Financial Strategic Management for Small Firms in the UK - Term Paper Example

1 Introduction and objectives Small and Medium Enterprises (SME) play a major role in any economy. In UK too they have a major role to play. It has been assessed that on an average the SME’s correspond to 90% of the enterprises in any economy. They also employ a high figure of 50-60% of the labour force of the country (Luetkenhorst 2004). This fact contributes greatly to their support of the general economy in providing livelihood to a vast number of the population, even in the developed countries like UK. Here they sustain a majority of the working population as well as provide sustained assistance to the larger companies. They are the lifeblood of the economy as they tend to use more labour intensive production methods in comparison to large enterprises that are more mechanized. This creates huge employment opportunities and provides a more equitable income distribution for a large section of the society. They thus provide work opportunities through use of simple but value adding processes. The SME’s also provide entrepreneurial prospects to a large number of creative individuals who generate a system of flexible activities that link up with larger companies for providing them with competitive advantage. Burns (2001) commented that in fact small firms were not just a smaller version of large organisations, and differed in the manner in which they go about their business. He states further that small firms go about their business with a fundamentally different approach. There is a strange but very apt definition of entrepreneurship by Stevenson, Roberts and Grousbeck (1989) who call it to be the pursuit of opportunity without regard to currently controlled resources. This is the crux of the whole subject of this research. Despite the versatility and innovative practices, most SME’s die an unnatural death within the first two years of their existence due to ill planning of their resources, especially finances. It is the objective of this study to find the causes and to make a case for formalized financial strategic management for the small firms in UK. 2 General overview It needs to be understood that SME’s are vital to the economy in more ways than one. Because of this status it is important to understand why they fail to adopt formalised financial strategic management. In contemporary times when management concepts are so widely understood and practices, why is it that they lag behind and face failures while they have brilliant ideas that could help the industry and the economy. Most SME’s are owned by either individual owners or a small group of persons in a partnership or even in a small company formation. The entrepreneurial spirit is the motivation for their formation and the adventurous spirit is behind most ventures. It is therefore useful to understand the nature of this entrepreneur to find out how this weakness permeates the system. There have been several definitions of entrepreneurship. Peter Drucker (1964) called it the maximising of opportunities, while Hisrich and Peters (2002) in more recent times have endorsed the same view. But in 1968 Harvey Leibenstein, as quoted by Binks and Vale (1990), had observed in 1968 that when there is a synchronisation of inputs from several markets it makes for a successful entrepreneur. By implication of this observation two distinct kinds of entrepreneurs can be identified. One is the type who arranges and excels in making new combinations. The other is the kind who is a management expert and manages or organises these traditional combinations in different ways (Binks andVale, 1990). In a different vein the entrepreneur has been described as one who is a specialist in taking critical decision in coordination of scarce resources. (Mark Casson 1982, Deakins and Freel, 2003; Deakins, 1999; Binks and Vale, 1990). All these authors point towards the various characteristics of entrepreneurship that display productive, managerial and marketing acumen but do not highlight any financial prowess. Katz and Green (2007), Burns (2001) and Storey and Sykes (in Burns and Dewhurst, 1996) took this description to another level by highlighting the following characteristics of a small firm, in marked contrast to bigger organisations. They said that in the first place all small firms are strapped for cash that leaves them with few strategic options. Secondly, they approach their objectives more with emotions than with rationality. Therefore they are unmindful of the risks involved. Thirdly, the firm is undoubtedly influenced by the character and mind set of the owner and not by strategies determined by external environments. Fourthly, the establishment of the small firm revolves around the society within which it functions and is largely a result of and dependant upon personal relationships. Fifthly, the target of such ventures is quick payoffs, hence the need for urgent encashment to ward off cash constraints. This brings about the sixth factor that is short term objectives and short term decisions. As a result, the seventh characteristic is that these firms work in a small market with limited products and services looking for quick returns. This makes them overly reliant on a few people or customers and makes them vulnerable to failure. The ninth attribute is that decisions involve fewer people and are more impulsive. This makes them more responsive to market changes but they are less likely to influence markets. It has become abundantly clear that the root cause of the failure to formalize strategies, especially of the financial kind, is the entrepreneur himself. With this general view and background of how and why SME’s are formed, the literature view will throw light on the subject as to why SME’s fail to have a formalized structure for strategic operations. 