TOPIC 2: FINANCING SMALL-SIZED BUSINESSES
OUTLINE OF THE TOPIC
2.1. The concept of Small-sized Business
✓ Meaning of Small-sized Business
✓ Classfication of Business According to SME Policy of 2003
✓ Characteristics of Small-sized Business
✓ Importance of Small Business
2.2. Sources of Finance For Small Business
✓ Loans
✓ Personal Savings
✓ Funds from Family and Friends
✓ Differred Payments
2.3. Microfinance and Cooperatives
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2.1. THE CONCEPT OF SMALL-SIZED BUSINESS
SMALL BUSINESS
A small business is a privately owned and operated business that has a limited number of employees and
a relatively low volume of sales or revenue compared to large businesses. Small business examples in
Tanzania includes
— Retail shops (duka la rejareja)
— Food vendors (Mama Lishe/Baba Lishe)
— Tailoring and sewing services
— Poultry keeping
— Bodaboda or Bajaj transport services
CLASSIFICATION OF BUSINESS ACCORDING TO SME DEVELOPMENT POLICY OF TANZANIA OF 2003
According to the Small and Medium Enterprise (SME) Development Policy of Tanzania (2003), a small
business (or small enterprise) is defined based on the number of employees and capital investment. The
classification is as follows:
Category No. of Employees Capital Investment in Machinery (TZS)
Micro enterprise 1 – 4. Up to 5 million
Small enterprise 5 – 49 Above 5 million to 200 million
Medium enterprise 50 – 99 Above 200 million to 800 million
Large enterprise 100+ Above 800 million
Therefore, in context of this topic, the small business, means both micro and small enterprises.
CHARACTERISTICS OF A SMALL BUSINESS
1. Small number of employees
A small business typically has a limited number of workers, usually fewer than 50. This makes it
easier to manage operations and maintain close contact with employees. For example, a tailoring
shop with 10 employees.
2. Small capital investment
Small businesses require relatively little money to start and operate. Their machinery, tools, or stock
are not as expensive as those of larger firms. For example, a local food vendor operating with a
capital of TZS 3 million.
3. Owner-managed
In most small businesses, the owner plays an active role in daily operations and decision-making. This
allows for direct supervision and personalized service. For example, a small retail shop where the
owner manages sales and stock.
4. Localized market
Small businesses tend to serve customers in nearby or local areas rather than operating on a national
or international scale. For instance, a bakery selling bread within the neighborhood.
5. Simple organizational structure
Due to their size, small businesses have a simple structure with few departments. This makes
communication and coordination more efficient. For example, a printing shop where one person
handles customer service and production.
6. Flexibility and quick decision-making
Small businesses can adapt quickly to changes because the decision-making process is not delayed
by many layers of management. For instance, a small boutique adjusting clothing styles based on
customer feedback.
7. Limited access to finance
Small businesses often face challenges in obtaining loans or large investments from banks and
financial institutions. This can limit their growth. For example, a carpenter struggling to get a loan
to buy new tools.
IMPORTANCE OF SMALL BUSINESSES
Small businesses play a vital role in the economic and social development of a country. Their contributions
go beyond just profits — they support communities, create jobs, and drive innovation.
1. Employment creation
Small businesses provide jobs to a large number of people, especially in developing countries. They
help reduce unemployment and offer income to families. For example, a local carpentry workshop
employing five young people.
2. Income generation
By offering self-employment and profits, small businesses help individuals earn a living and improve
their standard of living. For example, a food vendor earns daily income to support her family.
3. Poverty reduction
Through job opportunities and income generation, small businesses contribute to reducing poverty
in both rural and urban areas. For instance, women’s craft groups selling handmade products to
support their homes.
4. Promotion of entrepreneurship
Small businesses encourage creativity, self-reliance, and the spirit of starting something new. They
give people a chance to use their skills and talents. For example, a youth using digital skills to run a
small online marketing business.
5. Contribute to economic Growth
They contribute to national income through taxes, local production, and services, helping the
economy grow. For example, a small-scale maize mill that contributes to food processing and local
trade.
