Causes of Finance Failures in Small and Medium Enterprises - Coursework Example

Causes of finance failures in Small and Medium Enterprises (SME) Introduction: The causes for finance failures of small and medium enterprises (SME) is a major cause of concern during recent times in the UK. This is because the SME’s contribution to the National Exchequer has been substantial and “SME’s are the lifeblood of most economies. On average they represent over 90% of the enterprises and account for 50-60% of employment at a national level.” (Small and Medium Sized Enterprises (SME,s) and Corporate Social Responsibility 2005) . Since the characteristic features of the SME’s are that they are labour oriented and production based, their requirements of capital inputs tend to be on the higher side. However, they have the advantage of being catalyst for “employment generation and wealth creation.” (United Nations Conference on Trade and Development 2005). SME’s also sets a broader and more equitable wealth distribution system. However, the main reasons for the finance failures of small and medium enterprises are as follows: 1. Financial ineffectiveness and future planning and goals settings. 2. Difficulties in matching up with competitors pricing and marketing strategies 3. Lack of financial resources or working capital for funding major projects. 4. Government barriers and “regulation barriers” in the forms of regulations, taxations and strict laws which may not always be practicable for the SME’s to implement and adhere to. (Northwest Entrepreneur network 2004). 5. Inability to introduce new technology and undate existing methods to suit customers needs, and to service highly demanding market requirements. “When any of these external contexts changes radically and the company is either unable or unwilling to change, it often results in failure.’ (Robinson, Carl. 2004). 6. Lack of financial structure, budgetary forecasting, and capital protection. 7. Inability to “Design, implement and maintain adequate business strategies and systems (including policies, procedures, standards and business structures);” (Jonker, Michiel. 2006). Controlling costs and maximizing revenues may not be feasible for certain SMEs due to inherent deficiencies in their financial systems which needs to be completely overhauled. The financial failing of these units begin when it is unable to liquidate its dues to creditors, and to stakeholders. The debts of the company are too heavy in relation to its sources of income and thus it may not be in position to fully meet all its debts, and may have to resort to external borrowings. “the debt holders or other creditors will force reorganization if a firm is unable to meet contractual obligations because working capital is slow and the firm cannot obtain more debt.” (Bankruptcy prediction, 2002). The interest on the external borrowings are high, and sometimes the SME’s may reach a stage, when even this interest payment cannot be met. Interest dues on external debts are compulsory payments and have to be met, whether or not the company makes profits. The vicious cycle of debt borrowing and its repayment continues, until the company has very little resources left for carrying on the business. A low or a negative cash flow is a sign of financial distress and needs to be urgently addressed “Financial distress begins when a firm is unable to meet scheduled payments or when the cash flow projections indicate that it will soon be unable to do so.” (Brigham F. Eugene & Ehrhardt C. Michael. 2004). The question that comes to mind is that SME’s, at this stage, should seek the financial help from governmental credit institutions to reduce the interest burden, but “SME’s have not been getting enough support, specially for their funding needs. Banks have been wary to lend to small and medium enterprises because it is regarded as costly, risky and more difficult.” (Good news: Pilipinas Archives). As is evident from the Model in Appendix 1 the finance factor has been a major contributory factor for Business failures and needs to be sorted out for future progress. Research Methodology SME Play a vital role in the economic well being of nations “Competitiveness policy embraces SMEs because they can contribute to the flexibility and resilience of the economy, and because they can be a good source of technological innovation.” (National Competitiveness Council 1999). In order to understand its causes and its implications, the research methodology would be taken up in the following methods: 1. Questioneries circulated to the Managing Directors, directors and principal officers of the selected SME’s in the various districts of the UK. This is in order to seek their viewpoints on the likely issue of the factors causing the finance failures of the SME’s the present attitude of the senior officers responsible for the workings of the specified SME’s whether this is being seen as a major problem by them, and the reasons, according to them on how it could be resolved. For the purpose of the dissertation, the views of the stake-holders of the SME’s shall also have to be considered and it is felt that distribution of questionnaires should also be made to the major stakeholders in order to understand their view-points and recommendations also. The operational aspects of the dissertation could be discussed with the stakeholders since they are the core group for the purpose of this study. Although the questionnaires submitted to the Managers of the SME’s would be different from that circulated to the stakeholders, the ultimate aim would be to provide invaluable source materials for achieving a consensus on this matter. 