The Role of Small Business

Business is going to change more in the next twenty five years than it has in the last hundred years. And driving this change would be the small businesses. Way back in 1973, economist E.F. Schumacher had predicted that small business grant money is likely to be beautiful for the emerging world. As it turns out, this was, indeed, prophetic.

An overwhelming percentage of businesses in the U.S. are small business grant money starting from garages to small joint stock companies. According to Administrator Hector V. Barreto of U.S. Small Business Administration, for the first time in history, small businesses in the U.S. received a record-breaking $79.6 billion in federal prime contracts in 2005, which is $10 billion more than 2004. Like in the U.S., in the European Union (EU) too, small business represents 99.8% of all EU enterprises providing two thirds of employment. With the digital revolution and the booming of the services sector in advanced developing countries like China and India, small business grant money are increasingly playing a pioneering role in pushing national growth rates across a broad spectrum of countries.

Credit for Small Business

One of the critical aspects that small businesses typically have to deal with is the varied financial issues from finding start-up capital to resolving cash flow problems. Most small businesses rely on accumulated earnings to provide the capital for investment and growth. Given that sources of capital are often limited for small businesses; the primary task is to ensure that the right quantum of money is mobilized from appropriate sources so that the resulting average cost of resources is minimal. When mobilizing all the resources from the cheapest source the question of risk enters the picture. The cheapest source need not necessarily be the safest source. The task, therefore, involves mobilizing resources for a small business involving a judicious mix between costs and risks thereby ensuring that the business has the lowest cost of capital, in line with the level of risk the business is willing to bear. In recommending the choice of financing, one will have to bear in mind aspects such as future maneuverability, the state of debt and capital markets and the implications, if any, in terms of control over the business. The choice should be so made as to allow for flexibility in mobilizing resources in future. Also, while from the point of view of costs, a certain source might appear to be cheaper and therefore desirable, conditions prevailing in the stock market, for instance, many not allow raising money in the form in which it is desired.

Sources of Financing Small Business

For small businesses, typically short term credit needs is of the most requirement. Broadly, there are two types of sources: internal and external. The internal sources are in the form of personal savings of the business proprietors, partners or even shareholders. Retained earnings, if the business has already been in operations for a while, depreciation charges, etc are the other forms of using internal resources for financing business operations. Then there are the external sources of funds: banks and financial intermediaries provide for both short term and long term credit facilities. Most countries assiduously try to promote small businesses, given the dynamism and employment opportunities small businesses provide. The U.S. Small Business Administration, for instance, provides a range of loan options of varying tenures to meet the credit needs of small business grant money. Suppliers credit is another option that small businesses with some amount of credibility can look forward to for meeting their fund requirements. The stock market is the clearly another option that small businesses can tap, but there are costs attached to raising money from the capital market.

Cost of External Sources

From external sources, money can be raised in the form of loans and shares. Loans can be raised in various forms such as public deposits, term loans, deferred credit and debentures. The first feature of loans is the certainty of its repayment. The time period may vary but ultimately the debt will have to be repaid. Loans always have a prior claim on income as opposed to the clams of the shareholders. Interest must be paid before the shareholders can enjoy profits. Further, in case of insolvency or liquidation, debtors have a prior claim on assets.

The equity or ordinary capital, as it is called, is raised from the shareholders of a company and represents true ownership in the business. In raising capital for expansion, diversification, new company formation, etc, equity is an important source of capital. The cost of equity capital is the earnings yield required by an investor. In other words, it is the rate of return the company must earn to maintain its market price. There are, however, good years and bad years for most companies and especially small businesses and the convention is to calculate the average earnings yield available to investors over a period of three to five years.

Financing Small Business in the U.S.

In the U.S., the Small Business Administration (SBA) is the principal source within the federal government assisting small business. The SBA administers loan guarantee programs for financial assistance to small business meeting certain criteria and has special funding programs for the physically challenged, veterans, victims of disasters and minorities. It issues a number of publications of interest to small business with special emphasis on teaching financing options and techniques. Apart from SAB, other government agencies also administer specific grant or loans programs of interest to small entrepreneurs seeking credit. Information on such programs is catalogued in the Catalog of Federal Domestic Assistance published by the U.S. Office of Management and the Budget. Trade associations and Chambers of Commerce, such as the United States Chamber of Commerce also provide small business toolkits to assist new business enterprises.

Financing Small Business in the E.U.

Financing small business is a weak link in the European Union. Keeping this in mind, the European Commission last year announced a Euro 29 million funding program for small business. It must, however, be stressed that the E.U. spends a lot of money funding companies and NGOs in over 80 programs. More often that not, funds are not spent up because of lack of knowledge or awareness on the part of small businesses or organizations entitled to utilize such funds.

To conclude, there is no magic wand for financing small businesses. The process of accessing credit by small business is an, indeed, a challenging task and requires some understanding of the both credit and stock markets. While the choice before small business for choosing the source of funds is widening, the challenge is to adopt the appropriate source of credit and developing a viable business model to service the credit source.