MAKERERE UNIVERSITY BUSINESS SCHOOL

ACCESSIBILITY OF SMALL AND MEDIUM SCALE ENTERPRISES TO DEBT

FINANCINCING IN UGANDA

CASE STUDY: NAKAWA DIVISION

GROUP C5

RESEARCH PROPOSAL SUBMITTED TO MAKERERE UNIVERSTY BUSINESS

SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD

OF BACHELOR OF COMMERCE

NAMES SIGNATURE CONTACTS

1.1 Introduction………………………………………………………………………

1.2 Background………………………………………………………………………..

1.3 Problem statement…………………………………………………………………….

1.4 Purpose………………………………………………………………………………..

1.5 Objectives………………………………………………………………………………

1.6 Research questions………………………………………………………………………

1.7 Scope………………………………………………………………………………….

1.7.1 Functionality scope……………………………………………………………….

1.7.2 Geographical scope…………………………………………………………………….

1.7.3 Time scope……………………………………………………………………………….

1.8 Significance………………………………………………………………………….

SECTION TWO

Literature review

2.1 Introduction…………………………………………………………………………….

2.2 Definition of debt financing……………………………………………………………

2.3 Objectives of debt financing………………………………………………………………

2.4 Advantages of debt financing…………………………………………………………

2.5 Disadvantages of debt financing………………………………………………………

2.6 Conclusion…………………………………………………………………………….

2.7 Recommendation…………………………………………………………………….
SECTION ONE

1.0 INTRODUCTION

This chapter looks at; the back ground to the study, statement of the problem, purpose of

the study, objective of the study, research questions, scope of the study which includes the

conceptual scope, geographical scope and time scope and finally the significance of the study.

1.1 BACK GROUND TO THE STUDY

There is consensus among policy makers, economists, and business experts that small and

medium enterprises (SMEs) are drivers of economic growth. A healthy SME sector contributes

prominently to the economy through creating more employment opportunities, generating higher

production volumes, increasing exports and introducing innovation and entrepreneurship skills.

The dynamic role of SMEs in developing countries insures them as engines through which the

growth objectives of developing countries can be achieved.

It is estimated that SMEs employ 22% of the adult population in developing countries1. United

Nations Industrial Development Organisation (UNIDO) estimates that SMEs represent over

90% of private business and contribute to more than 50% of employment and of gross domestic

product (GDP) in most African countries (UNIDO, 1999). A recent study conducted by Abor

and Quartey (2010) estimates that 91% of formal business entities in Uganda are SMEs, and that

these SMEs contribute between 52 to 57% to GDP and provide about 61% to employment.

The importance of financial services to businesses cannot be overemphasized. Businesses

particularly those in developing countries need a range of enabling and sustainable financial

services in order to enable them effectively exploit abundant resources in their areas and fulfil

their productive potential (Nwanna, 2000). It has however been noted by scholars like Hogan

(2001) that the financial service sector focuses its success on the effective management of credit
risk. This has therefore triggered financial services providers to put more emphasis on credit

terms while lending to clients especially the SME borrowers. This is because MFIs consider

lending to small businesses as profitable though a risky business. Providing financial services to

large businesses is considered to be more costly and difficult. This leaves MFIs with no option

but to lend to SMEs though at unfavorable credit terms.

Over the past twenty years or so Uganda has constantly been embarking on a long process of

political, economic and social reforms to improve the business environment, promote economic

growth and reduce poverty in the country. The economic hardship the country has been facing

has been attributed to a lot of factors among them being the underdeveloped private sector

which accounts for over 80% of employment (IFC 2006). Unemployment has been a chronic

problem in the country. Today the unemployment rate stands at a staggering ……% (UBOS

… est.) forcing a large number of the working population to opt for self-employment. But due

to a number of reasons the newly formed businesses fail to operate on profits and eventually

close down or continue operating without a good return on investments constrained from

growth and expansion. Recent studies on Small and medium enterprises by Mfaume R and W.