2. Structured interviews with the Managing Directors, directors and senior responsible officials of the SME’s regarding the matter under discussion. These senior officials, being professionally equipped, have been appointed by the Board of Directors of the Company, in order to oversee the day-to-day activities of the Company and they are, in many ways, totally responsible for the smooth functioning of the enterprises. Personal interviews with them would help gain insights into the inside workings of the SME to overcome the problems faced by them. The personal interviews with the principal officers would also throw some light on the reasons why certain Small and Medium Enterprises have ended in failures, to assess the reasons for the same, and to offer solutions in order to alleviate the problems and to avoid its recurrences in the future. These interviews would further highlight the comparative advantages and disadvantages facing the SME’s and what impact this would have on the future working of the SME’s. 3. Through Case Study: Case study would be taken up wherein the operation of the SME would be considered and the results evaluated 4. Websites: Information gleaned from visiting different websites dealing with this aspect of SMEs would help arrive at a consensus regarding the topic under dissertation. The various ideas posted by the different organizations would be useful in finding out a result for the subject under research. The legal aspects governing the workings of the SME’s shall also need to be considered in order to arrive at the consensus on this matter. The strengths and weaknesses of the different methods are that regarding the questionnaire methods, the attitudes of the respondents are important, since any bias or discrimination on their part may tend to vitiate the results, and further, the questionnaires need to be widely distributed in order to get a correct assessment of the actual facts. However, the major advantages are that, if correctly carried out, they would be authentic and would be able to present the facts in its correct perspectives. Regarding personal interviews, it could be said that the respondents may not be ready for specific questions, or may be barred from answering them due to ethical or corporate confidentiality reasons. However, the personal interviews could serve as the correct source since many areas outside the scope of the questionnaires could be addressed in the personal interviews with the directors and other responsible officials of the company. The answers received through the sample personal interviews could serve as being representative of the industry as a whole, since the finance problems faced by the major players could be, more or less, of the same nature and characteristic features, since all the players may be facing similar situations. It is necessary that the web sites visited are authentic and updated since the purpose of this study is to assess the facts. The data presented by the websites should be genuine and free of controversy and should be relevant in the present context ands the scope should be within that of this study. The comparative advantages of using websites as a secondary source is that, the information contains the results and recommendations already made by previous study in the subject, and the current study could, therefore, serve to add to the knowledge already existing for the subject matter under the present study. In the Case Study referred in Appendix 2, it is seen that cash flow difficulties and high external debt has been the principle reasons for the failure of the Canterbury Foods. The main reason for nearly all finance failure of companies have been low cash flows and revenue generation, which coupled with bad management and lack of financial planning and control has proved to be the bane of most SME s. Moreover, ‘inadequate enforcement mechanism and overly ambitious targets are among the reasons for failure.’ (United Nations Conference on Trade and Development 2005). Since they do not belong to the large group companies who could command financial redressals because of business reputation and large equity capital base, SME’s sometimes find themselves crippled due to lack of operating funds and revenue generations which could prove disastrous in the long run. Moreover, they are not in a position to seek financial injections through Public issues through equity and debenture issues nor could they seek the capital market owing to the size constraints and the fact that most SME’s are privately owned and therefore could not seek public funds. It is now planned to see the main reasons for the failures as per the findings of the survey conducted: 1. Most of the respondents believed that the primary cause of failures was due to poor financial management. “However, SME’s are