Finance Options for Small and Medium Scale Enterprises in Nigeria: an Empirical Analysis

International Journal of Empirical Finance Vol. 2, No. 3, 2014, 123-129 Finance Options for Small and Medium Scale Enterprises in Nigeria: an Empirical Analysis Oluitan Roseline 1, Kehinde James 2 Abstract This paper examines the role of finance for small and medium scale enterprises in Nigeria and the finance options available. The study covers 1992 to 2010 and observes that most enterprises are dependent on informal sources which have very low impact on their growth. Finance from banks has the largest impact but fraught with issues as lenders are unwilling due to information asymmetry and moral hazards The capital market source follows the banking source, but equally not readily available. This results in truncation of many proposals or their untimely exit. If enterprises are to really develop, the banking and capital market source should be given adequate motivation and support. The current scenario is inadequate for the expected output. 1. Introduction The Nigerian economy is a public driven economy with so much dependence on the government to lubricate the economy. The discovery of oil in the 1970 s has not helped the situation as many people abandoned their hitherto source of livelihood in the villages to source for greener pastures in the cities. Gradually, the country drifted from a multi-product agricultural economy to a mono-product oil driven economy. Resources from oil are no longer sufficient for the economy due to declining g oil revenue hence the government is making frantic efforts to channel the economy to being privately driven. In the light of this, there have been aspirations for small scale industries to assist the economy to achieve their laudable objective. With the adoption of the economic reform programme in Nigeria in 1986, there was a change in the emphasis of the government from the hitherto capital intensive, large scale industrial projects to the small and medium scale enterprises with immense potentials for developing domestics interlarded for rapid, sustainable industrial development. It is argued that support for the small and medium scale enterprises (SMEs) will energize the economy faster. Apart from their potential for ensuring a self-reliant industrialization, in terms of ability to rely largely on local raw materials, small and medium scale enterprises are capable of boosting employment generation, guarantee a more even distribution of industrial development in the country, including rural areas and facilitate the growth of non-oil exports products. According to Uzor (2004), SME s have locational flexibility which aids industrial dispersion and regional balance for economic development. Small and medium scale Enterprise (SMEs) have been fully recognized by government and development experts as an important engine for economic growth and a major factor in promoting private sector led development and partnership. The development of SMEs is an essential element in the growth of most economies. Their ability to mobilize financial resources which otherwise would be idle by the formal financial institutions in economic activities is a major strength of the SME s. Often, the initial capital invested is sourced from personal savings or from funds diverted from luxury or unproductive uses. Furthermore, their resource utilization 1 Accounting & Finance Department, Lagos State University, Ojoo, Lagos, Nigeria 2 Accounting & Finance Department, Lagos State University, Ojoo, Lagos, Nigeria 2014 Research Academy of Social Sciences http://www.rassweb.com 123

O. Roseline & K. James encompasses the greater use of local raw materials or by product of the Large Scale Enterprises (Les) which will normally be discarded. In spite of the growing awareness of the role of SMEs in Nigeria, the sector is unable to attract sufficient resources to aid its operations despite measures put in place by the Federal Government of Nigeria to facilitate its growth. One of such is the establishment of specialized funding schemes such as the NIDB, NNIC, NBIC and various Development Finance Institutions (DFIs). Most times, SME s complain of inadequate access to institutional credit and discrimination against them by the banks. It is against this background that this topic Finance Options for SME s in Nigeria becomes necessary and apt to appraise the available options whether they are contributing significantly to the funding needs of the SME s. 2. Literature Review Introduction to the SMEs Issue The opinion of people on the contributions of SME s to a country s economic development is increasing at all levels. This is supported by the growing awareness of the potential, social and economic importance of a viable SME s sector. It is an issue that has attracted widespread comments and many studies have shown that regions or economies where SME s are actively encouraged the level of development increases and the rate of poverty declines. According to Fabayo (1989), SME s are vital tool for handling unemployment and poverty within the economy. He opines that strong evidence exists with countries and regions to show that SME s are a major source of employment opportunities for a wide cross-section of the populace. Similarly, Meyanathan (1994) and Ukpabio (2004) equally postulate that SME s are very instrumental to reduce rural urban migration as they create employment in the rural areas. Uzor (2004), follow the argument of the previous scholars on the positive contribution of SME s to economic development. According to him, they influence income distribution both in functional terms and nominal terms. This view cuts across both developed and developing economies, though with varying levels of impact. For this reason, the government in Nigeria established various support institutions and laws aimed at improving the capacity of the SME s. Some of the measures include establishment of the bank of Industry; Small and Medium Scale Equity Investment Scheme (SMIEIS); THE Second Tier Security Market; THE SME loan scheme by the Central Bank of Nigeria; Nigeria Export and Import Bank (NEXIM); the Small and Medium Scale Development Agency of Nigeria (SMEDAN) etc. These institutions are expected to provide solutions to the problems of the entrepreneurs. According to Baadom (2004), the problems of SME s in Nigeria include but not limited to the following: - - Poor implementation of policies because many hitherto good policies formulated in the past were weakly implemented which made realization of anticipated goals unachievable. - Lack of continuity because many enterprises are privately owned hence death or otherwise of the proprietor may result in termination of business activities. Due to this reason, finance institutions are weary of support. - Poor Capital Outlay because many proprietors are forced to look inwards for finance hence limited by the amount available. Financiers often regard the sector as high risk area and unwilling to commit funds to it. - Poor Management Expertise Many SME s lack the requisite knowledge and expertise required to be successful. - Inadequate Information Base Proprietors often fail to keep proper financial and administrative records and this makes information gathering difficult. - Unstable Policy Environment Government policies are numerous and changes frequently. This 124

