Entrepreneurial Finance for MSMEs

Joshua   Yindenaba   Abor

Entrepreneurial Finance for MSMEs

A Managerial Approach for Developing Markets

ISBN 978-3-319-34020-3 ISBN 978-3-319-34021-0 (eBook) DOI 10.1007/978-3-319-34021-0

Library of Congress Control Number: 2016953820

© Th e Editor(s) (if applicable) and Th e Author(s) 2017 Th is work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifi cally the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfi lms or in any other physical way, and transmission or informa-tion storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. Th e use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specifi c statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Th e publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made.

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Joshua   Yindenaba   Abor University of Ghana Business School Accra , Ghana

To my parents, Mr. Abor Ndobire and Madam Amina Tobga. And to my wife, Dr. Patience Aseweh Abor and children, Ivana, Bastien and Venka for their love,

support and encouragement.

vii

Th e important role micro-, small- and medium-sized enterprises (MSMEs) play across the world cannot be overstated. MSMEs represent the ‘engine’ of economic growth, especially in developing and emerging countries. Th is book deals comprehensively and clearly with entrepreneurial fi nance and represents a timely and excellent contribution to our understanding and knowledge of this sector from a managerial perspective. MSMEs are the drivers of entrepre-neurship and innovation, and fi nance lies at the heart of the success or failure of these fi rms!

Professor Abor must be congratulated on providing such a clear and detailed treatment of this subject. Th e book is written with exceptional clarity and insight. Th e 15 chapters deal with the complexity of managerial fi nance relating to MSMEs in a way that makes the material accessible to a wide read-ership. Th e book is essential reading for all concerned with the sector—both those from within the sector itself and others, including analysts, academ-ics, consultants and policy-makers. As more and more developing countries emerge from the ‘Base of the Pyramid’, we will witness the birth of many new enterprises day by day—and inevitably, there will be many failures. But this book off ers hope and guidance for the future of small businesses!

Joe   Nellis School of Management

Cranfi eld University Cranfi eld , UK

Foreword

ix

Micro-, small- and medium-sized enterprises (MSMEs) have been noted as important contributors to the economic growth of many countries. Issues regarding MSMEs are therefore critical not only for the entrepreneur, but also for regulators, policy-makers, academics and the general public. Most start-up fi rms fail in their embryonic stage due to a multiplicity of factors, and espe-cially so in sub-Sahara Africa. One of the main pandemics that plague small businesses is their lack of understanding of fi nancial issues regarding their operations. Finance is critical for the survival of any entrepreneurial venture, and a good understanding of the fi nancial issues confronting MSMEs will increase the chances of the entrepreneur surviving.

Entrepreneurial fi nance deals with both institutional fi nance and fi nance as a structured approach to decision-making. Institutional fi nance is con-cerned with identifying the various sources of fi nance available to MSMEs and showing their extent of use. Th e focus of fi nance as a structured approach to decision- making is on the allocation of resources and how the enterprise should be structured. Th is text combines both approaches, with more empha-sis on fi nance as a structural approach to decision-making. Th e entrepreneur must consider the sources of fi nance and how to allocate the funds to produc-tive ventures. Th e aim of this book, therefore, is to show how entrepreneurs and managers of MSMEs can add value to their fi rms by applying mana-gerial fi nance tools. Entrepreneurial fi nance is also relevant for managers of large corporations because it is increasingly being advocated that these organ-isations should be more entrepreneurial in their approach. Th is concept is referred to as intrapreneurship , where managers in existing organisations are encouraged to be innovative and are expected to operate like entrepreneurs.

Pref ace

x Preface

Th is book is essential reading for entrepreneurs, small business managers, managers of venture capital fi rms, managers of microfi nance institutions, policy-makers and experts in small- and medium-sized enterprises (SMEs) development. Th e text is also useful for students studying fi nance and entre-preneurship. Specifi cally, it is appropriate for both undergraduate and grad-uate students: MBAs, Executive MBAs as well as Masters in Development Finance.

Divided into 15 chapters, this textbook deals extensively with entrepre-neurial fi nance and provides a comprehensive framework for understanding the MSME sector. Th e fi rst three chapters, which provide the entrepreneurial setting, focus on the introduction to entrepreneurial fi nance, new venture development and sources of fi nancing, and business planning. Chapters 4 , 5 , 6 and 7 examine the fi nancial environment within which MSMEs operate and discuss the importance of venture capital, microfi nance and the public sector in supporting MSMEs. Chapters 8 , 9 and 10 deal with fi nancial per-formance and planning. Th ey specifi cally look at understanding and analysing statements, fi nancial planning and forecasting, and working capital manage-ment. Th e relevance of time value of money, evaluating capital investment decisions and valuation of new ventures and small businesses are discussed quite extensively as useful tools in taking business and investment decisions. Th ese are covered in Chaps. 11 , 12 and 13 . Th e last two chapters concen-trate on fi nancing choice by the entrepreneurial fi rm and how entrepreneurs and other investors, such as venture capitalists, can harvest their investments. Th ough the text gives the reader a global view of entrepreneurial fi nance, it provides more examples within the context of developing countries, which are often ignored in most books on this subject matter.

