While they already face the problems of arrears and mismanagement, SMEs today face new financial problems. In particular:
- The volatility of the foreign exchange market
- The fluctuation of commodity prices
- Interest rates
SMEs are more fragile than large companies and present a particular sensitivity to financial risks. This greater exposure to risks is explained first by their size. Less structured SMEs underestimate their working capital requirement (WCR) and neglect the debt recovery part.
The Financial Risk goes Beyond Simple Debt Collection
Interest rates, dollar prices, commodity prices, etc. The instability of the financial markets represents a significant risk for one in three SMEs. They are, however, rare to act to protect themselves from it. The reason? The solutions proposed are still unknown and raise many reservations for a large part of the 60,000 failures recorded yearly concerning small and medium-sized enterprises, which are more vulnerable to financial risks than large companies.
Large companies have integrated the risk culture linked to the financial markets. It has put them at the heart of their overall development strategy. Small businesses suffer the most from these risks due to their ignorance of existing solutions or distrust of a universe perceived as opaque, speculative, and complex.
Insufficient Preventive Strategies
Many SMEs have implemented preventive strategies by reducing their debt to avoid interest rates, diversifying their offers, or forming partnerships to diversify risks. However, these measures have their limits. Solutions to transfer all or part of the risk to a third party, offered by banks and specialized brokers, can be particularly attractive for entrepreneurs. Among them is the futures contract, which consists of the SME buying an asset at a fixed price for delivery and subsequent settlement. This asset can be traded on a futures market or over the counter. Another possible solution for small businesses is to bet on the future value of an underlying asset.
Whatever strategy the company chooses, it is advisable to favor simple products with a precise mechanism. The objective for the entrepreneur is to opt for a strategy to protect against the level and volatility of future prices and to apprehend the financial consequences of erroneous anticipation. Efforts have been made at the national level through different programs to facilitate SMEs’ access to the equity and bond markets. Despite this, many SMEs are reluctant to use so-called “hedging” instruments, perceived as complicated or expensive. Yet the financial risks are currently very evident in the context of high global volatility. SMEs have every interest in preventing these risks.
Global Financial Crisis
International Monetary Fund (IMF) has encountered multiple crises after the Great Depression. In a recession, the financial condition of SMEs worsens. The loan-taking prices increased, and banks started enforcing many restrictions while lending to SMEs. Also, banks shorten the debt payment time to cope with the risks of the global financial crisis.
Consider and carefully understand the Chinese PR case study.
The statistics of the China Banking Regulatory Commission reveal state-controlled banks lent 2.2 trillion as a total estimation in 2008. The small businesses got only 300 billion in loans, equal to 15% of the total ratio of the state bank’s lending amount. As a result, a maximum of 20% of registered SMEs face massive bankruptcy, while other SMEs still encounter severe capital shortages with the same ratio of enrolled ones. If we compare the state-owned enterprises, SMEs did not get much protection and support from the Chinese government during the pandemic.
SMEs in other states are also facing the same situation. Therefore, all governments must consider the financial status of their SMEs. They should reduce all SMEs’ problems, especially financial ones. So, consider information asymmetry, relationships between banks and enterprises, and internal restrictions within the SMEs’ financial system.
Determinants of SMEs’ Financial Structure
It is beside the dependent variable like total debt and total asset ratio. It has the returns on assets, non-debt tax shields, liquidity that you can measure by a quick ratio, the asset’s size of the firm, tangibility, and strong growth qualities. All of them operate and maintain the profit margin for SMEs
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