modes of debt financing

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FINANCIAL MANAGEMENT

Submitted to : Sir Farooq Shabir

Submitted by : Group _G

Ambreen Kusar_____02

Asma Hameed _____05

Bilal Ahmed _____09

Mehwish Sadiq_____18

Adnan Tousif _____22

Atif Sattar _____23

MBA (MorningM1)

DEPARTMENT OF MANAGEMENT SCIENCES

The Islamia University Bahawalpur


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Modes of debt financing & SMEs 24/05/2012

2 Department of Management Sciences, Islamia University Bahawalpur

MODES OF DEBT FINANCING & SMALL AND MEDIUM

ENTERPRISES SECTOR

Introduction:_________________________________________________________________________

Small and medium enterprises (SMEs) always have a requirement of external finance. It is an important

issue availability of finance for SMEs and Government body who make the policies must think about

this. The finance for SMEs is very helpful it is observed from current research knowledge and observed

markets where external fianc regulated. Financial institutions have different structures and lending

infrastructure due to which system affect SMEs in finance availability. These financial institutions are the

sources of credit availability. Sources of debt finance are very important for SMEs because these provide

funds for small and medium enterprises growth and development. Domestic banks, foreign banks, loan

companies, credit co-operatives and life insurers are the sources of debt finance. Except these sources

of finance government also take interest for the improvement of small and medium enterprises (SMEs)

and make polices about the external finance. These sources use the different modes of finance. Every

institution use specific modes of finance which is collaborating with policies are design in institution for

the purpose of the provision of finance. There are different modes of finance factoring by a bank, trade

credit, short term loan, personal funds, overdraft and working capital these are short term modes of

finance which is provided for small and medium enterprises (SMEs). Commercial paper, project finance

and long term loan these are the long time modes of finance for SMEs. Bank is a most popular source of

finance. Commercial banks are contributed in the boost up of small and medium enterprises (SMEs).

Different banks provided different types of finance facilities for different sector of SMEs. United bank

limited mostly provide finance for manufacturing sector of SMEs. For expansion in unit or new

machinery vehicles MCB bank advances finance on the particular conditions for small and medium

enterprises (SMEs). Standard chartered bank have many policies about financing for textile sector inmanufacturing concerns. Agriculture sector is also supported by advances to agriculturist from bank of

standard chartered. SMEs are the strong base of the economy of our country with the improvement of

SMEs industry the economy of the country also goes up. That why Islamic banking also promoted small

and medium enterprises (SMEs) industry by providing facilities like finance without interest base. Islamic

banking provides facilities on contract base with the involvement of risk factor which is managed from


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also can be vary from three to ten years .Interest can also be vary and mostly base on company risk

profile. Collaterals for bank are assets of a company. (National federation of independent business,

2001-2012)(Different type of debt financing).

Personal Funds: If business needs debts for its business then business owner also can get debt for

business from close relatives and with no disturbance of amount for equity in the company owner can

easily get debts from their peers .they return money to them with easy terms and conditions .Its a

flexible there is no formal agreement (National federation of independent business, 2001-2012).

Agreement of overdraft: In this mode, agreement always done between bank and its business for debt

financing. In this mode owner have limitations that he can get debt up to limit to the account which is

set by bank .If in owners account insufficient deposits which is not covering the amount which he is

going to get loan then owner has to pay interest with the principle amount. And bank charge high

interest rate, five percent rate plus prime rate. Its also called overdraft lines of credit (Nationalfederation of independent business, 2001-2012) (Different type of debt financing).

Working Capital Loan: It is mostly use for short term. Its mostly use by business for the purpose of fulfill

the working needs .Business need such type of debt for purchase the material, marketing and for

support the supply chain ,for production purpose, for mange the cash flows internally. Business can debt

financing only when business gives security to bank against loan .companies that get such type of debt

they repay the loan regularly and maintain the proper accounts. (diffrent types of debt financing).

