Definition of Small and Medium Enterprises Finance Essay

The definition of ''small business '' differ by different country and by different industry. Small enterprise have limited employees, sales is also low and focus on certain localised business regions. Some of the small business are run by families. Most of the small or medium business are run by single owners, for example: a neighbourhood restaurant or a local bakery. Being small seems to bring them many advantages. The majority of businesses are considered small businesses and they currently employ 13.2 million people which accounts for greater than 58% of the UK private sector workforce (Connell,2007),and Mack(1999) also claims that virtually all the net new jobs being created are by small firms. Moreover, they play an important role in increasing the GDP of households. Haynes(2007) demonstrates that the wealth and income of households owning businesses tend to grow faster than ones that do not own businesses. Small businesses can be set up easily, entrepreneurs have their independence in making decisions and they do not need to consider others' opinions. Small businesses serve fewer customers and usually have more frequent contact with those customers than large businesses. They also get the direct information from customers about what they like or dislike. Therefore, small businesses gain an advantage when customers have unique needs, want more individual attention, and are willing to pay a bit more for the product or service to obtain what they really want.

On the other hand, all small businesses are not succeed. In fact, their failure rate seems to be higher than larger businesses. There is only one owner thus capital is very limited and difficulties in many areas become noticeable. As a result of having difficulty in getting loans from the banks. In the SAM's the main daily financial source is a from the customers. Some small enterprise have cash flow problems frequently due to customers who are late payers; some are closed down as a result of the inability to pay suppliers or debts in time. Additionally, over one third small businesses experienced cash flow problems during the past two years . Furthermore, depending on the size and nature of businesses, environmental legislations have brought them difficulties in seeking efficient environmental solutions such as sourcing environmentally friendly products and limiting manufacture waste. Further, one of the business needs is insurance, which provides an important means to handle business risks. In recent years, insurance has become hard to find for small businesses, is less affordable and gives less protection.

Cash is like the blood in human body for all companies. So, the problem of financing is one of the most important issues in company operations. Appropriate and healthy sources of capital is the primary issue for an enterprise, especially for the SMEs. As policy, the reasons for their ideas, and SMEs' own flaw, so that the financing channels for SMEs is relatively narrow, a shortage of funds has become a major bottleneck for the development of SMEs. This paper is trying to explore into the financing problems that SMEs face and provide some feasible sources of finance which can ease the cash flow pressures for SMEs.

SME's can be defined as having three main characteristics:

• Companies are not quoted on a stock exchange - they are "unquoted"
• Ownership of the business is typically restricted to a few individuals. Often this is a family connection between the shareholders
• Many SME's are the means by which individuals (or small groups) effectively achieve self-employment

When an SME is not growing significantly, financing may not be a major problem. However, the financing problem becomes very important when a company is growing rapidly, for example when contemplating investment in capital equipment or an acquisition.

Few growing companies are able to finance their expansion plans from cash flow alone. They will therefore need to consider raising finance from other external sources. In addition, managers who are looking to buy-in to a business or buy-out a business from its owners, may not have the resources to acquire the company. They will need to raise finance to achieve their objectives.

Sources of finance for SME's

There are a number of potential sources of finance to meet the needs of small and growing businesses:

• Existing shareholders and directors funds ("owner financing")
• Overdraft financing
• Trade credit
• Equity finance
• Factoring and invoice discounting
• Hire purchase and leasing
• Merchant banks (medium to longer term loans)

Overdraft financing is provided when businesses make payments from their business current account exceeding the available cash balance. An overdraft facility enables businesses to obtain short-term funding - although in theory the amount loaned is repayable on demand by the bank.

There are several important factors to consider when assessing the appropriateness of an overdraft as a source of funding for SME's:

 The amount borrowed should not exceed the agreed limit ("facility"). The amount of the facility made available is a matter for negotiation with the bank;

 Interest is charged on the amount overdrawn - at a rate that is above the Bank Base Rate. The bank may also charge an overdraft facility fee;

 Overdrafts are generally meant to cover short-term financing requirements - they are not generally meant to provide a permanent source of finance

Depending on the size of the overdraft facility, the bank may require the SME to provide some security - for example by securing the overdraft against tangible fixed assets, or against personal guarantees provided by the directors

The amount of an overdraft at any one time will depend on the cash flows of the business, the timing of receipts and payments, seasonal trends in the sales and so on.

For the past few years, apart from traditional financing as said above, a new form of financing was known as Trade financing. It's a popular method in order to solve the cash flow in the international trade.

The trend is reflected partly in the growth in factoring volume. Trade finance gives you access to additional working capital and can help your business grow by funding the gap between the purchase and sale of a product or service. Trade finance terms are usually flexible and cost- effective, complementing existing banking relationships.

