Risk Management in SMEs - Research Paper Example

 Chapter One 1.0 Introduction The present day of the 21st Century has been presented with an unprecedented growth of Small and Medium Enterprises across the globe. It is not uncommon for one to find these types of businesses in almost all the sectors of production in any country. However, of importance to note is the fact that there is no conventional definition as to what really constitutes this type of business. For instance, nations such as Germany have defined this type of business as the one with not more than 250 employees. In Belgium on the other hand, this type of business is the one which has a workforce of up to 100 persons. The case is also similar in the United States of America where there has been no definitive description of what really constitutes this type of business. Others have classified these types of businesses basing it on their asset base. Yet still, in other nations, SME’s have been classified based on their annual sales or revenue turnovers. However, despite the apparent lack of a clear-cut explanation regarding this type of business, there is the general consensus that these types of business have emerged to be the backbone of economies in their respective countries. The present-day and unprecedented world economic meltdown is a perfect example of just how important Small and Medium-Sized Enterprises can be to the economy. During this period, majority of nations across the globe relied on their SME’s to salvage their economy. To add to that, Harvie, and Boon-Chye, (2002) note that these types of businesses comprise of about 99 percent of all firms within the European Union region. Also, they have been approximated to have offered employment opportunities to approximately 65 million persons in this region as well. This can be attributed to their large numbers in almost all the countries across the globe. On a positive rejoinder, OECD, (2005) states that these businesses have been hailed to be the main initiators and the driving force for both competition and innovation. Hence, that these types of business are very critical to the overall global economic development is a fact. On the other hand, a closer look at the financial framework in various countries especially in the European region brings to the fore the challenge of difficulties in securing funds by these businesses. In this regard, most Small and Medium-sized Enterprises have been constantly faced with financial barriers in their quest to secure external funds for their various development strategies. It is not uncommon for one to notice that the various fiscal policies in both developed and developing countries have numerous barriers which make it extremely difficult for these types of business to access and eventually secure funds. This can be positively correlated to pace at which these types of businesses grow and thereby be able to transform themselves into leading corporate players in their respective sector industries. The need for this status quo can not be overemphasized. 1.1 Problem Statement That Small and Medium-Sized Enterprises play a pivotal role in the overall economic development of their respective countries and can not be ignored. Their continued increase in almost all the sectors has had the effect of offering a range of employment opportunities to individuals. As was stated above, currently it is estimated that these types of businesses have provided meaningful employment opportunities to approximately 65 million individuals. In addition, they have been credited for providing the much needed impetus for both competition and innovation. Hew and Wee (2004) note that these aspects are useful to the economic development since they create a business atmosphere suitable for diversity which in turn fosters growth of other businesses. Other statistics indicate that these types of businesses currently account for about 99 percent of all the business market players which in turn translates to between 40 and 50 percent of the total global GDP. In India for example, Small and Medium-Sized Enterprises have emerged to take the center stage in the country’s overall industrial economy. With respect to value, it is approximated that these types of businesses account for more than 39 percent of the nation’s manufacturing output and about 33 percent of the country’s overall export. This is also the case within a majority of other nations in the Asian region such as China, Japan as well in Europe as put forward by Hew and Wee (2004). In the United Kingdom for instance, these types of businesses are virtually in all the sectors of production and have been very instrumental in the economic development and acted as buffer zones during harsh economic times within the country in the recent past. However, traversing through these regions, it is apparent that majority of these forms of businesses are faced with the challenge of accessing and securing funds. This implies that majority of Small and Medium-Sized Enterprises have not been able to grow despite their enormous potential. To this end, many market segments have continued to remain untapped due to the inability of these types of businesses to secure funds and finally be able to venture into such markets. To add to that, their competitive ability is adversely affected when faced with the challenge of sharing their market with other established market players. Simply put, the existence of barriers subject to accessing external sources of funds by SME’s is an inhibitor to their growth. Unless this issue is addressed exhaustively, then the present-day benefits which have been brought by these forms of business shall be a mirage a few years from now. The inability to access external finances by the Small and Medium-Sized businesses due to several fiscal barriers impacts on their growth negatively. This might result to continued poor performance within their respective market and sectors. 