Commercial Papers: These commercial papers issued by companies as a tool of debt financing at

discount on face value. Commercial papers usually purchase by banks and persons.

Syndicated Loan: These are huge amount of capital loans and large companies move up it from a cluster

of banks. One bank act as a leader among others bank. Banks expect to obtain domestic or international

companies (Different type of debt financing).

Project finance: Those projects which infrastructures is long term and large these type of projects call

for equity and debt both in huge amount of money. Assets of projects can be collateral for banks and

projects generate cash flows for repay the debts .projects can be dams, ports and building of roads

(Different type of debt financing).

Debenture: This is also tool of debt financing and company sell it for long time and both seller and

buyer make deal of debenture with this understanding that pay back the money at assured interest rate

to the payer (Different type of debt financing).

Inter Corporate Deposit: When one firm need of debt for its business then it can get debt from anther


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corporations for fulfill the need of debt financing. But it is short term help of company (Different type of

debt financing).

__________________________________Sources of finance____________________________________

Domestic Banks: Domestic banks play very important role in the provision of financial services to its

customers. SMEs are am important customer sector for banks. Commercial banks provide debt finance

to many institutions and organizations also. It can be said that domestic banks are most important for

provision of debts to SMEs (Shutt & Vanasse, April 1988).

Foreign Banks: Foreign banks also provide debt finances to the SMEs and other financial services.

Foreign banks provision on debts is twice as domestic banks. Increment in the debt financing from the

foreign banks is seen in past few years as the financial services are not any more limited to the territory

of the country only. Role of foreign banks is important in the debt financing of SMEs in developing

nations (Shutt & Vanasse, April 1988).

Trust and Mortgage Loan Companies: Trust and different mortgage companies are also providing loans

or debts for SMEs. Their ratio is increasing day by day. Trust companies are at decline in this sector and

loan companies provide more of the debts. In year 1944 to the year 1947 net worth of trust companies

begin to come down which effected debt financing for the SMEs also (Shutt & Vanasse, April 1988).

Credit Cp-operatives: Credit co-operatives also provide the debt finances to the SMEs and other finance

needed companies. Focus of credit do-operatives for the debts mortgage is on non-residential

properties. Lending activities of credit co-operatives also includes loans provision (Shutt & Vanasse, April

1988).

Life Insurers: Life insurance companies mainly provide the life insurances but the provision of loans or

debts for the SMEs is also done by insurance companies in many countries. Developed countries are

more focuses for the provision of debt finance by the insurance companies. Mortgages for the security

are residual and non-residual properties of SMEs. Loans provided to SMEs are 192 billion dollars in the

year 1997 only (Shutt & Vanasse, April 1988).

Specialized Financial Institutions: Debts are also provided by the specialized institutions of the country.

These institutions provide loans or debts for years, and also increase the growth rate of the industries in

countries. This is not major source but a good one for the small businesses and industries. Practiced in

many countries is increasing the trend of loans provision to SMEs (Shutt & Vanasse, April 1988).

Credit Cards: Studies and researches have shown that credit cards are providing important funding

sources for SMEs. Nevertheless the calculation of loans ratio provided by credit cards is very difficult.


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Reason for the difficulty of measuring the use of credit cards is because the data is not easily available

for the use of credit cards. Different techniques can be used for the estimation of debts provided by the

credit cards (Shutt & Vanasse, April 1988).

SME Financing Related Initiatives of Government: Many governments also take the initiatives for the

provision of debts to the SMEs for their improvement in national level. Different countries have

managed through their policies the provision of credits and loans to the SMEs. Corporations and

agencies are made for this purpose. These specially made organizations or agencies make possible the

direct involvement and support to SMEs in the countries (Shutt & Vanasse, April 1988).

______________________________Commercial Banks_______________________________________

Habib Bank Limited:Habib bank is providing running finance, cash finance and demand finance for

all sectors and all types of SME concerns. Providing (Min 0.5 Million-Max: 75 Million), for maximum 1year. This product is cash flow based and collateral based. Time of loan approval for this product is 9

days.

