Financial Management in Small and Medium Enterprises

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Introduction

Small and Medium Enterprises – SMEs as a whole play a very vital role in the stability of a country’s economy and this importance becomes more relevant in the wake of the recent financial crisis which started in the United States of America and eventually affected other parts of the world like a giant tidal wave which swept the entire financial sector of the world. The role of SMEs in trying times of today becomes all the more relevant and important as larger organisations continue to report huge losses and file bankruptcies due to a large credit crunch and deteriorating economic conditions.

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The importance of SMEs in a recovering economy is quite significant as in times of an economic downturn the small and medium enterprises take benefit of strategic business conditions and grow with the stable recovery in an economy. In light of recent events and given the significance of SMEs is recovering economies, the need to support SMEs and address several problems related to SMEs is elevated. SMEs face several problems related to financial management, human resources and marketing management. To solve these problems the appropriate identification of these problems is necessary.

This essay highlights the financial management problems faced by SMEs by answering a critical research question. The essay addresses the question of what the major problems of financial management and financing in small and medium enterprises are. The essay answers this question by briefly describing SMEs and the major problems these enterprises face generally in financial management with specific attention to problems in obtaining finance.

Small and Medium Enterprises

The companies and organisations which have a small capital structure, and which operate on a lower scale with a minimum number of employees and earn low profits are termed as Small and Medium Enterprises – SMEs. The interpretation of SMEs based on size and structure varies from country to country and author to author. The size of SMEs is based on different variables such as operating levels, number of employees, amount of investment and level of profits in different parts of the world. Countries in the United Kingdom which employ less than 50 workers and do not operate as subsidies of other corporations are termed SMEs.

The important aspects to consider while defining and classifying SMEs should be both qualitative and quantitative. The quantitative factors to consider include the number of employees, amount of capital invested, turnover and annual profit or losses of the company. The qualitative aspects on the other hand include the overall objectives, policies and procedures implemented in an organisation (Romm and Sudweeks 1998).

Many authors classify organisations as SMEs based on the number of people employed in an organisation. As identified above the interpretation of SMEs is based on several qualitative and quantitative factors. Companies that employ less than 200 workers are classified as SMEs in several parts of the world. The two most important factors used while classifying companies as small or medium enterprises in several countries of the world are company turnover and the number of people employed (OECD 2008). Although SMEs are small in size their overall importance in a country’s economy is quite important as these enterprises provide employment and contribute significantly to stable but slow growth in an economy by providing innovative business operations.

The financial management process in SMEs is quite different from financial management processes in traditional larger organisations. The survival of SMEs depends on efficient financial management and appropriate financing strategies implemented by the management of these enterprises. The size of an organisation is directly related to the financial management process in that organisation. The financial management process in large organisations is managed by departments with skilled and experienced experts who apply their skills and knowledge to achieve optimal financial conditions.

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The finances in a smaller organisation are more important as the management of finances in these companies is performed by individuals who may not have the appropriate knowledge, training and expertise required for efficient results. There are several problems regarding financial management processes in SMEs which include lack of control on financial resources, implementation of obsolete and outdated financial systems, stringent government rules and regulations, compliance issues and very low access to affordable financing.

General Problems in SMEs

The failure of SMEs is inevitable if these problems are not identified and addressed with a high priority. The best way of analysing problems in a situation or business is to review problems in a similar business. This would not only help in the identification of problems but also help in the prevention of activities that lead to financial trouble and eventual failure. One of the main problems which cause SMEs to collapse is lack of financial control.

Thomas Chippendale was a famous cabinet and chair maker who sold many of his creations to high paying customers and generated a large number of revenues but due to lack of financial control, he was unable to make his business profitable. Another significant problem is the implementation of outdated and obsolete financial management systems. Companies tend to outgrow the financial management systems with the passage of time and the initially implemented financial management system is rendered useless. Pekarna Pejac is one of the largest producers of bread and pastries in Slovenia and employs almost 230 people.

The company was initially launched as a family run business and the company experienced major problems as it tried to implement several alternative financial management systems to cater for the company’s growing financial needs (AME Info 2004).

