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Shortage of Working Capital Financing for (SMEs) in Somalia

Mohamed mukhtar Ibrahim & Adam Hussein Roble:

Ali, 35-years old, walked into our offices with a food delivery contract award tightly tucked in his hands. His face beamed with excitement and optimism; this was a once-in-a-lifetime opportunity that he had always wished for. In his thoughts, all his hard work was finally bearing fruits. The $37,500 lucrative contract meant that Ali was to deliver food for eight consecutive months without fail.

The payment terms as stipulated in the contract would be at the end of every month. The high prospects and optimism notwithstanding, Ali, a highly committed, hardworking, and aggressive entrepreneur does not have the requisite cash reserves and or savings to kick-start his business operations in the first months. Moreover, large food distributors are not ready to extend credit to him, nor are banks offering working capital finance to fund his inventory; this to them is the high-risk business not worth venturing into. However, we (GSM Business Solutions) saw a great potential worth investing our time in. We took up the responsibility to knock on a few doors to seek possible credit access solutions to our newfound potential client.

We approached different banks to secure a loan for him; unfortunately, the banks do not have products designed for people like Ali. 

Somalia’s financial market is in its infancy, and the commercial banks provide financing for various business operations in strict conformity with the various Islamic Financing Instruments. The most prevalent business financing instrument in use is known as ‘Murabaha’, also referred to as cost-plus financing, which is an Islamic financing structure in which the seller and buyer agree to the cost and markup of an asset.

Authors

To provide liquidity and funds for day-to-day operations, most companies resort to short-term loans in the form of working capital financing. In more developed financial markets, there exist varied types of working capital financing solutions for companies to choose from based on their needs. One of the options is accounts receivable factoring. This is a method where a company sells its receivables to a financial company to free up capital that is tied up in accounts receivable.

Another option is invoice discounting which allows business owners to leverage the value of their sales ledger to a third party to accelerate the receipt of cash. In addition, the purchase order financing provides funding for businesses with purchase orders to pay their suppliers and smooth out cash flow while customer advances are cash payments received before a company provides goods or services to its customer. Finally, vendor credit allows a company to withhold payment for a certain period while receiving goods or services in advance.

Somalia’s financial market is in its infancy, and the commercial banks provide financing for various business operations in strict conformity with the various Islamic Financing Instruments. The most prevalent business financing instrument in use is known as ‘Murabaha’, also referred to as cost-plus financing, which is an Islamic financing structure in which the seller and buyer agree to the cost and markup of an asset. All the other Islamic financing instruments are not a loan in nature and give banks (or other sellers of the instruments) the right to share ownership, profits, and losses.

For example, Modaraba, which is an Islamic contract in which one party to the contract brings capital and the other party brings personal efforts and experience to run the business, does not have any loan feature and does not dilute the ownership status. Another instrument, Musharakah, is a pure partnership contract in which both parties share both profit and loss on pre-agreed proportion. It is however not a form of debt financing and involves sharing of ownership of the business. You might by now be wondering what the difference between Modaraba and Musharakah is when both involve co-ownership and sharing of profits.

Well, the difference lies in the loss sharing and capital contributions. In Modaraba, only one part (Rabal Al-mal, the financier) contributes all the investment capital in the business, while the other part (Modarib) contributes only personal/individual efforts and management experience. In contrast, Musharakah means that the investment capital comes from both parties on certain proportions. On the other hand, all losses are taken by the Rabal Al-mal, in the Modaraba case while for the Musharaka losses are shared on pre-agreed proportion. 

With the technical classification of the various Islamic financing instruments, it is arguably clear, albeit for now, that the Murabaha financing option would be the most appropriate and best-suited instrument for local SMEs in their quest to deal with capital shortfalls; this can be largely attributed to the fact that financing for working capital implies getting cash without any dilution of ownership status. However, the hectic and long processes involved make it an impractical method of financing for the working capital shortage.

One investment manager expressed to us that after all the documentation, collateral, guarantees, and other background checks are conducted and the necessary due diligence ascertained, it takes a minimum of one week for the loans to be processed and paid out to the borrower. SMEs on the other hand, need more immediate funds other than the conventional Murabaha to cover their pressing working capital shortfalls.

The unpredictability of the financial and business environment in Somalia necessitates Somali SMEs to have immediate access to working capital financing even more. Unpredictable policies, security incidents, red tape, poor regulations, and weak financial institutions create an unconducive framework for businesses to operate. Customs and trade regulations are no exception. The Somali customs are full of informalities, inconsistencies, bribes, and other charges for which the traders, often than not, do not even get a payment receipt.

For example, besides the official taxes collected under the authority of the Ministry of Finance, importers from the Mogadishu seaport pay on average $1,000 per container. Some of the payments do not have payment receipts. The traders do not have the working capital to cover such unexpected and variable costs. Usually, they end up having their goods trapped in the seaport for failure to pay the tariffs and other informal charges required by the authorities. At this point in time, the importer will be forced to wait for a while to get funds and as a result, incur additional port holding costs and in turn miss the first-mover advantage of the market.

Event management companies experience a considerable time-lag between the time they render services and when they get paid. It is during this time-lag that these companies have urgent cash needs. For example, event management companies are asked to make venue arrangements, provide food, and transport guests before any payment is made. These activities are urgent by nature and cost a lot.

In conclusion, with the projected growth in the country’s economy, and with the financial market still in its infancy, there is a reality-check on the glaring gap in the financial sector characterized by a shortage of working capital financing for small and medium enterprises (SMEs) in Somalia.

With the country’s business environment continuously changing in dynamics, it is incumbent upon the key stakeholders including the government, financial institutions, religious institutions, and the private sector to explore and come to a consensus on the possible ways in which this gap can be narrowed.

The world is a global village, drawing lessons from other economies with similar characteristics will be key to establishing the best business capital financing solutions and or instruments for the Somali market.  

Mohamed Mukhtar Ibrahim is the former Minister of Petroleum of Somalia and CEO GSM Business Solutions. He can be reached at: mohamed.mukhtar@gmail.com

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