Bank Alfalah | SME Toolkit

Leasing Equipment

Provided by the International Finance Corporation

Financing new equipment — from computers to phone systems to capital equipment and other gear you need to run your company — is a major issue for many small business owners. Leasing, instead of purchasing, can be a cost-effective option, particularly if you don’t have the cash on hand, but need the equipment.

In fact, you might want to consider leasing even if you do have the cash to invest. By leasing, you might find that you can regulate your cash flow more effectively, because you have predictable, regular monthly installments as opposed to a single lump sum payment. Plus, leasing can help you avoid tying up lines of credit, or you might want to use the money for another area of your business.

To learn more about leasing, click on the topics below:When you sign a lease you are assigning the rights for the equipment to the lessor. The lease-holder owns the equipment and is making it available to you for your use in exchange for the lease payments you make. There are several ways to acquire equipment through leasing. Among the most common are the following:

  • Select equipment yourself and then seek financing through a lessor. You locate a system from the vendor of your choice and then work out a leasing agreement for that system with the leasing company. In this scenario, you usually still get service and support for the system from the vendor, rather than the lessor
  • Select equipment by working with a retailer or manufacturer which offers leasing through its own subsidiary. Once a purchase price is established, your vendor will translate that into a lease payment based on the terms you’ve requested
  • Obtain equipment directly through a lessor. If you choose this route, you will work with a leasing company to figure out what you need and what you can afford. The lease and the equipment in this scenario, comes from the lessor. If you choose to get your lease and equipment from the lessor, you may want to shop for your equipment before tackling the lease. A leasing company is not necessarily the place to get your technical information

Here are some of the issues you need to consider when you’re looking at leasing:

  • Ownership — The most obvious downside to leasing is that when the lease runs out, you don’t own the piece of equipment. Of course, this may also be an advantage, particularly for equipment like computers where your technology needs may change very quickly
  • Total expense — Leasing is almost always more expensive than buying, assuming you don’t need a loan to make the purchase. For example, a 3-year lease for a $5,000 computer system (at a typical rate of $40/month per $1,000) will cost you a total of $7,200
  • Finding funds — Lease arrangements are usually more liberal than loans. While a bank might require 2-3 years of business records before granting a loan, many leasing companies evaluate your credit history on shorter terms (6 months is fairly typical). This can be a significant advantage for a start-up business
  • Cash flow — This is the primary advantage to leasing. It eliminates a large, single expense that may drain your cash flow, freeing funds for other day-to-day needs
  • Taxes — Leasing almost always allows you to expense your equipment costs, meaning that your lease payments can be deducted as business expenses. On the other hand, buying may allow you to deduct up to $19,000 worth of equipment in the year it is purchased (as part of first-year expensing); anything above that amount gets depreciated over several years. With the first-year expense deduction, the “real cost” of a $5,000 computer system may be only $3,400
  • Technology needs — Technology advances at a rapid rate. If you buy a computer other high-tech equipment outright, you may find yourself with outdated equipment in 2-3 years, with no discernible resale value. Leasing may allow you to try out new equipment configurations, and update your system regularly to stay on top the technology curve. On the other hand, if you have a “pass-down” policy in your company (where older technology gets used by certain departments), buying may be more effective

Here are some of the issues you should look for when negotiating your lease, or reviewing your lease contract:

  • Length of the lease — This is often called the “term” of the lease, and is usually between 12 and 36 months. The shorter the term of your lease, the higher your payments. 36 months is typical for a computer lease, although you might want to look at a 24-month lease to keep up with changing technology. The cost of 12 month leases is usually prohibitively high, and many experts only recommend you look at this option if you have a compelling reason
  • Total cost — Analyze all the charges for which you will be accountable for the entire length of your lease. These include your initial down payment, monthly payments, a security deposit, any insurance charges, service/repair costs, etc
  • Cancellation clause — This allows you to break your lease, although you will be liable for substantial penalties. This way, if you close your business, change its focus, or no longer need a piece of equipment, you won’t be liable for the entire term of the lease
  • Assignment — Find out if you can assign the lease to another party, and if so, what it costs
  • Modern equipment substitution — If technology changes rapidly, you might want to consider this option. This allows you to update or exchange your equipment so you don’t get stuck with something that’s obsolete
  • Service plans — Find out if your lease comes with an on-site service plan, and if so, determine its length. If you have only 1 year of on-site service, you may need to extend it to the length of the lease; otherwise, you will be responsible for all repairs yourself after the first 12 months. Also, be sure the contract spells out when the service will be performed (ideally, next business day)

Read the fine print of any lease you sign. There is such a thing as a lease that is considered a purchase — which means you would not be able to deduct your monthly payments. A capital purchase has occurred if the terms of your lease agreement are constructed so that you meet one of the following criteria:

  • You have a “bargain buyout” in which you can purchase the machine for a token amount at the end of the lease
  • You are leasing the machine for 75% of its useful life
  • The total payments made during the period of your lease equal more than 90% of the fair market value of the machine. Keep in mind that payments include finance charge and sales tax, and they need to be deducted to find the true price you’re paying for the equipment

Copyright © 1995-2016, American Express Company. All Rights Reserved.