more vulnerable than large firms, they usually lack financial and human resources, especially for planning and analysis, and they suffer disproportionately from imperfect information.” (National Competitiveness Council 2006). Due to lack of financial foresight and controls and having an inadequate hierarchy of power, command and accountability, they soon fall prey to market competitiveness and their products cease to be competitive both quality and price wise. 2. The financial problems that stem for SME’s is basically from the fact that most of them are undercapitalized and need large amounts of funding to remain truly competitive in a global market. Even new entrants may find it difficult to compete because of resource inadequacies and its resultant fallouts. “Small business owners never start their business with the intention of failing, however statistics show that in all likelihood, they will not be successful”. (Free-Research-papers.com). SME’s often cannot become highly competitive because of their inherent structure and may not be able to compete in global settings in which bigger and better technologically equipped companies participate for getting global orders. 3. The local and Federal Governments often impose barriers to trade which may, directly or indirectly, also affect the performance of SME’s. The legislation on Companies Laws, taxation laws, labour laws and other relevant rules and regulations may sometimes, pose as a destabilizing factor for SME’s and may hinder their future growth prospects. 4. Perhaps the main deterrent factor that impede most SME’s is their resistance to change agents. This may be the result of management policies or because SME’s are not flexible to adapt to new technological advancement or better management practices. Hence the companies, which adapt to change, perform better than the others who do not. 5. The findings of the study show that the underlying cause for finance failure among SME is their inability to generate operational funds and meet “debt servicing.” (United Nations Conference on Trade and Development 2000). There is another aspect to this .The management of SME’s should analyze whether the debt repayment inability is a temporary aberration, or is caused due to the erosion of the company’s assets. If this problem is of a temporary nature, capital could be acquired to pay off the creditors and rectify the situation, but if it were due to loss of asset value, the matter is serious and would need the attention and advice of financial experts who could suggest the best method of averting a major crisis in the SME. Recommendations: 1. It is first of necessary to identify the cause of the impeding failure. If it the culmination of financial deficits, then the management team of SMEs would have to devise ways and means to increase the generation of cash flows. It could be in terms of vigorously monitoring debts and recoverable more efficiently, and also increasing sales volumes to accommodate more debtors. 2. The other method of increasing revenues is by cutting costs. The management team needs to work around cutting unnecessary costs in all areas and also eliminating wasteful expenditures through achieving of overall efficiencies. 3. Management needs to carry out “regular checks on both new and existing customers can often make a real difference and can ensure that the risks of exposure to business failures and bad debts are significantly reduced. (UK failure hits historic high 2006). 4. In order to generate more cash flow the management has to explore new markets and consolidate existing ones. This is by offering better options for the customers in terms of better products at more competitive prices with good servicing. It must not only have good customers but should also retain them. on a long-term basis. 5. The SME’s brand image needs to be improved so as to increase its financial viability and bring increased sales/ revenues. It is only by a policy of increased sales turnover and keeping costs to the minimum that the company can stage a ‘turnabout’ and can hope to overcome the effects of failure. It also needs to improve on all parameters of functions like Debt equity ratio, Return on Investments, Capital, Operating, and other Profitability ratios in order to be sustainable in the long run and make positive contributions to the overall growth and development of the economy. 6. The final recommendation based on the study relates to improving the technology and making it suitable for present day operations. It has been seen that the lack of technological advancement has been a major deterrent for the SME’s since they may not be having either the funding or the infrastructural facilities to respond quickly to technological changes in the business environment. Conclusion: Through this study, an attempt has been made to analyze the causes for finance failures of the Small and Medium Enterprises (SME’s), their organizational structures that may be the primary cause for their failures and certain recommendations based on the findings of this study has also been made. The SME’s play such a vital role in maintenance of the European economy, and constitute a very large part in European Union. (Refer Appendix 3 ). Their contribution has been undermined by the strong presence of large Multinationals and Big Corporations in the corporate world. In real business life, the SME act only as suppliers to large corporations who use the services of SME’s for furthering their own economic ends. 1. For SME’s to flourish in future years, it becomes necessary for them to. 2. Have a very strong base of comprehensive business planning, profit protection and business development strategies. 