Financial Management in SMEs

Abstract

1. Introduction Many people who start to run a business do not engage themselves in financial matters. The reason may be because they do not have enough knowledge or interest in recording transactions, preparation and analysis of financial statements and secondary they are extremely involved in other aspects of business like managing people, sales purchasing and production. These entrepreneurs rely on their accountants to run the financial side of their business. While financial management is a critical element of the management of a business as a whole, within this function the management of its assets is perhaps the most important. In the long term, the purchase of assets directs the course that the business will take during the life of these assets, but the business will never see the long term if it cannot plan an appropriate policy to effectively manage its working capital. In effect the poor financial management of owner-managers or lack of financial management altogether is the main cause underlying the problems in SME financial management. A great many small businesses fail not because the owner does a poor job or provides an inferior service, but because their firm is not run like a business. Most small business people only know one-half of what it takes to succeed. The part they are missing is how to manage and grow their business. Small business owners that succeed in this part learn these issues while working or they already have the knowledge. 2. Previous literature on finance in small business Literature on small firms' financial management is quite voluminous and it concentrates on different aspects of firm's management. For this research paper we have selected just a few studies from the recent period concentrating predominantly on various issues of financial management and small firms' strategy. The following table summarizes studies across the globe and points out the main point of interest. 2.1. Studies on causes of financial failure Prediction of Financial Failure Some researchers tried to predict small enterprise failure to mitigate the collapse of small businesses. McNamara et al. (1988) developed a model to predict small enterprise failures giving the following four reasons: a) to enable management to respond quickly to changing conditions, b) to train lenders in recognising the important factors involved in determining an enterprise's likelihood of failing, c) to assist lending organisations in their marketing by identifying their customer's financial needs more effectively, d) to act as a filter in the credit evaluation process. The authors argued that small enterprises are very different from large ones in the area of borrowing by small enterprises, lack of long-term debt finance and different taxation provisions. Involuntary liquidation Hall and Young (1991) performed UK a study of 3 samples of 100 small enterprises that were subject to involuntary liquidation in 1973, 1978 and 1983. The authors have found that the reasons given for failure were of financial nature in 49.8%. In the study of perceptions of official receivers interviewed for the same small enterprises, 86.6% of the 247 reasons given were of a financial nature. The positive correlation between poor or non-existent financial management (including basic accounting) and business failure has well been documented in western countries according to Peacock (1985, 2004). Default behaviours of SMEs and the credit characteristics of their owners Bhunia (2012) examined relationship between default behaviours of SMEs and the credit facets of their owners. Identifying and measuring credit risk of SMEs should be different from that of large firms, for SMEs appear to be influenced by their owners more directly and significantly, so that a more appropriate and effective way of credit management of SMEs could be applied in practice. …