SMEs vs. Large Companies - Essay Example

Name Tutor Title: SMES vs LARGE COMPANIES Institution Date Introduction Finance is the most significant factor determining the growth and survival of SMEs in both developing and developing nations. Access to finances permits SMEs to carry out productive investments so as to expand their businesses and to acquire the most recent technologies, thus enhancing their competitiveness. Braga and Venturelli (2008) argue that in spite of their dominant figures and significance in job creation, SMES have faced difficulties in attaining equity or credit because they are not investment ready to access several financial options from the financial institutions. According to Eddi (2005) lack of access to finance is the key element affecting growth of SMEs and their drive to compete, to create productive capacity, to create jobs and contribute to alleviation of poverty. With no finance, SMES are not able to absorb or acquire new technologies or expand in order to compete in international markets and strike business connections with larger enterprises. In order to eliminate the overcome the obstacles faced by SMES in acquiring capital for growth, sustainable and well functioning schemes for SMEs funding need institution building and a market model. Lending bodies are supposed to promote their capability to offer financial services to the SMES via commercial schemes that reduce costs and lower their hazard exposure (Eddi, 2005). Investment readiness Investment readiness and is an aspect of development preparation and quickening in small and medium sized enterprises and failure to appropriately evaluate it results to several SMEs failing to recognize their prospects. Investment readiness refers to a set of processes deliberately performed to make venture acceptable as prospects for equity investors. According to Silver, (2010), these processes are mainly oriented toward packaging information in a concise and clear manner and they include business modeling, business planning establishment of management practices, market connection and utilization of informal networks to create consultancy services, academic secondments, and specialist equipment to improve prospect of a venture (Kristen, 2006). Growth of SMEs is majorly hindered by practices of management the several SMEs are engaged in which are usually found to be ineffective and inefficient thus minimizing chances of acquiring access to working capital. Financial access by SMEs is restrained by demand side weakness since businesses are not investment ready. Owners of SMEs are not willing to seek external equity finance and those willing don’t understand what equity investors are really looking for or the way to sell their businesses and themselves to potential investors. These weaknesses then compromise effectiveness of supply side inventions, like the initiative to induce business angels or initiatives which develop public sector venture capital funds (Eddi, 2005). Factors that determine the investment readiness of growth in SMEs Market information The setback of investment by SMES may highly be attributed to the lack of market information and the commitment of financial managers to access a variety of finance sources. The universal consciousness and understanding of finance options by SMES is regarded to be poor and the main obstacle is poor investment readiness. The major factor that determines investment readiness in small and medium sized enterprises is the attitude of business to finance (Eddi, 2005). Financial forecasting aspect of management in firms Another determinant of investment readiness in SMES is the financial forecasting feature of management in firms. Financial forecasting entails the financial managers foreseeing the organization’s future revenues utilizing the accessible financial information. The utilization of steadfast forecasting methods improves the investment opportunities of the SMEs since they are able to recognize the quantity of funds required in the future to run activities of the firm (Douglas, & Shepard, 2002). With appropriate forecasting, financial managers can attain finance for the financing institutions since they can be able to borrow debt finance and also convince these funding institutions that they can be capable to repay the principal as well as interest on principle without any failure. This implies that financing will enable SMEs to have adequate collaterals to borrow their funds. Also, possession of financial forecasting by SMES will enable them to attain targets of revenues that will promote investment readiness (Silver, 2010). Financial decisions Financial decisions made by finance managers are another determinant of investment readiness of growth in SMEs. There are four main levels of decisions involved and they include financing decision, in which financial manager has the obligation of determining the excellent source of finances suitable for the business. The managers are responsible for recognizing cheap sources that won’t constrain the financial ability of the firm in terms of repayment if the organization is debt financing (Elaine, 2002). The other form of decision is the investment decision which entails the particular financial managers of the SMEs recognizing the viable opportunities of investment. This will entail coming up with effective and effective frontiers of the portfolios to be invested in. According to Jacob (2006), this implies that financial managers are supposed to access hazards involved as well as returns anticipated form a chosen investment. The other financial management decision that determines SMES investment readiness is the dividend decision, in which financial managers are involved in recognizing excellent dividend policies that are applicable in SMEs. This implies that the dividend policies utilized determines success of SMEs in investment readiness. For instance, if the shareholders are entitled to both ordinary and preference shares, then the confidence of the investors is created in them and therefore the success of the