Liquidity Management Of Smes Finance Essay

This chapter will dwell of garnering adequate research stuff and empirical grounds from old surveies to supply a foundation to the survey. This chapter presents an overview of empirical literature on liquidness direction of SMEs. It reviews findings

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2.1 Introduction

The little and moderate-sized endeavor sector is frequently viewed as the brooder of employment, invention and growing ( Craig et al. , 2003 ) . Jovanovski, Klein and Mancini ( 2003 ) stated that the SME sector has emerged as the chief driver of universe economic growing. This peculiar sector has contributed a batch in the creative activity of employment, poorness relief, wealth creative activity, monetary value stableness, influx of foreign exchange net incomes, economic development and democratisation. Such concerns are seen as critical to the publicity of an enterprise civilization and to the creative activity of occupations within the economic system ( Bolton Report, 1971 ; Padachi, 2006 ) . In many states, such as Singapore and United States, they are the driving force of the economic system. In Europe, two tierce of all new occupations created are from little endeavors ( The Entrepreneur, 2004 ) .

In Mauritius besides the part of SMEs is widely acknowledge. The SME sector is mentioned each twelvemonth in the Government ‘s budget and it is showing its enterprise to advance, consolidate and overhaul the SME sector. Consecutive Governments have put in topographic point a broad scope of support establishments and continuously increasing its assorted inducements. An array of services runing from preparation, concern guidance services to fiscal aid in the signifier of both loans and grants are being provided by assorted establishments to hike up SMEs development so as fitting economic and societal challenges of the state.

2.2 Definition of SME

Different states use different standards to find their SMEs sector. The definition varies depending on the comparative development of the state ‘s economic system. However, there are some parametric quantities by and large considered by most states and the common 1s are:

Number of employees employed

Sum of capital invested

Entire assets

Employee turnover / Gross saless volume

Capacity of production

2.3 Importance of SMEs

SMEs play a important function in the socio economic development of most states around the universe. The part of SMEs in the development of end product, employment and economic growing is being acknowledged universally ( Beyene, 2002 ) . They constitute the bulk of endeavors found even in all industrialised states.

SMEs exist because of their built-in belongingss. Bing little and less hierarchal, they are more flexible and determination devising is faster, hence doing them on a better border than big houses. Nowadays, SMEs are increasing the degree of end product and employment by traveling bit by bit from local operations to export-led houses.

Furthermore, SMEs are an of import occupation generator. This is because they are likely to be involved in more labour intensive concerns that require less capital disbursement on engineering when compared to larger organisations ( Storey, 2004 ) . Harmonizing to De Ferranti and Ody ( 2007 ) , SMEs which employs between 10 and 250 individuals, forms the anchor of modern economic systems and can be important engines of development through their functions as seedbeds of invention.

2.4 Nature and Importance of Liquidity

Liquid is considered ‘king ‘ ; it keeps a company dissolver and provides it with the flexibleness to prehend concern chances. Liquidity is defined as a step of the extent to which a individual or company has ( or has the ability to rapidly set custodies on ) hard currency to run into immediate and short-run duties. Therefore the liquidness place of a house is about the grade in which it can dispose of money. Liquidity is a stipulation to guarantee that houses are able to run into its short-run duties and its continued flow can be guaranteed from a profitable venture ( Padachi, 2006 ) . Liquidity jobs of many little concerns are chiefly caused by hapless fiscal direction and in peculiar the deficiency of planning hard currency demands ( Jarvis, Kitching, Curran, and Lightfoot, 1996 ) .

2.5 Liquidity Hazard

Liquidity hazard is the hazard that a concern will hold deficient financess to run into its fiscal committednesss in a timely mode. In easier footings, liquidness hazard can be defined as the hazard of being unable to neutralize a place seasonably at a sensible monetary value ( Muranaga and Ohsawa, 2002 ) . This hazard can adversely impact both net incomes and capital. Therefore, it becomes the top precedence of a house to guarantee the handiness of sufficient financess to run into future twenty-four hours to twenty-four hours disbursals. All concerns need to pull off liquidness hazard to guarantee that they remain solvent. Liquidity hazard has become a serious concern and challenge for SMEs.

