# General Business Category > Business Finance Forum > [Question] Value depletion due to financing

## Rocky

Hi all,

I am a mature student with extensive business experience.

I am completeing a dissertation on the affect that financing has had on the value chain of SME's in South Africa. I believe that the onerous requirements and restrictive practices of many financial intstitutions has had a large impact on the high failure rate of the SME in South Africa which has been ignored up until now with the focuss being on access rather than value adding.

If you have any thoughts or experiences in this area I would really like to hear them.

Rocky

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## Dave A

> I believe that the onerous requirements and restrictive practices of many financial intstitutions has had a large impact on the high failure rate of the SME in South Africa which has been ignored up until now with the focuss being on access rather than value adding.


I've read that over and over, and I still don't understand what you're getting at.

Have the onerous requirements increased or decreased the failure rate?

Who's focus has been on access rather than value-adding?

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## Blurock

Borrowing changes the balance sheet and dilutes value. High interest rates increase the cost of funding and dilutes returns.

The problem with bank funding is that SME's require expert financial advice, yet they deal with virtually untrained junior bank officials who mostly have no clue about business. Bank loans usually have to be secured by collateral which virtually changes it to pawn broking. Banks are keen to finance franchises where they can paint by numbers, but assistance for any entrepreneurial venture which requires a bit of understanding is almost non existent. 

A much neglected form of finance is factoring. Factoring is not borrowing, as an existing asset, the debtors book is discounted in order to improve cash flow. The balance sheet is not affected as an asset is converted to cash, with no borrowing shown on the balance sheet. Unfortunately factoring is a form of supply chain finance which is not suitable for retail business or very small entities. It works very well in a manufacturing environment though.

You are welcome to send me a private mail for more information on this topic. :Smile:

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wynn (11-Oct-11)

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## IanF

I did a course on EVA years and years ago. What I remember is as long as your return on capital exceeds the cost of capital then it should have a positive effect. So if the cost of borrowing exceeds the profits then that will cause value depletion. That is a management problem and not a lenders problem.. Joel Stern is who you should google about EVA.

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## Blurock

Ian is correct. Economic value added is the calculation to determine the viability of a project. EVA = NOPAT  (Cost of Capital x Total Capital)

If finance cost increase, it reduces EVA. If the Company can reduce Stock, Cash or Debtors (without affecting operating income) Cash will be freed Up. Cash can be used to repay debt, which reduces the interest paid. Reduced finance cost will raise EVA. The solution is however not so simplistic as the time value of money and a whole lot of other equations have to be considered.

I do however think that the question here is whether banks are adding value or not. I have seen many cases where banks will only fund the secured portion of a loan application. By not approving the total amount required, they are doing the SME a disservice as you can not fund half a business. 

One of the biggest reason for SME's failing is being under capitalised. If you can not fund your debtors book, it may gobble up all your cash and leave you with nothing to pay creditors. If debtors do not pay you, they can close your business. The same with carrying too much stock. If too much capital is tied up in slow moving stock, it may also strangle your business to the extent that you have no cash left to trade.  

An important principle for me is: 
SALES   =  VANITY
PROFIT  =  SANITY
CASH     =  REALITY   :Wink:

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KimH (13-Jan-12), Miro Bagrov (13-Jan-12), roryf (11-Oct-11), wynn (11-Oct-11)

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## Just Gone

> I am a mature student with extensive business experience.
> 
> Rocky


So are you a student that left school and has been studying for long or are you an older person that became a student with the "extensive" business experience you have ?

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## Dave A

> I do however think that the question here is whether banks are adding value or not. I have seen many cases where banks will only fund the secured portion of a loan application. By not approving the total amount required, they are doing the SME a disservice as you can not fund half a business.


On the flip side, it *does* reduce the funding you might have to raise via other channels.

That's what's troubling me about the OP. Who is being "blamed" here?
Can we really blame a bank for a business plan being launched when it's under financed?
And you can't lay "onerous requirements" and "focus on access" at the same door, surely?

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## Blurock

> That's what's troubling me about the OP. Who is being "blamed" here?
> Can we really blame a bank for a business plan being launched when it's under financed?
> And you can't lay "onerous requirements" and "focus on access" at the same door, surely?


It is important to determine the sources of funding and even more important to determine the sustainability of the business. Many entrepreneurs realise their dreams by being unconventional and literally pull themselves up by their bootstraps.

Unfortunately, statistics show that one of the biggest reasons for business failure is a lack of cash flow. An under capitalised business carries so much more risk. If a financier does not look at the sustainability of a business, but only at the security offered, he becomes a pawnbroker who  simply cashes in his security when things go belly up. The loser is the person(s) who put up the security.

One can not expect the lender to see into the future, but lenders do have a responsibility to determine that the business is adequately capitalised to sustain operations. There are other qualifying criteria, but the access to funding and the generation of cash flow must be the most important.

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## Miro Bagrov

Hi Rocky and everyone,

I agree with you, but since you seek empirical evidence, you need to find sources of statistics. Try CIPRO. And DTI.

Absolutely financing rates are killing SME's. South African lending rates are so high that an SME needs to be at least 80-90% Owner's Equity.
I would like to discuss it more - but the South African context, using American Capital Theory does not play very well. Interest rates there are 2 -3 %, here 10 - 25% - considering that the Net Profit Margins on JSE listed companies are about 20 - 30%..

In South Africa, Equity is cheaper than Debt. Retained earnings are the cheapest source of funds, in the USA, debt is the cheapest source of funds. Here some companies don't even pay dividends.  :Big Grin:

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Blurock (13-Jan-12), Dave A (13-Jan-12)

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## Blurock

> I am completeing a dissertation on the affect that financing has had on the value chain of SME's in South Africa. I believe that the onerous requirements and restrictive practices of many financial intstitutions has had a large impact on the high failure rate of the SME in South Africa which has been ignored up until now with the focuss being on access rather than value adding.
> 
> If you have any thoughts or experiences in this area I would really like to hear them. Rocky


Can you share any of your insight on the topic thus far?  :Cool:

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