The Effect Of Financial Constraints On Small And Medium Enterprises Finance Essay

The Effect Of Financial Constraints On gauzy And Medium Enterprises Finance screenCHAPTER 1IntroductionThe relation between pecuniary admitts and the pick and result of the SME has been muniment across Africa and world. The investigateer go forth look at the thrift of Kenya and bewilder evident of the fiscal constraints that argon facing the diminished and mean(a) enterprise indeed affecting the option and product of micro and average surface enterprises. There is a need to question in this product line since the SME atomic matter 18 the bunsbone of the Kenyan economy. In situation with the growing inflation, non to mention the difficulties the SME take in accessing the monetary aids they atomic number 18 dimly making it to the second birthday.Overview of the ContextKenyan is a exploitation estate in Africa. The increasing role of the SME welkin is con squ ared by the late completed Kenya 2003 sparingal Survey, According to the keep up, total e mployment recorded in the in coordinateulateal arena increased from 3.7 employees in 1999 to 5.1 million in 2002, era the imposing sector increased tho from 1.74 million to 1.76 million employees during the identical period. However, the ontogeny of the informal sector in add of employees does non of necessity reflect re make for and high productivity of the enterprise itself, as the come up of informal sector companies grew largely beca ingestion of the depressed formal economy and nether employment in the formal heartys.Having said that, the SME in Kenya faces a plenty of ch on the wholeenges and one of them is the financial constrains which sincerely inhibits its harvest-time and natural pickax. Hence the call for this explore paper. The police detective appropriate out use the research methodologies to extract record that satisfyingly financial constraints is a study factor that affect the emersion and survival of the SME in Kenya.Statement of the probl em.In Kenya, SME wee-wee little access to pay, which frankincense hampers their emergence and eventual issue and survival. Financial constraint preserve a major challenge facing SME in Kenya Wanjohi and Mugure (2008) and this allow be evidence in this research paper. Their main sources of pileus are their retained pelf and informal savings and bestow associations, which are unpredictcapable and not very(prenominal) secure.SME plenty rarely meet the conditions set by financial institutions, which square off them as a risk because of little guarantees and lack of teaching just about their ability to repay loans. The financial system in most of Africa is infra-developed still and so nominates few financial instruments.The researcher has come up with slightly of the reasons why SME strike it hard to access pay in Kenya risque interest judge by the financial institutionsDelay in the loan processing due to lack of securities and an separate(prenominal) requirements by the financial institutions. many of the SME do not brook a good track records hence most of the topical anaesthetic chamfers fear to give them the unsecured loans.Banks are especially nervous of weensyer tradees due to a perception that they represent a greater denotation risk. Kariukis (1995) check of trust credit access in Kenya illust pass judgment this point further. A survey of 89 small and sensitive-scale self-coloureds in manufacturing and assist industries, combined with secondary entropy from commercialised banks, found that from 1985 to 1990 the average real volume of credit for the sample firms fell, except for the year 1986 which showed a peripheral increase of 1.5 per cent. low-down scale assumeers were found to be faced with high nominal interest evaluate at higher inflation frame in the latter half of the 1980s. Moreoer, the explicit transactions costs of borrow were found to be high in relation to interest costs.Because the information is not available in new(prenominal) ways, SME result have to provide it when they seek pay. They will need to give a note plan, key of the company assets, details of the experience of directors and managers and demonstrate how they deal give providers of finance some security for amounts provided.The researcher blotd that in the current background of the most severe financial and economic crisis in decades, various factors such(prenominal)(prenominal) as increased risk aversion, decreased liquidity, bleak prospects for economic growth, etcetera are having or are expected to have a highly negative loading on SME and entrepreneurs access to short and long edge financing. comminuted firms are particularly vulnerable becauseIt is to a greater extent difficult for them to down coat since they are already small.They are individually less diversified in their activities.They have weaker financial structures or unhopefuler chapiterization.They have lower or no credit ratings.They are heavily imagineent on credit.They have less options for finance, especially in financial markets. With this in view, the measures that most presidential terms are victorious or planning to take to counteract the set up of the crisis and stimulate their economies should allow easing SME and entrepreneurship access to finance. Numerous money