SME is the one that provides a strong base to the economy of any country

Credit & Marketing Department 
Askari Leasing Limited

Dec 27, 2004 - Jan 02, 2005





Today, if largest profit organizations are investigated, it becomes evident that they started off as an SME. At present, It's an open secret that these largest companies have their birth as an SME, backed by some idea, hooked by some entrepreneur. For example, Honda Company, today is one of the largest car manufacturing company in the world, renowned for quality product and its brand is recognized all over the world. The idea was started by Mr. Honda who was fascinated by motorcycle and thought to bring this idea to market. Mr. Hery Ford, who used to tinker with engines in his garage, initiated Ford Company which revolutionized auto manufacturing and brought the concept of assembly line manufacturing to the world. IBM, the world largest computer manufacturer company was started by Mr. Watson, whose idea to bring computer to market generated, through selling typewriters to the offces. All of them and many more had their inception as an SME.

Amongst the gamut of sectors, SME is the one that provides a strong base to the economy of any country. But today, in Pakistan SME are in worst of conditions. We must realize the axiom, that without the growth of SME sector, no body can reshape their economy base, and every effort will be futile. Today, nobody can deny the gigantic contribution of SME sector towards the GDP of Pakistan. It also employs more than 50% of Pakistan workforce and provides equal opportunity, irrespective of gender differences. SME is also a backbone of mega industries and provides sustainability and fuel for their growth. It would be difficult for us to sustain and grow without a strong SME, in the emerging WTO scenario. It's an opportunity for us for a strong place in WTO, as exports market offers lucrative potential for their products and services.

The sheer size of this sector place it amongst the largest sector in our country providing a major source of employment and reshaping the economy base, but unfortunately the productivity and growth of this sector is not impressive. The factors that have retarded the growth in this sector are inadequate capital resources, inability to access the modern technology, lack of professional know-how and systematic approach, no existence of effective supply chain network, inaccessibility to wider markets, leading to low bargain positions, lack of knowledge and skills, lack of vision and vulnerability to alternative ideas. Amongst all of the mentioned factors, the paucity of capital resources and access to modern technology are those, which are a main stymie for SME sector.

It is an indication of effciency of the SME sector and has been noted time and again that the contribution of SME sector to country's economy is on a much higher scale in comparison to the established larger corporate sector. However, in spite of the importance of SME sector, which all and everyone recognizes, the SME sector does not get the financial resources it deserves. Reasons are many and they include lack of track record, lack of financial resources and information, no additional collateral, lack of acquaintance due to low level of education, introduction to formal banking process and many more.

It is still a viable sector which need to be explored and it offers great opportunity to leasing sector and may indeed provide an edge to the leasing due to inherent flexibility and selling culture which is present in leasing companies. Leasing companies can play an important role to haul out this sector from the feeble and atrocious conditions. Though it's a long haul but leasing sector can provide vigorous footing and kiss of life to this sector, so that our country could confidently enter into new emerging arena of WTO. SME sector has genuine financing requirements unlike the large industrial sector and entrepreneur. Also the recovery in this sector is quite good as compared to large industrial sector. At present, SME has emerged as a high potential sector for financing, epically for leasing companies. In the battle of interest rates, leasing companies have great opportunity in this ever-growing sector. SME sector, not only offers higher yield but also low risk of default. The risk is also divided and diversified. Leasing companies have also a comparative advantage of an asset based financing. Companies can easily finance them without additional collateral, as required by the banks. Leasing can provide both long term and short term financing to SME sector for the acquisition of plant and machinery. It considered being the most Islamic way of financing. In case of direct lease finance, the collateral for the leasing company would be the leased asset itself. Working capital financing can also be considered under a sale and lease back arrangement of existing asset. As Leasing is an asset based financing, therefore there is no need of charge, hypothecation and additional collateral, where there is an enough comfort.



Though SME sector provides an opportunity to Leasing sector but at the same time leasing companies are confronted with many challenges concerning this sector such as, sector is too disorganized, inconsistent practices and policies, undocumented environment, no entry and exit barriers, vulnerable to systematic changes, political scenario, no financial records and lack of professional skills. Leasing companies should get the advantage of its strength in order to take advantage and exploit opportunities in SME sector, but at the same time leasing companies must be careful in making their credit decision, to mitigate the threats and weaknesses. The credit decision should be based on prudence and detailed analysis instead of blunt decisions based on gut feeling and experiences.

Its worth to mention here that leasing companies can only provide financial patronage to SME sector for building up the effective and effecient asset-based and access to modern technology. As leasing companies are providing assets-based financing, therefore the anatomy of the credit analysis should be focused on the assets to be leased. Lesser must ensure the optimized utilization of leased assets. This means that the leased assets must be an addition to the assets base of lessee. There should be a need of such assets and lessee can effectively utilize this assets. The lesser should suss out the actual requirement of such assets. If the assets requirement is to meet increasing demands, than whether such demands exist and whether the leased assets have the capacity to meet such demands. Lessee must also have proper infrastructure and skilled labor to operate it. In short the leased assets should not create burden on the company or increase its cost.

Another important factor related to the asset is its effecient operating leverage. Effecient operating leverage means that lessee should also ensure the running expenses of such machinery. Lessee should be in position to meet at least all the operating expenses of the machinery through its operating revenues. In short, lesser should confirm the effective utilization of the assets at minimum cost. By ensuring this, lesser will automatically secure its interest, as high capacity to meet higher demand will eventually surge sales and therefore result in higher profits.

Further to this the credit analysis should also cover the other important factor by answering that how would the new lease assets effect income statement, cash flow statement and balance sheet, what would be internal pay back period of the asset, what would be additional periodic financials payments, what about potential business risk and potential debt servicing ability, the length of business (the longer the business, more established the business is considered), weather the place of business is rented or owned (if rented that rental amount, and if owned than approx value of asset owned), number of person employed, salaries paid to employees, approximate value of machinery owned, status of liabilities/loan, monthly installment, status of business relationship with other financial institutes, general reputation of the business, sales revenue generating on daily/weekly/monthly and annually basis, cost of operation and operating profits, variable cost and contribution margin, margin of safety and Z-test analysis.

Further to the above, another important factor that should be a part of credit analysis of SMEs is their working capital conditions. It is observed that, today many SME sector companies are facing paucity of working capital. Working capital is like a blood for any company. Shortage of working capital can be risky for any company. Lesser must ensure that lessee have enough working capital to meet its operating expenses. Without the adequate working capital the survival would be precarious. Many leasing companies are financing working capital requirement of SME through sale and lease back transaction.

In addition to the above lesser must also indulge themselves in proper follow-ups of its lessee through regular inspections, reporting and reviews and recovery tracks. Lesser should keep consistent track of lessee business and its performance, ensure that lessee business is generating adequate profits, rentals are regular and also the extemal factor like political changes, government policies, industry conditions etc.

Though, ever-growing lucrative and luminous SME sector provides a good opportunity for leasing companies but at the same time leasing companies must be prudent in credit decision and consider the entire ramification before such move. It is worthy to mention here that leasing is a process of determining the underlying financial requirements by understanding the nature of assets. Lesser must maintain a balance between the finance requirement and finance provided by lesser. Inadequate lease facility will leads to chaos and more that required finance facility will eventually and subsequently lead to insolvency.

It is important that the financial institution adopt an innovative, progressive and optimist approach to support the SME sector of Pakistan. The sector is one of the major sectors in the economy of Pakistan. The total production of this sector is consumed in the market, and the demand for the product is perpetual and increasing.