3 Literature Review There has been extensive research on the subject of planning in the big business context, and many principles, theories and conceptions have been developed based on these studies (Jennings and Beaver 1997). It is usual to find that in such organisations, planning has been a deliberate and well thought out and results in unambiguous clear cut policies that are designed to work towards attaining competitive advantage in the market. This termed as formalising strategies. In a marked contrast, in case of small firms, planning usually starts in the face of adversity, or emergencies, or in response to specific events in the SME’s operating environment. This then becomes an adaptive and is short term solution. The main concern is the manipulation of scarce and limited resources (Gibson and Cassar 2002; Risseeuw and Masurel 1994). In SME’s such planning is highly personalised and is usually a result of personal preferences developed out of experiences, attitudes and prejudices of the entrepreneur or the person in control of the firm (Gibson and Cassar 2002; Lyles, Baird, and Kuratko 1993; Cragg and King 1988; Bracker and Pearson 1986). Without doubt it is certain that formalisation can augment the competitiveness and general overall performance of the firm (Brokaw 1992; and Branch 1991). But the matter is still a subject of argument and opposing views (Mintzberg 1994). Some researchers have claimed that SME’s do not plan at all (Berman, Gordon, and Sussman 1997; Robinson and Pearce 1984) while others find that not only planning is a part of and SME, it contributes to its enhanced performance. Indeed Jones (1982) and Schwenk and Shrader (1993) have gone full length to establish facts about planning and resultant performance evaluations with high success rates. Other like Perry (2001) concluded after their research that it was the failed companies that did not plan and this was the main reason of their collapse. Similarly the correlation between success and planning was established by Bracker and Pearson (1986) and Joyce, Seaman, and Woods (1996) came to the conclusion that those who planned outperformed those who did not. The inherent inability of the SME to gear up to financial and strategic management is highlighted in academic literature. Jennings and Beaver are of the view that the root cause for failure as well as poor performance is due to the lack of adequate management of strategic issues and little attention paid by the owner-manager to such important issues. In yet another observation Megginason et al (2003), Kuratko and Hodgetts (1995) and Hall (1995) have categorically pointed towards lack of capital being the major contributing factor for business failure in case of SME’s. Making decisions is considered as a personal domain by an entrepreneur and he dislikes delegation of authority in this area. If strategic decisions are to be made professionally this becomes the most difficult stage for the owner-manager as they have to let go of their power and control over key resolutions that they always made (Timmons 1994). There is an alternative proposed by Kuratko and Hodgetts (1995), Burns and Dewhurst (1989), Churchill and Lewis (1983), and Tyebjee et al (1983), as an option available to the owner-manager. They propose the development of managerial skills in the entrepreneur himself. In practice however there are not many takers of this practical suggestion as by nature the entrepreneurs are arrogant and self-centered. They believe that they are masters of their own art and any further training is abhorrent for them. However, respecting the fierce independence of the SME Megginson et al (2003) believe in the owner-managers’ ability to plan and suggest that it is imperative for future growth and survival of the business venture that they plan for this as well. Another factor that put the SME’s under financial pressure is their need to offer credit terms to their customers. As suggested by Hall (1995) this phenomenon could put a great strain on the cash flow of the business. The conclusion of the above review about the nature of entrepreneurial business of the SME is that due to their inherent inabilities and individualistic character availability of finance was a constraint on the business which is typical of firms in the growth phase of the organizational life cycle (McMahon, 1998). 