lenders in the name of benefit schemes comes up, promising hope among the SME that they end make it to the financial freedom by soft borrowing. The rationale behind turning to these schemes among a good number of entrepreneurs is mainly to seek alternatives and soft credit with low interest pass judgment while making profits.ObjectivesThe general objective of the research is to establish the operations that the financial constraints have on the survival and growth of the small and fair enterprises in Kenya.Some of the specific objective that the researcher will bare in the study will evolve around the small and medium sized enterprises in Kenya.To establish effect of economic activities on the survival and growth of the SME in Kenya.To assess the impact of high interest rates by local commercial banks on the survival and growth of the small and medium sized enterprises in Kenya.To establish the effect of commercial banks impart policies and access to credit on the growth and financial performance of SME in Kenya.To establish the effect of the firm capital structure on the growth and survival of the small and medium enterprises in Kenya.To establish the impact of government policies in Kenya on the economic growth on the survival and growth of the small and medium wrinkle.1.5 Research QuestionsHow do high interest rates affect the survival and growth of the firm in Kenya?What effect do the banks lending policies and access to credit have on the growth and survival of the SME in Kenya?How do the government policies in Kenya on the economic growth affect the survival and growth of the small and medium sized headac he?What effect do the external borrowings have on the survival and growth of the small business enterprises in Kenya?How the economic activities affect the growth and survival of the firm in Kenya?1.6 The significance of the study. lessened and medium sized enterprises are the backbone of virtually all economies in the world. However, the process has long been restrict by the special availability and accessibility of financial resources to meet a variety of actional and investment needs within the SME sectors. SME and entrepreneurs play a significant role in all economies and are key agents of employment, launching and growth. A significant number of entrepreneurs and SME could use funds productively if they were available, besides are often denied access to financing, thus impeding their creation, survival and growth. Although SME form a broad spectrum as far as their relative size, sector of natural action, seniority, location and performance are frettinged there is a ratt ling need for innovative solutions for their financing in particular for innovative and high- growth SME in a globalised knowledge-based economy.The researcher however will be elicit to know how does this financial constraints really affect the growth and survival of SME and she will undertake the study t establish the necessary fact that make the growth of SME restrained in Kenya.1.7 The scope of the study.The Kenya government is commitment to advance the growth of SME emerged as one of the key strategies in the 1986 level frugal Management for Renewed Growth. It was reinforced as a priority in the 1989 report, The Strategy for Small Enterprise Development in Kenya a document that set out the mechanisms for removing constraints to growth of the SME sector. In 1992, the government published the SME insurance policy report, Sessional Paper No. 2, Small Enterprises and Jua Kali Development in Kenya. This report was reviewed in 2002, leading to a new policy framework that provides a balanced focus to SME development in line with the national goals of procreation growth, employment creation, income generation, poverty reduction and industrializationSME in Kenya have not seen much development since Kenyan independence due to financial constraints and other factors that are not going to be discussed on this research paper. Small enterprises have a potentiality of boosting a kenya economy. Although they are faced by many challenges, they still have opportunities to grow. These include linkage with multinational companies, networks with other businesses, diversification of market and products, enabling environment and franchising opportunities which is geatly being encouraged the conglutination government that is currently running the government of Kenya although the impact has yet to entangle on the small and medium enterpeises due to its size and limied resources.CHAPTER 2lit REVIEW2.1 Introduction.Kenya being a developing country, the researcher will borrow some of empirical research done by experts in other developed and developing countries.A large number of empirical studies have addressed the issue of financial constraints, mainly in order to study the relation between the firms investments and the availability of home(a) and external funds. Under perfect(a) capital markets, internal and external sources of financial funds are perfectly substitutable Modigliani and Miller (1958), so that the availability of internal funds should not affect investment decisions. Small firms cannot exploit economies of scale in the aforesaid(prenominal) way as large firms can they face more financial constraints. Since young companies