MCB Bank Limited: MCB is providing demand finance (for BMR expansion/new units), working

capital facilities and for all Sectors, all types of SME business concerns. Amount (min: 0.5 million-max

75 million). Tenure of Loan is from 1 year to 5 years. These loans are Cash Flow based, Collateral based

and Program based. For demand finance (for BMR expansion/new units) and working capital

facilities Collateral Requirement are Land, Building, Inventory, PGs, Current assets etc. Time of Loan

Approval-Disbursal is Max 37 days. MCB is providing lease financing (vehicle/machine/tractor) for all

Sectors, all types of SME business concerns. Amount (min: 0.5 million-max 75 million). Tenure of Loan is

from 1 year to 5 years. These loans are Cash Flow based, Collateral based and Program based. For lease

financing Repayment Modes are Equal, Monthly, Quarterly and half yearly installments all branches of

MCB are designated for this type of loan. Time of Loan Approval-Disbursal is Max 37 days.

United Bank Limited: UBL is providing NICF/FAPE for all Sectors and all types of SME business

concerns. Amount of loan is from 1 Million to 75 Million. Tenure of Loan is 1 year minimum -1 year

(Renewable) maximum. This loan is Cash Flow Based and Collateral Based with Flexible Repayment

Mode. For this loan Time of Loan Approval-Disbursal is 4-5 Weeks. All UBL branches are Designated

Branches for this loan. UBL is providing NIDF for all Sectors and all types of SME business concerns.

Amount of loan is from 1 Million to 75 Million. Tenure of Loan is 1 year minimum -7 year (Renewable)

maximum. This loan is Cash Flow Based and Collateral Based. Repayment Modes are as allowed by the

business cash flows or Quarterly. For this loan Time of Loan Approval-Disbursal is 4-5 Weeks. All UBL


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branches areDesignated Branches for this loan. UBL is providing Rice / Paddy AdvancesSpecifically for

SMEs which are working in Rice growing Sectors/ Clusters, and are manufacturing businesses.Amount

is Minimum 1 Million- Maximum 20 Million. Tenure of Loan is 3 year minimum-7 years (Renewable)

maximum. It is Program Based or Collateral Based, with quarterly repayment mode. Time of Loan

Approval-Disbursal is 2 Weeks; some Branches in different cities are designated for issuing this loan. UBL

is providing Cotton Ginners Advances Specifically for SMEs which are working in Cotton growing

Sectors / Clusters, and type of business is manufacturing or trading. Amount of loan is Min: 1 Million-

Max: 75 Million while Tenure of Loan 9 months. It is Program Based and Collateral Based loan with

quarterly repayment mode. Time of Loan Approval-Disbursal is 2 Weeks; some Branches in different

cities are designated for issuing this loan. UBL is providing Credit Facilities against Liquid Securities

Specifically for SMEs of any sectorand business concerns. Amount of loan is Min: 1 Million - Max: 75

Million while Tenure of Loan is Minimum 1 year- Maximum 3 years. It is Program Based and CollateralBased with quarterly repayment mode. Time of Loan Approval-Disbursal is 2 Weeks; some Branches in

different cities are designated for issuing this loan. UBL is providing running finance specifically for

SMES of all sectors and business concerns. Amount of product is Up to 75 Million; Tenure of Product is 1

year. It is Collateral Based with quarterly repayment mode. Time of Loan Approval-Disbursal is 40 days;

some Branches in different cities are designated for issuing this loan.

Askari Bank Limited: Askari bank is offering running finance, cash finance and term finance

generally for all products and all sectors, and all business concerns of SMES. Amount of this loan is

Maximum 75 Million, Tenure of Product Maximum 1 year. It is Cash Flow Based and Collateral Based,

with Repayment Mode like Monthly, Quarterly, Flexible, Bullet repayment. Time of Loan Approval-

Disbursal is 21 Days. All branches of Askari bank are designated.