6. Utilization of Local Resources
Small businesses often use locally available materials, which helps reduce imports and supports the
local economy. For example, a brick-making business using local clay.
7. Development of Rural Areas
They bring goods, services, and jobs to areas that are often ignored by big businesses, helping balance
national development. For instance, a motorcycle repair shop in a village.
8. Supplier to large businesses
Most of small business supply raw materials to large businesses at low cost. This reduces production
costs of large industries. For example, local cotton farmers supplying cotton to the textile industries.
2.2. SOURCES OF FINANCE FOR SMALL BUSINESS
There are different ways in which a small-sized business can finance its operation. Such sources include,
loans, personal savings, deferred payments and funds from family and friends.
A. LOAN
A loan is a sum of money borrowed from a lender (bank, financial institution, or individual), with the
agreement to repay it at an agreed time with interest. An interest refers to the monetary cost of borrowed
money. It is usually expressed as a percentage rate of the borrowed funds.
ADVANTAGES OF LOANS FOR FINANCING SMALL BUSINESSES
1. Access to capital
Loans provide small businesses with the money they need to start or grow their businesses when
internal funds are not enough. For example, a small grocery store borrows money to restock products
during high-demand seasons.
2. Business ownership is maintained
Unlike investors who may ask for shares or control, loans do not take away any ownership from the
business owner. For instance, a tailor borrows money to expand but remains the sole owner of the
business.
3. Fixed repayment schedule
Loans usually come with a clear repayment plan, making it easier for business owners to manage their
finances and plan ahead. For example, a shop owner repays TZS 300,000 every month for one year.
4. Helps build credit history
Regular and timely repayment of loans builds a positive credit history, which can help the small
businesses qualify for bigger loans in the future. For example, a farmer who repays a small loan
successfully gets a larger loan the next season.
5. Supports business expansion
Loans can help small businesses increase their production, open new branches, or enter new markets.
For example, a poultry farmer uses a loan to build more chicken houses and expand operations.
6. Flexibility of use
The business owner usually decides how to use the loan – whether for buying stock, paying salaries,
or investing in equipment. For example, a mechanic uses a loan partly to buy tools and partly to
improve the workshop.
7. Promotes economic growth and employment
Loans enable small businesses to grow, which leads to more job opportunities and contributes
to national economic development. For example, a small textile factory borrows money, expands
production, and hires more workers.
DISADVANTAGES OF LOANS FOR FINANCING SMALL BUSINESSES
1. Repayment pressure
Loans must be repaid within a fixed time, whether the business makes a profit or not. This can create
financial pressure. For example, a small shop struggles to repay the loan during a slow sales season.
2. Interest costs
Loans come with interest, which increases the total amount the business must repay. This reduces
profits. For example, a loan of TZS 5 million may require a total repayment of TZS 6 million.
3. Collateral requirement
Banks often ask for security (collateral) like land or buildings, which small businesses may not have.
For instance, a young entrepreneur is denied a loan because they don’t own property.
4. Risk of losing assets
If the business fails to repay the loan, the lender may seize the collateral. For example, a furniture
maker loses his workshop because he couldn’t repay the loan.
5. Limited loan amount
Small businesses often get smaller loans than they need due to lack of credit history or collateral. For
instance, a business requests TZS 10 million but receives only TZS 4 million.
6. Strict qualification requirements
To get a loan, SMEs must meet several requirements such as a business plan, financial records,
and bank statements, which can be challenging for informal businesses. For example, a street food
vendor may be rejected because they lack formal registration and records.
7. Discourages risk-taking
Loan repayment obligations may make business owners afraid to take new or innovative risks. For
example, a boutique owner avoids trying new designs for fear of losing customers and being unable
to repay the loan.
B. PERSONAL SAVING
Personal saving refers to the money that an individual sets aside from their own income, rather than
spending all of it. It is often the first and most accessible form of financing for many small business
owners. For example, a person who works as a doctor saves part of his/her salary every month and uses
that money to open a small pharmacy.