Managing Debt

Adapted from content excerpted from the American Express® OPEN Small Business Network

For a growing business, having a manageable level of debt can be an effective way of doing business. While some small business owners are proud of the fact that they’ve never taken on debt, that’s not always a realistic approach. Growth often demands considerable capital, and getting that money may require you to seek a bank loan, a personal loan, a revolving line of credit, trade credit, or some other form of debt financing.

The question for many small business owners is: How much debt is too much? The answer to this question will lie in a careful analysis of your cash flow and the specific needs of your business and your industry. The guidelines below will help you analyze whether taking on debt is a good idea for your company.

Explore your reasons for borrowing

There are a number of scenarios when it may make sense to take on debt. In general, debt can be a good idea if you need to improve or protect your cash flow, or you need to finance growth or expansion. In these cases, the cost of the loan may be less than the cost of financing these moves through ongoing income. Some common reasons for seeking a loan include:

  • Working capital – when you’re looking to increase your company’s work force or boost your inventory
  • Expanding into new markets – when companies enter new markets, they often face a longer collection cycle or must offer more favorable terms to new customers; borrowed funds can help weather this period
  • Making capital purchases – you may need to finance new equipment in order to move your business into a new market or expand your product line
  • Improving cash flow – if you have less than 10 years left on an existing long-term debt, refinancing can improve cash flow
  • Building a credit history or relationship with a lender – if you haven’t borrowed before, taking out a loan can help in developing a good repayment history and can help you obtain financing in the future

Plan effectively

Before taking out a loan or any other kind of debt financing, you should spend time planning your capital needs. The worst time to take on any kind of debt is during a crisis. A sudden loss of trade credit, the inability to meet a payroll, or other emergency could force you to take on debt immediately, and that can result in highly unfavorable terms. A plan will allow you to forecast your cash requirements, allowing you to determine what you will need and when you will need it. This will give you the extra time to explore all possible borrowing sources and negotiate the most favorable terms. A capital plan should consist of a complete review of your balance sheet to help you analyze cash flow, assets and liabilities. You’ll also want to construct a pro forma statement, which is a projected balance sheet for the coming 1-3 years.

Examine short-term vs. long-term debt

Just as you need to be certain you’re taking out a loan for the right reasons, you also need to make sure you’re taking out the right kind of loan. For example, taking out a short-term loan when a longer term loan is required can quickly create financial problems since you may be forced to take unnecessary measures (such as selling a piece of the business) to meet the obligation.

In general, use short-term loans for short-term needs. This will help you avoid higher interest expense and more restrictive conditions of longer-term borrowing. For instance, if you experience a temporary rapid increase in sales — such as that brought on by increased seasonal demand — then you should look at a short-term loan. If the growth will continue over a long time, take a look at longer term options such as an expanding line of credit based on sales, accounts receivables, or inventory ratios The term of your debt will have no impact on your debt-to-equity ratio. However, you will see changes in liquidity indicators such as your current ratio, since current liabilities include only the debt that must be repaid within one year, not debt due at later dates. So longer term loans can positively affect your liquidity ratios.

Base new debt on current needs

When interest rates are low and money is cheap, you may be tempted to take out loans to buy equipment or make other capital purchases. If that’s the case with your business, be sure to base your decision solely on your current needs. The possibility of rates increasing is not a rationale for spending money on something you don’t need. For example, if your business needs additional computer equipment, you might want to take out a loan to buy it. But buying additional computers now because they’ll be more expensive next year is not ample justification. You can end up getting stuck with equipment you don’t need and debts that you are still obliged to pay off.

Copyright © 1995-2016, American Express Company. All Rights Reserved.

How to Finance Your Business

Provided by My Own Business, Content Partner for the SME Toolkit


Money makes your business go, and usually banks make loans only to businesses with operating histories. In this session we will give you some alternatives, strategies, and things to think about in your search for financial help. You will learn how to locate, negotiate for, and maintain sources of money to help you start and expand your business.

  • First Things First
  • How Much Money Do You Need?
    • What do you need it for?
    • Unsecured Loans
    • Secured Loans
    • Collateral
  • Loans (Debt) vs. Investment (Equity)
  • Where to Get the Money
    • Types of Funding Sources
  • The Art of Getting the Money
    • Business Loans
    • Repayment Plan
    • Other Quick Tips
  • After You Get the Money
  • Suggested Activities
  • Top Ten Do’s and Don’ts
  • Business Plan

Featured Video: Sources of Funding for New Small BusinessesMoney makes your business go. But don’t try going to a bank to get it when you’ve just started in business. Banks normally make loans only to businesses with operating histories. This section will give you some alternatives, some strategies and some things to think about as you go about finding the money to make your business work.

A banker’s primary concern is your timely repayment of loans. The fuel to make loan payments come from your cash flow. So your management of cash flow is of utmost interest to your banker and you must convince the banker that you are an expert in making cash flow projections that safely include your loan payments.