4 Critique of conclusions of the chosen literatures The above literature review has brought about the development of several schools of thought on the working of and formalization of an SME. Financial/Capital School of Thought Under this school the central theme is to approach the issue from a financial perspective. The entire life cycle of the business is governed by various financial decisions taken from time to time. Each phase of the business is dealt with keeping in mind the capital requirements. In the start up stage there is need for either seed capital or venture capital for a take off and the decision on whether to continue or not depends largely on the availability of the right amount of capital at the right time (Kuratko and Hodgetts, 1995). Under this view an individual would only engage in an entrepreneurial venture if capital was readily available. Similarly in the other life cycle phases the decisions become more difficult as unavailability at critical period makes abandonment both costly and more unacceptable. The focus of this theory therefore is the importance of financial planning. Strategy Formulation School of Thought Some authors propagate the need for formulations based on strategic approaches. Steiner (in Kuratko and Hodgetts, 1995: 24) suggest that the strategy formulation approach in entrepreneurial theory lays emphasis on the planning practice for a successful business enterprise development. This particular approach covers the entire extent of managerial capabilities that are required in an interdisciplinary approach, while Steiner (in Kuratko and Hodgetts, 1995) is of the opinion that strategic planning is inextricably interwoven into the process of management. Another view is that planning is the leveraging of exclusive markets, people, products or of unique resources that are recognised, used, or created to form a business. Economic Approach The focal point of the Economic Approach is the application of the economic theory in the entrepreneurial environment. Deakins and Freel (2003) believe that while the entrepreneur can be viewed as somebody who is capable of organising the different factors of production, yet the vital difference is that this role is not considered to be of importance. He is considered as only a pure risk-taker with the reward being the ability to enjoy the profits. The proponents of this approach however are unanimous in the fact that he is the key player in conditions of uncertainty and change. The above theories highlight one fact that the entrepreneur is short on strategy but is vital in establishing and SME due to his knowledge and acumen. This is both his strength and weakness. With his ability to take unforeseen risks he is able to survive the initial stages. This weakness can be converted into strength if somehow he can formalize the strategies, especially of financial nature, since he is able to venture into areas where others are afraid to tread. His abilities should indeed be backed up as he is able to provide both innovations and employment on a large scale and when his efforts are consolidated, they can be the backbone of the economy of the country. 5 Key research questions Since the short term economic survival is always the bottom line for the SME, their priority is always to go for short term solutions that do not in the end help them to survive (Luetkenhorst 2004). This vulnerability has to be addressed in order that the SME can take long term measure for not survival but growth and prosperity. They rarely have the financial resources to enable them to plan long term strategies and cannot invest in measures that will create the opportunities for such planning. They are usually out of sync with the external environment and suffer the consequences of ignorance. The key question of this study therefore is to explore how to link up with the environment and make a strong case of formalizing the strategic financial management that will become the enabler for sustained growth. A Research needs to be carried out for establishing the requirements by finding the shortcomings on which basis a plan of action can be devised for formalizing the strategic plan. 6 Research Methods Several studies have been carried out in the past in this area and it is suggested that the method be adapted from the one used by Caralli that is based on the classical research carried out by Rockhart (1979). This is a practical research and useful in assessing SME’s. It is suggested that this method will consist of five segments. Defining the scope. Collecting data. Analysing data. Deriving Critical Success Factors (CSF) Analysing CSFs. (Caralli 2004) Defining the Scope The research will begin by establishing the success factors of the SME that will help in decision making and in defining the strategic direction. Caralli (2004) has recommended that the scope of the exercise must pass through the entire organization so the sphere of influence of each executive-level manager is included and considered. This will mean that interviews will be conducted with directors, managers