2.6 Importance of Liquidity Management

Liquidity direction refers to direction of current assets and liabilities. It plays an of import function in the successful direction of a company and secures future growing. The liquidness place of a company is about the grade in which a company can dispose money. Liquidity direction in little houses can be described as the planning and controlling of hard currency flow by owner-manager in order to run into their twenty-four hours to twenty-four hours committednesss ( Collis and Jarvis, 2000 ) .

If a company does non pull off its liquidness place good, its current assets may non run into its current liabilities ensuing in hard currency deficits and trouble in paying duties. Liquidity place of a house is of major importance to both the internal and the external analysts because of its close relationship with daily operations of a concern ( Bhunia, 2010 ) . In short, liquidity direction is necessary for procuring the operational procedures of a company and the continuity of the company.

A house should be able to change over its net incomes into hard currency from operations within the same operating rhythm, or else the house would necessitate to borrow from external beginnings to back up its working capital demands. Smaller and medium sized endeavors ( SMEs ) are normally unable to happen external funding easy because they are seen as less creditworthy than larger companies ( Bernanke, 1991 ) . On the other manus for those that are able to ticket external funding, the cost of adoption may be expensive ( Jose et al. , 1996 ) .

Liquidity direction takes the signifier of hard currency direction and recognition direction. Whilst the most of import facet of hard currency flow direction is avoiding drawn-out hard currency deficits, recognition direction involves non merely the giving and having of recognition to clients and providers, but besides involves the appraisal of single clients, the recognition periods allowed and the stairss taken to guarantee that payments are made in clip ( Poutziouris et al. , 1999 ) .

2.7 Cash direction

Cash is king but for SMEs, hard currency agencies flexibleness, the ability to do acquisition, to put in new works and machinery and to introduce. The importance of hard currency as an index of go oning fiscal wellness should non be surprising in position of its important function within the concern and this requires that concern must be run both expeditiously and productively ( Padachi, 2006 ) . Cash plus is besides referred to as hard currency, hard currency equivalent or selling securities on the statement of fiscal place of an organisation. Keynes ( 1936 ) identified three grounds for keeping hard currency:

Minutess motive

A concern needs hard currency to run into payments originating in its ordinary class. Such payments include merchandise purchases, administrative disbursals and distribution costs.

Precautionary motivation

A concern needs hard currency to keep a shock absorber or buffer to run into unexpected eventualities. The more predictable the hard currency flows, the fewer precautional balances are needed.

Bad motivation

A concern holds hard currency to take advantage of expected alterations in security monetary values.

Fraser ( 1998 ) stated that there may be no more fiscal subject that is more of import, more misunderstood, and more frequently overlooked than hard currency direction. In order to pull off hard currency in an efficient mode, it is of import that owner/manager prepare frequents studies on hard currency balances at bank every bit good as awaited hard currency grosss and hard currency expense. Consequently, these will enable them to break program and derive control over major influxs and escapes.

2.8 Cash Conversion Cycle

Besley and Brigham ( 2005 ) specify hard currency transition rhythm as the mean length of clip from the payment for the purchase of natural stuffs to until the aggregation of receivables associated with the sale of the merchandise. The hard currency transition rhythm is a traditional theoretical account introduced by Richards and Laughlin ( 1980 ) . It is a powerful public presentation step for finding the public presentation of a company in pull offing its working capital. Harmonizing to Gentry, Vaidyanathan, Lee and Wai ( 1990 ) , short hard currency transition rhythm is indirectly related to a house ‘s value. In other words, short hard currency transition rhythm indicates that the concern is roll uping the receivables every bit rapidly as possible and detaining the payments to providers every bit much as possible. Consequently, this leads to comparatively high net present value of hard currency flow and comparatively high house value.