have not accumulated sufficient cash mix and are unable to rely on bank financing, they have to depend on the equity investments. The analysis of the effects of financial constraints on the firm survival and growth therefore is most-valuable.2.2 Theoretical account of financial constraintsThe financing constraint literature has been the first to recognize that partitioning firms helps to provide important insights into their behaviors. The pioneers in this field have undoubtedly been Fazzari, Hubbard and Petersen (1988) who point out the fact that firms are definitely not homogeneous. They classify firms harmonise to their dividend payout ratio. Their main occupy in doing this is to show that firms that have unlike dividend payout ratios and therefore belong to different categories, have differential access to finance. Some firms are financially cumber while others are not. Following Fazzari, Hubbard and Petersen (1988), a number of studies have seek to recognize between various categories of firms. For instance, Whited (1992) uses measures of indebtedness, interest coverage, and whether or not a firm has a bond rating to discriminate among firms. Kaplan and Zingales (1997) use twain quantitative and qualitative selective information to distinguish among firms.Bond et al (1999) class ify firms according to whether a firm operates in a bank-based or market-based system.Cleary (1999) uses a financial constraint index to differentiate between firms, which takes into account a number of factors such as firm liquidity, leverage, profitability, and growth. Carpenter and Guariglia (2003) use the number of employees to distinguish between large and small firms. However, the factor common to all these studies is that they have tried to discriminate only within firms that have access to capital markets.A high pctage of Small and Medium Scale Enterprises sojourns in the informal sector with limited opportunities for growth. Africa has one of the largest informal sectors in the world, instauration Bank, (2006). In Kenya the availability of finance tends to be extremely limited and difficulty to get external financing as researcher came to capture out on this quest on the Kenya town and from the SME managers. The SME financial resources are ordinarily restricted to equit y capital and bank debt to those who are able to access it. As the business establishes itself, however, it gains access to resources from its own productive activity and sources of external finance. According to Aghion (2007), access to external finance improves market selection by allowing small firms to be more competitive. Additionally, financial accessibility significantly facilitates the growth of firms. Unlike large firms, SME are restricted in their backing options. Therefore, a new hierarchy of sources of finance for SME can be defined. In this new hierarchy of sources of finance for SME there are three sources of finance, internal finance, debt finance and new capital contributions. Large firms that have access to capital markets are able to issue equity however, SME do not unremarkably have access to this form of finance of new capital contributions represent of new debt financing Cost of internal finance2.3 The Financial constraint variablesAccording to many studies, small firms do not even recognize their own growth potential Scott Rosa (1996).This is more evident in the research since most of the managers of the small and medium size enterprises are more concerned about the survival of the firm rather than the growth of the firm in most Kenya region. This research however will look at some of the variables that help to clarify this phrase in the Kenyan market.2.3.1 The effect of government policies.Similar evidence witnessing the lack of importance given by small scale enterprises to tax policies is withal found in southern Africa, including Niger, Botswana, Swaziland, Lesotho, Malawi, and Zimbabwe Mead (1994). Studies for these locations found little concern for government regulations, except from those enterprises concentrated in targeted locations and specific sectors such as food processing. Instead the greatest concern for the majority of those surveyed was the lack of access to working capital, credit and finance.2.3.2 The effect of commercial bank lending rates and access to credit.According to Holmes and Kent (1991), SME are characterized by 2 factors they cannot issue equity and are concerned about willpower and control. Small firms usually do not have the option of upshot additional equity to the public. Even if they were able to issue private equity, managers of SME would restrain from doing so as issuing equity would lead to a dilution in ownership and control. Therefore, managers of SME will usually prefer to go for debt financing, mainly comprising of bank financing. On the other hand, managers of larger firms usually consider a broader range of funding options.As Steel (1994) highlights, high transactions costs and risks associated with small loans, a lack of collateral and an historical orientation towards larger enterprises, bear to restrict small scale enterprise access to formal credit. This no different from Kenya where access to credit is really issue and Kariukis (1995) study of bank credit access