and supervisors to determine critical factors. Collecting Data A variety of data will be collected for later analysis. It will consist of interviews conducted with various individuals including key staff; collection of critical documents; and gathering performance data like return on sales and revenue growth. Analysing Data In this stage the data collected will be assimilated and analysed. The view is to gain an insight on and understanding the direction of the organisation and its various divisions. The mission statements and vision of the organisation and their strategic objectives will shed light on how the stakeholders perceive their positions in the organisation. According to Caralli (2004) this documentation will reflect on what has been considered important or critical by the managers of the organisation. Deriving CSFs The data will then be cleaned by removal of all identities, immaterial comments and emotional or charged up proclamations. The outcome will be factual data that is valid and descriptive of the organisation’s status and direction. This can then be converted into activity statements. These are the facts that are gathered from the various interviews, notes and documents, including financial and personal appraisals and will show, without names and biases, as to what is really happening or is believed to be happening in the organisation. These will be indicative of what the managers perceive should be happening for attaining success. Collectively these statements will portray the set goals, objectives and activities performed by managers for achieving them through the length and breadth of the organisation or in the operational areas that support the existence and/or attainment of a CSF. (Caralli 2004). Another use of the activity statement will be to determine the future aims and objectives of the organisation and can assist in framing the CSF for the SME. Examples of Activity Statements Two activity statements that will be most useful will be the Financial Activity and the Strategic Management Activity. They will have the following information. Financial Stability: Keeping of accurate records and using information for monitoring finances. Details of the account maintenance methods and information derived from them; checking of input discipline through data accuracy, integrity and validity; reporting methods and their veracity; skills in ability to use data for projections. Strategic Management: Institution of key performance indicators and using information for improving on planning. The issue will be to find if targets were set and monitored; evidence of decision making based on facts and not assumptions; and laying down of procedures and processes for decision making. Analysing CSFs Once the CFSs emerge, they can then be further analysed for framing strategies that will be built around them for sustaining and managing the organisation. This will be the foundation of building or formalizing the strategies, especially the financial ones that will give both direction and stability for growth. Conclusions and Recommendations Financial pressures can impede SMEs. Achanga et al (2006) found the small businesses to be financially inept; lacking financial skills, knowledge and resources and finance emerged as a critical success factor for small companies. Dickinson and Ferguson (1984) stated that cash was a universal success factor for small businesses, Yusof and Aspinwall (1999) have also acknowledged the deficiency of resources as a constant problem faced by small businesses, affecting negatively on the quality of business operations. It is firmly believed that a research on the above model will assist in finding the gap in the functioning of an SME and for enabling it to formalize its strategy. It is already established that generally the entrepreneur is not qualified for devising strategic plans on his own as this is usually not his area of expertise. It will therefore be prudent for him to engage qualified outside consultants to assist him in this planning. This research will provide the raw data to the consultant on which he can draw his conclusions and make a formal financial strategic plan for the SME which will be geared not only for sustenance but for future growth as well. It is recommended that this research be carried out for the reason that it will provide the SME a complete outline with timelines for fulfillment of their main objective. SMEs are the mainstay of most economies, including that of UK, especially in terms of their impact on employment and development. Indeed their cumulative social and environmental weight is greater than those of large enterprises. Therefore there is a strong case for formalizing their financial strategies to enable them to do more in this direction. 