Accounting Project Topics

The Problems of Financing a Small-Scale Business in Nigeria

The Problems of Financing a Small Scale Business in Nigeria

The Problems of Financing a Small-Scale Business in Nigeria

Chapter One

Objectives of the study 

The main objective of this study was to determine the financing problems faced by Small and Medium Enterprises in Lagos. The sub-objectives of this study were as follows:

  1.  To determine the financing problems faced by SMEs operating in Lagos.
  2. To study how financing problems, affect the operations of Small and  Medium Enterprises.
  3. To make recommendations to policy makers, on how they can make funding more accessible to SMEs and actions required to improve their performance and growth in Nigeria.




This chapter reviews literature on financing of SMEs. Specifically, literature related to the need for financing, impediments to access of finance by SMEs, the effects of limited access to finance by SMEs on the operations of the same and ways of easing financing problems faced by SMEs. Journal articles, published books, articles from the Internet and student papers are used in the review of literature.

Definition of SMEs 

Different countries use different yardsticks to determine whether or not a business qualifies to be regarded as an SME. Overall, most definitions adopted in various counties use two main yardsticks (the number of employees and the amount of capital invested in the venture) in defining SMEs. In Malaysia, a business is regarded as an SME if it employs between 50-150 workers (SMECORP, 2013). The definition of SMEs adopted in the European Union by OECD (2005) is that of non-subsidiary and independent firms which employ a maximum of 250 employees and whose annual turnover does not exceed EUR 50 million.  In the United States, SMEs are enterprises which employ fewer than 500 employees (OECD, 2005). In Kenya, SMEs enterprises are divided into two categories: micro, and small and medium enterprises. Micro enterprises are those which employ less than 10 people and employ capital of less than 10 million Kenya Shillings. Small enterprises are those which employ between 10 and 50 employees and have capital range of 10 to 50 million Shillings (Ong’olo, & Awino, 2013).

In Nigeria, SMEs are defined using three main indicators; annual sales turnover, capital outlay, and the number of employees (Ogbokor and Ngeendepi, 2012). Ogbokor and Ngeendepi (2012) define SMES as enterprises whose annual turnover is less than one million Nigerian dollars, employ less than 10 employees and has a capital outlay of not more than five hundred thousand Nigerian Dollars (N$500 000).

Theoretical Framework  

There is a general consensus among scholars regarding the relationship between access to finance by SMEs and their growth. Access to finance is considered a key ingredient in  SME growth, sustainability and a source of competitiveness (Rambo 2013). Mira and Ogollah (2013) hold the view that the only way to enhance the competitive position of SMEs in the market-place is through enhancing SME access to finance. Through enhancing SME access to finance, SMEs will be able to thrive, grow and create sustainable job opportunities. Wu, Song and Zeng (2008) consider access to finance as the engine for SME growth. According to Wu, Song and Zeng (2008), one of the key reasons why SMEs in China involuntarily exit the market arena is limited access to finance – an important ingredient for the continued existence of SMEs. Abdulsaleh and Worthington (2013) opined that, sustainable growth and profitability of SMEs squarely rests on the ability of SMEs to access finance. Ackah and Vuvor (2011) consider access to finance as the bloodline of SME existence.

Although access to finance is considered as the engine for SME growth, the study by the World Bank (2015) on Small and Medium Enterprises Finance revealed that the majority of SMEs especially those in developing countries find it difficult to access finance from the conventional banking system. The World Bank estimates that over 70% of SMEs in developing countries find it hard to access finance from mainstream financial institutions. In Sub-Saharan Africa, access to SMEs financing is particularly important since SMEs account for about (90%) of all enterprises and over (80%) of all new jobs that are created (Rambo, 2013). In as much as SMEs play a pivotal role in employment generation especially in developing countries, the World Bank notes with concern that government of developing countries are not doing much to support SME growth. They are not doing much to make it easy for SMEs to access funding. Makena, Kubaison, and Njati (2014) attribute limited access to finance by SMEs in developing countries, to the sector in which most SMEs in developing countries operate in. According to Makena, Kubaison, and Njati (2014), the majority of SMEs in developing countries operate in the informal sector, which is hardly financed by the conventional banking system.

