Small and Medium size Enterprises Grading

Small and Medium Enterprises (SMEs) contributes significantly to the economic development in Ghana. The main challenge for SMEs raising finance is information asymmetry between lenders and SMEs. SME grading provides information on creditworthiness, credit risk and credit quality on SMEs and thereby facilitates financing for SMEs. There is therefore SME credit grading to support investors and financial institutions to make smooth SME investment and lending decisions.

Beacon Ratings SME grading is an independent professional opinion on business fundamentals of SMEs. The grade assigned represents a relative assessment of business fundamentals, both qualitative and quantitative, underpinning the performance of SMEs.

Industry growth prospect is assessed to determine performance and associated risks of the industry. Industry parameters such as

• Demand-supply situation
• Level of entry and exit barriers
• Industry competition
• Availability of substitutes
• Technological trends
• Government support
• Seasonal situations

SMEs with relatively strong positioning and high market share in their business segment have competitive advantage and long-term sustainability. In evaluating performance of operations, the following are assessed:

• Products and services profile
• Scale and size of operations
• Timely availability of raw materials, manpower and utilities
• Bargaining power with key customers and suppliers
• Value addition in the product and services
• Product and service distribution networks and channels
• Business contracts with customers and order quantities

Operating activity and efficiency are assessed using financial ratios such as:

(a)  Cost of production per unit compared to competitors

(b)  Stock turnover

(c)  Debtors’ collection period

(d)  Creditors’ payment period

(e)  Turnover to total assets

(f)   Current capacity utilisation

(g)  Operating expense to income

(h) Sensitivity key drivers, selling prices and input costs.

Supply chain partners

Supply chain partners need to be operationally effective and efficient for SME to be competitive as they play key role in the smooth running of the SME. The scale, efficiency and effectiveness of such business partners are assessed. The business partners include:

• Suppliers
• Vendors
• Bankers
• Customers

SMEs use of modern technology and infrastructure helps to achieve an efficient production cycle, reduce wastes, sustain quality products and demonstrates the willingness of management to grow the business within changing times.

Operating activity and efficiency are assessed using financial ratios such as:

• Cost of production per unit compared to competitors
• Stock turnover
• Debtors’ collection period
• Creditors’ payment period
• Turnover to total assets
• Current capacity utilisation
• Operating expense to income
• Sensitivity of key drivers, selling prices and input costs

The performance of management is critical in determining the quality of management for effective and efficient management of SMEs. Parameters evaluated include the following:

• Business insight and vision
• Track record and experience
• Succession planning
• Employee relations
• Future growth strategy and approach

The quality of management is critical in determining the effective and efficient management of SMEs. While large entities employed professional managers, SMEs mostly rely heavily on owners and family members to manage the business, making it necessary to evaluate their track records and experience. Parameters include:

• Track record and strategy
• Succession planning
• Employee relations

Audited financial statements and bank statements are assessed to determine financial performance, financial position, cash generating capacity, financial risks and business efficiency of SMEs.

Profitability: Profitability is a measure of earnings generated as against the resources deployed. Profitability indicators are:

• Gross profit margin
• Operating profit margin
• Net profit margin
• Return on assets
• Return on equity

Gearing and debt coverage: Borrowed funds typically have fixed obligations in the form of interest and principal repayments, irrespective of the cash flow generation. Gearing and debt coverage indicators such as:

• Debt to total assets
• Debt service coverage
• Interest coverage

Liquidity management

Working capital: SMEs need to operate an optimal working capital to sustain operations. Working capital is assessed using:

• Current ratio
• Quick ratio
• Cash ratio

Cash flows analysis is critical in assessing creditworthiness of SMEs as it provides indication of whether operations are capable of funding itself or rely on external sources of finance. Cash generating capability measures cash flows from:

• Operating activities
• Investing activities
• Financing activities