1.2 Justification of this Research Study Based on the above stated problem, this study is justified as it shall seek to explore the various sources of the fiscal barriers to which the Small and Medium-Sized Enterprises are exposed to. The existence of such barriers carries the potential effect of negatively affecting their growth. At the same time, they increase the level at which these businesses are predisposed to other risks within the market. The absence of a level-field in terms of access to finances by both the established and small and medium-sized enterprises also reduces their competitive ability at the expense of the former as argued by Darmer and Laurens (2000). Owing to the fact that these types of businesses play an important role in the overall economic development of their respective countries, there is the urgent need to identify sources of these barriers. By so doing, it would be possible to come up with a comprehensive framework in order to address the said sources. In addition, this would enable the stakeholders to accurately map out their impact on the growth of these types of business based on the unique needs within their economies. As a result it would be possible to develop sector and country –based approach in order to address these barriers as far as access to external funds by the small and medium-sized enterprises is concerned. In this regard, this study shall help to identify the sources of barriers to the SMEs’ access to financing and how they impact on their overall market growth. Against this backdrop, the study shall propose feasible strategies to address this issue based on a holistic approach. 1.3 Research Questions In order to address and investigate the above stated problem, this study shall be based on questions that shall seek to identify the sources of barriers to external financing of Small and Medium-Sized enterprises. This shall be reflected in terms of difficulties that these forms of business face when seeking external financing for their various development strategies. Furthermore, these questions shall also seek to bring to the fore the impacts of such barriers to the growth and development of the aforementioned enterprises. Hence this research study shall seek to the answer the question; how do the barriers to access financing by Small and Medium Enterprises affect their Growth? In order to answer the above question comprehensively, this research study shall be guided by the following series of questions. When is the business established? What is the type of this business in terms of ownership? Which sector or industry is your business involved in? In your own opinion, is it easy to start this type of business in this country? What is the average cost of starting this form of business in terms of capital requirement? Are there any sector-specific requirements or government regulations for the operation of this type of business? What is the average annual sales turnover for this business? What is the total workforce in your business? What are the external sources of financing for this business? What are the reasons for this business to require external financing? In your own opinion, is it easy to access the sources you have mentioned above? What are the reasons for your answer above? In your own opinion how can the government address this issue? How does this problem impact on the growth of your business? What are the other challenges that this business is faced with? How does this business overcome these challenges? 1.4 Research Objectives From the above stated research problem and questions, the broad objective of this study is to determine how barriers to access financing by the Small and Medium-Sized enterprises affect their growth. However, this broad objective shall be based on the following specific research objectives; To determine the average life span of Small and Medium sized enterprises in the UK. To determine the common type of business ownership of SMEs in the UK. To determine the average cost of starting SMEs in the UK. To determine the various barriers to accessing financing by SMEs in the UK. To determine how these barriers impact on the growth of SMEs in the UK. 1.5 Assumptions In order for this research study to achieve the aforementioned broad objective, it would be based on the following assumptions. I. Respondents shall give truthful and reliable information for this study. II. The types of businesses covered are SMEs in the United Kingdom business context. III. The SMEs captured in this study shall have been in existence for a period of not less than five years. IV. There are barriers of access to financing to SMEs in the United Kingdom. 