3.4 Financial Aspects
3.4.2 Financial planning
Financial planning is one of an SME owner-manager’s processes for estimating the capital required for the development and management of the enterprise (Amelia, Nauli & Desriani, 2020). Specifically, financial planning is a process of determining how an SME can meet its goals and objectives through the proper management of finances (Alexander, 2018). Financial planning processes include various financial frameworks, such as understanding financial terminology and data, financial viability, sources of financing, financial structures, forms of financing, and financial control (Albert et al., 2020; Delen & Ram, 2018; França & Hershey, 2018; Lawlor, 2020). Each of these frameworks are detailed further in the following subsections.
3.4.2.1 Understanding financial terminology and data
An SME owner-manager must understand financial terminology, data, and reports before engaging in financial planning (Al-Najjar, 2019). This is because owner-managers’
understanding of financial terminology helps them with understanding the impact of numbers and financial reports, as well as their implication on the SME, which can enables owner-
managers to better understand financial issues and make more informed decisions (Wojcik, 2017). An SME owner-manager’s understanding of financial terminology, thus, improves the process of financial planning and business financials (Al-Najjar, 2019). By obtaining and building financial terminology, an SME’s owner-manager can better understand financial data analyses and the interpretation of reports (Xu & Wang, 2018). A study by Griffin (2017) further indicates that the greater an SME owner-manager’s understanding of terminology, the greater the overall financial literacy of the company.
According to both Wojcik (2017) and Writer (2020c), the basic financial terminology that every SME owner-manager should know in order to develop, manage, and grow their SMEs includes:
• Assets: resources with economic value that an SME owns with the expectation that said resources will provide future benefits or profit. Assets are an item of value owned by SMEs that fall into six categories, namely, current assets, fixed assets, tangible assets, intangible assets, operating assets ,and non-operating assets.
• Liabilities: financial obligations or debts associated with everything that an SMEs owes – both now and into the future. Liabilities are legal responsibilities that fall into two types, namely current and non-current liabilities.
• Expenses: costs of operations that an SME incurs in order to generate a profit.
• Income: money that an SME takes in and comes through the selling of its products or services.
• Accounts receivable: the balance of money due to an SME for products and services delivered and used but which has not yet been paid for by the customer or client (i.e., the amount clients owe to an SME).
• Cashflow: the movement of money (i.e., entering and leaving an SME) – can be real or virtual.
• Profit: financial benefit realised when revenue generated by SME activities exceeds the costs, expenses, and taxes involved in sustaining said activities. Profit relates, then, to money earned by an SME when its total revenues exceed its total expenses.
• Loss: the sum total of expenses exceeds the total income or revenue generated by an SME.
• Income statement: the financial statement document that shows and summarises an SME’s total income and expenses within a specified period of time.
• Net profit: the profit that remains after all expenses and costs have been subtracted from revenues.
3.4.2.2 Financial viability
Financial viability relates to the ability to produce enough revenue to cover operational expenses, debt obligations, and to allow for growth while maintaining product and/or service levels (Nkambule, Blignaut, Vundla, Morokong, & Mudavanhu, 2017). In order to determine financial viability, it is necessary to establish an SME’s ability to survive and be sustainable (Chiva, 2020). In particular, financial viability consists of the financial flow balance, financial risk, and diversification of SMEs’ financial activities (Christian & Airativich, 2020). SME owner-managers should perform financial viability analysis prior to any financial planning, as such an analysis offers their SMEs the ability to produce enough revenue to cover all operational expenses and debt obligations (Chiva, 2020). Hence, financial viability allows SMEs to grow while still maintaining the same standard of products and/or services (Christian
& Airativich, 2020).
The assessment of financial viability is an integrated process involving the review of financial statements, financial performance reports, business operations, business planning, and other supports of financial analysis (Olsen, 2021). The completion of this process helps to determine the financial viability of an SME (Chiav, 2020). A study by Mbatha and Ngibe (2017) concludes that financial viability is a significant factor for the success of SMEs, as its purpose, prior to financial planning, assists in determining the financial changes necessary to enable SMEs to implement financial strategies and/or address financial limits. Therefore, SME owner- managers should first determine their SMEs’ financial viability, as such can make it easier for them to make financial-related plans (Mbatha & Ngibe, 2017).
3.4.2.3 Small and medium-sized enterprises’ sources of financing
SME financial planning and financial cycles begin with sources of financing, which ensure that there is enough capital for the SME to operate (Thompson, 2020). These sources of financing are, thus, essential for an SME’s growth and development (Pticar, 2017). However, sourcing finance is a decision that SME owner-managers should make with caution, as it can leave permanent scares on the finances of SMEs. The owner-managers should make sure they get financing which they could repay (Pticar, 2017)
According to a study by Pticar (2017), SMEs’ financial processes can be financed from various sources, which can be categorised into the following groups, based on their formation:
• Financing from operations: SMEs can source finances for financial planning, processes, and development from their own activities or operations. These revenues made through operations can be used as a source of finance for further development and growth. This source of income implies that SMEs use their own capital for their own development. However, this type of financing can be risky, as SMEs can lose revenue and become bankrupt while trying to expand and develop financially.
