Financial Challenges Experienced by Small Businesses in the United Kingdom - Case Study Example

Financial Challenges experienced by Small Businesses in the United Kingdom Student’s Name: Institution: Date: Financial Challenges Facing Small Businesses in the United Kingdom Introduction Small businesses have been a major pillar in the economy of the UK and they form a stable source of employment in the country. There are many small scale producers in the economy who have the potential to grow their businesses but they cannot access the finance they require. Many debates have been going on as people try to get the best solutions for the issue and this research paper wishes to add more information on the financial options available for businesses and the challenges they face accessing them. Many government policies are hard on the small businesses and do not favour their financing options. For example, the taxation system has been a major burden to the small entrepreneurs and they have to meet the regulations for them to survive. Some of the options available are equity, where they can sell shares to investors to make money and debt finance which involves borrowing from the financial institutions. External financing remains one of the best options they have, since equity dilutes their ownership. However, the interest rates are high and they are not able to meet the payments on time. Financing helps new businesses to get an economic churn and to introduce better and more efficient business methods and products. The government in the United Kingdom needs to improve the access of finance for the small businesses. Small businesses are the backbone for a rapid growth of the economy in future, with most o the young entrepreneurs establishing their ideas in them. The rate of their death is still high in the world, with most of them lacking money to progress and operate fully. Human resource is also a challenge for most of them and it’s also related to finance since they have little money to recruit and maintain the best workforce. With a better support from the government, the level of employment will be reduced and the GDP will increase through these small businesses. Research Questions (1) Do tax payments affect the level of profits made by small companies in the United Kingdom? (2) Does additional working capital affect the level of profits made by small companies in the United Kingdom? (3) Does the cost of debt affect the level of profits made by the small companies in the United Kingdom? Analysis of Business Financing in the UK According to Tony Morgan, the CEO of Verus360, one of the challenges likely to face the small businesses is cash flow (2015). Most of the larger business partners use long term credit terms and there is little money for operations in the businesses. Accessing finance remains a challenge as many options are stringent with policies and need for security. Most financial institutions charge a higher amount than the headline amount. Hidden charges are common and management fees are applicable. Sometimes the loans are paid regardless of whether the business is operational or not. For the ethnic minority, the case is even worse. For the Black Africans and Black Caribbean, they make up to 35% and 28% of the population respectively. They are more than the Whitish British who make only about 10% of the entrepreneurs. The start up rate for the minorities is way low as compared to the majority groups (Devenport, 2013). Several researches have shown that many small companies Berry et al., 2002). This means that this support has not been effective. Debt financing refers to borrowing of funds for use to run operations of business operations. There is enough evidence which links the performance of a small company with the use of debts. According to Cecchetti, Mohanty and Zampolli (2011), lending helps in increasing the growth rate and performance level of small companies. Currently, the small companies have an economic contribution which is so vital and has been realized by several governments which have eventually included them in their development strategies through increased support and advice. Support services and funding at decreased interests rates have also been improved. In many of the countries in the world today, the small companies contribute a huge part of the economy. The same trend is seen in developed countries such as Europe and America and in the developing countries like China and many others (Cecchetti, Mohanty and Zampolli, 2011). For better growth of small companies, there should be a reliable way of financing their operations in order to get the necessary working capital for their activities, and this is necessary for the daily running of the business. The performance of small companies needs financing which can be gotten in different methods. Debts from the financial institutions can be short-term or long-term depending on the amount and the period of payment given. Entrepreneurs can use external or borrowed funds to finance their initial operations or to increase the scope of their business. Some of the vital reasons of having finance are increasing capital capability and meeting working capital available for the business. Debt finance is a meant to increase the return on owners’ investment and also assist in generating a greater return on borrowed money which should be higher than the costs of borrowing the funds. Most of the banks have taken a step of educating their consumers on the best methods to follow in order to have a better management of the debts they get. Training of the management is one of the effective ways to make sure they are effective. Miwa and Ramsey (2008) found out that trade credit is an effective way of financing emergency cases in a business. However, it should not be used to finance long term functions like research and development (Mensah 2004). Research is still