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Effect of Modern Finance on Small and Medium Enterprise – SME

There are views about the relevance of modern finance which is usually tailored or formulated with the view of large organisations in mind thereby ignoring small enterprises (McMahon et al, 1993). This neglect of financial management in SMEs is understood to be as a result of neglecting SMEs in the development of economic theory. However, the situation is changing due to globalisation. Thus there is the view that small enterprise financial management has not been developed with the small enterprise in mind. New empirical evidence raises the possibility that size may affect financial relationships in an important manner. These findings might themselves justify an expanded research emphasis on the effect of business size on financial policy. Sahlman (1983, 1990) refers to what he terms as ‘primitive rules’ in modern finance. In effect this attitude accounts for the inefficiency of small enterprises in financial management.

Ghanaian SMEs like other SMEs are missing out on modern finance theories. For example, CAPM is based on the following:

o The principle of risk aversion i.e. investors seeking higher returns and lower risks all things being equal.

o The principle of diversification i.e. investors do not place all their wealth into one investment portfolio, and

o The principle of risk-return trade-off i.e. the willingness to face a higher risk for a higher return. (Emery et al, 1991).

This can be related to the behaviour of the owner who is not risk-adverse .He is looking up to make a lot of profit by importing from other countries with unstable political situation.

These uses to CAPM to the SME are really unparalleled in the study. Most owner-managers in Ghana are risk-averse yet they seek higher returns from their investments.

Working capital policy is somewhat related to SMEs in terms of its operations. In relation to the reasons with which an owner-manager operates a business, there is no obligation to account for their actions. Thus the management of working capital is influenced by this style of running the small enterprise.

Working capital management thus seeks to meet two objectives-

i.to minimise the time between the initial input of materials and other materials into the operating process, and the eventual payment for goods and services by customers; and

ii.to finance those assets as efficiently as possible for an optimal return on capital employed.

Operations of SMEs in Ghana were found to relate to the working capital policy in their quest to be efficient and timely.

With all intents and purposes, debtors’ control and management are difficult tasks. To effectively-manage debtors, the following issues must be carefully considered, well-planned and controlled:

Credit period- The credit period given to each customer must be considered in terms of the customer’s credit rating; whether the costs of increased credit matches the profit to be made on the sales generated by the credit terms; and the general credit period being offered in the industry.

Credit standards must be set- For example customers must be taken through credit assessment ratings to weigh the risk they pose. Usually in giving credit to customers, the appropriate standard rule is to check the maximum period of credit granted; the maximum amount of credit; and the payment terms including any discounts for early payment and the interest charges on overdue accounts.

From my working experience in Ghana, one of the effective means was to take post-dated checks in addition from debtors. These must be spread across the duration to make the payment as agreed with the customer. Default, however, is inevitable in all circumstances.In spite of any shortfalls, the techniques used above can enhance a firm’s ability to control working capital effectively. For most small business enterprises whose total investments are represented in greater proportion by current assets, the techniques discussed above prove to be as useful for their management as the importance of their financial management.

This is very significant here because it clearly shows that most SMEs could stay in business for a very long time to come if they could apply financial management techniques effectively.

There are many published research including those of Olsen et al. (1992); Higgins (1977 pp7); and Babcock (1970) who are strongly of the view that growth must be viewed in a strategic context of financial management. They emphasise on a concept, which has variously been referred to as sustainable or affordable or attainable growth. This sustainable growth is defined by Higgins (1977) as “the annual percentage of increases in sales that is consistent with the firm’s established financial policies”.

Agreeing with this definition in this context; suffice it to say that it makes sense to relate a firm’s growth to its financial policies. By tailoring one’s financial management policies to the annual percentage increase in sales(which might be controlled),there is the possibility of achieving the sustainable growth and the ability to finance its permanent current assets as well as the non-current assets due to the rapid expansion in growth.

One can, however, argue that the rate of growth in sales can be influenced. For an enterprise which is intended to realise its full growth potential in the long-run in spite of the problems in securing an external equity funding, the only viable growth strategy is the profitability of the firm’s operating activities and the careful profit distribution policy. It could also be argued that those SMEs which “do not want to grow” can also apply the financial management techniques effectively and survive in the market.

Financial Management of small enterprises is thought to be different from that of large enterprises. In a paper entitled ‘Small business uniqueness and the theory of financial management’ Ang (1991), and ‘On the theory of finance for privately held firms’ Ang (1992), Ang considers businesses to be small if they have certain features and small business to share common circumstances, respectively. He later on concluded, “Small businesses do not share the same financial management problems with large businesses…the differences could be traced to several characteristics unique to small businesses. This uniqueness in turn creates a whole new set of financial management issues…. There are ‘enough differences between large and small firms’ financial management practices and theory that justify the research effort to study the latter”.

Another significant difference between SME financial management and modern theories on financial management is Capital Assets Pricing Model theory (CAPM). It is a finance model which captures the relationship between return and risk; specifying how it affects the valuation of financial and physical assets.

CAPM is simple, market-based and an objective means of estimating required rates of return for investments which reflect the collective preferences of all investors in the capital market. To a small enterprise, however, there is difficulty in estimating systemic risk-the risk that the whole system will fail, for example the stock exchange- because small business enterprises are not publicly traded or the investment is in a physical asset with no well-informed market due to the fact that the parameter is more effective if the investment is publicly traded. (McMahon et al.1993). The question then arises. What has this got to do with a small business enterprise then?

In real-life situation when there is a degree of uncertainty, the financial manager(just as the owner-manager) decides on the course of action to determine the level of finance required and for that matter the long-term financial strategy.

Because Owner-Managers have many duties to carry out,it was found out in the study that they frequently do not have enough time to devote to long-term planning of the company. Instead, most of their time is spent on day-to-day operational activities and in solving the current day’s crisis.Also due to cyclical or seasonal nature of many small businesses the amount of working capital required can vary enormously. The greater the seasonality the less permanent capital a firm has in relation to its total requirements in peak periods. SMEs are for that matter vulnerable to working capital management fiasco which can degenerate into poor financial management.

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