• Financing from investments: SME owner-manager can source financing through internal and external investments. Internal investments occur when an SME’s owner- manager uses or invests the business’s capita, which would otherwise be idle, to generate maximum gains so as to advance the SME’s strategies or as a reserve against fluctuations or downturns in the business. In comparison, external investment occurs when SMEs source finances from external investors who invest in the SME, such as venture capitalist, angel investors, bank loans, incubators, governmental grants, and subsidies. The disadvantage of external investment is that these investors often demand a share of the SME’s ownership.
• Financing from monetary sources: SMEs’ money sources are primarily related to the financial activities of the enterprise. These sources come from earnings on interest for loans, deposits, and/or dividends. Earnings can also come from transactions related to stocks and securities.
3.4.2.4 Financial structure
The mix of debt and equity that an SME uses to finance its operations is referred to as a
‘financial structure’ (Young, 2020). Thakur and Vaidya (2020) state that a financial structure refers to sources of capital and the proportion of financing coming from short-term liabilities, short-term debts, long-term debts, as well as from equity in order to fund both an SME’s long- and short-term working capital requirements. Financial structure, thus, details an SME’s compositions of debts and equity (Carlson, 2020). Hence, SME owner-manager is also responsible for deciding the best mix in order to optimise the financial structure (Thakur &
Vaidya, 2020).
A study by Pticar (2017) highlights differentials between SMEs’ financial structures, vertical financial structures, and horizontal financial structures. There structures relate to various types of financial structures, including equity, debit, and optimal capital structures:
• Equity financial structure: money owned by shareholders or the SME owner. The equity financial structure consists of two different types, namely 1) retained earnings (i.e., and that part of the revenue to be kept separate and used to help strengthen the SME); and 2) contributed capital, which relates to capital that SME owner-managers have invested at the time of opening the SME, or which they have received from shareholders as a price of ownership of an SME.
• Debit financial structure: referred to as borrowed capital that is used in an SME. There are two forms of debt financial structures, namely long-term bonds and short-term commercial papers. Long-term bonds are the safest type of debt, as they have long payback times and owner-managers simply have to pay interest while the principle is paid at maturity. Short-term commercial papers are short-term debt instruments that are used by an SME to raise capital for a short period of time.
• Optimal financial structure: referred as an ideal combination of debt and equity that helps in maximising an SMEs’ market value while lowering its cost of capital. In this instance, SME owner-managers are required to determine the suitable financial structure for their respective SMEs, as this can vary across SMEs and industries.
3.4.2.5 Forms of financing
A study by Pticar (2017) states that there are three main forms of financing: 1) initial financing, 2) current financing, and 3) development financing. All the three forms fall under the ‘equity financing structure’ (Pticar, 2017). SME owner-managers need to include all three forms of financing in their SMEs’ financial plans. These forms of financing should also, always, pergtain to the management, development, and growth of SMEs. The form of financing presented in financial planning is, furthermore, significant as it establishes the focus of the financial plan (Hayes, 2021b). Pticar (2017) further indicates that it is possible for enterprises to have all three main forms of financing present in their plans, as they serve different functions:
• Initial financing: ensures initial capital for the foundation and establishing of SME operations.
• Current financing: ensures that there is an adequate supply of short-term finance sources to meet SMEs’ present short-term needs.
• Development financing: ensures sufficient quantity of extra long-term finance sources for new investments, development, and growth.
The development and management of SMEs as well as their financial plans requires all three forms of financing so as to ensure success (Pticar, 2017).
3.4.2.6 Financial control
Financial control is a process implemented to manage finances (Schubert & Kirsten, 2021), and relates to monitoring and directing an SME’s direction, allocation, and use of financial resources (Baker, Kumar & Rao, 2020). SMEs’ financial controls can be implemented through procedures, policies, and control electronic systems (Schubert & Kirsten 2021). These financial controls must be implemented in respect to ensuring accountability, responsibility, and automation (Schubert & Kirsten, 2021).
Financial control is an essential part of SME finances, as both financial planning and financial performance become meaningless if a strategy to control these processes is not established, defined, and implemented based on the given SME’s financial planning objectives (Fatoki, 2014). However, a study by Ayoko (2021) indicates that financial control is effective only when combined with strategic controls, and that it also has to possibility of discouraging innovation. Conversely, Matsoso, Nyathi & Nakpodia (2021) indicate that in order for
innovation to occur, financial controls must be in place to monitor and save on excessive capital so as to ensure that innovations can be implemented. Financial control, thus, promotes SME profitability (Lubawa, 2021; Vu & Nga, 2021).
The 21st century and 4IR have changed financial control processes by introducing digital and technological real-time guidance systems (Hassan, 2021). These guidance systems enable SME owner-managers to successfully develop and manage finances (Francis, 2021). Most of the current real-time guidance systems consit of software that has specifically been designed to promote financial control. The most popular financial control and management systems include QuickBooks, Kissflow Finance, Zoho Finance Plus, Xero, Oracle Finance Cloud, and Sage Intact (Freedman, 2021). These software solutions act as financial control mechanisms for SMEs by providing data and analysis that can be used during financial decision-making and/or to control finances on both a daily and monthly basis (Francis, 2021). These digital financial controls are necessary for SME financial development, management, and growth, as they assist SMEs with budgeting – which is discussed further in the following subsection (Francis, 2021).