As pointed out in the first session on picking a business, don’t be discouraged by not having much money to start with. Many businesses can be started with no money at all. You can start small and humbly and grow one order at a time. Here is a sample, partial list of businesses you can start with very little cash: Businesses You Can Start for Little or No Money.

Our first reminder is that personal savings should be considered the primary source of funds for starting a business. If you haven’t started already, start now to begin accumulating cash through personal savings.

Also, don’t overlook the Small Business Administration (SBA) loan guarantee programs available for start-up businesses. With a SBA guarantee program in hand, your bank will be happy to talk with you!

Finally, start your search for financing with a good credit rating. Most all sources of financing or credit have come to rely on a four-letter word to score your credit worthiness: FICO. FICO is a numeric method, using just three digits, to predict the likelihood of paying your credit as agreed. FICO scores range from 365 (not good) to a high of 850 (great). The score evaluates your credit payment history, number of open accounts, overall credit balances and public records such as judgments and liens.

Generally, a FICO score above 680 will produce a positive response while a score below this will cause a lender to be cautious. Before seeking financing or credit, it is a good idea to know where your FICO score stands. A number of credit cards now provide your FICO score on your monthly statement. You can also visit to purchase your credit score and to review your credit reports.Or, how much can you reasonably expect to get? Refer back to your business plan. If it still doesn’t answer the question, let’s go step-by-step. In Session Accounting and Cash Flow, you will learn how to predict future cash needs by using a cash flow control form.

The cash flow control form will spell out all of your sources of income and expenses. For example, some expense items might include:

  • Buying supplies and inventory while waiting to get paid
  • Paying payroll and rent
  • Buying equipment and fixtures
  • Getting a computer
  • Buying the business

Prioritize those areas where your options are limited to paying in cash, and review your alternatives where there may be another way. For example, it is not necessary to pay all cash for a delivery truck when you can rent or lease one. Next, review what might serve as collateral for your loans.

Unsecured Loans

Some credit is granted on an unsecured basis, such as credit cards, but most small business loans are secured by the assets of your business, your personal assets, or both. Unsecured means that there is no collateral granted for the loan. Examples of unsecured are

  • Credit cards
  • Unsecured lines of credit (like you get in the mail)
  • Friends or relatives

Secured Loans

Secured loans mean that there are assets pledged to secure the payment in the event you are not able to pay. Examples of this are

  • Computer lease
  • Home mortgage
  • Car loan or lease
  • Small Business Administration loan


Common types of collateral are equity in your home, accounts receivable, inventory of the business and equipment. Lenders go through an evaluation of the collateral to determine how much they can lend. Some key variables as to what kind of loan terms you can get are

  • Number of years in business – This is your track record and is very important. Banks usually require three years while others are less stringent.
  • Size of your company and the amount needed – Financing institutions vary in the way they service the public. For example, you would probably not get a car loan and a large corporate loan at the same place. Do your research. Ask around. Get to the right spot.

You are most likely familiar with a straight loan (debt) where the lender gets an interest rate and fees.

Equity is where the money raised gives the investor an ownership interest. This is common in the sale of stock to a limited number of investors or participation by venture capitalists. The sale of stock is highly regulated by state and federal agencies and you will need the help of a corporate lawyer. Normally the initial sale of stock to the public (initial public offering or IPO) is deferred until an earnings history is established.

Sometimes such a discussion arises with friends and family who want to be your partner. Consider this carefully because they will then participate in the increased value of the business and have voting rights.

It is well beyond the scope of this discussion to cover all the aspects of debt and equity. Just be careful! Your lawyer and accountant would be appropriate sources for more information on this subject.Entrepreneurs have a wide variety of options when it comes to funding. Below is a list of possible options for a small business to research and consider regarding lender types.

Terms will vary considerably from lender to lender; important issues to consider:

  • Cost
  • Payback program/terms
  • Loan size

As an entrepreneur, you will be legally obligated to have individual responsibility for the credit obligation of your business. Regardless of legal organization, lenders will have documentation to circumvent the organizational structure. This is usually called a personal guarantee. Don’t panic! It is very common.

Lending options for small businesses:

  • Personal Savings
  • Friends and Family
  • Banks/Credit Unions
  • Home Mortgages (Traditional or Second)
  • Peer-to-Peer (Prosper, Lending Club)
  • SBA Loans
  • Micro-Finance Options (Accion, Opportunity Fund, Grameen Foundation)
  • Alternative Lenders (Kabbage, Dealstruck, Fundation, Funding Circle, OnDeck)
  • Crowd Funding (Indiegogo, Kickstarter, RocketHub, Peerbackers)
  • Equity Funding
  • Venture Capital
  • Angel Investment
  • Commercial Mortgage
  • Specialized Lenders (Industry expertise, auto, business brokers, high-tech, specialized equipment, etc.)
  • Lending Companies (OneMain)
  • Finance Companies

Featured Video: What do business investors look for?This starts by knowing what your lender wants. A common way is to simply ask. A better way is to ask a friend or business advisor such as your CPA. Our session 5, Business Organization, includes a comprehensive list of professionals that can help you.