Leonard(2003) and Kuzilwa J.A (2003), all of which were undertaken have identified the factors

limiting the success of small and medium sized businesses among them being lack of financing,

corruption, lack of education and training, government policy among others.

1.2 Statement of the Problem

Despite the significant importance and SME contribution to economic growth, SMEs across

the whole world and in Uganda in particular, are still faced with numerous challenges that inhibit
entrepreneurial growth. Apart from SME funding and access to credit (which is the focus

of this study), the Global Entrepreneurship Monitor (GEM) Reports (2001-2010) noted that

SMEs also suffer from poor management skills which is a result of lack of adequate training and

education. This results in high rates of business failure. There has been improved access to credit

by businesses overtime. However, businesses have continued to suffer financial challenges. For

this, existing research indicates that 50% of the businesses operate in a financial deficit and some

of the businesses owners are still not comfortable with such credit extended to them, (Sendawula

2002). The SMEs have registered a low return on capital employed, low net profit margin and

kept a small capital size (AMFIU 2010) and some of them fail to run their daily operations

because they do not have the capacity to maintain adequate liquidity levels Chowdhury (2002).

As such, the relationship between the MFIs and businesses keep on deteriorating due to failure

to fulfil their loan obligations O’brien (2007). This could be due to the stringent credit terms to

include interest rates, collateral securities, and loan repayment schedules among others which

seem to frustrate businesses financially. In Uganda, there is little empirical data on credit terms

and how they affect the businesses performance.

1.3 Purpose of the study

The study aimed at establishing how the accessibility to credit affects the level of usage of debt
financing in SMEs in Uganda.

1.3.1 Objectives of the study

i) To investigate the factors that affect accessibility of SMEs to credit Uganda.

ii) To establish the level of usage of debt financing of SMEs in Uganda.

iii) To establish the relationship between accessibility of SMEs to credit and usage of debt
financing in SMEs in Uganda.
1.4 Research questions

i) What are the factors affecting accessibility of SMEs to credit in Uganda?

ii) What is the level of usage of debt financing in SMEs in Uganda?

iii) What is the relationship between accessibility of SMEs to credit and usage of debt financing
in Uganda?

1.5 Scope of the study

1.5.1 Geographical scope

Geographically, the study will cover Nakawa division, Kampala because it has
both small and medium scale business enterprises.

1.5.2 Conceptual scope

The study was limited to SMEs as an independent variable, liquidity levels and

MFI-SME relationships as intervening variables as well as SME performance as the dependant

variable.

1.5.3 Time scope

The study covered a period of five years from 2006 to 2010 since during this time the market

experienced the highest rates of credit financing.

1.6 SIGNIFICANCE OF THE STUDY

The study will be of significant to the business community and organizations, Government, and

policy makers as follows:

The study will also add to the existing literature on credit terms and performance of SMEs. Like

any other research, the findings will be used as a reference as far as further studies are concerned

and spark off further research in credit terms and performance of the Business Sector.
This study will generate data and information on MFI credit terms and how they affect

performance of SMEs in Uganda. The MFIs can use this to come up with acceptable terms to

their clients. The SMEs can also use the findings of this study as ground to negotiate appropriate

credit terms that will not constrain their performance.

The study will also provide empirical data that may help policy makers to formulate appropriate

policy environment for the operations of financing institutions system in the economy.
 SECTION TWO
2.0 LITERATURE REVIEW

2.1 INTRODUCTION

This chapter entails the literature on credit or debt financing in businesses and accessibility to
debt financing.

What is debt financing?

According to Advameg, (2014), debt financing is a strategy that involves borrowing money from
a lender or investor with the understanding that the full amount will be paid in the future usually
with interest.

In most cases debt financing does not include any provision for ownership of the company
(although some types of debts are convertible to stock) instead small businesses that employ debt
financing accept a direct obligation to repay the funds within a certain period of time. The
interest rate charged on borrowed funds reflects the level of risk that the lender undertakes by
providing the money since this entails less risk than equity financing as lenders are paid off
before owners in the event of business liquidation.