 Empirical studies  

According to the World Bank Enterprise Survey (2014), 40.9% of small and 28.6% of medium enterprises identify access to finance as a major constraint, whereas only 1% of large enterprises see access to finance as a challenge for their development. As much as SMEs play a pivotal role in the economic development of countries such as creation of employment, resource mobilisation, wealth creation, spurring of innovation, many SMEs fail to live long enough to continue providing those benefits because of high mortality rate (Odeyemi, 2016). A study by Kamunge, Njeru, Tirimba (2014) in Kenya found out that most SMEs in Kiambu County had a life span of two years – a period too short for SMEs to make an impact in society. Kamunge et al., (2014) attribute early mortality rate of SMEs in Kiambu county limited access to finance. Another study done by Fatoki and Odeyemi (2016) confirmed the findings by earlier study done in Kenya by Kamunge et al., in 2014. According to Fatoki and Odeyemi (2016), SME mortality rate is very high in Sub-Saharan Africa, with South Africa taking the lead. Fatoki and Odeyemi (2010) estimate SME mortality rate in South Africa at 75%, the highest in the world. The demise of SMEs poses a great threat to developing economies like Nigeria which have an already soaring and worrying rate of unemployment. Therefore, in order to ensure continued existence of SMEs, there is need for developing countries like Nigeria to put into place financing mechanisms to support SME growth. Based on the above discussion, to prolong SME life-span, there is need for developing countries to support the SME sector through making it easy for SMEs to obtain financing.




 Research design 

The study used a quantitative research design to produce descriptive statistics of the  SME sector and their experiences when starting up and applying for funding. Quantitative data was collected using questionnaires. Quantitative research involves the analysis of numerical and quantifiable data (Creswell, 2014). According to Leedy and Ormrod (2012), quantitative research is used for testing the relationships between given variables and the main tool used in quantitative research is a questionnaire.


Leedy and Ormrod (2012) define a population as the total number of elements that are of interest to a researcher. The members of the population of interest should be in a position to provide answers to the questions raised should they be selected to form part of the sample. The exact number of SMEs registered and operating in Lagos could not be precisely established by the time of conducting this study. However, previous studies estimate the number of SMEs operating in Lagos to be close to 40,000 (forty thousand) (Ogbokor and Ngeendepi, 2012). Without concrete data on the contrary, this study therefore concurs with the estimates of the above scholars regarding the number of SMEs operating in Lagos. The assumption held is that there are roughly 40000 SMEs operating in Lagos, and therefore, the population under study is 40000 SMEs.  Furthermore, it was not possible to establish the number of SMEs per sector of operation as this data is not specifically documented by government agencies.



Biographical data of the research participants

Gender of research participants




This chapter concludes the study by giving the summary of key findings, offering recommendations to be adopted in order to improve funding of SME businesses in Lagos, and suggests areas for further research.

 Summary of research findings  

This study aimed at investigating the financing problems faced by small and medium enterprises in Lagos city. The specific objectives that this study sought to address were to ascertain whether SMEs have challenges in accessing credit in Nigeria and if so, determine the specific challenges; determine how financing problems affect the operations of Small and Medium Enterprises; and make recommendations to policy makers on how to overcome the financing problems. This would in turn help improve accessibility of funds by SMEs so as to improve the performance of the SME sector.

To achieve the above objectives, this study adopted a quantitative research design and used a sample of 293 that was drawn from Lagos City using simple random probability sampling. The sample was drawn from various business sectors including construction, retail, manufacturing, beauty and cosmetics, transport, and others.

This study found out that most of the small and medium enterprises operating in  Lagos were established to create employment opportunities for their founders who mostly were college educated or higher, had previous experience in their chosen business line and were in the most productive age group whom you would normally expect to be in formal employment. This suggests that other motives could have played a role in propelling them into business.  The motives included to contribute to the national growth of Nigeria, taking services nearer to the people, and to make profit.  Control over their earnings and mode of operation may also have been factors.  More interesting is that the majority of SMEs operating in Lagos did not receive government support such as incentives, regional assistance, and subsidies. Given that the majority are college educated and had previous relevant experience and therefore would be aware of government support programs. This would suggest that either there is no government program to support SME start-ups or that the process to access such support is convoluted and therefore unattractive for SMEs to attempt to access.