seems not helpful to the business. International Journal of Empirical Finance The importance of finance to the growth and going concern of the enterprises cannot be overemphasised. According to Ogujuiba et al (2004), finance contributes to about 25percent of the success of SMEs. As a result, most SMEs are folding up because they lack adequate financial support which is very crucial to prosecute their manufacturing concern. A large number of these enterprises are unable to access long-term loan while short-term finances are not readily available. Godfried and Song (2000) studied the sources of finance for small scale manufacturing firms in Ghana. With the aid of panel data which was analysed through linear regression and probit models, the study found that a greater proportion of Small Scale Enterprises (SSE s) utilized informal loans than formal loans. A considerable proportion used private sources to finance their business while formal credit is the most insignificant source of finance utilised. Specifically, the study revealed that a great number of SSE s included in the research used internal sources of finance, mainly personal savings and retained earnings in the financing of capital equipment. This opinion transcends developing countries as the study by Oliveira and Fortunato (2006) which investigated Portuguese manufacturing firms for twelve years (1990 2001) with the aid of a pooled OLS and GMM methodology on an unbalanced panel opines that the businesses are constrained with finance and could experience more robust growth if availed with sufficient credit. The World Bank report (2001), states that about 50 percent of micro, 39 and 37 percent of the small and medium scale firms are financially constrained in Nigeria as opposed to 25 percent of the very large firms. This suggests that small and medium scale enterprises are either discriminated against or cannot access funds readily from the market. Likewise, the conditions precedent are often too stringent for the enterprises to comply with and are readily discouraged from such sources. However, banks and money market generally are very cautious in investing in SME s. They have to consider the risk content of the portfolio before investing. Generally, banks view SME s as high risk ventures because many are owned by individuals or families who are not willing to share ownership. Similarly, such ventures seize to operate with the death or otherwise of the proprietor. This motivates the study to consider finance options for SME s in Nigeria. As far as we know, several studies have considered money market options for SME s finance, this study analyses the impact of both money and capital market options in providing the much needed capital by the enterprises for developmental purposes. 3. Research Methodology The aim of this research work is empirically investigate the finance options for SME s and examine whether they have significant influence on the growth of enterprises. The period to be examined for this research study will be between year (2000-2010). The date is limited due to in availability of data. Model Specification and Analysis The model tested examines the relationship among SMEs Loan, Credit to the Private Sector, National Savings and Equity Finance set aside by the Government. The SME loan is used to as a proxy for access to loan by the SME s. Credit to the Private Sector examines the level of funds committed by the banks (money market) to the SME s. National Savings is used to measure the level of funds available from private sources to use by the proprietors while equity finance measures the extent of long term funds available for investment in the sector. This is used as a proxy for capital market as a source of finance. The study makes use of econometrics tools and essentially multiple regression analysis in analysing the research problems. A Stationarity test was conducted on the variables and the result shows that all the variables are integrated to the first order (see Table 1 in Appendix) Model Specification and Analysis The econometric model to be estimated in a log form is: 125