Financial Management Problems in SMEs

The characteristics of SMEs which are reflective of their small size cause several problems to these enterprises. According to research by KPMG the three characteristics of small size, managerial skills and insufficient information cause several problems for SMEs such as formulation of strategies, organisational structure, operations, marketing, accounting system and financial management. According to the report problems in financial management include inadequate financial information which causes bad investment decisions to be made, lack of information regarding alternative investment options, complexity in borrowing procedures and challenges in obtaining finances (KPMG 2006).

According to Wetzel & Jonsson (1989), the investment decisions made by owners in a small firm were a common factor among small companies which failed. The poor investment decisions may be due to a lack of information, experience and expertise in financial management. Inability to manage finances properly results in financial chaos which causes major problems and threats to SMEs (Wienrauch, Mann, Robinson and Pharr 1991).

The inappropriate implementation of ERP software which also includes components of financial management also causes severe problems for SMEs (Spathis & Constantinides, 2003). The risk of improper implementation is based on several factors such as high costs of implementation, conflicts with systems already working in organisations, growth of a firm without any changes in the system and untrained or undertrained workforce. The company may also face problems of experienced workers leaving the organisation if they are unable to adapt to a new system incorporated in business operations. The management faces the challenge of opting for experienced workers or new systems of financial management at the cost of these workers (Stair and Reynolds 2008).

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Nayak & Greenfiled (1991) surveyed West Midland companies to evaluate problems of bookkeeping, accounting and information gathering and concluded that small businesses need to keep records of their debtors through the implementation of proper systems for rapid collection and recovery from these debtors and these systems should be managed in a way that they change with the growth in an organisation. Nayak and Greenfield in their study have stressed the need for proper implementation of accounting and financial management systems which can be amended with the growth in an organisation over time. The inability of management to alter or adjust financial systems with changes in the size and structure of an organisation results in financial distress and eventual failure of that organisation.

Monk (2000) presented several reasons for the failure of SMEs which include low levels of working capital, selection of improper markets and swift changes in the external environment and market conditions. Working capital in an organisation is the operational requirement of a business and caters to the everyday needs of a business regarding settlement of short term liabilities and obligations. The research carried out by Monk implies that working capital management has critical importance in the success of SMEs and managers or owners of SMEs should have excellent working capital and financial management abilities.

Ang (1992) states that SMEs in comparison with larger organisations have a shorter life expectancy and face more problems in the transition from one stage of the business to another. SMEs have lower profits due to lower levels of finance and deficiency in managerial resources especially in times of economic distress. The ideas presented in the research are quite relevant today as both small and large companies face tremendous pressure due to economic instability and recession-like conditions throughout the world. To remain stable and avoid failure SMEs need to focus on several alternative options available for financing operations and employ personnel with appropriate training and experience in their relevant fields.

Although the economic downturn affects the availability of finance for SMEs these enterprises can take advantage of the high unemployment ratio and recruit amply trained and experienced workers for operations at affordable salaries and wages. (Bruderl and Schussler 1990) also identified some disadvantages of SMEs as compared to larger organisations which include poor contracts with creditors, stringent government regulations, unfavourable tax policies and undertrained staff and management.

The scarcity of financial resources and lesser options available for financing causes major problems for SMEs. The main constraint in the growth of SMEs is inadequate and low access to financing alternatives. Banks, financial institutions and investors prefer larger organisations for investment as these organisations have an advantage of economies of scale, properly audited and published annual reports, collateral or guarantee required for obtaining a loan and credit ratings which help financial institutions and banks in making decisions about lending money. SMEs on the other hand are unable to provide adequate collateral, have lower management skills and inability to generate stable cash flows which eventually causes banks, financial institutions and investors to refrain from investing in these companies.

SMEs face problems with financing as investors and banks are reluctant in lending or invest in these enterprises due to several reasons. The first reason is that creditors, banks and financial institutions view SMEs as high-risk companies due to a low level of assets and insufficient capital. The second reason is information asymmetry which is caused mainly by lack of financial records and unavailability of financial statements. The cost of transactions is quite high and would not be recovered from a low level of financing required for business operations in SMEs (OECD 2002). A survey conducted on South African SMEs also reflected that low sources of business finance and poor financial management by company personnel were the main reasons for the failure of most enterprises (Creamer Media 2003).