Bank Al-Falah Limited: BANK ALFALAH is offering ALFALAH KAROBAR finance which is specific SME

Product, for all sectors and all SME business concerns. Its Amount is (Min: 0.5 Million - Max: 10 Million)

with the Tenure of Product of 1 year. Cash Flow Based and Collateral Based product, having Repayment

Mode like Quarterly and Flexible Mode. Time of Loan Approval-Disbursal is 30 Days. Designated

Branches are some Specific branches in different cities. BANK ALFALAH is offering ALFALAH MILKIAT

FINANCE For Infra-structure Capacity Building, which is specific SME Product, for all sectors and all SME

business concerns. Its Amount is (Min: 0.5 Million - Max:20 Million) with the Tenure of Product of 2-12

year. Cash Flow Based and Collateral Based product, having Repayment Mode like equal monthly

installments. Time of Loan Approval-Disbursal is 45 Days. Designated Branches are Gujranwala, Sialkot,

Lahore, Peshawar and Islamabad branches.


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Standard Chartered Bank Limited:Bank Standard Chartered Bank Limited offers Specific SME Product

TANA BANA, for which Targeted Sector is Textile Weavers for all manufacturing SME concerns.

Amount of loan (Min: 0.5 Million - Max: 20 Million), it is Evergreen facility renewed annually, and it is

Secured by Program or Collateral Based. Repayment Mode is Monthly markup payment. Time of Loan

Approval-Disbursal is 16 Days while the Designated Branches are Direct Sales Representatives. Bank

Standard Chartered Bank Limited offers Specific SME Product RANG HI RANG for which Targeted

Sector is Textile Dyers and Printers for all manufacturing SME concerns.Loan Amount ratio is (Min: 1

Million-Max: 20 Million). it is also an Evergreen facility renewed annually, Secured by Program or

Collateral Based with Repayment Mode Monthly markup payments, its Average time of Loan Approval is

16 Days while Designated Branches are Direct Sales Representatives. Bank Standard Chartered Bank

Limited offers Specific SME Product KISAN CARD for which Targeted Sector is agriculture for all SME

farmers.Loan Amount ratio is (PKR 32,000-Max: PKR 125,000). It is also an Evergreen facility renewedannually, unsecured Program Based with Repayment Mode; Bi-annual markup payment. Its Average

time of Loan Approval is 16 Days while Designated Branches are Direct Sales Representatives. Bank

Standard Chartered Bank Limited offers Specific SME Product AGRI DEAL for which Targeted Sector is

Dealers of agri. inputs, fertilizer and pesticides; for all SME traders.Loan Amount ratio is (0.5 Million

Max: 30 Million). It is also an Evergreen facility renewed annually, secured by Program / Collateral

Based, with Repayment Mode; Monthly markup payment. Its Average time of Loan Approval-Disbursal is

16 Days while Designated Branches are Direct Sales Representatives. Bank Standard Chartered Bank

Limited offers a general Product BUSINESS POWER for all Sectors and for all SME business concerns.

Loan Amount ratio is (1 Million Max: 20 Million). It is also an Evergreen facility renewed annually,

secured by Program / Collateral Based, with Repayment Mode; Monthly markup payment. Its Average

time of Loan Approval-Disbursal is 16 Days while Designated Branches are Direct Sales Representatives.

Bank Standard Chartered Bank Limited offers a general Product BUSINESS INSTALMENT LOAN for all

Sectors and for all SME business concerns.Loan Amount ratio is (1 Million Max: 2 Million).Tenure of

Product is Minimum 1 year- Maximum 3 years, Unsecured Program based, with Repayment Mode; Equal

Monthly installments. Its Average time of Loan Approval-Disbursal is 14 days. It could be called clean

lending. Designated Branches for this are Direct Sales Representatives.

