Introduction and Background
In Nigeria, available
data from the Registrar General Department indicates that 90% of companies
registered are micro, small and medium enterprises (Mensah, 2004). This target
group has been identified as the catalyst for economic growth of the country as
they are a major source of income and employment to many Nigeriaians. According
to Mensah (2004) Small enterprises employ between 6 and 29 employees with fixed
assets of $100 Thousand with Medium enterprises employing between 30 and 99
employees with fixed assets of up to $1 Million, Hallberg (2001) put forward
that SMEs account for majority of firms in an economy and a significant share
of employment. Like other countries of the world, SMEs in Nigeria have the
tendency to serve as sources of livelihood to the poor, create employment
opportunities, generate income and contribute immensely to economic growth.
Small firms are the engines for economic development of several developed
countries such as the US and Japan (Hallberg, 2001).
countries such as Zimbabwe have also identified the potential of small firms to
turn economies with negative growth into vibrant ones. For this reason, several
governments in developing countries offer funding to small firms either
directly or by guaranteeing the payment of such loans as lack of funding is
cited as one of the major challenges faced by small businesses. Obert and
Olawale (2010) argues that due to limited resources by governments, not all
small firms receive funding from the government; therefore, the other option would
be to go for bank loans Obert and Olawale (2010). Despite its increasing
roles, access to credit by
remains one major constraint to Nigeriaian SMEs. According to Augusto et al
(2008), most large companies usually start as small enterprises, so the ability
of SMEs to develop and invest becomes crucial to any economy wishing to
countries’ definitions of what constitutes an SME for legal or statistical
purposes are typically based on the number of employees, banks generally define
SMEs in terms of average annual sale; an indicator that is more easily
observable, a good proxy of an SME level of business activity, and, thus, more
useful to banks’ business and risk management purposes (Augusto et al 2008).
Augusto et al (2008) further points out that the threshold of annual sales used
by banks varies by country, according to the size of the economies and
structure of their corporate sector. Augusto et al (2008) hints that in
Argentina, a company is considered to be an SME when its average annual sales
are approximately between 300,000 and 30 million US dollars. In Chile, the
range goes from around 90,000 to 24 million US dollars.
banks consider SMEs those firms with annual sales between 400,000 and 13
million US dollars (although for most domestic banks the range is between
100,000 and 5 million. In Serbia, SMEs are typically defined as having annual
sales between 500,000 and 10 million Euros. A vast number of data on SMEs in
Nigeria also suggest SMEs are more financially constrained than large firms.
For example, using data from 10,000 firms in 80 countries, Beck et al (2006)
showed that the probability that a firm rates financing as a major obstacle is
39% for small firms, 38% for medium-size firms, and 29% for large firms.
states that a major barrier to rapid development of the SME sector is a
shortage of both debt and equity financing. However Mensah (2004) postulate
shortage occurs because Equity investors seek highest return consistent with
risk of the investment and since SME investments are difficult to evaluate,
their investments take time to mature and among others major institutional
investors such as insurance companies are not allowed to invest in private
SMEs. Hence there are many who believe that the single most important factor
constraining the growth of the SME sector is the lack of finance.
There are many
factors that can be adduced for this lack of finance according to Mensah
(2004). For instance a relatively undeveloped financial sector with low levels
of intermediation; Lack of institutional and legal structures that facilitate
the management of SME lending risk; High cost of borrowing and rigidities
interest rates. Thus Because of the persistent financing gap, many
interventions have been launched by governments and development partners to
stimulate the flow of financing to SMEs over and above what is available from
exiting private sector financial institutions. Karimunda and Barumwete (2006)
put forward the fact that, there are several reasons why a SME need a loan such
us the financing of new branches, of new projects and more. Companies do not
always have the capacity for finance their own business that is why they have
sometimes to turn to other financers. However, when companies need new capital,
they firstly resort to their internal generated funds.
sources, SMEs turn to equity financing by addressing closely related investors.