SMEs also face a major problem in obtaining finance from external equity due to higher floatation costs of stock issues for smaller companies and initial public offerings of smaller companies are also underpriced in several cases (Buckland and Davis 1990). Another option available for financing to SMEs is through venture capitalists which can be used to overcome problems present in equity and debt financing. Although financing for SMEs can be obtained from venture capitalists it too can be quite expensive (Sahlman 1990). SMEs can also opt for financing from internal sources such as sale proceeds and working capital (Hew and Loi 2004).

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The identification of several problems in financial management and issues in obtaining financing for SMEs as discussed in previous sections is necessary to solve these problems so that adequate resources are available for SMEs to operate efficiently especially in periods of economic downturn. SMEs need to focus on implementing strategies that are beneficial on a long term basis rather than short term.

Financial management systems need to be implemented in a manner that not only benefits the current organisational structure but also adapts to any future changes in the organisational structure or financial needs of the organisation. SMEs need to focus on appropriately presenting financial information and strive for higher profits as this would help in acquiring finance from external sources such as debt and equity from financial institutions, banks and investors. SMEs also need to apply strategies to make themselves more attractive to these entities and venture capitalists.

Conclusion

This essay outlined several problems in the financial management process of SMEs and barriers in financing these enterprises. The main theme of the essay was to describe these problems as an answer to the research question presented at the beginning of this essay. The several problems identified for SMEs have been identified through research of books, journal articles, previous researches and websites. The analysis of evidence acquired from these sources implies that there are several problems in the financial management of SMEs and these enterprises face several obstacles in obtaining finance from traditional sources.

It is concluded based on the research and evidence provided in this essay that there are several problems in financial management and financing for SMEs which include no or low financial control, inadequate representation of financial activities, use of outdated or obsolete financial management systems, undertrained or untrained management personnel, low or no access to traditional financing sources, harsh regulatory policies and compliance issues.

List of References

AME Info. (2004). Solid Financial Management is key to SME success. Web.

Ang, J. (1992). On the Theory of Finance for Privately Held Firms. Journal of Small Business Finance , 185-203.

Bruderl, J., & Schussler, R. (1990). Organizational Mortality: The liability of Newness and Adolescence. Administrative Science Quarterly , 530-547.

Buckland, R., & Davis, W. (1990). The pricing of new issues on the unlisted securities markets: the influence of firm size in the context of the information content of new issue prospectuses. British Accounting Review , 207-222.

Creamer Media. (2003). Many SMEs face financial problems in SA. Web.

Hew, D., & Loi, W. N. (2004). Entrepreneurship and SMEs in Southeast Asia. Singapore: Institute of Southeast Asian Studies.

KPMG. (2006). SME Finance: Issues and Recommendations. Bangkok: KPMG.

Monk, R. (2000). Why Small Businesses Fail? CMA Management , 12-14.

Nayak, A., & Greenfiled, S. (1991). Very small businesses, accounting information and business decisions: a question of definition. 14th ISBA National Small Firms Policy and Research Conference. Blackpool: ISBA.

OECD. (2002). Official development assistance and private finance. Paris: OECD Publishing.

OECD. (2008). Removing Barriers to SME Access to International Markets. Paris: OECD Publishing.

Romm, C. T., & Sudweeks, F. (1998). Doing Business Electronically: A Global Perspective of Electronic Commerce. London: Springer.

Sahlman, W. (1990). The structure and governance of Venture Capital Organizations. Journal of Financial Economics , 473-521.

Spathis, C., & Constantinides, S. (2003). The Usefulness of ERP Systems for effective management. Industrial Management and Data Systems , 677-685.

Stair, R., & Reynolds, G. W. (2008). Fundamentals of Information Systems. London: Cengage Learning.

Wetzel, W., & Jonsson, E. (1989). Accounting and Marketing Business Problems. Administrative Science Quarterly , 91-109.

Wienrauch, J. D., Mann, O. K., Robinson, P. A., & Pharr, J. (1991). Dealing with Limited Financial Resources: Marketing Challenges for Small Businesses. Journal of Small Business Management , 44-55.

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