Wednesday 10 March 2010

Financial management challenges for SMEs

SMALL and medium enterprises (SMEs) are a very large sector in our economy in terms of the number of entities that fit into the category. This is not unique to Malaysia. Consequently, a healthy SME sector would certainly be great for Malaysia in an increasingly challenging environment where product life-cycles are shorter and competition could come from any angle, domestically or abroad.

One of the key drivers in sustaining a business is the quality of the financial management practised in the economic entity. Cash is the blood for business and when cash flow is not managed properly, sooner or later, the entity will have to face its eventual demise.

In a 2003 report which looked into the management needs of SMEs in Canada, it was noted that SMEs would need to go through four stages of growth before reaching the stage when they could compete globally. The stages are:

  1. Start-up stage where the business model applied is validated;
  2. Fast-growth stage where the business is growing for survival; revenue starts to grow as products or services receive market acceptance;
  3. Sustainable stage where profitability can be sustained and the entity reaches a maturity level with proven business model and leadership;
  4. Global enterprise where the entity continues looking for other opportunities to sustain growth.
The funding needs of entities at the different growth stages differ as well. Entities at the start-up stage hunger for seed financing as what drives most of the entrepreneurs at that stage is purely their vision of being successful.

The financing risk at this stage is very high as the entities have yet to prove the validity of the business model adopted. While passion and energy are appreciated, they could not mitigate the risks of selling products with no market or demand for them or with manufacturing outfits that could not produce products at the right quality.

The fast-growth stage, as the name suggests, is when funding is required to support a growing business. This is a critical stage as failure in managing finance could turn an optimistic outlook into an ugly nightmare.

A growing business would require additional funding to support the growth of inventories, receivables as well as to bring in new production capacity. This stage could also inject the false sense of success into the business owners. Some may end up allocating the limited funds to worldly rewards to themselves such as new cars or even life partners.

Once an enterprise reaches the sustainable stage, the financial management capabilities are expected to reach certain maturity in ensuring earnings are retained and returns to the entrepreneurs are maximised. However, if the entrepreneur is not careful, cost could outpace profitability and the risk of declining business remains real.

At the global enterprise stage, the issues are about growing and competing with competitors in different markets. This could be through acquisitions which may require external financing. Establishing cross-border presence could also create new financing challenge as access to finance in the new market abroad may not be as straight forward as it is domestically.

The issue of whether adequate financing is made available to the SME sector is a never-ending one. The reasons are very simple.

First, the number of entities in the sector will continue to grow, and any amount of financing will not be enough. 

Second, chances are the group that may have difficulties in accessing funding from banks and other institutions would be those in the start-up stage or even at the fast-growth stage as these are the stages where the risks are the highest.

Banks and financial institutions are there to make profit, and taking risks unnecessarily may not be a great corporate governance practice either. In Malaysia, the government has and continues to address this gap through guarantee schemes and other incentives. We have to remember, whenever this sort of initiatives are made, we the taxpayers are the taking the risks.

There is no single solution to improve the financing gap apart from efforts by all stakeholders in this delicate issue.

The SMEs themselves should shoulder the highest responsibility by ensuring efforts are made to improve financial management in their enterprises. It is not uncommon for SMEs not to keep proper accounting records. How do they demonstrate to the bankers that they deserve financing when they are not sure of the financial position of their businesses?

As mentioned earlier, a growing business requires additional financial management capabilities. Costing, for example, is very critical as a business should not be selling products below their production cost. But don’t be surprised if this is happening in many enterprises simply because they do not operate with the correct information.

SMEs must be willing to invest in people and system in building capacity in financial management. Funding is meant only for deserving entrepreneurs with good business model and responsible management. The challenge is how do entrepreneurs prove this to the potential funders? Answering the question is part of entrepreneurship.

This article is also published at the Edge Malaysia website here:

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