Habib Metropolitan Bank: Habib Metropolitan Bank is providing a general product for all sectors and all

types of SME concerns WORKING CAPITAL FINANCE. Its Amount of loan is from Min: 0.5 Million to

Max: 2 Million. Tenure of Product is Up to 1 year, while it is a Cash flow based and Collateral based

product. Its Repayment Mode is like Monthly, Quarterly, and Bullet Repayment. Time of Loan Approval


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is One month. Designated Branches are All Branches. Habib Metropolitan Bank is providing a general

product for all sectors and all types of SME concerns TERM FINANCE. Its Amount of loan is from Min:

0.5 Million to Max: 2 Million. Tenure of Product is from 3.5 up to 7 year, while it is a Cash flow based and

Collateral based product. Its Repayment Mode is like Monthly, Quarterly, and Bullet Repayment. Time of

Loan Approval is One month. Designated Branches are All Branches.

SMEs in which Islamic Banking Finance: SMEs are the one of the targeting growth of Islamic banking. As

SMEs is one of the most flourishing industries of the country. Therefore Islamic banks are also making

financing in SMEs. Following are the main important SMEs in which Islamic banking financing on priority

basis, Sports Goods, Dairy industry, Textile Industry, Livestock and cattle farming, Fisheries, Light

Engineering, Medical Equipment, Auto Financing, Bio gas plants, Fishing Boats & Engines, Furniture

Industry, Housing Sector, Carpets, Metal products, Leather industry, Edibles (State Bank of Pakistan,

2008). Following table shows the Islamic banking financing in SMEs sectors.

Source: adapted from State Bank of Pakistan (2008). Islamic banking also concentrates on risk

management. There is a defined and systematic procedure to manage all the risk in the business. This

process involves in following steps are identification, measurement, monitoring and controlling. Another

main function of the risk management is to consider all the following factors and to ensure that all the

contracts and financing are in compliance to the Islamic shriah. All this is done to eliminate the fraud

and misrepresentation in contracts and financing (State Bank of Pakistan, 2008).


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______________________Modes of Financing in Islamic Banking in SMEs________________________

Murabaha Financing: As charging interest in Islam is prohibited, but charging a profits on the sales of

product is allowed by the Islam. This term of financing is used in this in which a profit is charged on the

sale of the product. Therefore this is also based on sale based transactions. In this term a bankpurchased a goods or commodity on the demand of customer and sells to the customers on the amount

of purchase price plus profit. The customer pays the price in following three ways, in installments, at

spot at the time of sale or in a lump sum after a period of time. This financing mode has a full structure

in which a customer asked a bank to purchase sudden goods through applications to pay the price of

goods to bank (State Bank of Pakistan, 2008). In Murabaha financing the bank also demand for the

security in order to return the prices of goods from customers. Following types of securities are asked

from a customer, personal guarantees, lien on deposits, bank guarantees, Pledge of goods and/or

marketable securities, Mortgage charge on movable and immovable properties (State Bank of Pakistan,

2008).If the prices of the commodities are rises, then it is essential to tell the bank about it. Then it will

depend upon the bank whether to accept it or not (State Bank of Pakistan, 2008).

Types of Financing in Murabaha Financing: There are six main types of agreement which are essential in

order to avail Murabaha financing, Master Murabaha Financing Agreement (MMFA), Agency Agreement,

Order form, Murabaha Agreement (Declaration), Demand Promissory Note, and Payment Schedule

(State Bank of Pakistan, 2008).

Ijaraha base Financing: It is the types of financing in which bank transfer an asset to its customer at an

agreed consideration, for an agreed period of time. There are some terms and conditions that the asset

should have some value, quantity and identification (State Bank of Pakistan, 2008).It is the type of lease

in which two or more parties are involved. There are two main parties lessee and lessor. Lessor is the

owners of the assets which leases its asset to the lessee which takes it on lease and use it for a period of

time that is liable for the wear and tear of the asset and also of its misuse or damage. Lessee has to pay

the rent of the asset utilize over the period of time. Lessee can also acquire the ownership of asset at

any period of time or after the contract period is over (State Bank of Pakistan, 2008).

Lease Document: There are number of documents required to acquire this financing from the banks.

