SME Methodology

SMEs are often described as the “missing middle” in access to finance.  SME’s have difficulty documenting their debt service to lenders.  Lenders have difficulty justifying the cost of building the information needed to justify positive credit decisions.  Business plans provided by consultants often lack credibility with lenders and may not even be understood by borrowers.  Needed is a way to enable:

• SMEs to better understand their own financial condition and performance and communicate this information credibly to banks.
• Banks to lower the cost of evaluating the risk profiles of SME customers and improve their credit appraisal, credit scoring, and credit monitoring capacity.

FMI and Global Financial Bridge provide a unique and cost effective approach to satisfying both these needs by providing an interactive bridge between borrower and lender that reduces the information asymmetry and facilitates financing decisions.  

Major Impediments to SME Lending
SME owners, bankers and development officials on four continents have provided valuable insight into the challenges to SME access to finance.  The consensus identified three principal problems: 

• First, the SMEs lack the know-how to provide standardized, transparent, understandable, and credible financial information to potential financial sources. 
• Second, bank credit policies are risk averse, and typically stress “clan and collateral” rather than cash-flow analysis and credit worthiness – in large part due to distrust of SMEs’ financial data.
• Third, banks, and other financial intermediaries lack the techniques and systems to efficiently assess credit worthiness and manage the SME repayment risk. 

Enabling SMEs in developing countries to expand their business activities and employment by leveraging their own resources through external financing is key to meeting USAID’s Economic Growth Objectives (generate rapid, sustained, and broad based economic growth). Effectively addressing these three impediments to access to finance for SMEs is essential to achieving this fundamental objective. The software addresses the financial information needs of both bankers and SME owner/managers. It bridges the information asymmetry gap (lack of standardized financial information) and streamlines a reliable evaluative process. 

Our methodology begins with a common, shared financial information communications platform, and employs it to bridge the gap between financial institutions and SMEs.   The methodology recognizes the importance of addressing constraints to SME access to bank credit that arise from SME inadequacies in their own operations.  The methodology enables SMEs to readily understand their financial operations’ results, and communicate these results to banks.  Our methodology simultaneously enables the bank to evaluate an SME’s credit worthiness by dramatically improving the bank’s financial analysis, credit scoring, and loan monitoring capacities.  Further, the methodology includes training bankers and SME owner/managers in a highly similar manner regarding financial management according to standard financial ratios. In this way, we bridge the gap between SMEs and banks, enabling them to converse on profit and loss, cash flow, financial projections, and evaluate credit worthiness to facilitate capital mobilization and build economies.

Key to Success
The problem is a failure to communicate across differing business cultures.  The solution is to provide a common language based on financial operations, financial performance, risk measurement, and creditworthiness.  When both the supply side (bankers) and the demand side (SMEs) learn to communicate on the same platform and methodology, then the three impediments to SME lending can be overcome.

The key to the success of the methodology is that it harnesses the key motive that ultimately drives economic activity:  the profit motive.  Banks will lend money when they are convinced it will be repaid at a profit.  Whatever a business does (make bread, construct walls, deliver products), its function is to make a profit.  Because banks and businesses have the fundamentally identical objective of making a profit, they must communicate in the language of finance.  Only when communication is about cash flow, cost of goods, and financial indicators can loans be made on credit worthiness (not clan or collateral), and thus much more capital will flow to SMEs.  This facilitates access to capital by the “missing middle” and results in sustainable economic growth, job creation, and increased standards of living.

Bank Value
The software enables the banker to efficiently evaluate the financial condition of the SME in an interactive format.  In less than 30 minutes, a banker trained in the methodology can enter a company’s financial data to arrive at an income statement and balance sheet and begin to evaluate the financial risk of an SME.  Depending on the level of the SME’s understanding of the bank’s requirements, financial information is captured in different ways:  1) through an interview process asking the SME key questions about his business such as revenue, costs of raw materials, operating costs, etc; 2) by importing financial data into the application from spreadsheets; or, 3) by entering data by line item directly into the application.

Once the data is captured, the standardized format of the software will generate financial statements and a set of financial ratios to enable the banker to analyze the financial risk, arrive at a credit score, and understand the financial management of the SME’s business.  Approximately 30 numbers are required to perform the total loan evaluation process.  This process dramatically reduces time, and thus transaction costs, permitting a greatly increased volume of SME lending.  Consider this comparison:   a U.S. bank loan evaluation takes an average of 12 hours and costs between $500 and $1000; the FMI methodology takes 30 minutes and costs between $50 and $100.

The software allows the bank executive to manage the SME Portfolio and conduct data analysis.  The program turns data into information, allowing the bank to successfully market, and profitably lend to creditworthy SMEs.  The software allows executives to view the summary of the bank’s SME portfolio (e.g., view new loan accounts added or net increase in loan outstanding),  examine trends by various factors (e.g., industry, geography, business size, loan size, etc.), and summarize the portfolio by various categories/industries (e.g., revenues, earning, working capital, interest cover, etc.).  This capability also permits benchmarking and “peeling the onion,” or the ability to disaggregate performance data at various levels of detail.

SME Value
SMEs uniformly acknowledge their inability to present a business plan in the financial terms a banker needs to process a loan application.  Training with the FMI software revolutionizes the SMEs ability to communicate to bankers in the requisite language of finance. The software helps the SME enter financial data to produce an internationally accepted income statement and balance sheet, and a set of financial ratios. 

SMEs frequently complain that they do not understand the loan application process, nor how to communicate to banks in terms bankers understand.  FMIs training and software program introduces them to financial concepts based on practical examples, and assists them in better understanding the operations of their own firm.  Our approach of “working both sides of the street” empowers SMEs by facilitating their understanding of why (or why not) their financing needs are met by a bank.  No longer will an SME owner/manager be able to say, “I do not know why we did not get financing.”