O. Roseline & K. James Log SMEs Loan = β o + β 1 Log CPS + β 2 LogSav + β 3 Log EQF + U t.eq. 11 Where: SMEs Loan = Loan to Small and Medium Scale Enterprises Sav = Savings CPS = Credit to Private Sector. EQF = Equity Finance set aside by the government for SME s β o = constant term or the intercept of the regression equation β 1 β 3 = Coefficient of the variables ; U t = Error term or stochastic variable. A priori expectation: βo>0 β1, β2, β3>0 4. Model Result Table 1: Dependent variable: LOG (DSMES LOAN) Variable Coefficient Std. Error t-statistic Probability C 12.33997 1.328544 9.288344 0.0000 DCPS 0.429627 0.210232 2.043584 0.0000 DSAV 0.040561 0.252213 2.330820 0.0002 DEQF 0.336403 0.259448 4.296610 0.0001 R 2 = 0.899922 Adjusted R 2 = 0.745890 D-W statistic = 2.103945 F-Statistic = 60.17737 Interpretation of Result An examination of the equation shows that the three independent variables were able to explain 74.5% of the systematic variation in SMEs Loan during the reference period. The F statistics at 60.177 is greater than the F-prob. The F- Statistics of 60.177 is significant when compared with F-prob. of 0.00023. This further justifies that the explanatory variables does contribute significantly to the variation in the dependent variable SMEs Loan. Thus, the hypothesis of a significant linear relationship between the three regressors and the dependent variable SMEs Loan is validated. The goodness of fit of the overall model is indicated by the high value of the adjusted coefficient of the determination (R 2 ) value of 0.745890, which shows the overall model has a good fit. Only about 0.25411 or 25.411% is left unexplained, this is attributed to other economic factors represented by the disturbance term µ t. In the model, the coefficient of the three independent variables conforms to the a priori expectation.. The t-statistics shows that the coefficient of the constant term is the most significant while all the Independent variables are also significant. The result also shows that a unit increase in saving holding other factors constant will increase SMEs Loan by 0.040561 or 4%. A unit increase in credit to private sector will bring about 0.429627 or 42.9% increases in the SMEs Loan holding other factors constant. SMEs Loan will increase by 0.336403 as a result of a unit increase in equity finance or venture capital. At 5% level of significance, Durbin Watson Statistics is 2.103945 this shows there is positive autocorrelation among the values in the residual model. It implies that there is a bit of Serial correlation and the coefficients are unbiased. Based on the above discussion the model shows statistically significant and the unit root test shows that we are not running a spurious regression; therefore; there is significant impact by the finance options on loans by SMEs with the bank proxy giving the greatest impact followed by the capital market proxy. The private source proxy is having a very little impact on loans by SME s. Research Implication The research work has been able to show the finance options available to SME s in the broad sense and empirically justified that the options have contributed significantly to the funding of the sector. However, most of the SME s have had to depend on private sources to fund their business because institutionalized investors have apathy to such projects mostly as a result of adverse selection and moral hazard problems. 126

International Journal of Empirical Finance Adverse selection problems arise when investors find it difficult to confirm whether the business has access to quality projects. Moral hazard relates to the possibility of SMEs diverting funds made available to them to fund other projects that are possibly not bankable and without their consent. This is against the background that SME s are not presently strong with the capital market though that source has over 33% positive impact on SME loan for every unit change. From the above analogy, the finance sources that have greater impact on the enterprises are not readily available while the most common has little impact. This suggests the reasons why many entrepreneurs are financially truncated in their ventures. The viable finance options should be made available to support the aspirations of the entrepreneurs if the objective of SME s as a viable channel of growth is to be realized. The assumed risks of the banks should be adequately dealt with either by the government insuring them or otherwise and the capital market which is a potent source for long term funds should be readily accessible. 5. Conclusion The study shows that banks and capital market sources of finance for SME s have greater impact than private sources if available. Presently, the SME s are using funds generated from private sources. This shows a mismatch in the funding portfolio for the enterprise. The government needs to urgently step in to address the fears of the institutional investors that preclude them from funding the sector. This could be achieved through insuring them against assumed risks and some other incentives that will make funding of the SME s attractive. No matter the level of private funds, it is likely going to be inadequate and possibly short tenured. Long term and stable funds are more desirable for the entrepreneurs. Secondly, the entrepreneurs should be given adequate training and exposure that will address some gaps in their operational cycle. This will assist them to handle their businesses more maturely and possibly reduce moral hazards and even adverse selection risks. According to Lawal (2011), proper planning, good financial control, technology, sustainable and improved employee productivity are important factors for SME success. A level playing field that will be fair and beneficial to all parties is highly desirable for the SME s to survive and compete globally. References Baadom S B. (2004), Fundamentals of Small Business Management in Nigeria Fabayo J A. (1989), Small and Medium Scale Enterprises Development Strategy: A Critical Option For Long-Term Economic Progress in Nigeria; The India Journal of Economics, Vol. 58, pp 159-171 Godfried A O. and Song G P. (2000), Financing Small-Scale Manufacturing Firms in Ghana; Thesis submitted to the Graduate Business School, School of Economics & Commercial Law, University of Gothenburg, ISSN 1403-851X. Lawal A A. (2011), Strategic Importance of Nigerian SME s: Separating the Reality from The Myth; 22 nd Lagos State Polytechnic Inaugural Lecture. Meyanathan S D. (1994), Industrial Structures and The Development of SME Linkages: Examples from East Asia; The World Bank. Ogunjuiba K K., Ohuche P K. and Adenuga A O. (2004), Credit Availability to Small and Medium Scale Enterprises in Nigeria: Importance of New Capital Base For Banks Background and Issue; Bullion, Central Bank of Nigeria. Oliveira B. and Fortunato A. (2006), Firm Growth and Liquidity Constraints: A Dynamic Analysis; Small Business Economics, Vol. 27, pp 139-156. 127