Growth in open accout trade have implications to trade financing for SMEs

• Cash Flow financing vs Balance Sheet financing
• Knowledge in trade finance is waning among SMEs and some local banks (some even do not see trade finance as bank lending)
• Open account trade is less structured and leads to lower appetite for banks to finance due to risk concern, especially to SMEs who are weak in corporate governance and in weathering economic downturn
• Trade finance needs to be in different forms under documentary trade and open account trade, requiring investment in staff training, customer education and systems

The Importance of Trade Financing:

Making international trade easier to SMEs and allowing more new start-ups to participate in international trade

• Trade financing helps banks develop a complete picture of SME customers' trade pattern, which would help long-term relationship development between banks and SMEs
• Trade financing encourages a more stable relationship between suppliers and buyers because trade finance tend to be less transactional and buyers and suppliers are always identified
• Less pressure in arranging unstructured revolving loans to SMEs in general

Equity Finance is the money raised for company activities by selling common or preferred stock to individual or institutional investors. However, this method is not feasible for SMEs. So, it's necessary to repeat more.

Factoring also known as 'debt factoring' involves selling invoices to a third party. In return they will process the invoices and allow to draw funds against the money owed to business. Essentially, these companies provide a finance, debt collection and ledger management service.

It is commonly used by businesses to improve cashflow but can also be used to reduce administration overheads. Businesses that supply this service are called factors or debt factoring companies.

Invoice discounting is an alternative way of drawing money against invoices. However, business retains control over the administration of your sales ledger. As well as providing finance, it offers valuable support services and credit insurance.

Commercial banks as a group are the main source of external finance for SMEs. The characteristics of the banking system in emerging markets frequently inhibit SME lending. The root cause of this is could because most banks are state-owned in China. Histories of substandard lending may leave many banks with weak balance sheets. Significant shares of total credit are often allocated on the basis of government guarantees or under special programs to support targeted sectors. Banks may also be subjected to interest rate ceilings that make it difficult to price credit to SMEs in order to fully reflect the risk of lending to SMEs. In some countries, the authorities have been reluctant to allow banks to fail and the banking system was therefore supported by implicit or explicit government guarantees. Many banks may have ownership and other ties to industrial interests and, thus, tend to favor state-owned enterprises.

If the banking system has possibilities to earn acceptable returns by lending to other borrowers, it will not develop the skills needed to do SME lending. If the formal banking system shows little inclination to lend to SMEs, there is little incentive for firms to produce credible accounts and operate transparently.

The objectives for all SMEs are to motivate banks to make loans Risk awareness and high proportion of default in loan repayment from stop banks to grant loans to SMEs.

It is necessary to establish a sound financial system for SMEs. Draw on marketing methods, popularize the corporate culture and the project dominant and development plan. It will attract banks who are willing to loan money to enterprises. However, the repayment of the first loan is very significant. This come down to the repayment terms problem. These do not just include how long the loan will continue and how much of each regular payment is of capital, and how much of interest, but also the circumstances in which the bank can call in the loan early. For instance, the terms may state that the entire loan should become repayable, with penalty interest, if more than two consecutive payments are late.

At establish a sound financial system and the same time, SMEs should pay attention the long-term planning, draw up a financial plan for the development of the company.

Importance of Financial Planning

It is important to plan finances in order to reap long term benefits through the assets in hand. The investments that one makes are structured properly and managed by professionals through financial planning. Every decision regarding our finances can be monitored if a proper plan is devised in advance. The following points explain why financial planning is important.

• Cash Flow: Financial planning helps in increasing cash flow as well as monitoring the spending pattern. The cash flow is increased by undertaking measures such as tax planning, prudent spending and careful budgeting.
• Capital: A strong capital base can be built with the help of efficient financial planning. Thus, one can think about investments and thereby improve his financial position.
•  Income: It is possible to manage income effectively through planning. Managing income helps in segregating it into tax payments, other monthly expenditures.
• Enterprise Security: Financial planning is necessary from the point of view of enterprise security.
• Investment: A proper financial plan that considers the income and expenditure of an enterprise, helps in choosing the right investment policy. It enables the enterprise to reach the set goals.
• Financial Understanding: The financial planning process helps gain an understanding about the current financial position.
• Assets: A nice 'cushion' in the form of assets is what many of all company desire for. But many assets come with liabilities attached. Thus, it becomes important to determine the true value of an asset. The knowledge of settling or canceling the liabilities, comes with the understanding of finances. The overall process helps enterprises build assets that don't become a burden in the future.
• Savings: It is good to have investments with high liquidity. These investments, owing to their liquidity, can be utilized in times of emergency.

Planning of financial always helps enterprises in the long run.

Conclusion

Financing have many ways. In the article, we say about borrowing from the bank, business owners, government aid and free market funds entered. We can be flexible to take these ways link together.

However, the purpose of the financing is to do the business better and make the product better. Overall, enterprises must be integrated with each department to improve its effetiveness. Only through the effective financial management, the enterprises will not lose its creditbility and will become feasible in accessing bank loans and government aids.

Since the Government have already recognized the importance of SMEs, more good policies have been released to help SMEs. Government have already taken several measures to help small and medium enterprises to get out of difficulties. Measures such as the SME Funds, the SME collection of bonds, equity loans, accounts receivable collateral loans, small loan companies, Security agencies and financial resources into the financing of the GEM Listing can be applied by the SMEs to ease their cash constraint. SMEs should select with discretion what are the best financing tools which suit them most. As emphasized previously, successfully seeking for the finance is nessary to integrate with an effective financial planning and its management if the achievement of the overall business success is to be reached.

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