These sources exhibit very low costs and may be for example equity capital from
the owner, family or friends. Despite these, there are others types of
financing that one can use: external equity financing and external debt
financing. For SMEs, possibilities for using external equity finance are
limited since the majority of these companies are privately managed. Companies
can also use venture capitalist as alternative means of equity financing.
these possibilities are difficult for SMEs since most of them do not always
meet the return expectations. They thereby become less attractive for this
group of investors. Other alternatives to financing are private placements and
corporate bonds. Unfortunately, these types of financing are too expensive for
SMEs or have limited resources. Therefore bank loans seem to be an appropriate
way to finance SMEs’ capital requirements and seem to be an appropriate way. As
a result, SMEs prefer most frequently debt funding by bank loans. The bank
financing is tremendously attractive and seems to be realistic and a more
reliable source to SMEs. Mensah (2004) states that recently, as banks and other
financial institutions have sought to broaden their loan portfolio, SMEs have
become an increasingly attractive customer group. Traditionally, however,
financial institutions in Nigeria have been cautious with lending to SME groups
because of high default rates and risks associated with the sector. Few banks
have therefore developed an explicit policy for SME target groups taking the
particular requirements and needs into consideration, an example is the
development of customized financial products and appropriate credit management
few banks have SME specific loan products, and many of these are donor funded.
Since SMEs are scarcely finance by equity due to risk in its operation amongst
others, the last resort is thus debt financing and this is usually financed by
financial institutions through the granting of loans. Debt financing according
to Ayadi et al (2009) continues to be the primary source of financing for SMEs
in Europe, much more important than venture capital. This implies, for one
thing, that an efficient functioning of credit markets is of utmost importance
for SMEs – and the economy at large – to thrive. This problem seems to be
particularly severe in transition economies, whose catching-up may suffer from
of SMEs from external bank finance. Of recent, there has been an increase in
the recognition of the role played by small firms in national economies. Their
contribution to job creation and poverty alleviation has been recognized by
several governments of developing countries to the extent that they now include
them in their development plans.
(2005) proposed among the support structures include offering funding to the
small firms’ sector, usually at concessionary rates. But whether the use of
such debt improves the profitability, thereby enhancing sustainability, is not
well known Abor (2005). However, despite the importance of the small business
sector, access to finance is a frequently cited problem. Sources of capital are
more limited for SMEs compared to large firms.
unlike large, particularly publicly-listed firms, SMEs do not have the option
of issuing shares or debentures in the capital market. Even if they are allowed
to participate in the capital market, the high transaction costs associated
with publicly issued debt and equity will be too expensive for them. Owing to
their inability to access the public debt and equity markets, SMEs tend to be
heavily reliant on commercial banks as a source of debt financing (Berry et
al., 2002). Research by Berry et al. (2002), documents the reliance of
SMEs on bank debt as a source of financing. These researchers, however, point
out that access to bank debt is, paradoxically, a frequently cited challenge
are often relatively new and lack a consistent track record of profitability
that would demonstrate the capability to repay a loan. In addition, many SMEs
lack assets that could be used as collateral. SMEs are also more prone to
financial distress and failure. Commercial banks, because of these factors,
consider lending to SMEs a high risk. Therefore, commercial banks often deny
loans or offer loans to SMEs at higher
of interest to accommodate the perceived high credit risk of SMEs according
and Cohn (2001). The inaccessibility of debt finance to SMEs can further be
attributed to information asymmetry. Rwelamila et al. (2004) indicates that
this arises when one party to a transaction has better information than the
SMEs may have
more information about their future prospects than the banks. Since banks do
not have the necessary information, even small firms with profitable investment
opportunities are turned down when requesting credit facilities. Banks,
therefore, introduce restrictive covenants and also collect collateral from
small firms to mitigate this problem Bose and Cotheren (1997).The question is
what the impact of this loan on these SMEs is? Traditionally, debt finance has
been viewed as less expensive than equity. It furthermore has been used both to
decrease the average cost of capital and enhance shareholders returns.
is a negative side to debt, since interest payments must be made regardless of
market conditions. This vulnerability is an important factor that firms must
consider when making capital structure decisions. In addition Glen (2004) states,
there is a very strong economic and statistical link between macroeconomic
variables and a firm’s ability to meet debt obligations. The macro-economic
environment implies the level of aggregate demand, the level of interest rates,
and the level of inflation. A positive macro-economic environment results in a
rise in aggregate demand and positively impacts on the ability of a firm to
meet debt obligations.