Many concerns and peculiarly little concerns are faced with liquidness jobs since most have to run with fewer beginnings of both short and long term funding than larger houses. Given that less funding is available, more assets must be held in liquid signifier so as to run into day-to-day minutess and exigency demands. Larger houses, that have better entree to both the money and capital markets, can afford to keep fewer current assets and run into hard currency demands merely as rapidly and expeditiously through adoption.

The hard currency transition rhythm

2.9 Credit Management

Credit direction is besides known as history receivables, trade receivables or client receivables and is an of import component in the statement of fiscal place. It involves gross revenues that have been made on recognition which will be converted into hard currency at a ulterior phase. Christie and Bachuti ( 1981 ) specify recognition as the ability of a concern or single to obtain economic value on religion, in return for an expected future payment. Harmonizing to Ferris ( 1981 ) , recognition proviso can besides be viewed as an tantamount short term loan. Bad recognition direction can be lay waste toing since it straight affects working capital of a concern in the signifier of finance cost.

Leting recognition is common pattern, particularly for SMEs, as it allows them to take advantage of the recognition term to settle their histories. It is a sort of short term loan which will necessitate to be settled harmonizing to the footings agreed by both parties. However, after the recent recognition crisis, recognition is less readily available, and when it is, the cost has increased while footings and conditions are less favourable for the client.

A good recognition direction starts with a defined recognition policy which should sketch the concern strategic and operational demands. The company will hold to make up one’s mind the footings of recognition that it will offer to its clients ( the scheme ) every bit good as implementing processs, bounds and train forces ( operational ) .

2.4 Review of Previous Surveies

Review of findings from old research works revealed the undermentioned grounds behind the failure of SMEs. They are capable to a figure of restraints that affect their ability survives and their failure to run and turn arises from both internal and external factors.

Liquid refers to the degree of hard currency and near-cash assets held, every bit good as hard currency influxs and escapes of these assets. Harmonizing to McMahon and Stanger ( 1995, p. 24 ) liquidness in a little endeavor is a affair of life or decease for the little concern since such a concern can last for a long clip without a net income, but fails the twenty-four hours it ca n’t run into a critical payment.

Literature tends to propose that one of the major grounds for the high failure rates of SMEs was hapless liquidness direction patterns. Drever ( 2005 ) sees the soundness of liquidness direction as the most critical influence on endurance and fiscal wellbeing in little endeavors. SMEs in general do non follow best theoretical account of liquidness direction pattern that would accommodate their size, alternatively there is a inclination for them to follow big house. Pull offing in a little concern is non like pull offing portion of a big organisation. The appraisal of liquidness direction patterns in little houses every bit good as how they should be improved should non be based harmonizing to the criterions and patterns used by big companies, but instead attending must be paid to the patterns really being used by owner-managers themselves.

Harmonizing to Stokes and Wilson ( 2006 ) , little concern direction differs from big organisations in many ways, chiefly because of societal constructions, relationships and because of the degree of resources available. Waynarczyk ( 2001 ) identifies three cardinal facets in which little and big houses differ: uncertainness, invention and development. Nayak and Greenfield ( 1994 ) argue that owner-managers do non utilize fiscal direction techniques really efficaciously. As a consequence, the procedure of fiscal direction and associated decision-making in little houses remains something of “ a black box ” ( Deakins et al. , 2000 ) .

Furthermore, the demands and state of affairs under which SMEs operate differ from that of big houses, therefore they frequently require trim direction schemes. Small houses do non run under the same economic and fiscal environment as big houses ( Shutt and Whittington, 1987 ; Rainnie, 1989 ; Curran, 1990 ) . ( Hall, 1995 ) points out that little concern environment exerts some force per unit area that can be different to the influences on larger organisations. Problems of the handiness, cost of finance, and the load of authorities ordinances and paper work are illustrations of the preoccupation that concern the director of a little endeavor but perchance do non concern many corporate directors in big organisation ( Scarborough & A ; Zimmerer, 2000 ) . Consequently, most little houses become insolvent and fail because they frequently could non entree fiscal aid from the fiscal establishments due to miss of the necessary demand needed by the fiscal establishments.

