companies to whom they lend. This is recognised to be not only environmentally responsible but also good banking practice, since environmentally responsible investments such as Cleaner Production projects are likely to carry lower risks than other projects. For example, it is less likely that a project will have to be abandoned before the end of its full economic life due to tighter environmental legislation and regulation.
- This and the next slide list a number of issues and problems that can arise. Participants should share with their groups their past experiences related to these issues. It may be most effective to focus on a particular firm which is represented in the group which has had a particularly interesting and informative experience. Ideally, the perspective of both the fund applicants and the provider of capital should be presented in the experiences. Participants should be encouraged to consider not only project finance applications that were successful, but also those which were not, either because the application was rejected or because it did not even get to this stage since in the end the firm decided not make any application. The final bullet is on the criteria that were applied by the potential sources of finance. These may not have been clear to the firms - what is wanted here is what the firms’ perceptions of what the financiers were looking for. This may provoke some helpful comments from participants from financial institutions, and provide material which the banker can later address (if he/she is not yet at the course, the instructor should make notes on the comments made by participants to pass to him/her later).
- Terms and conditions” refers to interest rates, payback period, AND everything that the financier could require of the firm after the application has been approved and the finance has been granted. This could include requirements on:- - when and how the money should be spent - how the firm implements the project, e.g. any requirements concerning how a project management team is set up - information that the firm has to provide to the financier during the period that the finance is still outstanding. This last could include information either or both:- - the firm as a whole, e.g. its annual financial reports to demonstrate that it is in good financial health - developments with the specific project Lessons learned are the crucial questions - the conclusions that can be drawn from the experience which can help to inform and improve future project planning. The final question is particularly important - what gaps in knowledge by the firm did the experience demonstrate, which still remain unanswered? (The trainer should note these and report them to the banker, so that he/she can address them later).
- These are obviously not the only solutions to the problems identified. Hopefully, the group presentations will have suggested others.
- Past courses bear out that this general advice is frequently relevant. Hopefully, these points were raised by the group presentations as well. 1. It is worth approaching a wide range of different possible sources, both commercial and non-commercial. Even within a single sector there can be differences between institutions which do not reflect the attractiveness of the project. For example, one bank may refuse a project, or offer finance only on unattractive terms, simply because it is already over-committed in that sector, for which another bank would be happy to offer finance. 2. the availability of finance, on acceptable terms, may vary from time to time (and also from country to country) depending on the current state of the economy. Even if a project fails to attract finance when the economy is in recession, it could still be worth trying again when the economy improves. 3. There are several sources of independent advice on potential sources of finance, including the local accountancy profession, other business advisers, chambers of commerce and industry associations, and contacts from other firms (participants may be able to suggest more). Firms are well advised to build up and maintain databases of potential sources of advice even if there is no immediate needs for finance, in order to be able to move quickly if and when the situation does arise.