It is estimated that SMEs employ 22% of the adult population in developing countries1. United
Nations Industrial Development Organisation (UNIDO) estimates that SMEs represent over 90%
of private business and contribute to more than 50% of employment and of gross domestic
product(GDP) in most African countries (UNIDO, 1999). A recent study conducted by Abor and
Quartey (2010) estimates that 91% of formal business entities in South Africa are SMEs, and that
these SMEs contribute between 52 to 57% to GDP and provide about 61% to employment.
The democratically elected Government of South Africa (SA) realised, as early as 1995, the
importance of SMEs to the economy. The White Paper on National Strategy for the
Development and Promotion of Small Business in South Africa (1995) highlighted the fact that
“Small, medium andmicro enterprises represent an important vehicle to address the challenges of
job creation, economic growth and equity in our country”.
Despite their significant importance and SME contribution to economic growth, SMEs across
the whole world, and in SA in particular, are still faced with numerous challenges that inhibit
Entrepreneurial growth. Apart from SME funding and access to finance (which is the focus of
This study), the Global Entrepreneurship Monitor (GEM) Reports (2001-2010) noted that SA
SMEs also suffer from poor management skills which is a result of lack of adequate training
and education. This results in high rates of business failure (SA has one of the lowest SMEs
survival rates in the world).
This study investigates the extent of access to credit and support by SMEs in SA. The study
was commissioned by the National Credit Regulator (NCR) and it seeks to understand what
has been researched and written on SME access to credit and support in relation to juristic
persons as defined by the National Credit Act (NCA). The study is intended to assist the NCR
make policy proposal to the Minister for the Department of Trade and Industry (the dti) on
matters affecting the consumer credit industry in order to improve access to credit for persons
contemplated in the Act.

Objective of debt financing

Revenue Growth

Increasing revenue is the most basic and fundamental financial objective of any business.
Revenue growth comes from an emphasis on sales and marketing activities, and is solely
concerned with increasing top-line earnings — earnings before expenses. Companies often set
revenue goals in terms of percentage increases rather than aiming for specific dollar amounts. An
entrepreneur may set an objective of increasing revenue by 20 percent each year for the first five
years of a new company's operations, for example.

Profit Margins

Profit objectives are a bit more sophisticated than revenue growth goals. Any money left over
from sales revenue after all expenses have been paid is considered profit. Profit, or bottom-line
earnings, can be used in a number of ways, including investing it back into the business for
expansion and distributing it among employees in a profit-sharing arrangement.
Profit goals are concerned first with revenue, then with costs. Keeping costs low by finding and
building relationships with reliable suppliers, designing operations with an eye toward lean
efficiency and taking advantage of economies of scale, to name a few methods, can leave you
with more money after paying all of your bills.

Sustainability

At certain times, companies or brands may be primarily concerned with basic economic survival.
Retrenching is a marketing technique — based on a financial objective — that attempts to keep a
brand alive and keep current revenue and profit levels from falling any further during the
“decline” stage of the product/brand life cycle.

Companies may be concerned with financial sustainability during periods of economic turmoil,
as well. Common financial objectives for survival include collecting on all outstanding debts on
time and in full, de-leveraging by paying off debt and keeping income levels consistent.

Return on Investment

Return on Investment is a financial ratio applied to capital expenditures. ROI can be applied to
two basic scenarios. First, ROI is concerned with the return generated by investments in real
property and productive equipment. Business owners want to make sure that the buildings,
machinery and other equipment they buy generates sufficient revenue and profit to justify the
purchase cost.

Secondly, ROI applies to investments in stocks, bonds and other investment instruments. The
same principle applies to these investments, but there is generally no physical, productive asset
used to generate a return. Instead, ROI for investment products is calculated by comparing the
dividends, interest and capital gains realized from investments by the cost of the investment and
the opportunity cost of forgoing alternative investments.
Debt Financing

If you decide that you do not want to take on investors and want total control of the business
yourself, you may want to pursue debt financing in order to start up your business. You will
probably try to tap your own sources of funds first by using personal loans, home equity loans,
and even credit cards. Perhaps family or friends would be willing to loan you the necessary funds
at lower interest rates and better repayment terms. Applying for a business loan is another option.

