Small and Medium Enterprise Financing and Mentoring Services in Emerging Markets in the Dominican Republic
Recent work in the area of development finance has focused on poverty reduction through microfinance institutions (MFIs). These institutions are thought to enable entrepreneurship by providing small personal loans to borrowers who otherwise would have difficulty accessing capital markets, but new entrepreneurs are also faced with complex financial decisions for which they may be unprepared. Studies have shown that there is a strong association between higher financial literacy and better business decisions and outcomes, but there is little evidence on the best ways to quickly convey complex financial practices to business owners. Should courses place more weigh on conveying every aspect of complex materials, or teaching basic concepts in greater depth?
In the Dominican Republic, ADOPEM is a savings and credit bank which serves primarily low-income urban individuals and small businesses. They offer loans of US$70 – US$1,400 to both individuals and groups, and also operate a training center with programs covering basic computing, entrepreneurship, and trade skills. Many clients operate small businesses with few or no employees, including enterprises such as general stores, beauty salons, and food services, which bring in an average of US$85 per week. Many ADOPEM clients have been found to have errors in their accounting books, and relatively few individuals kept their business and personal accounts separate.
Researchers partnered with ADOPEM to evaluate two methods of financial literacy training: one which emphasized classic accounting principles, and one which focused on simple “rule of thumb” methods for decision making. From a pool of 1,193 ADOPEM clients who had expressed interest in financial training, two-thirds were assigned to receive five to six weeks of training, which was offered once a week for three hours at a time and included out-of-class assignments. These classes were taught by qualified local instructors with experience in adult education, and were offered for free or nearly free. Two variations of the training were tested:
Accounting Treatment: This program was adapted from financial education models designed by Freedom From Hunger and the Citigroup Foundation, and focused on a traditional, principles-based approach to accounting techniques. It covered topics such as daily record keeping of cash and expenses, inventory management, accounts receivable and payable, and calculating cash profits, and investment.
Rule of Thumb Treatment: This treatment taught participants simple rules for financial decision making, focusing on the need to separate business and personal accounts. It taught clients about paying oneself a fixed salary, distinguishing between business and personal expenses, and easy-to-implement tools for reconciling accounts.
Additionally, a randomly selected subset of each treatment group received weekly follow-up visits from a financial counselor, in an effort to distinguish between the effects of having learned the material and the effects of actually implementing it regularly in business practices. Counselors visited participants and answered any questions they had about course material, verified and encouraged completion of accounting books, and helped correct any mistakes that they found.
Effects on Business Practices: Results indicate that the “rule of thumb” treatment had significant effects on clients’ business practices. The likelihood that clients were separating business and personal cash and accounts, keeping accounting records, and calculating revenues formally increased by 6% to 12% relative to the comparison group. By contrast, the accounting treatment seems to have had no impact on business practices.
Effect on Revenue Streams: Participants in the “rule of thumb” treatment also reported increases in revenue during bad business weeks, suggesting that training may operate by helping alert individuals to changes in revenues and expenses and giving them tools to counteract those shocks. These increases in revenue were relatively large, around 25% of endline reported revenue. The accounting treatment had no impact on revenues.
There was no discernible impact of receiving follow-up visits from counselors on either treatment group. There were, however, some differences in treatment effects across various groups. Training had a larger effect on more educated clients’ likelihood to separate business and personal cash and likelihood to save. Additionally, the “rule of thumb” treatment also had a larger impact on people who had not expressed great interest in accounting training. This suggests that charging fees or making training programs optional may not target programs to those who will benefit most.