People always talk about economy in a context suggesting that economy was a self-confident issue. For instance, people would talk about the economy being in a bad shape while forgetting to discuss exhaustively the concept they are referring to. The most common measures that are used to determine an economy include; GDP, employment rate and businesses in general.
The major components of economy that are commonly talked about are referred to as market economy and centrally planned economy. In this kind of economy, decisions as well as the determination of the prices of commodities are controlled by the interactions between citizens and businesses. This implies that the government has very little influence in market economy. On the other hand, centrally planned economy refers to an economy in which most aspects of a country’s economic decisions are controlled by the government (Tozzi).
It has presently been proved that small businesses form the backbone of every country’s economy. It is only proper then, that issues relating to these small businesses are addressed in details. This paper is thus meant to explore the aspects of small businesses, their sources of income, their establishment and the common problems that they face among other aspects.
Small Businesses within As Drivers of an Economy
Small businesses refer to businesses that require small amount of capital to start and to push through. These small businesses are known for the big role they play in boosting an economy. Of recent, small businesses have become the best in offering job opportunities to a good portion of the citizens (Tozzi). There are several sources from which such businesses may obtain capital to start and operate. The sources include loans and credit cards among others.
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Small Business Loans and problems associated with these Loans
In order to improve job growth, banks are encouraged to increase the loans that they give to small businessmen. This has been an effective move of ensuring that even wary banks adopt new approaches in dealing with these small business enterprises. This move saw Small Business Administration (SBA) guarantying a total of $3billion in pools of banks’ 504 loans disbursed into such small businesses.
SBA 504 loan scheme functions in very economical way. One tenth of a project’s expenditure is shared amongst all the borrowers in the 504 program. The remaining portion of the project’s cost is then divided between two lenders. Certified Development Company (CDC) covers 40% with the remaining percentage taken by a commercial loaner. Even though, private lenders do not give any guarantee, the government through the CDC, offers guarantee to the small business individuals for the loan they subscribe for (Shane, 1).
In this kind of SBA system, failure by any small business firm to repay its loan is taken care of. The government would take to pay the loan that the owner might have defaulted to repay. 504 loans are quite important since they enable small business to favorably finance an investment in fixed assets such as machinery (Shane, 1).
Small Business Administration (SBA) loans offer important credits to small businesses since a small proportion of such businesses qualify for conventional loans. In particular, SBA’s 504 loans assist the small businesses to expand their projects in the bid to creating more job avenues. In fact, for a company to qualify for SBA loan, it has to prove that for every $65 000 of loan requested for, either a new job opportunity would be created or an existing one would be retained (Shane, 1).
On the event that a borrower fails to repay these loans, the SBA has the right to pool the loans into securities from which, they would resell them to other potential investors. Unfortunately, this action has not been able recapture a big number of lenders (Shane, 1). The banks and other financial lenders are still required by SBA to reserve 15% of the loans on their records with pool assemblers assuming 5% of the risk. The only challenge in this project may arise if lenders and pool assemblers may not be willing to accept the risks that might be imposed by unguaranteed portion of these loans (Shane, 1).
However, the banks do not sell these 504 loans as frequently as would be expected. The main reason being; majority of investors appear to have lost interests in the 504 loan schemes. As a result, many banks and other commercials lenders have pulled out of this scheme. Another reason for pullout owes to the fact that banks are always barred from reselling their loans (Tozzi).
Some small businesspeople can’t access bank loans since they are not able to meet the collateral requirements. Involvement of regulators in the activities of the banks, make the situation even worse. The regulators restrict banks on their exposure to property market. As required by the regulators, banks should secure their loans by collateral such as commercial real estate (Shane, 2).
SBA loan program has also increased guarantees to 90% while doing away with the unnecessary fees. Banks especially the small ones take advantage of this situation to sell the guaranteed portion. The banks would then use the money they obtain from the sale to make other loans that could be sold to new investors (Shane, 2).
Reduction in demand of SBA loans would result in a decrease of premiums that lenders obtain from such loans. In turn, this move is likely to cause inefficiency in banks to avail the loans to these small businesses. Besides, the SBA’s efforts to pave the way for 504 loans, would allow a larger number of small businesses to commit into new property and fixed equipment and thereby, creating more job opportunities (Tozzi).
Credit-Card for Small Businesses
In the recent past, several credit card issuers have been working hard to ensure that they survive in the over saturated market of consumer card. According to researches, a considerable good percentage of total offers on credit card have been focusing on the promotion of small business credit cards. The credit card companies have been aggressive in issuing small business cards to majority of early stage businesses (Tozzi).
Researches on small business borrowing have revealed that small scale entrepreneurs are resorting to credit cards as the best means of financing their businesses. The current percentage of small firms that use credit cards is approximately 48% a big rise from the 1993 16%. This study was carried out by a trade group known as the National Small Business Association (Tozzi). The trade group has also found out that the popularity of bank loans has been dropping drastically. Other research groups such as NSBA and the FED show that about 25% of the small businesses prefer to operate a revolving credit card balance to settling their monthly bills in full (Tozzi).