underway to determine whether the use of debts has been profitable to the users. There has been little attention to the performance of small companies with regard to the use of debt in daily operations. Ceccetti et al. (2011) found out that even though the use of debts can be associated with many advantages in the performance of the company, they can also lead to a slower rate of growth. According to Cecchetti, Mohanty and Zampolli (2011), when debt when the use of debts is poorly managed or has been directed to the wrong functions, there is a possibility of business failure. As mentioned above, it matters with the purposes which are funded using the debt. Over borrowing can also lead to a financial crisis and sometimes a bankruptcy case (Ceccetti et al. 2011). When a business has borrowed a lot of money from the banks, they are also at a risk of not getting more funding from the financiers. Research by Ebaid (2009) on the use of debt by companies, shows that if well managed, companies can grow using borrowed money as compared to when they use their own savings. Cecchetti, Mohanty and Zampolli (2011) studied the effects of debts on the activities of companies and found out that there are moderate limits within which the firms are expected to perform well when using debts, but also concluded that after a certain level of debt is taken from the financiers, then the business is at a risk of a crisis. As mentioned before, firms in the UK are also affected by the same conditions and therefore they have to manage their finances in a better way. They also added that a company which uses a lot of external financing, specifically debt finance, spend a lot of their resources in financing of the debts and may end up failing to do the possible more profitable processes, because they have a low access of extra money from the financial institutions (Cecchetti, Mohanty and Zampolli 2011). Excessively high debt ratio also raises the business risks and financial problems during temporary economic-wide downturns. Most of the businesses rely on their returns to meet some of the demands of their start ups. Approximately half of the small companies have been using informal methods of funding for the business. They depend on retained earnings and credit from their suppliers and donations from well wishers. Bank loans are also common in these companies and only a few of them use equity as a source of finance. It is also difficult for the small companies to use bonds and other large fund investments because they require small amounts of money and they also have less ability to repay back, which makes them less able to get the funds. In the UK, bonds are usually accessed by the companies which have enough financial muscles since most of them are in high amounts. Research by Levasseur (2002), reveals that the level and fate of an enterprise and therefore necessary in analyzing how well or poorly a company is doing. The choice of the evaluation method is dependent on the poignant factors that bring out the nature of the company. It is also not common for people to use the analysis of the balance sheet and profit and loss account to determine the performance of a company. Therefore the ratios are used to interpret the accounts, since they provide better data on the trends and patterns of a company (Irwin, 2001). Profitability of a firm is a major factor in the performance of a company in today’s business world and in the UK. Effects of Taxation Policies on Small Businesses Taxation is one of the determinants affecting the profit margin for most businesses in the UK and beyond. Small businesses are many and offer the most important growth chances in the economy due to the fact that they create wealth and employment. The small companies have had a great change and development in the economy of the United Kingdom and therefore cannot be taken for granted. The spirit of competition and innovation used by the small companies is healthy for the economy which is growing like in the United Kingdom. They also contribute to a more balanced income distribution in UK and other places. Most political and legal systems do not differentiate the small companies from the large ones and therefore they are treated unfairly. Political regimes therefore need to adjust the policies to be able to meet the expectations of the small companies. If well supported, the significance they have on the economy will be seen clearly. According to Holban (2007), paying taxes can as well be a source of development in a small business and can lead to better societies through three sources; It must generate enough money for financing public functions and social transfers at a high level of quality, it should give other incentives which will make it easy to create better and quality products and services for the UK people. A tax system should allow the businesses to pay their taxes without temptations to evade. The costs of complying are usually high and companies do not benefit from the taxes collected, thus reducing their morale to pay. In some cases, the cost of collecting taxes is higher than the advantages attached and therefore there is no need of spending more resources than the amount to be collected. According to Lewis et al. (2009), most of the small businesses use a lot of resources in tax payments and compliance. Such resources can be used to increase their capacity and to increase their growth and plan for their improvement. Hence, there is a belief that taxes in a complex tax system put disproportionate pressure on smaller companies. When a tax system is too complex, there are low growth rates for the small companies and they are not able to expand their operations. In the UK alone, there has been a high rate of death of the small companies and the trend can be changed with an improved taxation system (Masafo, 2009) and this result in a tax system that imposes high