Business Loans

For a business loan, the most common things are

  • Business financial statements
  • Business tax returns
  • Business plan with budget or projection
  • Personal financial statements
  • Personal tax returns

Be ready to answer questions about your business, and be ready to highlight your financial performance both in the past and in the future. You will be more impressive if you have carefully thought out and become familiar with your plan. Bring your accountant if you need help.

Be prepared to tell lenders why you need the money. “I just need the money,” does not inspire confidence or the fact that you have thought it through. Earlier in this session, you studied a number of different purposes. Give them some detail.

Repayment Plans

Propose a repayment plan. Examples of different structures are

  • A line of credit, payable at your discretion but subject to renewal annually by the bank
  • Term loan payable monthly over ___ years starting on ____ date

Most places have some flexibility. Potential lenders appreciate that you are thinking about paying them back instead of just getting the money.

Other Quick Tips

  • Needless to say, being well dressed and neat in appearance at bank meetings will reflect positively.
  • Most lenders (including the SBA) will want to see your business plan.
  • Keep your lenders informed on the status of your business: the good and the bad.
  • If you are unable to make a loan payment on time, call your lender in advance, advise him or her of the problem and request the extension you need. Explain the sources of repayment.
  • Virtually all lenders will do a personal savings and corporate credit check through a company called TRW or by other means. Be prepared to discuss any prior credit issues/problems. The best access to a lender is through a referral. Lending is a people business. Have your CPA, attorney, or friend introduce you to a lender.
  • The first thing that will spook lenders or investors is the fear you are “puff” rather than “substance.” Avoid giving the impression of being an over optimistic, “pie-in-the-sky” operator.
  • As a start-up, do not plan to spend money on expensive entertaining. Your lenders will be more interested in knowing how their money is being used to grow your business.
  • Do not depend on a bank to loan you money to start a business. Most small businesses are funded by personal savings.
  • Make a shrewd appraisal to minimize your risks and to limit losses to a predetermined limit.
  • Your suppliers and vendors can be sources of financing. For example, if you need an illuminated sign for your storefront, the company you contract with to make the sign may provide financing so you can make monthly payments rather than pay cash. Examples of financing from your suppliers include
    • Longer payment terms
    • Advertising and marketing assistance
    • Furnishing or financing of equipment, signs or inventory.
    • Advertising and promotional programs
  • Bartering, which is to trade by exchange one commodity for another, can provide a source of financing. For example, your advertisements in the local newspaper might be paid for by the bagels you make!

Getting the money is only the first step. You should strive to be a good customer so you can get cooperation if you need help later. A good customer sticks to his/her agreement. Make sure you understand the requirements and perform to them as much as possible. In a business relationship, lenders will ask for regular financial statements, which you should produce on time.

There may be covenants. A covenant is a written agreement in which you promise to meet specified obligations such as submitting the agings of your accounts receivable. The “agings” report will show the lenders if your credit customers are paying on time or not.

Be proactive. Contact them if there is a problem. Be sure to stay in touch even if nothing new is going on. Get to the next highest level within the organization.Selling your business will probably be the single most important time to exercise good negotiating skills. The earlier session, “Negotiating Tools” covers the basic do’s and don’ts. We’ll emphasize two points here:
Sources of financing can surface from unexpected sources: List at least five of them:


Some possible answers are

  • Suppliers: Ask for longer terms of payment.
  • Your landlord: Ask the landlord to provide you with tenant improvements.
  • Your customers: Ask for either cash or prompt payment.
  • Your capital investments: Ask the suppliers of your fixtures, equipment and signs to finance your purchases. They will be interested in doing so in order to get your business.


  • Live frugally and begin saving up money now to start your own business.
  • Use your cash flow projection as your key tool to determine financing required.
  • Complete a business plan for meetings with potential lenders or investors.
  • Have your business plan critiqued by appropriately informed people. Revise as necessary.
  • Ask the Small Business Administration for advice. (Have your business plan with you.)
  • Maintain a current financial information packet including financial statements and recent tax returns.
  • Consider bartering services if appropriate.
  • Use your CPA or attorney as referrals to lenders.
  • Keep your lenders informed of your progress and any potentially adverse events.
  • If you need a loan for 6 months, ask for 12 months to be on the safe side.


  • Expect a bank to help finance your new business.
  • Ask for a loan without a detailed repayment plan in hand.
  • Overlook vendors and landlords (for tenant improvements) as sources of financing.
  • Avoid being the bearer of bad news to your lender.
  • Ask for less than enough to meet your realistic needs.
  • Exaggerate. (Instead, be conservative in your presentations to lenders.)
  • Write a check without adequate funds in your bank account.
  • Risk losing your home by taking a “Home Equity” loan unless you are certain of your ability to repay.
  • Sign personal guarantees unless absolutely necessary.
  • Budget or spend money on expensive entertaining of potential lenders.

You can continue to assemble your business plan. We provided Microsoft Word templates for this section below:
Section: Financing

The full template for all sessions can be downloaded as one document:

Business Plan Template
Featured Video: Raising Capital for Your Business Copyright © 1993, 1997-2016, My Own Business, Inc. All Rights Reserved.

