DEBT FINANCING STRATEGY FOR SMALL AND MEDIUM ENTERPRISE BASIC INFORMATION AND TUTORIALS

Debt finance
In the eighth edition of its report, Finance for Small Firms (March 2001), the Bank of England points out that, in total, SMEs have become markedly less reliant on external finance in recent years. For those that do raise external finance, traditional bank loans and overdrafts remain the primary source of funding.

Bank lending to SMEs rose rapidly in 2000 after several years of decline, with term loans accounting for 72 per cent of lending as at the end of September 2000 and the maturity profile remaining stable.

A slight shift towards variable rate loans (nearly 70 percent of total bank lending at 30 June 2000) was discernible, while asset based and receivable finance remains significant (see Chapter 2.2).

The Bank of England’s report reveals that at mid-year 2000, approximately 37 per cent of SMEs throughout Britain had loans of less than five years outstanding totalling £39,400 million, of which £28,100 million was in term borrowing.

The banks were operating on a nationwide average lending margin of 2.7 per cent. The total stock of lending to SMEs reached a record high of £42.5 billion in September 2000, an increase of more than 14 per cent year over year.

The reasons why these firms are disadvantaged are easy to understand:
• The availability of external finance is crucial because those who set up businesses in deprived areas are less likely to be able to draw on internal funds than those in more affluent areas.
• Businesses in deprived areas tend to lack business experience as well as collateral and personal equity.
• Business tends to be concentrated in sectors subject to higher failure rates; they suffer from remoteness, small and localised markets and high crime rates.

Data collected by the Bank of England indicated that the major UK banks currently lend some £1.5 billion to small businesses in some of the most deprived areas, but that the proportions of overdrafts to term loans and fixed to variable rate loans are almost the same as for the country as a whole.

However, the average lending margin charged to SMEs in deprived areas is significantly greater at 4.1 per cent, which is attributable to the increased lending risk. From the data available, the default rates of small businesses in deprived areas may be over three times as high as the nationwide average.