Credit card provides crucial means of funding small businesses. Unlike banks, credit card issuers rarely to effect a loan application. In other words, application for these cards does not require a lot of formalities such as very valuable property for collateral. For example, for his business of Zip Express Installation, Chris Mauzy got two American Express (AXP) business cards without any restriction on spending limits. The small businessman had prior been denied a loan by a bank (Tozzi).
Credit-card companies regard these small business firms as fertile grown market and for that reason; profitable to trade with. Visa (V) estimation shows that small businesses in the United States spent up to $4.7 trillion in 2007. Using credit cards is very economical to small businesses. For instance, in this spending of 2007, the small businesses only paid $283 billion for the cards. According to bank card network networks, there is possibility of more growth in the use of credit cards (Tozzi).
Unlike other small business loans, the business credit card is a property of big banks. As witnessed in 2005 in the US, the top 10 banks were in control of about 83% of the small business credit card market. On the other hand, these banks had only 14% of other small business loans and 32% of the SBA loan market. However, the trend has been changing following the tight conditions imposed on the risky mortgage loans (Tozzi).
Shortcomings of Credit-Card for Small Businesses
Even though credit cards appear to be a better remedy to small businesses funding, small businesspeople who entirely rely on credit cards for a long time may suffer the consequences that come with the card’s slippery terms (Tozzi). Unlike banks or other lines of credit controlled by loan agreements, credit card issuers reserve most of the rights such as the right to alter the terms of contract at any time they feel necessary to do so. As NSBA’s survey put it, slightly more than a third of small business card holders carry more than $10 000 balances each month (Tozzi).
Unforeseen interest rates on larger monthly balances make it harder for small businesspeople to fund growth of their businesses with these credit cards. Even though business owners are allowed to surpass their limits and miss minimum payments, credits cards issuers have the tendency of increasing the rates anomaly (Tozzi). Rates can at time be varied from as low as 4% to a high of 28%. This variation is only comparable to situation of trying to put up a block house that keeps alternating in its shape (Tozzi).
Credit card is expensive to small businessmen especially those carrying revolving balances. With revolving balances, credit card holders are expected to pay a little more in order to borrow. The recent studies reveal that smaller businesses pay almost three times the prime rate since they rely mostly on these cards. A small business firm is locked from lower cost markets (Tozzi).
These cards have made small businesses to be risky to invest in. The banks take advantage of lending through credit cards to cover their risks by altering the rates whenever there is a change on the borrower’s credit profile (Tozzi). Credit card is considered the riskiest of all the forms of loan that banks make since they have the tendency of imposing charges on money to obtain greater returns to cover risks. Since credit cards have no collateral to back them, rates are not easier to in lock. Several small businesses have suffered credit card debt as a result of consistent increase of interest rates (Tozzi).
Credit card is viewed by some economists as a measure that the lenders employ to help them increase their profit. The credit-card issuers overlook the risks the card holders bare. To avoid making bigger loses on small business credit-cards than the expected, credit card companies indiscriminately clamp down on borrowers (Tozzi). A typical example of this practice of issuers was witnessed in the case of Advant-a company that specializes in small business cards. The company unexpectedly decided to close more than one million small business accounts as a result of suffering huge loss of $76 million. Credit card to some extent is unreliable (Tozzi).
Protection of Cardholders against Exploitative Practices of Credit-Card Issuers
Research firms such as FED have proposed better regulative measures to help control most of the aggressive practices involving credit-card such as unguarded rates alteration on existing balances. Adoption of ways that only maximize interest charges is another exploitative practice of credit cards issuers. Unfortunately, the regulative measures only apply to personal credit cards despite the fact that the personal and small business cards functions in a similar manner. Some businessmen have resorted to using their personal cards to perform business functions (Tozzi).
The reform law officially referred to as the sweeping credit-card reform law is the only law that exclusively protects small business card holders from the practices such as unnecessary rate increase. The law is intended in ensuring that issuers inform their clients in time about any planned alteration to be made on the contract terms (Tozzi).
In conclusion, as it has been demonstrated in this paper, small businesses are very important in an economy because of the role play in boosting a country’s economy. It therefore calls for the contribution from all the parties involved including the government so as to ensure that more small businesses are established and the existing ones are expanded to create more job opportunities. For instance, the government should strive to increase the maximum size of loans that SBA would give to these small businesses. The government should also ensure that these businesses are allowed to use 504 loans to refinance their commercial mortgages under relaxed terms and conditions.
To Nurture these small businesses to compete effectively with large scale enterprises, the government should expand the Credit-Card reform law to accommodate every small business. This measure would help prevent small business cardholders from the vulnerability caused by practices of card issuers geared at exploiting the holders. Potential businessmen should also be encouraged to venture into various small scale businesses by taking loans from the lenders such as SBA and Credit-Card companies to assist them start and maintain their businesses.