Business Valuation Methods

Adapted from content excerpted from the American Express® OPEN Small Business Network

There are a number of instances when you may need to determine the market value of a business. Certainly, buying and selling a business is the most common reason. Estate planning, reorganization, or verification of your worth for lenders or investors are other reasons.

Valuing a company is hardly a precise science and can vary depending on the type of business and the reason for coming up with a valuation. There are a wide range of factors that go into the process — from the book value to a host of tangible and intangible elements. In general, the value of the business will rely on an analysis of the company’s cash flow. In other words, its ability to generate consistent profits will ultimately determine its worth in the marketplace.

Business valuation should be considered a starting point for buyers and sellers. It’s rare that buyers and sellers come up with a similar figure, if, for no other reason, than the seller is looking for a higher price. Your goal should be to determine a ballpark figure from which the buyer and the seller can negotiate a price that they can both live with. Look carefully at the numbers, but keep in mind this caution from Bryan Goetz, president of Capital Advisors, Inc., a business appraiser: “Businesses are as unique and complex as the people who run them and are not capable of being valued by a simplistic rule of thumb.”

Here are some of the common methods used to come up with a value.Asset valuation is used when a company is asset-intensive. Retail businesses and manufacturing companies fall into this category. This process takes into account the following figures, the sum of which determines the market value:

  • Fair market value of fixed assets and equipment (FMV/FA) – This is the price you would pay on the open market to purchase the assets or equipment
  • Leasehold improvements (LI) – These are the changes to the physical property that would be considered part of the property if you were to sell it or not renew a lease
  • Owner benefit (OB) – This is the seller’s discretionary cash for one year; you can get this from the adjusted income statement
  • Inventory (I) – Wholesale value of inventory, including raw materials, work-in-progress, and finished goods or products

This method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses like service companies.

In his book “The Complete Guide to Buying a Business” (Amacom, 1994), Richard Snowden cites a dozen areas that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the “capitalization rate” which is multiplied by the buyer’s discretionary cash to determine the market value of the business. The factors are:

  • Owner’s reason for selling
  • Length of time the company has been in business
  • Length of time current owner has owned the business
  • Degree of risk
  • Profitability
  • Location
  • Growth history
  • Competition
  • Entry barriers
  • Future potential for the industry
  • Customer base
  • Technology

Again, add up the total ratings, and divide by 12 to come up with an average value to use as the capitalization rate. You next have to come up with a figure for “buyer’s discretionary cash” which is 75% of owner benefit (seller’s discretionary cash for one year as stated on the income statement). You multiply the two figures to determine the market value.This formula focuses on the seller’s discretionary cash flow and is used most often for valuing businesses whose value comes from their ability to generate cash flow and profit. It uses a fairly simple formula — you multiply the owner benefit times 2.2727 to get the market value. The multiplier takes into account standard figures such as a 10% return on investment, a living wage equal to 30% of owner benefit, and debt service of 25%.This approach finds the value of a business by using an “industry average” sales figure as a multiplier. This industry average number is based on what comparable businesses have sold for recently. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. This is where some people have trouble with these formulas, because they often don’t focus on bottom line profits or cash flow. Plus, they don’t take into account how different two businesses in the same industry can be.

Here are a few industry multiplier examples, as mentioned in “The Complete Guide to Buying a Business” by Richard Snowden (Amacom, 1994):

  • Travel agencies – .05 to .1 X annual gross sales
  • Ad agencies – .75 X annual gross sales
  • Retail businesses – .75 to 1.5 X annual net profit + inventory + equipment

To find the right multiplier for your industry, you can try contacting your trade association. Another option is to utilize the services of a broker or appraiser who specializes in businesses such as yours.Copyright © 1995-2016, American Express Company. All Rights Reserved.

MPS: changes not expected

Business Recorder (BR) Research

The market is expecting status quo to be maintained in tomorrow’s (July 25, 2015) Monetary Policy review. All nineteen research houses of brokerage firms, asset management companies and commercial banks contacted by BR Research are of the view that the central bank will not change the policy rate in the upcoming review on Saturday. Will SBPs decision match the expectations?

A review of recent MPS decisions shows that since November 2014, the central bank has been more aggressive in easing its policy stance than the expectations of the market. In November, half of all surveyed analyst expected status quo but SBP went for a 50 bps cut.

Similarly, in January, the prevalent expectation was a cut of 50 bps but the central bank surprised everyone with 100 bps of easing. In March, the outcome matched expectations (50bps cut) and in May once again the central bank was more lenient in its easing stance; beating market expectation to not only go for a cut of 100 bps but also narrowing the interest corridor to make the effective easing 150 bps.

The policy rate today at seven percent is 44 years’ low and the newly introduced target rate is 6.5 percent – benchmark for interbank rates. Is the question that does the economy have further room for easing? The efficacy of monetary easing in driving growth also merits analysis.

One of the most important indicators used by both producers and consumers in budgeting and expansion is currency value; Rupee-Dollar parity. According to a recent SBP staff note, a survey of 1,189 firms in manufacturing and services sector showed that the majority of firms consider currency depreciation as the most important factor in setting prices. The other key factors are the cost of raw materials, the overall cost of doing business and energy prices.