Furthermore, high failure rates or hapless growing rates among little houses besides arises from dominant of the proprietor directors ‘ direction accomplishment ( Cressy and Storey, 1995 ) . The endurance of little houses is mostly dependent upon the ability of the proprietors to pull off hard currency flows which in bend contribute to the direction of dealingss with Bankss, the premier loaners to little concerns ( Chittenden et al. , 1999 ; Storey, 1994 ; Cosh and Hughes, 1998 ) . Apart from investing portfolio and profitableness, liquidness is the other factor that is decisive in the growing or failure of a concern. Hence, determination devising affects these decisive factors and therefore contribute to the success or failure of the concern.

Liquidity direction is one of the most hard facet of little steadfast fiscal direction and is considered to be more critical than that indicated in the fiscal direction literature ( Jarvis et al. , 1996 ) . Small houses normally retain smaller sum of histories receivable and stock list. In add-on to this, they rely to a great extent on current liabilities due to their really weak fiscal place. Therefore, these houses maintain less liquidness and trust on recognition installation to finance their operation. This recognition installation most times comes from history collectible. Consistent with Zimmerer and Scarborough ( 2005 ) , little concerns are normally willing to presume greater hazard and this attitude is usually reflected in the little house ‘s liquidness.

Furthermore, harmonizing to the Small and Medium Enterprise Federation, SMEs are peculiarly vulnerable to bad debts because they tend to hold a smaller client base than big endeavors. In add-on to this, on mean 91 per cent of day-to-day concern minutess are on recognition footings ( Chittenden et al. , 1998 ) . The little concern experience state of affairs where the production and gross revenues rhythm is shorter than the mean age of history collectible and in this state of affairs, merchandise debt can construct up in an of all time increasing mode until a point is reached when it can non be paid off in due day of the month ( Geoffrey, 1969 ; Anyanwu, 1996 ; Levy, 1993 ) . Surveies revealed that the most of import ground behind little concern failure was hapless and/or careless direction ( Chittenden, Poutziouris and Michaelas, 1999 ) . They stated that recognition direction in little houses fall behind best patterns. As a consequence there is high rate and menace of insolvency in little concern.

Liquidity direction in little houses can be described as the planning and controlling of hard currency flow by owner-manager in order to run into their twenty-four hours to twenty-four hours committednesss ( Collis and Jarvis, 2000 ) . Therefore, it can be said that hard currency flow is an built-in portion of mundane operations. By and large talking, the root cause of many concern failures stems from the unequal direction of available hard currency, the deficiency of available hard currency resources, or deficiency of entree to allow funding installations. In add-on, there is besides hapless record maintaining system in most little house which reduces the ability of the house to supervise the proper hard currency flow. Consequently, they are precluded them from the ability to vie efficaciously.

Furthermore, several SMEs fail in a small clip after they are started and this is largely due to hapless liquidness direction. Harmonizing to statistics, out of 30 endeavors that are created ( start-ups ) , approximately 10 are likely to last to go SMEs and merely 3 out of the 10 concerns will go average endeavors. It was besides revealed that most little concern fail at most within 2 old ages, while the strongest fail within 6 old ages. Previous surveies confirmed that failure rate is high during start up phase of little houses ( DTI, 1995 ; Cressy and Storey, 1995 ) . Adequate fiscal capital is a pre-requisite at start-up every bit good as during the life-time of an endeavor. It is considered to be critical for its endurance every bit good as for its effectual trading and development, as it can move as a buffer against unanticipated troubles ( Cooper, Gimeno-Gascon, and Woo, 1994 ; Chandler and Hanks, 1998 ; Venkataraman and Van de Ven, 1998 ; Cassar, 2004 ) . Inadequate or inappropriate capital construction is frequently the most common ground for a big proportion of little concern failures ( Chaganti, DeCarolis, & A ; Deeds, 1995 ) .

At assorted phases of growing, different possible fiscal jobs exist. This is shown in table 2.1below.


Potential Problems

Inception Growth I

Under capitalisation “ over-trading ” liquidness crises

Growth II

Finance spread

Growth III

Loss of control


Keeping ROI


Failing ROI


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