Small and medium-sized enterprises (SMEs), in general, are very susceptible to the environment — both external and internal. Given their small size, it is common for SMEs to be exposed to concentration risks, i.e., serious dependencies either on a supplier or a client, a particular law or even an individual.

Internally, they are exposed to a flawed environment that is, more often than not, characterised by dominance of the owner in all aspects of the business. We have found in numerous cases the owner being the finance manager, chief salesman, HR manager and chief purchaser, all rolled into one. This leads to poor management practices, a weak structure and, critically, poor and almost always, non-documented processes.

SMEs have a susceptibility to having weak finance departments and this affects their performance and financials, and, therefore, their behaviour. It also impacts their "bankability" and as such remains one of the major concerns for bankers.

Appalling state

We have worked with dozens of SMEs and in almost 100 per cent of the cases found finance departments to be in an appalling state, usually characterised by an absence of a CFO (understandably unaffordable) or of a qualified chartered accountant. Also absent are a good system and processes as well as management information.

The second aspect of fin-ance is a lack of discipline on both the planning and the end-use of funds. Diversion of bank financing to uses other than those agreed to is a source of very serious concern to bankers.

On the first issue, the absence of qualified employees and proper systems affects both profitability and the management of risk at SMEs. There are many glaring gaps in the finance area and the following are the main ones.

First is the lack of basic financial information on how the firm is doing. We found most companies did not produce profit and loss (P&L) statements. Needless to say, a close eye needs to be kept on sales, margins and costs, and this can happen only if P&L numbers are produced regularly, preferably on a monthly basis.

Second, receivables tracking and related to processes need to be in place. Firms need to know everything about their clients — ageing of receivables, who is paying when, credit limits for clients, the process for collections, documentation of the same — when debts go bad, this is important — and the hidden cost of extending increasing amounts of credit to clients.

Third, you need to have a basic management information system in place that tells you about your clients, margins and costs. You need to see who your profitable clients are, their buying over the past few months and years, trends in profit margins and so on.

Strangely, we found this missing in most of the companies we work with. If you have more than one office or division, then branch-wise and divisional numbers are essential. Again, we have come across companies with multiple divisions, profitable as a company, but running some unprofitable divisions, thereby depressing overall profits.

Fourth, cashflow forecasting is absolutely critical and, sadly, almost always found missing. This is a very serious gap and can lead to embarrassing situations with repayments to banks. Delayed payments and last minute requests for payment postponements seriously upset banks and must be avoided at all costs.

Lastly, balance-sheet structuring and budgeting systems need to be in place. You need to take proper advice in building your balance-sheet over time.

Good track record

There are things you can do and things you must not if you want to build a good track record with banks. A good CFO or advisor can help with this, not an accountant.

We have seen remarkable changes in focus and profitability of firms when these gaps have been filled. Banks react very positively when they see good systems in place, proper reports produced on a timely basis and transparency of information. These give comfort for increased funding at better terms.

The absence of all of the above seriously affects behaviour as well. We have seen firms who do not plan well or do badly for a while and scramble to cover up their mistakes by doctoring their numbers. This is easily avoidable.

The problem with all this is affordability. There are several options you can work with. You could consult an auditor — if you have a good one — to put the systems in place. Or, hire the services of a part-time or virtual CFO to put processes in place. Lastly, you could hire an advisory firm to do the same and manage your banking relationships as well.

The benefits of doing this far outweigh the costs, as you will improve your bankability and secure better terms as well.


The writer is a partner at Salvus Strategic Advisors.