O. Roseline & K. James Safiriyu A M. and Njogo B O. (2012), Impact of Small and Medium Scale Enterprises in the Generation of Employment in Lagos State; Kuwait Chapter of Arabian Journal of Business and Management Review; Vol. 1, No. 11. Ukpabio S A. (2004), Development of Small Scale Sector: What Role for The Federal Government; Nigerian Banker, Vol. 17, No. 1. Uzor O O. (2004), Small and Medium Scale Enterprises Cluster Development in South Eastern Region of Nigeria; Institute for World Economics and International Management, pp 5-15. World Bank (2001), World Development Report; World Bank, Washington D C. Appendices Table 1: Unit Root Test Result Level form First difference Variable Critical values critical values pp-statistic pp-statistic 1% 5% 10% 1% 5% 10% CPS 2.71095 NS NS NS -4.085806 S S S SAV -1.065251 NS NS NS -6.113338 S S S EQF 1.824594 NS NS NS -5.851315 S S S Table 2: Regression Output Dependent Variable: LOG(SMSES_LOAN01) Method: Least Squares Date: 10/10/13 Time: 12:27 Sample: 1992 2010 Included observations: 19 Variable Coefficient Std. Error t-statistic Prob. C 12.33997 1.328544 9.288344 0.0000 LOG(CPS) 0.429627 0.210232 2.043584 0.0000 LOG(SAV) 0.040561 0.252213 2.330820 0.0002 LOG(EQF) 0.336403 0.259448 4.296610 0.0001 R-squared 0.899922 Mean dependent var 10.43111 Adjusted R-squared 0.745890 S.D. dependent var 0.575522 S.E. of regression 0.553642 Akaike info criterion 1.840069 Sum squared resid 4.597800 Schwarz criterion 2.038898 Log likelihood 13.48065 F-statistic 60.17737 Durbin-Watson stat 2.103945 Prob(F-statistic) 0.000231 128

International Journal of Empirical Finance Table 3: Data Used For the Analysis YEAR SMSEs Loan(N M) CPS (N M) SAVING Equity finance/venture Capital 1992 20400.0 58122.95 55116.80 41810.00 1993 15462.9 1271117.71 85027.9 48056.00 1994 20552.5 143424.21 108460.5 92624.00 1995 32374.5 180004.76 108490.3 141146.00 1996 42302.1 338596.56 134503.2 169242.00 1997 40844.3 316207.08 177648.7 240782.00 1998 42260.7 351956.19 200065.1 272895.50 1999 46824.0 431168.36 277667.5 353081.10 2000 44542.300 530373.3000 385190.9 508302.20 2001 52428.400 764961.5200 4880454 796164.80 2002 82368.400 930493.9300 592094.0 954628.80 2003 90176.500 1096535.570 644739.7 1210033.10 2004 54981.200 1421664.030 797517.2 1519242.70 2005 50672.600 1838389.930 1316957.4 1899346.40 2006 25713.700 2290617.760 1739636.9 2524297.90 2007 41100.400 3680090.190 2693554.3 4813488.8 2008 13512.200 6941383.410 4118172.8 7806751.4 2009 15825.175 9147417.170 5763511.2 8791801.00 2010 15106.175 10157021.18 5954260.5 9358450.3 Sources; Central Bank of Nigeria Statistical Bulletin various years; National Bureau of Statistic online compiled data 129