ADVANTAGES OF USING PERSONAL SAVING
1. No interest to pay
Money from personal savings does not come with interest, unlike loans, making it cost-effective. For
example, a tailor uses her own money to buy a sewing machine without worrying about extra costs.
2. Full ownership and control
The owner retains complete control over the business, as there are no external investors. For example,
a farmer starts poultry keeping without sharing profits with anyone else.
3. No collateral needed
Since the money comes from the owner, there is no need to provide security or assets as collateral.
For instance, a young graduate starts a mobile money business using her own saved funds.
4. Quick access to funds
Personal savings can be accessed easily without long processes or paperwork. For example, a vendor
uses her savings to restock her kiosk immediately after selling out the stocks.
5. Encourages financial discipline
Saving money for business teaches discipline and proper money management. For example, a student
learns to cut unnecessary expenses in order to grow future business capital.
6. Less financial risk
There is no pressure from lenders or investors, reducing the stress of repayment or meeting investor
expectations. For example, a shoe maker experiments with new designs using her own capital without
fear of losing someone else’s money.
7. Supports long-term planning
Personal savings are usually set aside with a goal in mind, making them useful for planned and purposeful business decisions. For example, a carpenter saves for 6 months to open a small furniture
workshop.
DISADVANTAGES OF USING PERSONAL SAVING
1. Limited capital
Personal savings may not be enough to meet all business needs, especially for larger investments. For
example, a person wants to start a car repair garage but only has enough savings to buy a few tools.
2. Slow business growth
Since the capital is limited, it may take longer for the business to grow or expand. For example, a
clothes vendor cannot afford to open a second shop due to low savings.
3. High personal financial risk
If the business fails, the owner may lose all their personal savings, affecting their financial security.
For example, a woman uses her life savings to start a salon, but the business does not succeed.
4. No financial backup (emergency fund)
Using all personal savings can leave the owner without emergency funds for personal or family needs.
For example, a man spends all his savings on a business, but has no money left when his child falls
sick.
5. May delay business start-up
It takes time to save enough money, which can delay the launch of the business. For example, a youth
who wants to start a printing business has to wait two years to save enough capital.
6. Lack of financial advice or support
When using personal savings, the owner might not get professional guidance that comes with funding
from financial institutions or investors. For instance, a first-time entrepreneur uses savings but lacks
a mentor or advisor to guide business planning.
7. Discourages seeking other opportunities
Over-reliance on personal savings might prevent the business owner from exploring better funding
options that could boost the business faster. For example, a baker refuses to apply for a grant or loan,
even though it could help buy a bigger oven.
8. Behavioural biases
Some business individuals may struggle with spending habits that my either hinder them form
saving, or depleting the saved money on impulse purchases. For example, a Food vendor may use her
business savings to pay for friend’s wedding contributions, instead of expanding her business.
C. FUNDS FROM FAMILY AND FRIENDS
Funds from family and friends refer to the financial support that a small business owner receives from
close relatives or trusted friends. This support can come in the form of a loan, a gift, or even a partnership
investment to help start or grow the business. It is usually based on trust and personal relationships, and it
often comes with little or no interest.
ADVANTAGES OF FUNDS FROM FAMILY AND FRIENDS
1. Easier access to capital
Getting funds from family and friends is usually quicker and less complicated than applying for bank
loans. For example, a young entrepreneur borrows TZS 500,000 from her uncle to buy raw materials
for her homemade soap business.
2. Flexible repayment terms
Family and friends often allow more flexible or informal repayment schedules. For example, a friend
lends money to a small business owner and agrees to be repaid after six months, once the business
starts making profit.
3. Low or no interest
Unlike banks, family and friends may offer loans without charging any interest. For instance, a brother
supports his sister’s poultry business by giving her TZS 300,000 as an interest-free loan.
4. Trust-based support
Since there is trust and personal relationship, the borrower may not need to provide collateral. For
example, a father gives his son capital to start a mobile money kiosk, trusting his son’s honesty and
commitment.
5. Boosts confidence and encouragement
Support from loved ones motivates the entrepreneur and builds self-belief. For example, a cousin
invests in a friend’s tailoring business and also encourages them to market their services on social
media.