1.6 Study Limitations One of the anticipated limitations during this research study is attributed to the fact that some respondents might not provide reliable and truthful information. This limitation carries the potential effect of greatly reducing the validity and reliability of the field study findings. In order to overcome this challenge, the researcher shall request the respondents to be as truthful as possible. Also, the research shall be based on the principle of voluntary provision of information by the respondents and thereby reducing the likelihood of collecting biased information. The second limitation that the researcher anticipates to be encountered with is the issue of insufficient resources in terms of man-power and finances. Time constraint is the other limitation to which this study is exposed since this research shall require at least one year to be completed. Chapter Two 2.0 Literature Review Small and medium sized Enterprises in Context The issue of availability of financing to the Small and Medium-Sized enterprises has emerged to become an area of concern among various stakeholders across the globe. The academic fraternity on the other hand has not been left behind as evidenced by a growing interest in research in this issue. The increasing interest in this area perhaps is an indication towards the realization of the fact that this is a serious challenge with far reaching social and economic ramifications. According to Ayadi (2005), the ability by any market player to access and secure external funding might result to the success or failure of that particular business entity. External sources of financing both from the banks and private financial institutions enable organizations to meet their market and development strategies. Through such means of business financing, organizations are able to venture into new markets as well as diversify their activities. As of today, there is no conventional and agreed definition of what really constitutes the term Small and Medium-Sized Enterprises. In this regard, this term has tended to vary from one country to another. In some countries, SMEs are often looked from the standpoint of the firm’s total assets. To others, these types of business entities are evaluated based on their total number of employees comparative to the accepted limit number in relation to the larger or established organizations. In some cases, the Small and Medium-Sized Enterprises are usually described based on their annual sales or revenue turnovers according to Harvie and Boon-Chye (2002). Despite the various attempts from different quarters, there is no agreed or uniform definition of this term which can be applied internationally. Attempts by the famous Bolton committee of the year 1971 did not yield much of a success due to the fact that there are several variables which make up these types of business (Baker, 2003). With particular reference to the UK Company Act of 2006 sections 382 and 465, Small and Medium-Sized enterprise has been defined from an accounting perspective. In this regard an SME is defined as a small company with an annual turnover of not more than $ 5.6 million with a balance sheet total amount of less than $ 2.5 million. The Act further states that this type of company/business venture should not have more than 50 persons as its total workforce in order to qualify as such. The same Act defines a medium-sized company as the one with the total turnover of less than $ 2.8 million with the balance sheet total not exceeding $11.4 and a workforce of not more than 250 persons according to Christensten and Flemming (2006). The European Union Commission on the other hand has defined small-sized type of business as the one with a turn-over of less than $7 million, balance sheet total of less than $5 million and with the number of employees not exceeding 50. A medium-sized company on the other hand has been described as the one with a turnover of less than $ 40 million, balance sheet total not exceeding $27 million while its total workforce not exceeding 250 persons as has been presented by Darmer and Laurens (2000). From the above definitions, it is clear that they have been construed from a quantitative approach. Qualitatively, these types of market players tend to share a number of features. First, they are usually established to serve local customers and thereby normally have a less share of the available market. Secondly, their owners usually deal with all the management issues which might arise in relation to the business. Lastly, these types of business entities exist as independent units and not as components of other established companies or organizations. A couple of researches indicate that majority of these small and medium-sized companies normally start as an idea from one or two persons. This is then followed with an investment by these individuals from the support from friends and relatives in addition to their own investments. In most cases, such form of help is based on condition that they are offered a stake in the business in terms of shares. In this way, the profit which is generated is usually re-invested into the business/company to support its growth and daily activities. In the event that they turn out to be successful, there is usually the inherent desire by the owners to expand them in terms of venturing into new market horizons. As noted by OECD (2007), this is the stage where they tend to be faced with difficulties in their attempt to secure external source of financing to support their development strategies. Their efforts to access financing from commercial banks, capital markets or other credit institutions is often characterized by a series of barriers which in turn make it impossible to get the much needed funds. 