firm (Jacob, 2006). The final financial decision of managers is the liquidity decision which also plays a major role in determining the investment readiness of the SMEs. The way in which organizations manages their finances is very vital to stakeholders, entailing funding institutions which might provide loans to the SMEs. Finance managers are therefore required to avoid the insolvency risks that might result to reduction of confidence of the investors or collapse of the SMEs via bankruptcy (Douglas & Shepard, 2002). Access to funds Access to funds is a major factor which SMEs financial managers must put into consideration. SMEs can solely be regarded to be investment ready if the financial managers recognize ways of accessing and attaining capital via intensification of security arrangements and through offering a quality array of products form a wider range of financial institutions. The setback is that financial managers of SMEs have failed to establish safe titling to improve their security foundation and they also do not have apparent policies of effective schemes of enforcement of existing procedures and laws of securing capital. The financial managers usually do not encourage an atmosphere that can help them to attain lease form financial bodies (Ferris, 2000). Accounting and taxation systems The other factor that determines the investment readiness in growth of SMEs is taxation and accounting schemes. The taxation and accounting systems of majority of SMEs are complex and therefore don’t favor their investment readiness and growth. This is so because such systems don’t facilitate enhancement of the SMEs accessing funds because the schemes fail to address the matters innate in the investment opportunities which is usually attributed to emerge from short of appropriate information (Silver, 2010). Opportunities of accessing diverse markets Opportunities of accessing diverse markets are another factor that determines investment readiness of SMEs. Most SMEs don’t enjoy opportunities of accessing diverse markets since they haven’t fully utilized their preexisting opportunities of marketing of their products. Silver (2010) argues that this is the reason behind their lack of experience in market information, poor research of the markets, poor development of services and products, and lack of effective promotional tools for their products which has made them to miss opportunities of accessing capital form numerous financial institutions. This difficulty has lead to SMES not taking the advantage of globalization and thus their decline of their competiveness and also poor access to the global markets which has in turn lead to lack of investment readiness in these firms (Braga, & Venturelli, 2008). Technology change in their respective industries Another significant factor that determines investment readiness in SMES is the technological changes in their respective industries. Their lack of ability to deal with novel innovations is an issue that has caused a reduction in the market share of SMEs and therefore a decline in their overall performance. As a result of globalization, technological shifts has deluged markets and financial managers are supposed to fully utilize these technologies so as to stay competitive and global in scope. This will then result to a rise in profits and SMEs can be able to attain access to increasing sustainable equity and offer a chance of getting debt finance from financial bodies (Braga & Venturelli, 2008). Business planning The final determinant of investment readiness is general business planning of SMEs. Growth may solely be attained if an evaluation of business plan performed is undertaken in SMEs. According Kristen (2006) plans that outline the alterations or changes required to make the best use of the chance of getting finances usually determines the investment readiness of SMES and financial managers must increase their willingness by seeking guidance and advices in establishing feasible presentation of business strategies adopted that usually promotes business growth. Typically the formulation of feasible business strategies is dependent on management skills that financial managers use in management of financial ventures (Ferris, 2000). Changes that could be undertaken to overcome the problems faced by SMEs in acquiring investment capital for growth Reduction of information asymmetry of SMEs According to Braga and Venturelli (2008), financial institutions are not always ready to lend SMEs because they are not able to evaluate risk as a result of lack of consistent financial information to be used by investors and creditors. In addition, most SMEs do not have basic financial information needed by entrepreneurs for effective management. Because information asymmetry is a major problem facing the access of SMEs access to finance from financial bodies, the key to improve risk management for their SMEs portfolio is for financial institutions or banks to have better information by reducing information symmetry that they face when tackling SMEs customers (Golis, 2002). In order to attain this individual financial bodies are supposed to have effective schemes so as to analyse and process huge amount of data to promote their decision making. Additionally, there is a requirement for the financial institutions to have suitable infrastructures in place that will enhance production of timely and reliable financial information on SMEs (Kristen, 2006). Use of credit scoring schemes to improve risk management Credit scoring refers to an automated statistical scheme used to evaluate risk default of credit applicants and entails analyzing huge quantities of historical data on borrowers, identification of particular characteristics that envisage the probability of borrower defaulting on loan in the future. Because the challenge that financial institutions face in managing the risks of SMEs is to make precise risk evaluation of a huge number of loan applications form SMEs without creating high costs in every application. Therefore, these institutions are supposed