The behavior is in contradiction to a conventional economic theory which would list labor cost, cost of capital and labor productivity as dominant factors to set prices. The departure from conventional theory limits the efficacy of interest rates tool in not only setting prices but also in boosting economic growth. The factors that can improve overall cost of doing business include law and order situation, energy provisioning and consistent economic policies; and all these have nothing to do with monetary policy.

Apparently, the philosophy of the Finance Minister is to provide impetus to the economy through pricing intensives – idea is to manage currency artificially to anchor inflation and once the inflationary expectations are low (prevalent case), lower the interest rates to boost economic activities. The first leg of the theory worked better than his expectations as depressed commodity prices went a long way to take inflation down to multi-year low.

The question is what will it translate into boosting economic growth? Without it, the policy of having managed exchange rate can be counterproductive as low inflation will boost consumption and without any production increase, the pressure on current account will build.

Sooner or later, the Balance of Payments troubles will resurface and that could lead to a sharp depreciation of the local currency followed by higher inflation and tightening monetary stance.

History suggests sudden shock is detrimental and a better way to avert crisis is to let the currency float at its real value. But Dar is betting on reaping fruits from managed currency.

So far, the demand factors are taking a back seat and supply-side elements are driving prices. Inflation is down primarily due to cost push factors – low oil prices and stable currency while credit to the private sector remains muted to negate any benefit to economic growth.

Macroeconomic stabilization has been achieved thanks to low inflation, building reserves and lower fiscal deficit; but the growth is largely missing. To boost it, the government is aggressively easing monetary policy but so far this has not worked.

The monetary aggregates picked up in the last quarter taking the full-year money supply growth to 13.2 percent. CPI recorded at 4.5 percent and real GDP grew by 4.2 percent. Where is the rest of 4.5 percent? Evaporated in thin air? The SBP staff paper note by Mushtaq Khan says that Pakistan has a substantial undocumented economy and accumulation of wealth is taking place in real estate, jewelry and/or foreign currency cash holding.

Now with stable rupee against USD and its appreciation against many other major currencies is limiting the scope of foreign currency cash holding. Gold prices are on a southward journey as well to discourage parking of savings. The most lucrative avenue left is to park the excess money in real estate market and probably four percent of money growth in FY15 is routed to the property market.

The untracked money is not a small amount; it’s Rs450 billion in FY15, and being diverted to real estate market, it will only boost property prices which are not captured in CPI as it is gross undervaluation. Is this what Dar envisages? If not, please revisit the policy of keeping artificially stable exchange rate and excessive monetary easing.

Yet there is some hope. Overall sentiments are better; economic and security perception of Pakistan is improving in international media with better outlook by rating agencies. All that it needs is to translate into expansions of existing businesses and a flurry of new ventures both by domestic and foreign investors. Failure to do so can bring another crisis like 2008 in a couple of years.

Coming back to tomorrows policy review, the circles close to policymakers are eying a cut of 50 bps which is against the expectations of the broader market.

The current account after showing a surplus in the third quarter is back in deficit in the fourth quarter to take full year CAD to 0.8 percent of GDP – barring CSF flows it was 1.4 percent of GDP. Now with expansion plans, there will be more machinery import and CSF money is hard to come by in FY16 – so the need is to keep a close eye on the current account deficit.

On the capital front, only debt flows or one-off disinvestment of blue-chip companies have raised foreign exchange reserves to $18.6 billion. But the debt repayments will start in FY17 by which time privatization flows will be dried. So we have a window of 12-18 months to revive the economy by building exports and attracting FDI. Otherwise, 2018 could be the dark year.

So better tread cautiously and simultaneously work on a model to boost economic growth and enhance productivity.

This article originally appeared in Business Recorder (BR) research on July 24, 2015.

Microfinance: teeming with spirit

Business Recorder (BR) Research

Microfinance graduated to a billion-dollar business in Pakistan last year. Gleaning the Pakistan Microfinance Review (2014), which was recently released by the sector’s representative body and data-aggregator Pakistan Microfinance Network (PMN), the year gone by, can be classified as the sector’s best in recent years.

The sector saw notable expansion in 2014. Microfinance branches had increased by 27 percent year-on-year to reach 2,026 establishments in 2014. Hiring kept pace with physical expansion, as total staff increased by 23 percent to reach 21,516 employees.

Data reporting by some 42 microfinance providers (MFPs) showed that they collectively held assets worth Rs105 billion as of 2014 end, with microfinance banks having a 70 percent share. This capital structure was broken down as 44 percent deposits, 33 percent debt, and 23 percent equity.

The increased MFP outreach picked up some of the unmet demand, thus reflecting very favorably in the sector’s core operations for the year. For instance, the number of active borrowers reached nearly 3 million, a 25 percent uptick over the previous year. It’s encouraging that female borrower to continue to make over half of this pool, having grown by over 17 percent to reach 1.7 million users in 2014.