 Debt financing allows you to have control of your own destiny regarding your business.
You do not have investors or partners to answer to and you can make all the decisions.
You own all the profit you make.
 If you finance your business using debt, the interest you repay on your loan is tax-
deductible. This means that it shields part of your business income from taxes and lowers
your tax liability every year. Your interest is usually based on the prime interest rate.

 The lender(s) from whom you borrow money do not share in your profits. All you have to
do is make your loan payments in a timely manner.

 You can apply for a Small Business Administration loan that has more favorable terms
for small businesses than traditional commercial bank loans.

Disadvantages of Debt Financing

 The disadvantages of borrowing money for a small business may be great. You may have
large loan payments at precisely the time you need funds for start-up costs. If you don't
make loan payments on time to credit cards or commercial banks, you can ruin your
credit rating and make borrowing in the future difficult or impossible. If you don't make
your loan payments on time to family and friends, you can strain those relationships.
 For a new business, commercial banks may require you to pledge your personal assets
before they will give you a loan. If your business goes under, you will lose your personal
assets.
  Any time you use debt financing, you are running the risk of bankruptcy. The more debt
financing you use, the higher the risk of bankruptcy. Calculate the debt to equity ratio to
determine how much debt your firm is in compared to its equity.

 Some will tell you that if you incorporate your business, your personal assets are safe.
Don't be so sure of this. Even if you incorporate, most financial institutions will still
require a new business to pledge business or personal assets as collateral for your
business loans. You can still lose your personal assets.

Which is best; debt or equity financing? It depends on the situation. Your financial capital,
potential investors, credit standing, business plan, tax situation, the tax situation of your
investors, and the type of business you plan to start all have an impact on that decision. The mix
of debt and equity financing that you use will determine your cost of capital for your business.

2.3 CONCLUSION

The literature review revealed that there are a number of sources of credit for SMEs. However, it
is not possible to determine with any degree of accuracy whether the financing available is
sufficient to meet the needs of the SME sector due to the lack of information, especially with
regard to the demandside and the specific causes for the lack of access. Therefore, more research
is needed in this area to(1) identify the specific needs of the SME sector when it comes to
financing and (2) whether the financing available meets those needs in terms of both “quantity”
and “quality”.

There is a possibility that there is sufficient credit being made available, but the terms and
conditions under which it can be accessed are not favorable for the SME sector it is intended to
serve. In other words, there is sufficient “quantities” of funding available, but the “quality” of
funding (i.e. the product design/services being offered) does not match the needs of the sector. In
this case, the policy response should not be designed to increasing the amount of credit available
to the sector, but should involve revisiting the product offering of the credit already available and
ensuring that it meets the needs of the SME sector it is intended to serve.
Another possibility that needs consideration is that in which credit is available and sufficient to
meet demand, but the lack of access is attributable either to the specific characteristics of the
SMEs alkpplying for the loan or the lack of awareness that the financing is available. In these
instances, the policy response required would necessarily be different from that of increasing
funding available, or indeed, changing product design/service offering.

If there is, in fact, a shortage of finance (quantity of loanable funds), the Government can
increase the supply of funds through funding of existing agencies like the National Youth
Development Agency (NYDA), Khula and other Government owned institutions.
With regard to the scenario whsere sufficient credit is available, but the terms and conditions of
accessing the financing is problematic for the SMEs due to poor product design/service offering,
then interventions will need to address this particular deficiency. With respect to private entities,
it is hoped that competition and the desire to increase returns from catering to this segment will
improve product design and services offered. For Government funded programmes, the
evaluation and monitoring of the various schemes and programmes on a regular basis should
help the Government keep abreast of the applicability of the various programmes and schemes.

