The University of Liverpool

The Management School

Managing Finance (ULMS767) Essay

Essay TITLE:
Explain what sources of finance are available for small to medium sized companies and explain why they sometimes face difficulties in raising finance

Name: KANG QIONGYU Student Number: 200840845 MSc Major: MSc Consumer Market

Contents
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Explain what sources of finance are available for small to medium sized companies and explain why they sometimes face difficulties in raising finance

Introduction

This essay focuses on financing alternatives for small to medium sized enterprises(SMEs). This essay would be separated in to two parts, in the first part, it would discuss about the sources of finance that are available for small to medium sized enterprises, and in the second part, it would talk about the reason why the small to medium sized companies face difficulties in raising finance. There are two types of finance that are available to small to medium sized enterprises, which are called internal finance and external finance. Small to medium sized enterprises often have difficulty in signalling their creditworthiness. Unlike large companies, much more Informational asymmetries between lenders and borrowers and incentive asymmetries between owners and managers are happen in the case of small to medium sized enterprises. As a consequence, small to medium sized enterprises are limited in the potential to issue stock, they also tend to be disadvantaged over large business in terms of access to bank loans. This article would like to analysis these problems from a theoretical perspective.

The sources of finance that are available for small to medium sized companies

Small and medium enterprises are companies whose headcount or turnover falls below certain limits. In most economies, there are much more smaller enterprises than large companies. In many economic sectors, SMEs usually show the ability to drive innovation and competition.

According to recent EBRD research, although they face many problems like economic, institutional and legal obstacles, small- and medium-sized enterprises (SMEs) are the ones show the ability to participate in the areas of comparative advantage and high value added, they are considered to potentially constitute the most dynamic firms in an emerging economy. There are many kinds of obstacles which include limited access to working capital and long-term credit, inadequate infrastructure, legal and regulatory restrictions, limited managerial and technical expertise and high transaction costs. Although there is a support to SMEs from international policies, and other
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problems like the presence of multiple and often interrelated constraints, the widespread belief is that the lack of finance constitutes would be the main obstacle to the growth of SMEs (Pissarides 1999).

To start and grow new business ventures, financial resources are critical, this is suit for anywhere in the world. Most of entrepreneurs start and sustain new businesses with their own assets or family and friends savings, they usually depend on tax breaks and other benefits provided by the state and attract access banks venture capitalists and commercial credits(Gratchev, M, & Bobina, M 2001).

In most countries and particularly in developing countries, finance is still a key limiting factor for small and medium-sized enterprises(SMEs). Generally speaking, banks are perceived as risky and unprofitable, so they refuse credit to SMEs. However, SME does not include more risk for the bank than lending to large enterprises or the public sector, because many research show that SME lending can be profitable.

The SMEs would turn to one or more methods of payment because of its financial plan and the analysis of its capacities of financing. In general, they are offered two major possibilities : Internal financing External financing

Internal financing

Internal financing is the most important part of all international development, and external financing which based on it would build an extra benefit. As a matter of fact, most small and medium sized enterprises must rely on internal financing, and external lenders would be refuse all intervention without internal financing.

Internal financing consists of :

income from transfers of the assets (debts, grounds, buildings, patents, and so on). allocations for paying off debts, deposits, and stock ;
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self financing formed by unallocated profits ;

External financing

The companies which assume international activities usually have good methods of financing when they facing import and export. For instance, in many countries that finance products destined for export or that do not have easy access to international capital markets, credit can be admitted to purchasers situated.

External financing consists of :

Bank overdraft Credit cards Bank loan/Commercial mortgage Leasing or hire purchase Loans/equity from directors Loans/equity from family and friends Invoice finance Grants Loans from other 3rd parties Export/import finance

According to the company's needs, it has been separate to three parts, as before delivery, during storage or after delivery.

1. Financing needs before delivery Client deposits: The small and medium sized enterprises can ask for deposits from their clients to reduce their need for financing. If so, the clients have paid part of the products that they have ordered. When the product or service would take a long time to produce, the companies would like to use deposits. Usually, their sum only demonstrate a small part of the contract's total value.

Pre-financing credits : The SMEs should turn towards other financing because that deposits which should be paid by the foreign purchaser are often insufficient. During the manufacture of products destined to be exported, prefinancing credits are granted by banks to companies. Consequently, they enable the products of exports to be financed, by this means, it linked to a very big gap between the manufacture and invoicing when reducing the financial deficit.

2. Financing of product stocks

Preparing for canvassing for orders oversea, company needs to launch a great amount of stocks of equipments or asserts. Whats more, some specific needs is also within consideration, such like the case for certain export markets, specific financing is necessary.

Through tough negotiation artfully, company can finance stocks by getting the payment deadline as long as possible. However, it does not always work. This prefinancing credits aside, loans in foreign currency is also available. Hopefully collection credit and warehouse relocation under customs may work to tight up the budget, by shrinking the fees and taxes this way, cost is expected to be largely cut down.