2.1 Importance of SMEs In all the countries both within and without Europe, SMEs have grown to become the major drivers of the economy. National statistics in the UK indicate that these types of business have significantly contributed to the economic growth and development as for the past five decades. According to this data, they account for a considerable portion of the GDP to the tune of 54.74 percent (www.lib.strath.ca.uk). In a positive rejoinder Hegge (2002), argues that SMEs contribute to the national development in their respective countries in a number of direct and indirect ways. One of such ways is through creation of employment opportunities to people and thereby acting as a reliable source of livelihood. Enhancement of the quality of the human resource is the other importance of SMEs to a country. The environment within which SMEs operate is faced with a great deal of dynamism which thus helps in the development of human resource. The small and medium-sized enterprises have also been cited to encourage the development of the culture of entrepreneurship amongst people. Also, they help to foster creativity and innovation which in turn promotes the development of a range of new business opportunities. Based on these benefits, it has justifiable to note that they have grown to become the backbone of economies their respective nations and regions. According to one of the survey conducted, the department of business in the year 2006 found out that there were about 4.5 million business entities in the UK of which the SMEs accounted for 99.9 percent of such businesses. The survey further indicates that they are the largest employer within the private sector accounting for 58.9 percent of the country’s total employment which thus translates to approximately 13.2 million people (Office for National Statistics, 2008) A World Bank report of 2004 also states that SMEs are quite instrumental in the overall process of economic development of a country and can not be ignored. According to this report, this can be attributed to their impact of enhancing competition and entrepreneurship and therefore presenting economic benefits in the form of increased efficiency, innovation as well as productivity and growth according to Lloyd-Reason and Leigh (2007). The report also stresses the idea that SMEs have emerged to be more productive than the established organizations. However their growth within their respective sectors or industries continues to be impeded by the failure of capital markets as well as other institutions according to Christensten and Flemming, (2006). With respect to the growth and development of the economy, the report notes that SMEs promote creation of more employment opportunities owing to the fact they are usually labor intensive, an aspect which helps to spur growth and development in a certain sector, industry or country. 2.2 Barriers in Accessing External Finance by the SMEs There is considerable evidence both in literature and from several studies indicating that accessing and securing of external funds is the major challenge facing the SMEs across the globe. This has had the impact of increasing their competitive vulnerability especially when sharing the market with the established firms. In addition, majority of them have not been able to grow while in some cases others have had to close down altogether. The internal sources of financing which are normally available to the SMEs are in the form of business internal equity. Though it is common, external equity has for a very long time remained to be elusive to these types of enterprises. Just as it is within the other countries of the world, banks are the main sources of external financing to the SMEs and other bigger market organizations. However, unlike the latter, SMEs are normally faced with a lot of barriers which greatly reduce their ability to access such external financing. One of the obstacles is attributed to the problem asymmetric information between the owners of SMEs and the banks. The challenge of asymmetry is reflected in terms of existence of disconnect between these two parties. In most cases, the owner(s) of such businesses tends to know exactly what the business needs due to a significant control of the business than the bank. To the banks, this is a source of risk in which case majority of them are not always willing to take by providing the required funds. This is further aggravated by the fact that a majority of SMEs do not have certified past financial records against which the banks might make their decision. The larger organizations in this respect find it easier to access external financing since they usually provide certified financial information from auditors as well as credit ratings from other financial institutions as opposed to the SMEs. Hence, banks are often left with the option of relying on their customer’s data which increases their risk predisposition in the event that they decide to give funds to the SMEs based on trust. According to Darmer and Laurens (2000), it is the existence of this asymmetry which makes the banks to be wary of providing funds to the SMEs. The need for collateral is the other obstacle which hinders SMEs from accessing external sources of funds. Throughout the history of time, collateral has become the most common of means of justification in acquiring any form of financing especially within the business community. Moreover, the use of commitments and personal collateral is the common method among the small and medium sized enterprises in the UK. Thus the availability of personal wealth and collateral plays a very important role in enabling the SMEs to access any form of external financing from the banks. In most cases, collateral provisions from the bank usually refer to the business