xi

I am very thankful to the Almighty God for the strength and wisdom to com-plete this book. I am also grateful to Professor Nicholas Biekpe (University of Cape Town) and Professor Ernest Aryeetey (University of Ghana) for intro-ducing me to research in small business fi nance. Th e book has benefi tted from useful comments from colleague academics, students, entrepreneurs and pri-vate equity and venture capital experts. I am particularly grateful to Professor Joe Nellis (School of Management, Cranfi eld University, UK), Professor Isaac Otchere (Carleton University, Canada), Professor Charles Blankson (University of North Texas, USA), Professor Paul Alagidede (Wits Business School, South Africa), Dr. Elikplimi K.  Agbloyor (University of Ghana Business School), Dr. Agyapomaa Gyeke-Dako (University of Ghana Business School), Dr. Kwame Adom (University of Ghana Business School), Mr. Perci Ampomah (Investment Manager, Venture Capital Trust Fund, Ghana), Mr. Matthew Adjei-Boadu (CEO, Oasis Capital, Ghana), Dr. Michele Ruiters (Development Bank of Southern Africa), Mr.  Brendon D.  Darroll (Small Business Project, South Africa), Ms.  Loyiso Ndlovu (Land Bank, South Africa) and Mr. Clive M. Mulumba (United States Agency for International Development [USAID], Zambia) for reviewing the manuscript. I also appre-ciate the excellent research support provided by my Teaching Assistants, Abel Agoba, Isaac Ofoeda, Gifty Adjei-Mensah, Vincent Asante-Asiedu, Ibrahim Jabir, Daniel Asante-Amponsah and Richard Akyeanfu. I am thankful to the Carnegie Writing Centre (University of Ghana) for editing the manuscript. However, I am responsible for all other errors in this book.

Acknowledgements

xiii

Part I Th e Entrepreneurial Setting 1

1 Introduction to Entrepreneurial Finance 3

2 New Venture Development and Sources of Financing 21

3 Business Planning 51

Part II Th e Financial Environment and Finance Providers 67

4 Th e Financial Environment and Small Businesses 69

5 Venture Capital Finance 87

6 Microfi nance Intervention 107

7 Public Sector Interventions and Small Businesses 153

Part III Financial Performance and Planning 169

8 Understanding and Analysing Financial Statements 171

Contents

xiv Contents

9 Financial Planning and Forecasting 199

10 Working Capital Management 225

Part IV Valuation 257

11 Time Value of Money 259

12 Evaluating Capital Investment Decisions: Capital Budgeting 293

13 Valuation of New Ventures and Small Businesses 321

Part V Financing Choice and Harvesting 357

14 Financing Choice 359

15 Harvesting the Business Venture Investment 371

Appendix A: Formula Sheet 391

Appendix B: Financial Tables 395

Glossary 407

Bibliography 427

Index 433

xv

Fig. 10.1 Investment in inventory 235 Fig. 10.2 Th e Miller–Orr cash management model 249

List of Figures

xvii

Table 6.1 Financial records of Capro Finance (2015) 120 Table A.6.1 Financial data of Leery Microfi nance Limited 152 Table 7.1 Features of SME and Entrepreneurship policy 164 Table 8.1 Income statement (statement of comprehensive income) 174 Table 8.2 Statement of fi nancial position 176 Table 8.3 Statement of cash fl ows 180 Table A.8.1 Rand Limited income statement for the year ended

31st December 2015 196 Table A.8.2 Rand Limited statement of fi nancial position as at

31 December 2015 197 Table 9.1 Quality Mechanics, cash budget for the four months

ending 31 December 2016 204 Table 9.2 Dallima Minerals Ltd. Balance Sheet as at 31 December 2015 210 Table 9.3 Dallima Minerals Ltd. Balance Sheet as at

31 December 2015 (as a percentage of sales) 210 Table 9.4 Dallima Minerals Ltd. Forecasted Income Statement

for the Year Ending 31 December 2016 212 Table 9.5 Dallima Ltd. Balance Sheet as at 31 December 2016 213 Table 9.6 Everlasting Products Enterprise: projected income statements 214 Table A.9.1 Bans Bakery Ltd.: Financial Status and Forecast 221 Table A.9.2 Sugar Cane Farms’ end of 2015 balance sheet 223 Table A.9.3 Sales and purchase estimates 224 Table 10.1 Aging of accounts receivable 241 Table 10.2 Quantity discounts 253 Table 11.1 Compound value 265 Table 11.2 Future value 269 Table 11.3 Present value of each of the cash fl ows and totals 269 Table 11.4 Loan amortisation schedule 288

List of Tables

xviii List of Tables

Table A.11.1 Looking for unknown variables 290 Table 12.1 Cummulative net cash fl ows 300 Table 12.2 Discounted net cash fl ows 302 Table 12.3 Cash fl ows 304 Table 12.4 Discounted cash fl ows 307 Table 12.5 Terminal value 310 Table 12.6 Sharp Engineering example Pt.1 312 Table 12.7 Sharp Engineering example Pt.2 313 Table 12.8 Sharp Engineering example Pt. 3 313 Table 13.1 Print Direct Limited example 324 Table 13.2 Venture capital method—NPV framework 331 Table 13.3 Venture capital method—IRR framework 333 Table 13.4 Venture capital method—considering

multiple rounds of fi nancing 335 Table 13.5 Appropriate growth models used for valuation of

free cash fl ows 342 Table 13.6 Lapell Limited’s annual fi nancial report example 343 Table 13.7 Lapell Limited’s free cash fl ow example 343 Table 13.8 Lapell Limited’s free cash fl ow to equity example 344 Table A.13.1 Small business cash fl ow example 353 Table A.13.2 TransValley Properties Limited cash fl ows example 354 Table 14.1 Various fi nancing sources for MSMEs and new ventures 360 Table B.1 Future value of US$1 at ‘n’ period 395 Table B.2 Present value of US$1 at ‘n’ period 397 Table B.3 Future value of an ordinary annuity of US$1 at ‘n’ period 399 Table B.4 Future value of an annuity due of US$1 at ‘n’ period 401 Table B.5 Present value of an ordinary annuity of US$1 at ‘n’ period 403 Table B.6 Present value of annuity due of US$1 at ‘n’ period 405