Business financial problems, challenges, and financial difficulties are part of the reality of businesses.
In this article, we try to illustrate, in general, the main causes of these problems that affect SMEs at the financial level.
In general, we can dissect the pitfalls of SMEs into three categories (St-Pierre 2018) :
| Financial Problems | Financial Challenges | Financial Difficulties |
|---|---|---|
| Limited access to external financial ressources | Growth and diversity | Bankruptcy |
| Thin capitalization and important use of debt | Growth SME's particularites | Causes of bankruptcies |
| Insufficient liquidity | Growth financial challenges | Bankruptcy Prediction |
What are the financial problems of SMEs?
No matter how big a business is, it can have financial problems. We have focused on SMEs, given that they represent the majority of operating private companies.
Overall, there are three financial problems among SMEs, namely:
- Limited access to external funding sources
- Weak capitalization and excessive use of debt
- Insufficient liquidity
Thus, we introduce you to the financial problems of companies, which are generally the main problematic factors that can affect the financial success of SMEs.
Limited access to external funding sources
External financial resources are funds that are provided by external stakeholders. The most common resources are :
- Community credit
- Crowdfunding
- Equity investment
- Grant
- Loan
- Loan guarantee
- Public funding
- Venture capital
On the other hand, internal financing can be called self-financing, i.e. financing of activities with the retained earnings generated by the company, while external financing requires the intervention of a third party.
Limited access to external sources of financing for SMEs puts obstacles in the way of companies wishing to pursue their growth. SMEs having optimized their internal financing and their commercial credit, will one day or another need other sources of financing to establish new large-scale projects.
Weak capitalization and excessive use of debt
Next, low capitalization and excessive recourse to debt are two factors that can lead to financial problems for an SME.
Capitalization or shareholders’ equity represents the money that has been invested by shareholders over the years. Mostly, it can come from the personal portfolio of a shareholder who buys share capital, or from the company’s retained earnings.
On the other hand, indebtedness is easily represented by the company’s liabilities, that is to say, all of its debts.
To understand the relationship between these two components of a company’s financial statements, we use the Debt/Equity ratio. Equity is synonymous with capitalization or having shareholders.
The resultant of the ratio above expresses the number of dollars of debt compared to the number of dollars invested by the shareholders.
Thus, a company with a ratio of 2:1 has twice as much debt as equity.
To immediately answer the frequent question which can be summed up as “What is a good or bad ratio?”, we specify that the answer to this question is relative to several factors including the industry, the objectives of the company, the type of debts contracted, the repayment capacity of the company, etc.
That being said, the higher this ratio, the higher the company’s debt to the money invested by shareholders, including retained earnings. All other things being equal, the higher the company’s debt balance, the higher the fixed charges it must pay to its creditors.
Thus, the higher the Debt/Equity ratio of a company, the better it must perform to support the debt payments it must repay.
Insufficient liquidity
There are several types of SMEs, not only in terms of the industry in which the company operates but also in terms of the choices of owner-managers. The owner-manager can choose to be stable by not trying to conquer his industry. For him, his current operations bring him enough income and he may be satisfied with what he has.
In contrast, other owner-managers seek growth. This search for growth leads to liquidity needs that are increasingly important over time. Liquidity needs are increasing and we can sum it up in a few examples, i.e. the company needs to hire new staff, it needs to do bigger marketing campaigns, optimize its website, store more to meet growing demand, etc.
Referring to several studies, Groleau (2012) classifies the needs relating to growth leading to the need for liquidity as follows:
- Organizational needs
- Human resource needs
- External relations (few relations, therefore fewer advantages)
- Operational needs
- Asset acquisition needs
How can SMEs deal with their financing difficulties?
Despite shareholders’ willingness to take the risk by investing all of their available funds in the business and reinvesting all of the profits back into the business, their access to capital may be limited.
The alternative to being able to face the difficulties of financing and thus be able to obtain sufficient financing to carry out large-scale projects is a venture capital investment.
When the company reaches the limit of its repayment capacity, it becomes risky for the creditor to finance a new project, despite its potential profitability. So the company must find solutions.
Venture capital is an attractive alternative that should not be overlooked by SMEs.
What are the reasons for the financial difficulties of SMEs?
Companies have always innovated and followed one another in conquering different markets. This process is constantly evolving. Since things are changing rapidly, it is important to stay on the lookout to stay ahead of the game. Thus, understanding what can lead to financial difficulties can help SMEs to prevent them.
The reasons for the financial difficulties of SMEs relate to factors both internal and external to the company. Managers do not have control over all the factors that influence the business.
They need to understand what factors they can control and then they need to optimize them. Factors they cannot control must be secured or covered.
Here are some examples of internal and external factors influencing the business:
| Internal factor | External factor |
|---|---|
| Staff knowledge | Environmental |
| Finances | Legal |
| Management of leaders | Macroeconomics |
| Lack of resources | Microeconomics |
| Resistance to change | Politics |
| Social | |
| Technologies |
Conclusion
The financial problems of companies, whether at the level of small, medium or large companies are non-negligible and deserve to be studied.
One of the main factors having a direct impact on the reality of the company is financial management. A company that lacks financial resources will not last long.
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