Lack of government support puts the full economic burden for both operations and regulatory compliance on the SME.  Given that the same SMEs have challenges obtaining funding for their operations, it is not surprising that most are unable to incur the cost of regulatory compliance.  A failure to be regulatory compliant means that from the outset the SME will miss out on generating the sort of data that banks find useful when assessing their loan application.  Interestingly, the majority of SMEs that took part in this study were registered with the Ministry of Trade as trading and service providers in Nigeria.  Presumably this was done to enable them to access government contracts as registration with the Ministry of Trade is a pre-requisite to enable SMEs to preferentially access government tenders.

More telling was that a sizeable number of SMEs operating in Lagos are not registered with the Social Security Commission as employers.  This means that the owners are also not saving for retirement and suggests that cashflow is constrained and/or that the owners are confident that the business will generate the required savings over time.  One of the advantages of self-employment is that one can choose when to retire.  The inability of the Nigerian government to find means of making it easier for SMEs to be regulatory compliant means that SMEs are pushed into an information culde-sac.  This in turn means that they learn very slowly, if at all, about the performance of their business, often only anecdotally and this in turn means that their response to adverse trading conditions is delayed placing them at ever greater disadvantage.

Although in terms of response, most SME owners indicated that the most common source of funding for their operations is owners’ savings and trade credit, it was clear that the source of funding used by SMEs does not provide adequate funding to cater for their business needs.  The implication of this is that the SMEs operate at a suboptimal scale of operations and this in turn increases their unit operational costs ultimately resulting in very low levels of profitability.  This would suggest that even if the SME were able to meet all the requirements of a lending institution including generating the relevant financial statements, the SME viability would come into question.  The attractiveness of trade credit is now obvious as it gives the SME room to trade with someone else’s money.  However, there is an inherent misalignment between when the SME has to pay its trade credit suppliers and when it receives cash from sales.  This typically results in over trading followed by rapid withdrawal of the trade credit lines.

The availability of less risky investment assets such as large corporate and government securities inevitably means that SMEs will face a challenge to access bank loans.  Even if they do, they will face higher interest rates because of the perceived higher risks as compared to large corporate and government securities.  The large number of SMEs also means that in total, funds demanded by the SMEs are much greater than available funds, again giving banks the opportunity to lend to SMEs at higher cost of interest especially since they have no access to alternative funding sources.  This contrasts with large corporates who may have access to international markets that would enable them to access cheaper international funding.  Since the local banks understand the available options to large corporates they are forced to negotiate lending terms with them.

Banks are limited in their capacity to lend funds.  It follows that they will use their funds in the most prudent manner possible so that they too can make profits.  This requires banks to have a rigorous process to evaluate loan applications.  Much of loan processing involves analysis of financial statements of the company, reviewing its management structure and strategy.  All of this analysis requires detailed data that most SMEs are unable to maintain mostly due to cost.  Conversely, SMEs need to know their performance in sufficient detail for them to understand where the profit opportunities are coming from.  This information typically comes from keeping and recording accurate financial and regulatory information – just the sort of records that a bank would require for loan application.  As SMEs are unable to pay for the keeping and recording of their financial data, this results in them not understanding where the profit opportunities are coming from in their business.  They are therefore unable to further exploit these opportunities and increase their overall profitability.  This puts them at a competitive disadvantage and thus on an unsustainable path.  To be able to grow, the SME must know where to put any additional money as this is where the returns will be highest.

Although this study has confirmed the results of available literature on financing problems faced by SMEs, the fact that most of the respondents were sufficiently educated and had experience in their area of business strongly suggests that capacity of the entrepreneur to perform in this instance may not be an issue.  Further, given their educational background and probably personal access to friends who may be qualified accountants, these are the SME owners that you would expect to understand and value the need to maintain accurate financial records as a driver for their business growth.  It is therefore surprising that most do not keep such records due to the costs or perceived cost of retaining such services.  However, when we further recognise that most of the SMEs do not register for VAT, this is a strong indicator that taxation may figure highly in their choice of record keeping.  The major disadvantage of keeping VAT records is that the tax authority has a clear view on the sales, purchases and therefore possible profits of the company.  The SME may be calculating that the loss of input VAT is far outweighed by the income tax payable on profits.  In any event, input VAT is negotiable with the supplier who may be willing to transact with reduced or no VAT on a cash basis.  It is important to clearly understand whether SME financial record keeping or the lack thereof is driven by tax or cost implications.