The ability to
service debt becomes problematic when the macro-economic environment
deteriorates; resulting in the insolvency of firms (Glen, 2004). Rwelamila et
al. (2004) affirm that, during the early stages of starting a firm, many
commit themselves to the use of debt, which might be one of the sources of
available to them. The use of debt can be disastrous, as high interest rates
and unfavorable repayment schedules are often overlooked due to the pressure of
financing the firm.
background, the study investigates whether SMEs in developing countries can use
debt and still remain solvent in this era of high interest rates. Furthermore,
SMEs often pay interest premiums and a host of non-interest fees such as
application and other transaction fees when borrowing from commercial banks.
The cause of this is that SMEs are considered a high credit risk compared to
large firms. This high cost of funds because of increased risk increases the
costs of debt for small firms.
the above, SMEs serve as sources of livelihood to the poor, create employment
opportunities, generate income and contribute to economic growth. There is also
the potential of small firms to turn economies with negative growth into
vibrant ones, not to mention the fact that most large companies usually start
as small enterprises, so the ability of SMEs to develop and invest becomes
crucial to any economy wishing to prosper. From the argument above the only
easier finance options for SMEs are loans (Debt financing) assess from
financial institutions, thus it’s necessary to examine the impact of these
loans on the performance of SMEs. Are they having negative or positive impact
on their performance .this is worth investigating because majority of the
businesses fall within the SME category especially in developing countries.
objective of this work therefore is to investigate the contributions of
loans to SMEs
objectives of the study are:
find out what SMEs classify as disadvantages and advantages of accessing loans.
find out how loans provided by financial institutions are utilized by the SMEs.
investigate whether loans to SMEs actually lead to increase in stated
performance or otherwise.
are the disadvantages and advantages of taking a Bank Facility?
do SMEs utilize loans?
SME loans affect performance ?
1.5 Relevance of
A research of
this sort is necessary with respect to the fact that;
the SMEs have been accepted as the engine of economic growth and for promoting
equitable development. Thus its leverage should be of great concern.
finance has been identified as a key element for SMEs to succeed in their drive
to build productive capacity, to compete, to create jobs and to contribute to
poverty alleviation in developing countries.
business especially in Africa can rarely meet the conditions set by financial
institutions, which see SMEs as a risk because of poor guarantees and lack of
about their ability to repay loans. Without finance, SMEs cannot acquire or
absorb new technologies nor can they expand to compete in global markets or
even strike business linkages with larger firms (UNCTAD, 2002).
Type of research
will be descriptive in nature and employs the survey method in assessing the
impact of loans on SMEs development Nigeria. In order to effectively conduct a
valid analysis in the presentation and analysis of the data collected on the
research field, the researcher will use descriptive statistics such as tables
and charts to depict the relevant data. The study will utilize primary sources
of data in which structured questionnaire are extensively used.
The purpose is to generate data about
the opinion and perceptions of SMEs owners in relation to the effectiveness of
loans to the performance of their companies. Thus, in addition provide means of
analyzing the likely impact of loans on SMEs.
Scope of study
The research covered the whole SME
industry in Nigeria since one SME was picked randomly from each sector .namely
primary, secondary and tertiary. Thus making it more representative of the
overall Nigeriaian industrial sector.
Although the data collected concentrated
on one SME each from each industry, it might not have reflected a true
representation of realistic issues, but at least it showed a bit of what
happens in each Segment. Another limitation may the fact that a single
researcher collected and analyze the data. Because of this, some explanations
skewed toward personal
interpretations to distort the meaning of the results. The research is also
constraint with time since the time frame for the thesis is limited.
Organization of the Study
The study is
divided into five main chapters and each chapter is divided into various sub
one is the general introduction. It
elaborates on the setup of small and medium enterprises (SMEs) and its
financing options among others reviews also focuses on the impact of loans on
SMEs and presents problems identified. It also presents the research
objectives, rational, methodology and scope of the study.
two reviews literature related to the
problem under study. It mainly reviews literature on Small and medium
enterprises and access to finance, Alternative sources of financing SMEs.
the methodology and approach for the study.
four focuses on the presentation of data and
analysis of the data collected. It starts with the test Accessibility to
loans and moves on to establish loans Contributions toward SMEs Sales and
Marketing Activities and overall performance. Chapter five which is the final
chapter is the presentation of the major findings, conclusions and