Following are some documents which required, Letter of Request, Lease Application Form, Credit

Memorandum, Offer Letter, Acceptance, Undertaking to Purchase Leased Asset, Lease Agreement, and

Letter of Continuity etc. (State Bank of Pakistan, 2008).

Salam base Financing: In this type of financing the supply of good is done on some future date whereas

the payment of the price is paid at the spot. In this the bank acts as Salam and purchase good for future


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date for trade and also get benefit of cheap prices, as the Salam prices is less than cash sale (State Bank

of Pakistan, 2008). The bank can also sell the Salam on the same terms and conditions to others, this is

called parallel Salam. The bank can also wait for commodity and can sell it others (State Bank of

Pakistan, 2008). There are few sectors in which Salam based financing can consider as good financing.

The Salam based financing sectors are Agriculture financing, Export financing, Working Capital Financing,

Commercial and industrial financing, Operations and capital cost financing (State Bank of Pakistan,

2008).

Diminishing Musharaka: It is the joint ownership in property in which one partner promise to purchase

equity share of others partner until all the equity transferred to that partner. In this the bank and

customer act as joint ownership in which customer purchases all the equity from the bank. Diminishing

Musharaka is mostly done in fixed assets like, House financing, Car Financing, Plant and machinery

financing, Factory/Building financing, Agriculture land financing, and All other fixed Assets (State Bank ofPakistan, 2008). The basic transaction start with customer approaches to the bank for financing. Then

the bank enters into joint ownership and purchases the fixed asset for the customer. In this the bank

charges rent until the customer purchases the entire equity (State Bank of Pakistan, 2008). When the

customer purchased all the equity share of the fixed assets, the bank transfers the ownership of the

property to the customer (State Bank of Pakistan, 2008). Following documents are prepared to complete

diminishing Musharaka financing, Musharaka Agreement, Payment Agreement, Undertaking to

purchase Musharaka Units, Undertaking to Sell Musharaka Units, Unit Sale Receipt Pakistan.

Astisna Financing: It is a type of financing in which an order is placed to the manufacturer to

manufacture a specific commodity at fixed prices by the consent of all parties. The basic uses of this

financing is where value added and production is required. The basic function of this financing is to fulfill

the working capital requirement for the SMEs. Islamic bank can use Istisna mode of financing in

following financial products, Financing technology industries, Working capital and export financing,

Financing construction industry such as apartment buildings, hospitals, schools and Universities, and

housing finance schemes (State Bank of Pakistan, 2008).


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Reference: ___________________________________________________________________

1. State Bank of Pakistan (2008).Handbook on Islamic SME Financing. Islamic BankingDepartment, State Bank of Pakistan...

2. SME Financing Products; Small and Medium Enterprises Department; State Bank of Pakistanwww.sbp.org.com

3. Mr. Mansoor Hassan Siddiqui Team Leader [email protected]. . Mr. Allauddin Achakzai Member [email protected]. Mr. Farzand Ali [email protected]. Shutt, T., & Vanasse, P. (April 1988). SOURCES OF SME BUSINESS DEBT FINANCING. The

Current Marke for Small Business Financing, Industry Canada.

7. National Federation of Independent Business. (2001-2012). mods of small business. NFIB.com.8. diffrent types of debt financing. (n.d.). Retrieved may 19, 2012, from

http://articles.maxabout.com/business-finance/different-types-of-debt-financing/article-6730.

9. file:///E:/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htm
http://www.sbp.org.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]://articles.maxabout.com/business-finance/different-types-of-debt-financing/article-6730http://e/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htmhttp://e/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htmhttp://e/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htmhttp://e/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htmhttp://e/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htmhttp://e/documents/Debt%20Financing%20%20Pros%20and%20Cons%20for%20Business%20Owners.htmhttp://articles.maxabout.com/business-finance/different-types-of-debt-financing/article-6730mailto:[email protected]:[email protected]:[email protected]://www.sbp.org.com/


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