By year-end, the sector’s gross loan portfolio was clocking Rs63.5 billion, a rise of 36 percent year-on-year. This had more than just the growth in borrowers and the branch spread-out behind it. There was visible enlargement in the sector’s resource-base as well. During 2014, deposits grew by 30 percent, to Rs42.7 billion. Besides, there was a 29 percent increase in the sector’s total debt that reached Rs34.7 billion.

Portfolio quality also seemed to be improving. About 1.1 percent of the loan book was deemed risky in 2014, down from 2.5 percent in 2013. It was more than credit that strengthened the sector last year. The number of deposit accounts nearly doubled to 5.7 million. Policyholders also showed double-digit growth to reach 3.8 million, with MFPs underwriting over 60 billion rupees of insurance as of 2014 close.

No wonder these all-around improvements last year produced an all-time high top line for the sector when revenues surged by 40 percent to reach Rs24.3 billion. Net income reached Rs3.4 billion for the year, a year-on-year growth of 59 percent that resulted in an attractive net margin of 14 percent.

The spell of macroeconomic stability – chiefly lower inflation and falling discount rate – and security amelioration which started last year, coupled with the sector’s internal risk management and organic expansion explain away a stellar 2014.

The sector, according to an estimate, is currently covering 10 percent of a potential market of 30 million micro-borrowers. With the favorable macroeconomic conditions expected to continue in foreseeable future, and as measures such as the amended credit guarantee scheme, upcoming MFI regulations, ongoing credit checks and faster clearing start to bear fruit, the sector is expected to be on an even stronger footing. The policy focus on financial inclusion will also hopefully lend support.

This article originally appeared in Business Recorder (BR) research on July 14, 2015.

Hollow monetary policy document

Business Recorder (BR) Research

There are three pricing elements which central banks usually evaluate to determine equilibrium by changing one or more to have an impact on the others. These are prices of goods and services – inflation, interest rate and currency exchange rate. The job of the central bank is to maintain equilibrium amongst these measures to stabilize the monetary system.

What SBP is doing lately is determining interest rates based on the inflation outlook while completely ignoring the exchange rate. Even, the premise of lowering interest rates based on low inflation is debatable. The link between inflation and interest rates is driven by demand; if you increase interest rates, demand for money should fall and subsequently, demand-driven inflation is lower and vice versa.

The reason for cutting the policy interest rate by 400 basis points since November 14, 2014; is that inflation has come down significantly and there is a need to spur demand for money through lower interest rates. But the chief reason for subdued inflation is supply-side positive shocks as international commodity prices nose-dived.

The demand side is rather showing a varying picture – monetary aggregates grew by 13.2 percent in FY15 while the nominal GDP growth is around 8.7 percent (4.2% real GDP plus 4.5% CPI). According to the Ministry of Finance numbers, the nominal GDP growth was 7.8 percent. This implies there is an excess demand (4.5-5.4%) and this can fuel inflation. On the other hand, SBP is consistently lowering the interest rates. The relation is not that simple and there is an anomaly in it. Is the monetary policy document explaining it?

The reason could be an overhang of low growth and high inflation era and it takes time for consumers and producers to change behavior. But the central bank should have explained it. The excess demand wasn’t there in FY14 as M2 grew by 12.5 percent while nominal GDP growth was similar (4% real GDP plus 8.6% CPI).

The point is that excessive easing can fuel inflation and the need is to find avenues where excess demand emanates from. The currency in circulation is growing rampantly lately so is it fuelling the informal economy, or there is something else?

The other important factor that is completely ignored by SBP is its own computed real effective exchange rate (REER) which describes the deviation of the nominal exchange rate from its equilibrium value. There are various methodologies used to compute the equilibrium exchange rate. The most widely used are REER. And within REER, there is a number of ways to compute and this article is confined to the calculations by SBP.

REER, as computed by SBP, was at 121.6 in July 2015. The nominal currency depreciated by two percent since then against the USD which may have lowered REER to 119, by now. This is the highest value since 2002, as per the data published by SBP. It ranged in the band of 94-106 during 2002-2013. In February 2014, the REER was 101.7 however it has slipped out of hand since then. As of March of this year, REER jumped to 107 while its last reported reading is 121.6.

Published on September 15, 2015.

Falling size of mutual funds

Business Recorder (BR) Research

Perhaps, these aren’t satisfying times for mutual fund investors. With the size of the country’s mutual fund industry being only a fraction of the banking sector’s deposits, even a slight strike to the industry’s assets can perturb its investors. March 2015 saw the size of the mutual fund industry shrinking to Rs453 billion, a fall of nearly three percent over the preceding month. But, don’t fret; the industry size is likely to mend soon.

It should be noted that this is the first decline that has come into sight ever since the beginning of FY15. Barring March 2015, mutual funds have consistently performed better and the expansion in industry size is a strong manifestation of that. Since the beginning of FY15, mutual fund industry size has expanded by over Rs66 billion, a healthy rise of 17 percent.

March’s decline is, however, attributable to the deadening of the stock market during the month that sparked selling pressures across the board. KSE100 shed 3,398 points or 10 percent during the month, thereby leaving investors with bleeding hearts. As has been the industry norm during distressed times, equity funds were faced with burgeoning redemption pressures, thereby taking the size of equity fund category down by more than 12 percent over the preceding month. Equity funds now form 21 percent of industry’s assets (Dec’14: 24 percent).