Thirdly, with respect to situations where credit is available, but access is constrained by SME
specific factors, then interventions will have to be targeted to deal with these specific SME
characteristics. To summarise, the characteristics being referred to relate to: (1) the lack of
information available with respect to the business, or where there is information available the
information is of very poor quality;
(2) the lack of collateral; (3) the failure to access financial services, including credit, due to
various perceptions small business owners have of the requirements needed for access; (4) the
poor level of managerial competence and skills of the small business owner; (5) the age of the
enterprise; and (6) the legal status of the enterprise.

RECOMMENDATIONS
o Increasing the levels of formality of SMEs – this can be achieved through the
compulsory registration of SMEs that have not yet registered, at minimal or no
cost to the SME.
o Training and capacity building – building on current programs and establishing
new ones if warranted to improve the levels of managerial competence of the
small business owner.
o Establishing of a Government department to deal specifically with SMEs,
entrepreneurship and support to this sector.
o The monitoring and evaluation by Government of its SME funding programmes
on a regular basis. This will help the Government keep abreast of the applicability
of the various programmes and schemes. The immediate objective of the
evaluation of current programmes and schemes is identifying the reasons why
awareness and uptake has been low.
 SECTION THREE

3.0 Introduction

This chapter shows the description of research design, study population, sampling design which
will include the sampling method, sampling procedure and sample size, sources of data, data
collection methods, data processing, analysis and presentation and the limitations to the study.

3.1 Research design

This study will use descriptive research design which will be quantitative so as to describe the
research findings appropriately so as to make conclusions and recommendations about the level
of debt financing. The study will also use a longitudinal research design since the study is to
consider a period from 2006 to 2011.

3.2 Study population and sample size

The population study will include small and medium enterprises in Nakawa Division which are
registered by the Registrar of companies and carryout various activities. A sample of 120
enterprises out of 250 enterprises will be selected and be approached by the use of simple
random sampling. 50 small scale enterprises and 70 medium enterprises will be approached.

3.3 Sampling method.

Stratified random sampling and purposive sampling will be used where attributes for small and
medium enterprises will be defined to identify enterprises appropriate for the study and
determine the sample items relevant to the study. The specific officers of the selected businesses
will be approached and these will include financial managers, business owners and promoters.
Bank managers will also be approached to know the credit terms offered to the business under
study.

3.4 Data sources/ Field work

This study will use both primary and secondary sources. Secondary data will be collected from
academic journals, bank reports, and accounting books of the enterprises under study. The
primary data will be collected by use of questionnaires and interviews.

3.5 Data collection methods and tools

Methods to be used include questionnaires and interviews to get well detailed information with a
considerable accuracy.
3.5.1 Questionnaire

The researcher will use open and closed ended items. The questionnaires will be both in
electronic and paper form. This instrument is important because it is easy to administer and also
track busy officers like Managing Directors.

3.5 Interviews

Interviews will be carried out using interview guides so as to have a face to face interaction with,
the various respondents selected as this will help gather more accurate information. Interviews
were chosen for this study because they provide in depth information from the respondents.

3.6 Data capture, analysis and presentation

The data from both the questionnaires and the interviews will be captured and then cleaned so as
to remove inconsistencies. In the due process, the data will be edited and coded where identifiers
will be allocated to similar responses where it does not apply directly. A data base and a structure
to capture the data will be designed. In analyzing the data, SPSS will be used, and later the data
will be verified to make sure that the soft copy results match with the hard copy results.

3.7 Limitations of the study

 The sample size considered may not give an accurate representation of the whole
population, so errors are probable.
 The quantitative research design used may leave out important qualitative information
relevant to the study, that is, exclusion of experts to explain the linkages between factors
contributing to limited accessibility to credit.

3.8 Budget

ITEM AMOUNT(SHS)
Logistics(tools, pens, bags e.t.c) 150000
Transport 100000
Collection of literature 120000
Binding 7000
Supervision 300000
Presentation 140000
Miscellaneous 80000
TOTAL 897000

3.9 Work plan/ Time frame

Period(2014) MAY JUNE JULY AUGUST

Literature review

Field work
Data analysis

Report writing
Presentation
Designing tools