Cashflow lending: Towards more appropriate micro-enterprise loan products
There are two basic microfinance loan products – group loan and individual loan. Group loan scheme is used for very poor clients for them to have a support group, which also functions as the pressure group for defaulters, and to develop financial discipline necessary for a sustained financial access. Individual loan scheme most often is provided for the “entrepreneurial poor” who has the capacity to venture into income-generating activities which we can call “livelihood activities”. These are simple buy-and-sell activities where the clients buy in bulk, place a mark-up and sell the products in the neighborhood or in areas with high foot traffic. Most of these activities are done by individuals and sometimes assisted by other members of the family including children.
At certain point, some of the more enterprising among the clients move up and increase their volume of trading. Some enterprises evolve from livelihood to “micro-enterprises” – economic activities that exhibit growth potentials, that when given the right inputs and resources can become big. To sustain the growth, entrepreneurs have to transform themselves from a jack-of-all-trades to managers with knowledge and skills in inventory control, marketing, finance, and the other requisites of an enterprise. As the operation goes more complex, profit also increases that further motivates the entrepreneur to go on further. Seizing the opportunity is the name of the game as the entrepreneur takes advantage of bulk sales, consignment from suppliers, and other marketing arrangement and balancing these with fast turnover of goods through credit sales, promotions and other schemes that ensures sales.
At this point, one of the most important factors is cashflow. Start-up and growing enterprises need cash to cover inventories, operating expenses to pay suppliers, workers and lenders. The entrepreneur may need big amount at one time, but he can also have big cash inflows in another time which allows him to immediately pay back his loans. Effective cashflow management is one of the marks of an entrepreneur, and to have it, the entrepreneur need a standby source of cash, or credit that he can access every time there are cashflow concerns.
This is where the mismatch happens. Most of the loan products of MFIs are inflexible and still in the context of developing financial discipline as if entrepreneurs are first-time borrowers. Despite the track record developed by entrepreneurs who are long-time clients of MFIs, they still has to contend with the standard loan features such as fixed amount, payments are in equal installments and made at regular intervals. The worst feature is at certain amount, hard collateral is required, limiting the amount that can be availed by the entrepreneur. The option for the entrepreneur is to borrow small amounts from different lenders to cover for his total cashflow requirement. This I think is a missed opportunity for MFIs. With minimal skills in assessing enterprises, credit staffs are limited to determining the value of the collateral as the basis for the loan amount. The danger of falling into the collateral lending trap was emphasized in the previous article.
A more appropriate loan product would be cashflow-based with the following main features:
- credit-line type of loan with a maximum amount based on the historical data of cash requirement;
- risk covering is not limited to hard collateral but a combination of real estate, chattel, inventory and even collateral substitutes like savings;
- fast processing of draw down from the approved amount;
- business development services to enhance the skills of the entrepreneur are a must.
Providing appropriate loan product should also be coupled with business development services to develop the soft skills of the entrepreneur. These skills will enable the entrepreneur to transform the economic activity from a livelihood to growing micro-enterprise and minimize risks as well.
The main skills that should be developed include but are not limited to the following:
- Basic management skills which covers how enterprises are systematically run. This involves skills in planning both for the short and long term; organizing different functions and delegating them to hired workers; and coordinating the overall operations.
- Marketing skills which covers understanding the needs of the clients and aligning the products, doing market research, price setting and promotion.
- Financial management and accounting to ensure that the funds of the enterprise are separated from the personal funds of the entrepreneur. Record keeping to develop track record for the formal financial institutions specifically for MFIs.
In the end the assistance is an investment that will be mutually beneficial to both the MFI and the micro-enterprise client.