3. Outsource and assess their current and potential corporates threats. 4. Evaluate and calculate the current and possible counter measures to reduce or eliminate the impeding threats. 5. Formulate, execute, and regularize sufficient business plans and programmes in order to ensure growth. It is believed that by adopting the above strategies, the incidence of failures of SME which is becoming a major problem area in the UK, could be addressed to and controlled to a very large extent. Works cited Small and Medium Sized Enterprises (SME,s) and Corporate Social Responsibility 2005.. Retrieved June 19, 2007, from http://www.iied.org/SM/CR/documents/CSRandSMEs.pdf Jonker, Michiel (2006): Small and Medium Businesses. Brigham F. Eugene & Ehrhardt C. Michael. (2004). Financial Management: Theory and practice. P 944 10th Edition (Singapore) Thomson Asia Pt Ltd. Pilipinas Archives: Inspirational views. SME’s as a global phenomenon. Good News. Retrieved June 19, 2007, from http://www.goodnewspilipinas.com/docs/inspirational_views/archived/global_phenomenon.html Annual Competitiveness Report 1999. National Competitiveness Council. Retrieved June 19, 2007, from http://www.forfas.ie/ncc/reports/ncc99/smes.htm Meatnews.com. (2007). U.K. Canterbury Foods Folds. Retrieved June 19, 2007, from http://www.meatnews.com/index.cfm?fuseaction=article&artNum=10882 National Competitiveness Council 2006. Annual Competitiveness Report 1999. SME structure and Performance. Retrieved June 19, 2007, from http://www.forfas.ie/ncc/reports/ncc99/smes.htm Bankruptcy prediction 2002.Retrieved June 19, 2007, from http://www.solvency.com/bankpred.htm UK failure hits historic high 2006. News Release. Retrieved June 19, 2007, from http://www.prnewswire.co.uk/cgi/news/release?id=169387 Advancing insights. Why do god companies fail? Retrieved June 19, 2007, from http:// www.advancinginsights.com/mybiz/why)do_good_companies_fail# Free-Research-papers.com. Free Research papers, term paper and book report topics. Retrieved June 19, 2007, from http://www.free-researchpapers.com/dbs/a5/bmu29.shtm Robinson, Carl. (2004). Northwest Entrepreneur network: Why good companies fail. Retrieved June 19, 2007, from http://www.nwen.org/venturer/1204/article4.htm United Nations Conference on Trade and Development (2005). Report on the Expert Meeting on enhancing Productive capacity of developing country firms through internationalization. Retrieved June 19, 2007, from http://www.unctad.org/en/docs//c3em26d3_en.pdf United Nations Conference on Trade and Development: Plan of Action 2000. Retrieved June 19, 2007, from http://www.unctad-10.org/pdfs/ux_td386.en.pdf United Nations Conference on Trade and Development (2205). Trade in Services and development implication.. Retrieved June19, 2007, from http://www.unctad.org/TEMPLATES/Download.asp?docid=5723&lang=1&intItemID=2078 . APPENDIX 1 Cause of Failures Percentage of Total (100 ) Financial factors 47.3 Economic factors 37.1 Neglect, disaster and fraud 14.0 Other factors 1.6 (Eugene F. Brigham & Michael C Ehrhardt 2004). APPENDIX 2 CASE STUDY: The case of M/s. Canterbury Foods, UK is being taken up for discussions: This Company had been functioning as a manufacturer of Pastry products and food materials suppliers to the UK foodservice Market. Its meat division was sold off to Transfield Foods Ltd on December 23, 2006. The administrator of the Company, Mr. Ian Green said, “the Company had been suffering cash flow difficulties for some months and its management has been attempting to reduce external debts and restructure the business to preserve its ongoing viability. Unfortunately, despite the recent sale of the company’s meat product division, it was not possible to complete the restructuring and Joint administrators were appointed on January 3, 2006.” (Meatnews.com 2007). APPENDIX 3 SME structure and performance In Europe Table 6.1 Percentage share of enterprise by size class and country 1996 Number of Employees Very Small 249 Total Austria 86.1 10.8 2.4 0.6 100 Belgium 96.5 2.9 0.5 0.2 100 Denmark 92.4 6.3 1.1 0.2 100 Finland 94.4 4.5 0.9 0.2 100 France 92.9 5.8 1.1 0.2 100 Germany 88.1 10.0 1.5 0.4 100 Greece 97.0 2.6 0.4 0.1 100 Ireland 89.8 8.0 1.6 0.6 100 Italy 94.4 5.1 0.5 0.1 100 Luxembourg 84.2 12.4 3.0 0.4 100 Netherlands 90.5 7.7 1.4 0.4 100 Portugal 93.8 5.3 0.9 0.1 100 Spain 94.9 4.4 0.6 0.1 100 Sweden 91.0 7.4 1.3 0.3 100 UK 94.5 4.7 0.7 0.2 100 EU 93.0 5.9 0.9 0.2 100 Norway 92.4 6.4 1.0 0.2 100 Switzerland 85.2 12.1 2.3 0.4 100 Source: The European Observatory for SMEs, Fifth Annual Report 1997 As the above table depicts, SMEs make up almost all the total of enterprises in all European countries, constituting on average 99.8 per cent of all enterprises in the European Union. (National Competitiveness Council 2006). Read More