Kesseven Padachi C

Topics: Corporate finance, Finance, Debt Pages: 30 (9686 words) Published: January 15, 2015
Working Capital Financing Preferences: The Case of Mauritian Manufacturing SMEs Kesseven Padachi*; C. Howorth1 and M. S. Narasimhan2
*School of Business, Management and Finance
University of Technology, Mauritius
La Tour Koenig, Pointe – aux – Sables, Mauritius

This paper investigates the approach to working capital finance among the small to medium sized Mauritian manufacturing firms, using a survey based approach and case studies. Finance has been cited as the most common problems faced by SMEs and is often viewed as a main barrier to growth. Using parametric and non-parametric techniques, the important variables affecting the demand for finance were examined. Interestingly, it is observed that the sample firms adopted more informal sources of finance and networking to meet their financing requirements. The financing preferences of the firms were predominantly short-term and there was conclusive evidence of a reluctance to move down the pecking order for fear of losing control of their businesses. The findings confirmed that internal resources, non-bank sources and short-term debt represent the main sources of financing. The research findings provided some new evidence in support of the different approach to financing of working capital. They used the more informal sources, such as shareholders loan and bootstrap finance. It indirectly suggests that the firms experience significant information costs which prevent them from getting access to traditional sources of finance. The findings of the study will be useful to financial institutions funding SME and policy makers. Keywords: Working Capital Finance, Mauritian SMEs, Financing Preferences, Informal Sources. INTRODUCTION

This paper investigates into the working capital finance (WCF) of the small to medium sized Mauritian manufacturing firms. Finance has been cited as one of the main barriers to SMEs growth and many governments have attempted to bring partial solution by the creation of specific financing schemes. There are various traditional sources of finance for the small business or SMEs ranging from bank loans, overdraft, own funds/savings, loan from family/friends and equity funding. However, there exists also non traditional sources of finance which could be well utilised by the entrepreneurs in the financing of their business, which has been described by many researchers as “bootstrapping finance”. Generally working capital (WC) is financed by a combination of long-term and short-term funds. Long-term sources of funds consist of capital (equity from owners) and long-term debt, which only provide for a relatively small portion of WC requirement (finance theory will dictate that only the permanent portion of WC should be supported by long-term financing, Gitman, 2000) . This portion is the net WC; that is the excess of current assets over current liabilities. On the other hand, short-term sources of WCF consist of trade credit, short-term loans, bank overdraft, tax provision and other current liabilities used to finance temporary WC needs. Sometimes, WC deficit exists if current liabilities exceed current assets. In such a situation, short-term funds are used to finance also part of non-current assets and the firm is said to be adopting an aggressive WC policy (Bhattacharya, 2001). No doubt, easy accessibility of finance is an important factor to decide about the source of finance, but its impact on risks and return cannot be ignored (Gitman, 2000). The financing preferences of firms are often explained using Myers’ (1984) pecking order theory. Though this theory was developed for large quoted companies, it is equally applicable to small firms. Firms tend to use cash credit as a first choice for financing their WC needs. However, the excessive reliance on the banking system for WCF exerts some pressure on the banks and a significant part of available resources are first channelled to the large firms (Narasimhan and...

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