expenses on the society. In general, tax systems should be in a way that the more advanced companies pay more and the larger companies pay more. A generalized or standardized tax system is disastrous to the small companies. If a tax system is not well structured, it leads to a lot of wastage of resources. Employees are allocated jobs which are not beneficial and there are many cases of misappropriation of resources. The issue can be avoided if the tax systems adopt the most optimum operation and all loop holes are sealed (Farzbod, 2000). Research done before shows that most of the companies are easily and adversely affected disproportionately by these expenses: Compliance costs for the small companies in United Kingdom are higher than for large companies. For the UK government to support the small companies and increase their expansion, there is a need to have a taxation system which favours their operations and does not increase their death rate. Working Capital Small companies greatly lead to the economic growth in the UK and other countries (Abor and Quartey, 2010). According to Halabi et al. (2010), the benefits of these small companies are measured using employment generated, cash flow creation and reducing the level of poverty in countries (Agyei-Mensah, 2011). Regardless of their importance, small companies have been facing financial challenges, poor budgeting skills, high operations costs and low rates of collecting their accounts receivables from debtors (Agyei-Mensah, 2011. Managing the available working capital helps small companies to meet their competition needs, meet the increasing costs raw materials and remain relevant in the market. Businesses need to have skills to manage their working capital to avoid the “risk of inability to meet due short term obligations on one hand and preclude excessive spending in short term assets on the other hand” (Agyei-Mensah, 2011) also found that the way working capital is managed has a visible impact on the profitability of businesses. Cost of Debt According to research by Abor (2005), the possible effects of the level of cost of debt on profitability of many firms which use a panel regression model are significant. The results of his research show a significant and a positive relationship between the use of short-term debt and the level of business performance realised. However, there is a negative relationship between use of long-term debt and the profits realised. In general, however, use of debts, if well managed, can lead to higher profits. The analysis above is in agreement with the research by Abor (2005), which shows a significantly negative relationship between the size of the company and the return on assets received from the use of long term debts, short term debts and total debt. The Future of Small Companies in the UK There is a chance that the small companies will perform better in the near future, considering that the economy has been growing steadily. Out of the 5,000 small companies, 51% confirmed they had hopes for a higher growth in the future. The growth rate is expected to be the highest since 2011. Most of them, about 44%, have also registered growth in the past few months, an increase from 39% that had registered growth last year. More research by the Confederation of British Industry shows that in the last one year, the service industry has enjoyed its best growth since 2007. In terms of the small companies which were able to access external finance, the number has increased from 39% last year to the current 44% this year. The use of loans is however low, with only one out of three businesses using loans, mortgages and bank overdrafts. The number may increase with the increasing use of credit cards (Burn-Callander, 2013). With his rate of growth, there should be a higher growth in financial services so as to place these businesses on a level platform to compete and grow without financial challenges. Current Issues Effects of Brexit on small businesses After Brexit, small business owners have had to wait and understand their fate. One of the facts they have to see is the change in business deals since new terms and conditions will have to be signed in the next few months or years. Most likely, the first business deals will be with the same EU that the UK voted to leave. Access to finance will be a challenge for most small companies. For example, there is a possibility that the price of the pound is likely to cause inflation. Financial institutions will raise the interest rate so as to fight inflation, which will in turn reduce the ability of property owners to get loans. The high interest rates will also affect the loans held by the small companies. It will also reduce the profit margins and reduce their rate of growth (Cumming and Zahra, 2016). Many international companies will also be discouraged as well as investors and therefore the growth rate will be low. Conclusion Businesses have a high chance of succeeding if they can access finance. There are many sources of finance but the most preferable one for small companies is debt finance. However, many small companies have not been able to access it because they do not have the qualifications that most financial institutions like banks need. Some have poor management which makes it challenging to manage their source of finance. In the United Kingdom, the economy’s growth relies on the survival of the small companies. Many of them have not been successful but there are many chances of succeeding in future if financing options are improved. Unfortunately, effects of Brexit may be extended to the small companies and it’s likely to affect their performance. References Abor, J. and Quartey, P. (2010), “Issues in SME development in Ghana and South Africa”, International Research Journal of Finance and Economics, 39(7), 218-228. Agyei-Mensah, B. 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