10.Bibliography Achanga, P., Shelab, E., Roy, R. & Nelder, G. (2006). Critical success factors for lean implementation within SMEs. Journal of Manufacturing Technology, 17(4), 460-471 Berman, J., D. Gordon, and G. Sussman (1997). "A Study to Determine the Benefits Small Business Firms Derive from Sophisticated Planning versus Less Sophisticated Types of Planning," The Journal of Business and Economic Studies 3(3), 1-11. Binks, M. And Vale, P. 1990. Entrepreneurship and Economic Change. London: McGraw-Hill. Bracker, J. S., Keats, B. W., & Pearson, J. N. (1988). Planning and financial performance among small firms in a growth industry. Strategic Management Journal, 9, 591-603. Bracker, J., and J. Pearson (1986). "Planning and Financial Performance of Small Mature Firms," Strategic Management Journal 7(6), 503-522. Branch, S. (1991). "A Good Plan Is Key to Business Success," Black Enterprises 22(4), 68-70. Brokaw, L. (1992). "The Secret of Great Planning," Inc 14(10), 151-157. Burns, P. 2001. Entrepreneurship and Small Business. New York: Palgrave. Burns, P. And Dewhurst, J. (eds), 1996. Small Business and Entrepreneurship, 2nd edition. London: MacMillan. Caralli, R.A. (2004). The critical success factor method: establishing a foundation for enterprise security management. Pittsburgh, PA: Carnegie Mellon Software Engineering Institute. (Technical report CMU/SEI-2004-TR-010. ESR-TR-2004-010.) Churchill, N.C. And Lewis, V.L. 1983. “The Five Stages Of Small Business Growth”, Harvard Business Review, 61(3): 30-50. Cragg, P., and M. King (1988). "Organisational Characteristics and Small Firms Performance Revisited," Entrepreneurship Theory and Practice 13(2), 49-64. Deakins, D. 1999. Entrepreneurship And Small Firms, 2nd Edition. London: Mcgraw-Hill. Deakins, D. And Freel,M. 2003. Entrepreneurship and Small Firms, 3rd edition. London: McGraw-hill. Dickinson, R.A. & Ferguson, C.R. (1984). Critical success factors and small business. American Journal of Small Business, 8(3), 49-57. Drucker, Peter., Managing for Results: Economic Tasks and Risk-Taking Decisions (1964) Gibson, B., and G. Cassar (2002). "Planning Behaviour Variables in Small Firms," Journal of Small Business Management 40(3), 171-186. Hall, G. 1995. Surviving and Prospering in the small firm sector. London: Routledge. Hisrich, R.D. And Peters, M.P. 2002. Entrepreneurship, 5th edition. New York: McGraw-Hill. Jennings, P. And Beaver, R. 1997. ‘The Performance and Competitive Advantage of Small Firms – A Management Perspective’, International Small Business Journal, 15(2): Jones, D. W. (1982). "Characteristics of Planning in Small Firms," Journal of Family Owned Business Management (July), 15-25. Joyce, P., C. Seaman, and A. Woods (1996). "The Strategic Management Styles of Small Businesses," in Small Firms: Contribution to Economic Regeneration. Ed. R. Blackburn and P. L. Jennings. London: Paul Chapman Publishing, 45-56. Katz, J. A. And Green, R. P. 2007. Entrepreneurial Small Business, New York: McGraw-Hill Irwin. Kuratko, D.F And Hodgetts, R.M. 1995. Entrepreneurship: A contemporary approach, 3rd edition. Orlando: The Dryden Press. Leibenstein, H., “Entrepreneurship and Development.” The American Economic Review, Vol. 58, No. 2, Papers and Proceedings of the Eightieth Annual Meeting of the American Economic Association. (May, 1968), pp. 72-83. Luetkenhorst, W. (2004) ‘Corporate Social Responsibility and the Development Agenda: The case for actively involving small and medium enterprises’, Intereconomics, May/June. Lyles, M., J. Baird, and D. Kuratko (1993). "Formalised Planning in Family Owned Business: Increasing Strategic Choices," Journal of Family Owned Business Management (April), 38-50. Mcmahon, R.G.P. 1998. Business growth and performance and the financial reporting practices of Australian manufacturing SMEs Available at: http://www.ssn.flinders.edu.au/commerce/researchpapers/98- 7main.htm [accessed January 2008]. Mintzberg, H. (1994). The Rise and Fall of Strategic Planning. New York: The Free Press. Megginson, L.C., Byrd, M.J. And Megginson, W.L. 2003. Small Business Management: An Entrepreneur’s Guidebook, 4th edition. New York: McGraw-Hill. Perry, S. (2001). "The Relationship between Written Business Plans and the Failure of Small Businesses in the US," Journal of Small Business Management 39(3), 201-208. Risseeuw, P., and E. Masurel (1994). "The Role of Planning in Small Firms: Empirical Evidence from a Service Industry," Small Business Economics 6, 313-322. Robinson, R. B. Jr., and J. A. Pearce, II (1984). "Research Thrust in Small Firm Strategic Planning," Academy of Management Review 9(1), 128-137. Rockart, J.F. (1979). Chief executives define their own data needs. Harvard Business Review, 57(2), 81-93. Schwenk, C., and C. Shrader (1993). "Effects of Formal Strategic Planning on Financial Performance in Small Firms: A Meta-Analysis," Entrepreneurship, Theory and Practice 17(3), 53-64. Stevenson, H., M. Roberts, and I. Grousbeck, New Business Ventures and the Entrepreneur (Homewood, IL: Irwin, 1989). Timmons, J.A. 1994. New Venture Creation, 4th edition. New York: Irwin. Tyebjee, T.T., Bruno, A.V. And Mcintyre, S.H. 1983. ‘Growing ventures can anticipate marketing stages’, Harvard Business Review, 61(1): 63-66. Yusof, S.M. & Aspinwall, E.M. (2000). Critical success factors in small and medium enterprises: survey results. Total Quality Management, 11(4-6), S448-S462. Read More