to utilize automated processes in making their lending decisions so as to drive down costs of every lending decision ( Eddi, 2005). Use of credit scoring will require investments into information technology schemes and training of the staff involved in SMEs lending. This will result to efficiency gains and improved risk evaluation when the financial institutions possess an adequately large SME portfolio. Silver (2010) argues that credit scoring will result to improvement in management control because management will have a real time figure of level of risk connected with the entire credit portfolio. This information is vital for regulating the risk level that the financial institution will accept and for establishment of a suitable credit policy independent of the subjective interpretations of the individual credit officers. Douglas and Shepard (2002) argue that it also results to increased speed of decisions on loans together with the number of loans that lenders are able to underwrite whilst holding loss rate constant, thus increasing revenues (Elaine, 2002). Inclusion of external information providers External information providers can help SMEs the obstacle they encounter in accessing capital for growth. Braga & Venturelli (2008) notes that external rating can be a helpful tool for assessing creditworthiness of upper segments of the SMES and creation of more transparency connections between SMES and financial institutions. Even though a financial institution also undertakes its own evaluation in form of scoring or rating, external rating by a competent institution will offer benefits like providing evidence of creditworthiness, strengthening credit negotiations of SMEs with financial institutions and reinforcing the positions of SMEs face to face meeting with their business partners and competitors. In addition credit rating evaluation will also SMES with an opportunity to perform sustained improvements or take remedial actions where required and will also make the financial institutions to reward readiness of the SMES to take a thorough look at their personal creditworthiness (Ferris, 2000). Sharing of risk with third parties Lack of collateral is a considerable barrier to SMEs obtaining credit from financial institutions. A remedy to this difficulty may be found in cooperation amid financial institutions and third parties such as mutual and loan guarantee schemes. Mutual guarantee schemes will operate as intermediaries between financial institutions and SMEs and entail private groups of companies which are linked to sector specific interest groups that offer loan insurance to financial institutions (Jacob, 2006). Risk self assessment for SMEs entrepreneurs Risk self assessment can be another means of reducing the problem and risk of information symmetry that will inform SMEs the risks that financial institutions assume when granting funds as well as the manner in which these financial institutions asses their funding requests. When a risk assessment form is filled, SMEs entrepreneurs will obtain risk profiles of their businesses which will enable them to understand reasons why financial institutions request for information and benefits of offering this information to the institutions. Risk assessment of SMEs will also display risk premium on top of net interest rate that the SME has to pay. Therefore, if SMEs entrepreneurs are informed on the way financial institutions asses the risks of their firms, they will be capable of taking the suitable measures so as to minimize the risks of their firms and pay reduced interest rates in future (Jane, &, John, 2007). Conclusion Inability to access is the major obstacle to growth of small and medium sized enterprises. Without enough finances SMEs are do not have the ability to obtain or absorb new technologies that have emerged as a result of globalization. They are also not able to expand their business and compete in the global markets or establish business connections bigger enterprises. Financial access by SMEs is restrained by lack of investment readiness because their managers are not willing to seek external equity finance and those willing don’t understand what equity investors are really looking for or the way to sell their businesses and themselves to potential investors. Therefore financial management is vital in SMEs and financial managers thus are required to shift their attitudes toward issues of financing and appropriate liability of financial activities must be a priority to all SMEs so as to be effective in their ventures of investment. Financial institutions are also supposed to eliminate the barriers encountered by SMEs in acquiring capital for growth by use of sustainable schemes that will promote their ability to provide funding services to SMES through commercial systems that will reduce lending costs and lower exposure to financing risks. Bibliography Braga, F, & Venturelli, V, 2008, Bridging the equity gap for innovative SMES, Palgrave Macmillan, London. Douglas, E, & Shepard, D, 2002, Exploring investor readiness: assessments by entrepreneurs and investors in Australia’. Venture Capital 4, (3), 219-236. Eddi, C, 2005, Managing Banking Risks, Woodhead Publishing Limited, England. Elaine, P, 2002, Business finance: small business management series, Institute of TAFE, Adelaide. Ferris, B (2000). Nothing ventured, nothing gained: thrills and spills in venture capital, Allen & Unwin, Sydney. Golis, C, 2002, Enterprise and venture capital: a business builder’s and investor’s handbook. 4th Edition, Allen & Unwin, New South Wales. Jacob, L, 2006, Guarantee Schemes for SMEs – an International Review”, Small Enterprise Development, vol. 8, (2), 4-17. Jane, S, &, John, S, 2007, Big play for small end, Business Review Weekly 11-17 October, 29 (40), 38-41. Kristen, L, 2006, Big banks want small businesses. Business Review Weekly, 28 (42), 58-59. Silver, L, 2010, The Impact of Investment Readiness on Investor Commitment and Market Accessibility in SMEs, Journal of Small Business and Entrepreneurship 23(1), 81–95. Read More