Moreover, the tale of money market funds wasn’t rosy either. Recall that money market funds had enjoyed the heavyweight status in our mutual industry for a long time. But trends are shifting gears now! With the fund size previously boasting the largest share of over 30 percent in the industry, its contribution has dropped to 23 percent (as of March 2015), thereby positioning it as the second largest category.

It seems like the outflows from money market funds is being diverted to income funds with revaluation gains on longer-bonds being investors’ primary consideration. Consequently, income funds now form the bulkiest category in this industry, boasting a preeminent share of 24 percent. The spell is likely to last for some time as with further cuts in interest rates in the offing, investors are likely to harvest better returns on income funds.

However, on a year-on-year basis, assets of mutual fund industry are still higher by 16 percent. Thanks to the strong performance of equity and income funds in general, which have depicted an increase in asset size of 13 percent and 113 percent, respectively.

Be that as it may, the industry size will pick up as soon as the equity market regains its lost strength. Addition of new mutual funds in diverse categories is also an encouraging sign. Since the beginning of CY15, four new mutual funds have been launched, bringing in an additional inflow of Rs4 billion into the industry. So for the investors, a temporary decline in asset size shouldn’t be a cause for concern!Source: MUFAP

* Includes Islamic and conventional both

This article originally appeared on April 13, 2015, on Business Recorder (BR) research.

Bank Alfalah and USAID to Provide Access to Credit for Small and Medium Enterprises

Business Recorder (BR) Research

Under the “US Pakistan Partnership for Access to Credit” initiative, Bank Alfalah has partnered with The United States Agency for International Development (USAID) to provide financial services to Small and Medium Enterprises (SME) across Pakistan. This 8-year collaboration will provide support to entrepreneurs, help create new jobs and facilitate broad-based economic growth in the country. Under this partnership, the United States will provide $10 million that will back $60 million worth of loans for SMEs in Pakistan.

The SME sector plays a pivotal role in the economic growth of Pakistan, contributing to more than 30 percent of GDP and over 70 percent of the overall employment in the country. According to the State Bank of Pakistan, SMEs face a tremendous challenge in getting the right set of facilities and services and less than 10 percent of SMEs have access to any formal credit from the Banking sector.

Speaking about the partnership, Head of SME at Bank Alfalah, Mr. Javed Iqbal said: “Bank Alfalah focuses on understanding the holistic needs of our customers and providing complete banking solutions that meet the financial, non-financial, transactional, investment and advisory needs of our SME customers.” He added that the Bank strives to enhance inclusion of the unbanked masses into the financial mainstream.

Bank Alfalah is the first Bank in Pakistan to have launched an SME Toolkit. Through this unique and one-of-its-kind offering, the Bank provides business development tools and knowledge to SME customers across Pakistan enabling them to make better and more informed business decisions.

USAID has entered into an agreement with Bank Alfalah, JS Bank, Khushhali Bank and The First MicroFinanceBank.USAID Assistant to the Administrator, Larry Sampler (second from the left) launched the U.S.- Pakistan Partnership for Access to Credit program in partnership with Bank Alfalah, Khushhali Bank, First Micro Finance Bank, and JS Bank.

April – a cheery month for mutual funds

Business Recorder (BR) Research

Mutual funds investors had a cheery month this time with returns on equity funds landing back in green. Mind you, the last two months had remained lackluster for equity funds with negative returns jolting their investor’s fate.

With a healthy gain of 12.3 percent during the month, equity fund category managed to outperform the benchmark KSE100 index by a decent 200bps, thus taking the year-to-date gain to 18.7 percent on an absolute basis. Moreover, a good number of 18 out of 22 funds in this category towered above the benchmark return, where NAFA Stock Fund and PIML Value Equity Fund maintained the lead with whopping returns of over 16 percent. This revival in stock market activity and hence the gain on equity funds was largely attributable to the excitement induced by the healthy financial results announcements of major sectors.

Besides, fixed income funds also made an impressive comeback with their monthly returns entering the double-digit territory once again. In recent months, the volatility in international oil prices had taken its toll on the prices of government securities bonds (Read BR Research column titled: Dismal March for mutual funds, published on April 02, 2015). However, that volatility is now ironing out while favoring the returns on fixed income funds.

Aggressive fixed income fund category, on average, generated a whopping monthly return of 18 percent, while income funds yielded a healthy return of 15.5 percent, thus tracing the levels spotted earlier during the year. Similarly, money market funds also did better than the preceding month. And considering that it was the month when selling pressures remain at the peak in treasury market owing to quarter end closing and hence the liquidity needs, the performance of money market funds happened to be fairly good.

With pre-budget uncertainties whirling around, the equity market is anticipated to stay dull. Therefore, it will be interesting to see how the fund managers are able to keep up the pace during such times. Also, for fixed income funds, there still seems to be some excitement in the offing with interest rates dropping further.This article originally appeared on May 11, 2015, in Business Recorder (BR) Research.