Formalizing Businesses to Improve Performance and Access to Financing for SMEs in Cameroon

By Laurent Brice Nsengue & Dr. Jean Cedric Kouam (Download full pdf)

Introduction

According to the International Labour Office (ILO), the informal sector refers to a set of units producing goods and services with the primary aim of generating employment and income for the people concerned. These unorganized units operate on a small scale, with a limited division of labor and capital. Business formalization is therefore the process of moving a business from the informal to the formal sector by giving it legal recognition and separating it from its owners. Today, business formalization is directly linked to financial inclusion, credibility, and business development, all of which are necessary for the viability of a business and the development of an environment conducive to entrepreneurship. The formal sector is considered to be a set of activities or businesses with a common objective, which are official activities recognized by the State, and which national statistics take into account when evaluating the public service. In Cameroon, the informal sector employs more than 9.5 million Cameroonians, representing 90% of the working population (OIT) and contributing more than 57% of the country’s GDP (OIL). To be an emerging country by 2035, the private sector must strengthen its impact on the local economy. For this to happen, it is imperative that businesses be formalized. With this in mind, Prime Ministerial Instruction No. 011/CAB/PM of 18, March 2010 on the administrative formalities for setting up businesses in Cameroon defines the specific features of a formal business in Cameroon. The main objective of this document is to show the role played by business formalization in the performance and access to finance of Small and Medium-Sized Enterprises (SMEs). Ultimately, this study should raise awareness among entrepreneurs, civil society, and other stakeholders about the importance of business formalization in terms of the competitiveness of Cameroonian SMEs.  Statistics show that only 12% of businesses are formal in Cameroon (Bakehe, 2016). The aim of formalizing businesses is not only to improve business performance and access to credit but also to increase the private sector’s contribution to the country’s inclusive and sustainable economic development.

Main Challenges of Business Formalization in Cameroon

According to the Survey of Informal Enterprises in Cameroon (OIL, 2017), around 10% of self-entrepreneurs are registered with the trade regime, 31% have a tax card, and 2% are affiliated with the CNPS. Similarly, around 84% of SMEs have already declared taxes since their creation, compared with around 16% who have never done so, according to the same survey. These figures reveal the difficulties encountered by businesses in migrating from the informal to the formal sector, even if it is also recognized that Cameroon’s entrepreneurial ecosystem is largely made up of small businesses, of which a vast majority operate in the informal sector with the primary objective of satisfying family needs.

In Cameroon, businesses spend an average of 624 hours making 44 payments per year to the tax authorities. The Cameroonian tax system is characterized by the instability of the tax system and the reasons for tax adjustments (72%), tax penalties and fines (66%), the rate of taxation (61%), and the multiplicity of tax administration controls (59%) (GICAM). It is also important to note that the total tax rate in Cameroon remains one of the highest in Central Africa, at 57.7% of corporate profits compared to 47.1% in Gabon (World Bank, 2020), all of which hinder the formalization of businesses in Cameroon.

Corruption serves as a legitimizing discourse for informal traders (Flynn, 1997). In Cameroon, the relationship between business promoters and the administrations in charge of formalization is characterized by a low rate of formalized business creation and a low rate of business formalization. These low formalization rates are justified by the poor perception of entrepreneurs towards the Cameroonian administration as a whole, which is characterized by a very high rate of corruption. Cameroon is currently ranked 142 out of 180 countries (Transparency International, 2023), a fact that is not surprising given that the country has always been plagued by controversies related to corruption and its components.

In addition to corruption, red tape is also an important factor in slowing down the momentum of business formalization in Cameroon (INS, 2016). One can also underline not only the weakness and ineffectiveness of communications but also the ineffectiveness of sensitization of organizations in charge of business formalization in Cameroon on the advantages of formalization in terms of tax incentives, performance, access to finance, access to new markets, and development of businesses as a whole.

While the Cameroonian government has implemented various initiatives to address the low formalization rate of enterprises, including the establishment of a formalization and enterprise creation center, the introduction of tax incentives for newly formalized businesses, and the option for enterprises to form cooperatives for formalization, the actual number of formalized businesses in Cameroon remains significantly limited.

The Importance of Business Formalization in Improving the Performance and Access to Finance of SMEs in Cameroon

For governments and society as a whole, business formalization is linked to a favorable business environment, economic growth, and better working conditions. It also significantly contributes to tax revenues, which are needed to provide public goods and services in a country.

Declining SME performance has been cited as one of the primary reasons for Cameroon’s drop in the Doing Business Index, given that most enterprises are in the informal sector. According to the latest World Bank annual ratings for 2022, Cameroon is ranked 167 among 190 economies in Doing Business. Migrating from the informal to the formal sector will improve the performance of SMEs through concrete entrepreneurial orientation and organizational innovations, and local economic development will enhance performance and create employment opportunities, which will automatically boost the nation’s economic growth.

According to La Porta and Schleifer (2008), an entrepreneur’s decision to formalize is based on a comparison of costs and the major benefits. They distinguish between the cost of formalization, the cost of remaining informal, and the benefit of formalization. Their analysis shows a negative effect of the cost of paying taxes, the cost of complying with labour legislation, and the cost of administrative formalities on formalization. As positive effects on performance, the formalization of enterprises secures business names and products, enables participation in open tenders or becoming suppliers or distributors of large enterprises; and allows enterprises to access several national and international markets that will subsequently require professional, vigorous business management and a quality workforce for the production of quality goods and services. Formalization also allows the enterprise to be competitive and increase its visibility. Based on the positive effects of formalizing an enterprise, we can clearly state that an enterprise has more to gain than to lose by formalizing, as it improves its performance and development.

The importance of financial inclusion is increasingly being recognized by policymakers around the world, and in particular, the financial inclusion of SMEs. According to the Professional Association of Credit Institutions of Cameroon (APPECAM), the rate of access to credit for small and medium enterprises (SMEs) is only 13.8% of the GDP. The lack of traceability and visibility in the development of activities, imprecise accounting with the difficulty of providing reliable financial statements, purchases, and sales without invoices or receipts, among others, are very often cited as reasons for the low rate of access to financing for SMEs, the non-formalization of SMEs remains the most determining factor because it does not protect financial institutions, making it difficult to comply with the regulatory requirements of the financial sector. This shows the essential role played by formalization in providing access to finance for enterprises.

Policy options

While it is true that every government needs tax revenue to be able to function and finance its public investment projects, it is also true that the main obstacle to formalization and to the development of entrepreneurship in general, cited by economic operators, is taxation (INS, 2016). For the World Bank, the use of an error correction model on secondary data between 1989 and 2018 shows that taxation has a significant negative impact on economic growth. In fact, a 10% increase in tax revenue would contribute to a 9.5 basis point fall in growth, so an expansionary fiscal policy would be needed to reduce the tax burden on businesses in order to stimulate growth and ensure development, or else give priority to non-tax revenue.

Policy recommendations

While improving communication on tax incentives and business development is good, institutionalizing the fight against corruption is a superior solution. This not only enhances the business climate but also rebuilds trust between entrepreneurs and the Cameroonian administration, empowering institutions to combat corruption, especially in light of Cameroon’s 142nd ranking out of 180 countries (Tranperency International 2022). This will strengthen the willingness of entrepreneurs to formalize their businesses and pay taxes, knowing that their money will be put to good use by the administration, which will increase the rate of business formalization in Cameroon.

Conclusion

The objective of this paper was to analyze the key role of business formalization in business performance and access to finance. Based on empirical evidence, business formalization is not only one of the keys to business development but also an important factor in the development of entrepreneurship as a whole in Cameroon.