in Kenya illustrates this point further.2.3.3 The impact of government policies information on the SME sector in Kenya is scarce, although the internal SME Baseline Survey provides omnibus(prenominal) and reliable information it has not been updated since 1999 and does not contain information for medium-sized firms. The survey indicates that the contribution of the SME sector to gross domestic product increased from 13.8 percent in 1993 to 18.4 percent in 1999.Thia shows that the government policies put in place in Kenya as well do affect the growth and survival of the small and medium size enterprises.2.3.4 The effect of internal capital structure.It should be noted that growth is not the objective of all firms. For example, when firms are faced with serious difficulties during periods of economic downturns, they may shift their objective from growth to survival waiting for better economic conditions to expand. This has been observed in crisis economies where firms down size and try to keep their costs as low as possible until the economic situation improves. Some firms may opt to remain small if their entrepreneurial capabilities are inconsistent with large size because financial constraints force the poor to start small business, the lack of firm growth could result in genial immobility where the small firms remain poor. On the other hand, if small firms have the potential of becoming large, poor firm owners could become rich as their firms expand. Moreover, firm growth in Africa, where technology is usually labour intensive, is usually associated with job creation, which in turn is the key to poverty reduction. Therefore, whether firms have potential to grow or remain small has important policy implications. Slow growth of firms in Africa has been explained as being the result of the lack of access to financial resources McCormick et al. (1997) and Biggs and Srivastava, (1996). This is particular to developing economies where financial markets are under-developed.2.4 Conceptual Framework.The financial constrained as depict above is a diverse business phenomena that need to be researched since its the back bone of any business growth and survival may it be a small business in the slums or a major manufacturing business. The researcher is mainly focused on the small and unquoted firms in Kenya. The local commercial banks have a role to play in all this and so is the government. The firm own capital structure also do contribute a lot to the survival and growth of the firm. In Kenya the economic activities that are carried out also influence a lot the GDP of the country hence the economic growth.CHAPTER 3METHODOLOGY3.1 IntroductionThe researcher will mainly use secondary research methodology although the tertiary methodology or the search tool will also be used for the purpose of this research. This will include books, magazines, newspapers to collect data and information regarding the topic. The researcher will also make use of the internet to sustain information about SME and other related information. Secondary data are data that have been collected for some other purpose. Secondary data can provide a useful source from which to answer the research question(s). Punch (1998) mentions several advantages of using existing data. Expenditure on obtaining data can be significantly reduced and data analysis can begin immediately, so saving time. Also, the quality of some data may be superior to anything the researcher could have created alone Thomas (2004). On the other hand, the chosen research method also has several disadvantages such as data that have been gathered by others for their own purposes can be difficult to interpret when they are taken out of their captain context. It is also much more difficult to appreciate the weak points in data that have been obtained by others.3.2 Research AreaThe propose research area is the SME in Kenya. The length of time within which to finish this expulsion w ill be estimated one month since time and resources might be a major constraint. The researcher proposes to choose at least(prenominal) 15 major towns in Kenya since Small business are all over the country and do research in a at least 10 firms in each town, so as to capture the operation of financial reporting in the country so as to get whether financial constraints are really a major constraint in the survival and growth of small and medium size business in Kenya.As a mean of testing the hypothesis of the study, the researcher will apply the methods below of data collection.3.3 ObservationTo judge the effect of financial constrains on survival and growth of a small business in Kenya. The researcher will have to visit the local banks and financial institutions and find out how ones access to finance limits the growth of the business. I propose to use time-series method to judge the observation. The observation will assist me to ascertain that the formal financial sector has prov ided very little or no proceeds to small business men hence they are unable to finance their small business.3.4 InterviewThis will be posted individually. Structured and unstructured questions will be used to collect information on the subject under investigation. This is to help the researcher obtain responses to questions