6. Faster business start-up
Immediate access to funds helps the entrepreneur launch the business faster. For example, a young
graduate receives startup funds from her aunt and is able to open a food vending business right after
school.
7. No formal requirements
Funds from family and friends usually don’t require formal procedures like credit checks or business
plans. For example, a mother gives her daughter money to start selling secondhand clothes without
asking for any written agreement.
8. Shared risk in case of joint venture
Sometimes family or friends become business partners, sharing in both risks and profits. For example,
two friends contribute money equally to start a small retail shop and run it together.
DISADVANTAGES OF FUNDS FROM FAMILY AND FRIENDS
1. Risk of damaging relationships
If the business fails or the money is not repaid on time, it can lead to conflict or loss of trust. For
example, a man borrows money from his sister to open a shop, but when the shop fails, they stop
speaking to each other.
2. Limited amount of capital
Family and friends may not have enough money to fully support the business needs. For example,
a woman wants TZS 3 million to open a small restaurant but can only raise TZS 1 million from
relatives.
3. Lack of formal agreements
Many times, these funds are given without written agreements, which can cause confusion or
disagreements later. For example, a friend gives money expecting to be a partner, but the business
owner considers it a loan.
4. Creates dependency
Relying too much on family and friends may stop the entrepreneur from seeking independent
solutions or learning how to secure formal funding. For example, a youth keeps asking for money
from relatives instead of learning to apply for small business grants.
5. No business guidance or mentorship
Family and friends may not have business knowledge, so while they offer money, they may not
provide useful advice. For example, a cousin funds a boutique but cannot help with marketing or
pricing strategies.
6. Not a long-term funding solution
This source is usually one-time or short-term, and may not be reliable for business growth or future
expansion. For example, after starting the business with help from friends, the owner struggles to
raise funds for expansion later.
D. DEFERRED PAYMENT
Deferred payment is a payment arrangement where a buyer receives goods or services immediately but
agrees to pay for them at a later date, either in one lump sum or through installments.
For example, a shopkeeper buys 100 bags of cement from a supplier in March and agrees to pay the full
amount after 60 days. The supplier delivers the cement immediately, and the shopkeeper starts selling it. He
uses the money earned from selling the cement to pay the supplier in May.
ADVANTAGES OF DEFERRED PAYMENT
TO THE BUYER:
1. Improved cash flow
The buyer can use the product or service immediately without paying upfront, allowing them to use
available cash for other needs. For example, a small business gets inventory on credit and uses sales
revenue to pay later.
2. Business continuity
Deferred payment helps businesses operate smoothly even when they face temporary cash shortages.
For instance, a retailer continues operating during a slow sales season by deferring payments to
suppliers.
3. Convenient for budgeting
Buyers can plan their finances and make payments over time. For example, a farmer buys fertilizers
and agrees to pay after harvest, when cash is available.
4. Access to better equipment or goods
Buyers can afford higher-quality goods or larger quantities through credit. For example, a shopkeeper
acquires a large freezer through deferred payment.
5. Opportunity to generate revenue before paying
Buyers can sell products and earn revenue before settling the payment. For example, a boutique sells
clothes bought on credit before the due payment date.
TO THE SELLER:
1. Increased sales volume
Offering deferred payment attracts more customers, increasing sales. For example, a supplier sells
more items to small shops by offering 30-day payment terms.
2. Competitive advantage
Sellers gain an edge over competitors who don’t offer credit terms. For example, a furniture seller
attracts more customers by allowing payment in three installments.
3. Stronger customer relationships
Building trust by offering deferred payment can lead to long-term business relationships. For example,
a distributor offers credit to regular customers, encouraging loyalty.
4. Potential to charge interest or fees
Sellers may include interest or service charges, increasing their revenue. For example, a seller adds a
5% fee on goods sold under a deferred payment agreement.
5. Faster movement of inventory
Credit sales can help clear stock quickly. For example, a wholesaler sells more goods to retailers when
payments are deferred.
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