Recommendations for action  

In order to improve the accessibility of bank loans to SMEs, there is need to adopt the following interventions:

  1. SMEs must be nurtured in such a way that they increasingly keep accurate records of their businesses so that they can understand exactly where the profit opportunities are.  This would allow them to position themselves in areas where they are more competitive and thus able to grow sustainably.  The government could, for example, develop legislation to simplify SME accounting supported by a free accessible IT app for SMEs to record their business transactions but that has sufficient detail to indicate to SME owners were the profits are coming from.

However, this approach would only work if it were coupled with a comprehensive SME tax structure since most SMEs would be reluctant to subscribe if it were to be used for tax purposes;

  1. Loan interest charged, and collateral requirements are related through default rates.  So, for example, if SMEs are perceived to have a high default rate, banks would ask for more collateral as well as charge higher interest rates.  Any action to reduce interest rates charged to SMEs should therefore also address the issue of default and collateral.  One suggestion in the literature is to use government credit guarantees to banks who fund SMEs.  However, there is the new risk that banks would become careless in their loan administration if they know that there is a government guarantee backing the loan.  Their sales people would aggressively sell loans knowing that bank capital would not be at risk.  This in turn would result in a huge bill for government as SME defaults increased placing a burden on the budget.  Such a scheme would inevitably fail.  What is required is a credit guarantee scheme that the bank will pay for if the lending to the SME was done in a negligent manner but which government pays for if the SME fails independently.  One such approach may be to use the Central Bank to allocate different capital adequacy requirements for every bank’s loan book.  It can also place special reporting requirements for bank loans guaranteed by government.  This would reduce the incidence of negligent loan selling and put the guarantee scheme on a more solid basis;

If the above-mentioned recommendations were adopted, then SME financial records would readily be available online for banks to access when evaluating loan applications.  Further, government could offer credit guarantees to SMEs subscribing to their online simplified accounting app.  And as long as the tax issues would have been addressed, this would start putting SMEs on a more sustainable growth path as they would now have access to profit opportunities in their businesses as well as access to loans that could be more appropriately used to grow their businesses.

Recommendations for further research  

This study focussed on the challenges faced by SMEs in Lagos in accessing funding. In order to develop an improved understanding of the SME sector, The Nigeria Business School should commence an annual survey of SMEs so as to improve on SME data that can then be further analysed and to determine if these challenges are reducing or increasing over time. This would typically involve following up on previous SMEs interviewed.  Such follow ups would give details on SME default rates and survivability and home in on identification of key success factors.  In addition, new SMEs should be sampled to identify trends.  For example, it may emerge that particular sectors are attracting SME owners.  This information may be used to formulate more appropriate policies around support for such sectors as well as look at the possible impact if the sector becomes saturated.

Government SME policy should be re-examined with the specific purpose of addressing how this sector should be supported.  More specifically, in the long-term, government would want SMEs to be fully regulatory compliant especially around the area of social security.  However, the cost to the SME for regulatory compliance may be too high.  It may be possible to off-set these costs through a combination of a simplified regulatory compliance framework that is coupled to both a tax initiative and access to a credit guarantee scheme.


This study aimed at exploring the challenges faced by SMEs operating in Lagos to access finance for their operations. It has been established that lack of collateral security, poor bookkeeping, relative newness of SMEs, and the high risk associated to small and medium enterprises limit their ability to obtain financing from financial institutions.

Further, survey results have revealed that although most SME’s were managed/owned by individuals with advanced education, most SME’s were not registered for tax and social security purposes.  This may imply that profitability and liquidity issues could be driving factors for this behaviour.  These findings are consistent with earlier studies done by other scholars. According to Yesseleva (2012), businesses that are relatively new in business are considered high risk businesses by banks, and therefore, banks are reluctant to extend credit to such businesses because of the uncertainty of their future. Wamono et al (2012) attributed failure by SMEs in Uganda to obtain financing from commercial banks to low profitability and liquidity levels of SMEs and high inherent risk associated with start-up businesses. Dankwa and Adoley (2014) identified poor book keeping by SMEs as a limiting factor to SME finance from commercial banks.

Unless there is a deliberate policy to address these challenges, SME’s in Lagos will continue to lack access to financing that would enable them to grow, increasingly formalise their operations, contribute to both the tax base and social security net and thus play an increasing role in job creation and the economy as currently happens in the developed world.


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