like in your view is business growing? How best can it be financed? ,and others. I propose to conduct the interview in such a manner that each sector will have equal probability of being selected. Interviews will modify me to do most of the qualitative part of my research, and the information gained here is usually more realistic.3.5 QuestionnaireI will prepare systematic and well make questions that will enable me have responses to the questions raised in the introduction and nevertheless test the hypothesis of the research. This is demonstrated in Chapter 1 where several questions to this effect have been formulated.3.6 Data analytic thinkingI will not on ly rely solely on the information from the various responses from the varied sectors but, also the statistical publications from international organization in Kenya who have done a similar research on SME. I propose to make a thorough analysis of the official and unofficial data received. I will propose the use of quantitative and the qualitative analysis.REFRENCESPunch, K F. (1998), Introduction to social research Quantitative and qualitative approaches.Kariuki N (1995) The Effects of Liberalization on Access to Bank Credit in Kenya, Small Enterprise Development, 6 (1), 15-23Central Bureau of Statistics, International Center for Economic Growth, and K-Rep Holdings, National micro and Small Enterprise Baseline Survey, 1999.Central Bureau of Statistics, Ministry of Planning and National Development, Economic Survey, 2003Wanjohi, A.M. and Mugure, A.(2008). Factors affecting the growth of MSEs in rural areas of Kenya A grammatical case of ICT firms in Kiserian Township, Kajiado Distri ct of Kenya.Republic of Kenya (1992). Sessional Paper No. 2 on Small Enterprises and Jua KaliDevelopment in Kenya. Government Printer, NairobiBiggs, T. and Srivastava, P. (1996) morphological Aspects of Manufacturing in Sub-Saharan Africa Findings from a Seven Country Enterprise survey, World Bank Discussion paper No. 346.Modigliani, F. and Miller, M. (1958), the cost of capital, corporation finance and thetheory of investment.Aghion, P., Fally, T. and Scarpetta, S. (2007) Credit constraints as a barrier to the entryand post-entry growth of firms, Economic Policy, vol. 22 (52) 731-790.Savignac, F. (2008) The impact of financial constraints on innovation what can be learned from a direct measure? Economics of transmutation and New Technology, Volume 17 (6)553-569.Petersen, M. and Rajan, R. (1994) The benefits of firm-creditor relationships Evidence from small business data, diary of Finance, 49, 3-38.Aghion, P., Fally, T. and Scarpetta, S. (2007) Credit constraints as a barrier to the entry and post-entry growth of firms, Economic Policy, vol. 22 (52) 731-790.World Bank. (2006) Doing Business in 2005. The World Bank. Washington D. C., USA.Scott, M. Rosa, P. (1996). assurance Has Firm Level Analysis Reached its Limits? Time for a rethink. International Small Business journal 14, 4, 81-89.Mead D (1994) The legal, regulatory and tax framework and small enterprises, SmallEnterprise Development, 5 (2), 10-17Steel W (1994) Changing the institutional and policy environment for small enterprise development in Africa, Small Enterprise Development, 5 (2), 4-9Kaplan, S. and L. Zingales (1997), Do investment-cash-flow sensitivities provide useful measures of financing constraints? every quarter daybook of Economics,112, pp169-216.Whited, T. (1992), Debt, Liquidity Constraints and Corporate InvestmentEvidence from Panel Data, Journal of Finance, 4 ,pp1425-1460.Kaplan, S. and L. Zingales (1997), Do investment-cash-flow sensitivities provide useful measures of financing constraints? Quarterly Journal of Economics,112, pp169-216.Carpenter R.E and A. Guariglia (2003), Cash Flow, Investment and Investment Opportunities New Tests using UK add-in Data, Unpublished.Fazzari, S., G. Hubbard, and B. Petersen (1988), Financing Constraints and Corporate Investment, Brookings Papers on Economic Activity, 1, pp141-95.Holmes, S. and Kent, P., (1991), An Empirical Analysis of the Financial Structure of Small and Large Australian Manufacturing Enterprises, Journal of Small Business Finance, 1 (2), pp141-154.QUESTIONNAIRES.Why did you choose to start a business in this area?Does your business follow the government policies in regard to paying taxesYes No What is the number of the employees in your business?How is the business in this area affected by the economy trends preferring at the moment?Who is the highest rank member of your business?What is the annual turnover of your business?Where does your business get the initial capital to start it up?What is your so urce of financing?What form of financial instruments do you have in place?Which banking or financial sectors do you operate in your business?How do the interest rates affect your business?What are some of the difficulties do you experience when acquiring bank access?What can you say is the reason for your business also-ran to grow?How is the government policies put in place in Kenya fortune you achieve your financial goals?What are the major issues does your enterprise face when accessing credit facilities in the banking sectors in the Kenya?What would you say is the challenge facing the small business in Kenya in terms of finances?