Business Finance and the Sme Sector

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Business finance and the SME sector
by David Brookfield
21 Sep 2001|  |
One of the most important problems accountants are likely to deal with in acting as advisors to a small or medium-sized enterprise (SME) concerns the issue of financing. More succinctly, directors and owner managers in SMEs often complain of the lack of finance for what are profitable investment opportunities. For candidates preparing for professional examinations, the problem of learning about sources of finance for small businesses is one of merely thinking of different ways of listing the available sources of finance. Of course, there is more to the problem than that although, in my experience, when directors and owner managers talk about sources of finance they do want to know what is available. Just as it is important for accountants to be able to advise on what financing is available - and I will identify some below - is the need to be able to understand and explain why the SME sector encounters difficulties in finding appropriate finance and what are the options in tackling the barriers that exist to financing. As I will argue, dealing with such barriers are natural territory for accountants acting in an advisory role and hence it is vital that aspiring professionals should understand the issues involved. Background There is no unequivocal definition of what is meant by an SME. McLaney (2000) identifies three characteristics: 1. firms are likely to be unquoted; 2. ownership of the business is restricted to few individuals, typically a family group; and 3. they are not micro businesses that are normally regarded as those very small businesses that act as a medium for self-employment of the owners. However, this too is an important sub-group. The characteristics of SME’s can change as the business develops. Thus, for growing businesses a floatation on a market like AIM is a possibility in order to secure appropriate financing. In fact, venture capital support is usually preconditioned on such an assumption.The SME sector is important in terms of contribution to the economy and this is likely to be a characteristic of SMEs across the world. According to the Bank of England (1998), SME’s accounted for 45% of UK employment and 40% of sales turnover of all UK firms. This situation is similar across the EU.Future developments mean that the importance of the SME sector will continue, if not develop. The growth in small, new technology businesses servicing particular market segments and the shift from manufacturing to service industries, at least in Western economies, means that economies of scale are no longer as important as they once were and, hence, the necessity for scale in operations is no longer an imperative. We know, also, that innovation flourishes in the smaller organisation and that this will be an important characteristic of the business in the future.The problem The obvious point to state is that directors and owner managers of SMEs often describe a situation of shortage of capital and consequential missed investment opportunities. At an economy wide level, if this is true, there is a reduction in the nation’s wealth through investment opportunities lost. Let’s see how this might be explained more fully.The market for finance Money for investment comes from savings. Taking a broad perspective initially, as individuals we can save money in the form of equity or debt. Equity is easy to understand and is represented in terms of stocks and shares. Debt saving is broadly everything else and is usually characterised as interest bearing. A bank deposit account is an example. As you will know, the form of business financing matches the methods of saving. Thus firms either have equity or a mixture of equity and debt in their capital structure.The total supply of savings is determined by disposable incomes and, in turn, tax policy. What is available to firms as sources of finance on a macroeconomic scale is determined by: * the...
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