assets or the personal wealth of the owner-manager of the business entity. To the banks, the use of collateral is paramount since it ensures for compliance and commitment by the owner of the SME in repaying the loan. Collateral also acts as a buffer to the banks in the event that the borrower is not able to repay the loan. Hence securities in the form of collaterals help banks and other financial institutions to take care of uncertainties within the market which would otherwise be source of loss to them. However, in most cases banks are usually wary of accepting collateral from SMEs due to the apparent low asset base which would compensate for the depreciating value of the collateral provided in the event of default by the borrower. In the overall, SMEs are often regarded to be high risk business investments by these financial institutions as noted by Baker (2003). Chapter Three Research Design and Methodology 3.0 Study Area This study shall be based within the City of London as the main focus of data collection. The decision to use London as the primary sample area is an informed one from the fact the city is a cosmopolitan with many and different types of SMEs which would provide diverse and valuable data for this study. Feasibility is the other reason why the researcher opted to choose this zone to be the main focal point of the study. This shall enable the researcher to overcome challenges associated with limited resources and time constraints all of which would have otherwise negatively impacted on the reliability and validity of research findings. 3.1 Sampling Procedure According to Patton (1990), the identification of the correct or suitable sampling procedure is positively correlated to the accuracy of the research findings. From the onset, it should be noted that this research is qualitative in nature and therefore the use of an appropriate sampling procedure shall be emphasized. Hence, this research study shall use systematic random sampling procedure to determine the sample for this study. This method has the merit of being easy to use while at the same time ensuring for accuracy in determining the sample size. 3. 2 Data Collection and Analysis This study shall involve the use of both primary and secondary methods of data collection. Administration of questionnaires shall be used as the primary method of collecting data in relation to the research question. This shall be supplemented by the use of probing to allow for the collection of accurate and valid data. Additional information shall also be obtained from secondary sources such as books and related previous studies into this area. The use of secondary sources of information has the merit of providing in-depth information on the topic under study which in turn helps the researcher to come up with responsive recommendations. The collected data shall be analyzed and represented through the use of score tables, pie-Charts and graphs. 3.3. Ethical Considerations One of the ethical considerations that the researcher shall have to take into account is the aspect of designing the field study to fit into the individual programmes of the SMEs. This shall ensure that the research study does not conflict with the day-to-day operations of such businesses. The researcher shall also have to ensure that the identity of all the SMEs used in this study is kept confidential. Also, the data provided for this study shall only be used for the intended purpose as per the research questions of this study and shall not be divulged to anyone without authority from the respondents. Lastly, the researcher shall be tasked with the responsibility of upholding copyrights by acknowledging all the secondary sources that shall be used in this study. 3.4 Research Plan This research study shall be based on the following work plan; Activity Time Frame (in Months) Reconnaissance and sampling 1st Month-2nd Month Preparation of questionnaires and booking of appointment 2nd Month Questionnaire administration and data collection 3rd Month to 4th Month Data analysis and review of findings 5th Month to 7th Month Preparation of report 8th Month Discussion of study findings with stakeholders and development of recommendations 9th Month to 12th Month References Ayadi, R 2005, The new Basel Capital Accord and SME financing: SMEs and the new rating culture, California, CEPS. Baker, MJ 2003, The marketing book, 5th ed, New York, Butterworth-Heinemann. Christensten, PR & Flemming, P 2006, Managing complexity and change in SMEs: frontiers in European research, London, Edward Elgar Publishing. Darmer, M & Laurens, K 2000, Industry and the European Union: analyzing policies for business, New York, Edward Elgar Publishing. Harvie, C & Boon-Chye, L 2002, The role of SMEs in national economies in East Asia, London, Edward Elgar Publishing. Hegge, B 2002, SMEs and European integration: internationalization strategies, London, Routledge. Hew, D and Wee, NL 2004, Entrepreneurship and SMEs in Southeast Asia, Institute of Southeast Asian Studies. Lloyd-Reason, L & Leigh, S 2007, Trading places-SMEs in the global economy: a critical research handbook, London, Edward Elgar Publishing. OECD Annual Report 2007: Washington, D.C, OECD Publishing. OECD, (2005), SME and entrepreneurship outlook 2005, Washington, D.C, OECD Publishing. Office for National Statistics, 2008, Social trends, London Palgrave Macmillan. Vol. 38 Patton, MQ 1990, Qualitative evaluation and research methods, London, SAGE Publications. www.lib.strath.ca.uk. Accessed on December 9, 2009. Read More