3. Financing needs after delivery Documentary credit: Documentary credit, which means the buyer should get to the buyer's bank to defray the exporters instead of turning over the documents which will prove that the provision of service has been performed and the delivery of goods. And than the documents will be sent to the buyers'bank or by the buyers' bank rather than repayment, at the end, the bank can own the goods. As a result, when the goods delivered the seller can set out his goods' payments by that way which has been illustrated above and at the same time the he can get the needed the transport documents and commercial to the bank of his. Loans in foreign currency (or advance in foreign currency): Advance in foreign currency, which handles a short-term financial credit, the one caused by business activities to be covered and enables the intervals of financing. The firm can get the loan which is the same thing as the amount of the
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invoice, the invoice will be rebuild its earning by the way of selling foreign capital during the circulate of the invoice, and once the customer paid the invoice the seller can use the client's debt to repay the loan. There is a advantage of loans in foreign currency, which is the loans can be a way of fleeing the foreign exchange risks equally. The reason why the small to medium sized companies face difficulties in raising finance

Basic reasons

At the present time, due to the influence of by internal and external factors, small and medium-sized enterprises still have the problems in raising finance, their trouble mainly displays in financing environment, financing structure and financing channels.

1. Financing environment According to the internal financing environment, the small to medium sized enterprises usually lack of their own fund, long-run stability of a business, risk resistance capacity, facility of production, core
competitiveness, at the same time, the scarcity of talent person and low-efficiency management also

make the small to medium sized companies have problems in raising finance.

According to the external financing environment, at present time the severe macroeconomic situation make adverse effect in external financing to small and medium sized enterprises. As the the deep influence of financial crisis, securities business and money corporation would have financial strain, it would make many problems to the small and medium sized enterprises in raising finance.

2. financing structure The small and medium sized enterprises always rely on their own fund and retained earnings not only in initial stage of pioneering, but also in the period of expansion. The roportion of internal financing in SMEs is too high, and they would have have low debt ratio. It would influence the goal of maximizing the profits of enterprises. This kind of financing structure was not propitious for further expansion of the company.
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The proportion of direct financing like public stock offering and public issuance of bonds is very low. It is difficult for the small and medium sized enterprises to fund raising with stock right financing. The bank usually supply short term credit to the SMEs, but lack of medium-term and longterm credit. 3. financing channels

According to financing method, the small and medium sized enterprises usually use indirect financing like bank loan, entrustment loans through bank or non-bank financial, and so on. They less use direct finance, like share issue and issue debentures. The SMEs almost never use the other method of financing, like financial leasing, note discount, receivables, risk investment, foundation, affiance, short-term financing. Based on these reasons, the financing channels for SMEs is limited.

Self reason

Bank loan is still one of principal pathway to gain financial support, many small to medium sized enterprises are still waiting for the opportunities. Most SMEs cannot fulfil the request for bank credit due to the problems they have in managing companies, so it would influence the companies to gain financial support from bank. 1. Lack of mortgage assets Most small and medium sized enterprises lack of enough mortgage assets and have high assetliabilities, other companies would not like to vouch for them, this makes most SMEs cannot demand for financing from bank. For instance, some high-tech enterprises, like IT companies have low net assets(NA) and high human capital, but software can not be mortgage assets, so it is hard for them to get the loan.

2. Lack of standard administration structure Many small to medium sized enterprises use family-based management mode, this kind of companies lack of scientific management pattern, when they facing stock financing, there may be many internal struggle, for these reasons external potential capital dare not participate in the companies.

3. Low degrees of comparison Most small and medium sized enterprises have less chance to build their degrees of comparison than large companies. Bank usually give large companies long term loan but not SMEs.

4. High operating risk Small and medium sized enterprises have high failure rate, to invest would have high risk. SMEs need not much at one time, but they need many times, this kind of method of loan would raise cost of bank, so bank would not like to invest SMEs.

5. Crude management Small and medium sized enterprises lack of high quality experienced manager, they usually care about development and speed but pay less attention to the quality, benefit and manage. As these reasons, they west a lot of resource.

Conclusion Finance is one of the most important parts of SMEs to develop themselves, there are many kind of ways to raise finance, like internal financing and external financing. There are strongly relationship between internal financing and external financing, and both of them are essential to SMEs. There are many reasons that make the limit to the development of SMEs, like self reasons and outside reasons. Not only the outside reasons influence the development of SMEs, but also self reasons play a important role of the affect to SMEs. Self reasons are also linked to outside reasons, so we should pay attention to all kinds of reasons which influence SMEs. Facing the present situation, the managers of SMEs would point out some measure to solve the problems.

Reference
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Almeida, H, & Campello, M 2010, 'Financing Frictions and the Substitution between Internal and External Funds', Journal Of Financial & Quantitative Analysis, 45, 3, pp. 589-622, Business Source Premier, EBSCOhost, viewed 22 November 2011.

Barnes, M, & Pancost, N 2010, 'Internal Sources of Finance and the Great Recession', Research Review, 14, pp. 29-32, Business Source Premier, EBSCOhost, viewed 22 November 2011.

Gratchev, M, & Bobina, M 2001, 'Financial resources for new business in Russia: desirable vs available', Venture Capital, 3, 3, pp. 263-274, Business Source Premier, EBSCOhost, viewed 21 November 2011.

Pissarides, F., 1999, Is lack of funds the main obstacle to growth? EBRDs experience with small- and mediumsized businesses in Central and Eastern Europe. Journal of Business Venturing, 5-6, 519539.

SWEENEY, P 2010, 'SMEs Tough Out The ECONOMY', Financial Executive, 26, 8, pp. 44-47, Business Source Premier, EBSCOhost, viewed 22 November 2011