Running Head: FINANCE

Significance of Financial Management

Planning for Small and Medium
Enterprise

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Contents
Introduction:..........................................................................................................................................2
Discussion:.............................................................................................................................................2
Variance analysis:..............................................................................................................................2
Periodic ratio analysis:.......................................................................................................................3
Monthly Cash Budgeting:..................................................................................................................4
Advantages of Financial Management:.................................................................................................5
Financial projections..........................................................................................................................5
Capital budgeting...............................................................................................................................5
Real-time information system...........................................................................................................5
Monitoring and controlling................................................................................................................5
Conclusion:............................................................................................................................................5
Recommendations:................................................................................................................................6
References:............................................................................................................................................7

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Introduction:
A small and medium enterprise (SME) is one in which less than 250 employees are
permanently engaged and have a turnover not exceeding £40 million or a cumulation of the
balance sheet does not come over £34 million (Lewis, 2019). SME enjoys certain privileges
over large corporate houses in terms of lenient taxation policy, smooth financial
accommodation, effectively targeting niche markets etc. The critical success factor for SME
is that they need to identify market gaps i.e. the lag between the prevailing market offerings
and the expectation of customers and fulfil those gaps in the best possible way to make
customers delighted. Hence, SMEs can focus on niche marketing where they will fulfil
customers' demand by offering a unique selling proposition (Business case studies, 2020).
This report will accentuate on financial planning, feasibility analysis, variance analysis,
investment appraisal, tax planning etc. in the context of SMEs.

Discussion:
Financial planning is critical to the success of any business as it provides guidelines to
business to leverage its limited resources for increasing shareholders’ value. SMEs are
distinctive as they sustain the limitation of resources and capabilities (Lewis, 2019). The
owner of such business is the sole authority to undertake decisions regarding product design,
capital investment, project financing etc. (Turban, 2018). Henceforth, the following points
need to be considered well enough in formulating a financial plan-

Variance analysis: Budgeting is a very popular tool to monitor and control cost. A budget is a
predetermination of revenue and expense figures for a specific period (Turban, 2018).
Usually, budgets cover a single financial year which are put forth either before the
commencement or at the very beginning of a financial year. To illustrate, Southern Business
Technologies is a renowned SME in Basingstoke where the following has been observed-

Variance analysis for the year 2019

Particulars Amount in Millions (£) Percentage Remarks
Budget Actual Variance
Revenue 21.00 19.65 -1.35 -6% Unfavourable. Sales quantity
has declined.
Expenses:          
Procurement 9.00 11.00 -2.00 -22% Unfavourable. Purchase has
increased
Rental 2.00 1.50 0.50 25% Favourable. Rental charges

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 were negotiated at a lower
rate.
Utilities 0.50 0.60 -0.10 -20% Unfavourable. Hike in power
grid consumption rate.
Insurance 1.00 0.65 0.35 35% Favourable. Grabbing a
promotional offer with an
insurance company.
Salaries 4.00 3.50 0.50 13% Favourable. Winning
negotiation and lay off.
Other 3.00 1.75 1.25 42% Favourable. Reduction in
charges prices of consumables.
Net Income 1.50 0.65 -0.85 -57% Unfavourable. Net income
declined from the budget.
Source: (Southern business technologies, 2020)

Periodic ratio analysis: When financial statements are presented for managerial or
shareholders' usage, they evaluate the financial condition of an entity by applying pertinent
ratio analysis. Several types of ratios are-

 Liquidity ratio: Measures the ability to settle instant obligations. Example- current
ratio, quick ratio etc. (Turban, 2018)
 Activity ratio: Measures efficiency in utilising the assets. Example- assets turnover
ratio, receivables turnover ratio etc.
 Profitability ratio: Assesses earning and effectiveness. Example- return on assets
(ROA), Return on equity (ROE) etc. (Kerzner,2018).
 Leverage ratio: Evaluates debt and equity proportion. Example- debt-to-equity ratio,
interest coverage ratio etc.

The following analysis and recommendation have been prepared for Rebellion Developments
which is an SME located in Oxford:

Particulars Formula Calculation Comment

Profit (1-dividend pay- 76% The dividend payout for the year 2019
retention out ratio) is 24%. However, the industry average
ratio dividend is only 12%. This SME can
reduce its dividend pay-out to 14%.
Return on Net profit after 19% Higher than the industry average of

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 Investment tax / Average 28.65% globally. Improvement is
Investment possible by leveraging more debt
financing to accelerate debt by 21%.
Return on Net profit after 12% The industry average for it is also the
Net Assets: tax / (Total same. So, the SME is performing up to
Assets-Total the mark.
liabilities)
Current Current 0.72 The standard of it is 1:1. This SME
Ratio: Assets/Current should retain more current assets or pay
Liabilities off some current liabilities to strike an
equilibrium.
Receivables (Receivables / 85 days The standard is 45 days. It seems that
Days Turnover) * 365 the company is making a trade-off
between liquidity and profitability. The
company should strengthen its credit
policy by offering 2/10, net 30.
Source: (Rebellion, 2020)

Monthly Cash Budgeting: Liquidity is the lifeblood for any business. At times, it is even
important than profitability (Gelders, 2020). When traded-off between liquidity and
profitability occurs, the SME suffers overtrading which may eventually thrust the business
into closure. By furnishing cash budgeting report, SME can decide on the following-

 Is the SME going to experience any liquidity crisis during the coming month?
 How to finance the temporary shortfall?
 Should the SME adopt a restricted or lenient credit policy?

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Advantages of Financial Management:
Financial management is a ramification of management that focuses on the pecuniary aspect
of SME (Kerzner,2018). When applying the knowledge of financial management, certain
benefits can be derived which are stated herein-

 Financial projections can be furnished so that forecasted profitability can be

visualised, and decisions can be undertaken on that basis.
 Capital budgeting tools like Net Present Value (NVP), Internal Rate of Return (IRR),
Profitability Index (PI), Accounting Rate of Return (ARR) etc. can be applied while
making capital investment decisions (Business Case Studies, 2020). For example,
Connect Catering, SME located in Wallingford, was planning to invest in Broadband
services for which it carried out the NPV, IRR and ARR appraisals. Later, based on
NPV it turned out that £1.3 million project financing will be worthwhile for the SME
to proceed (Tanda, 2019).
 Real-time information system helps SME to pursue more profit. For example, if any
customised order arrives at Hicks Holding (SME), it can quickly decide over the
minimum sales price for its products due to the financial management system
(Dedoussis and -Papadaki, 2018).
 Monitoring and controlling of performance becomes even more feasible due to
applying financial management means (Tanda, 2019). For example, Natural Motion
being SME located in Oxford has implemented an efficiency management system in
which if any production team achieves more than 75% efficiency, the SME rewards
them and if any team secures less than 35% efficiency, it penalises them both
financially and non-financially (Gelders, 2020).

Conclusion:
It is undeniable the fact that financial management bears the utmost significance in dealing
with the limited resources of SME. Nevertheless, some SME owners use it to manipulate the
results so that they can extend loan facilities from financial institutions or receive extended
trade credit. Since SMEs sustain limited resources and abilities, they must use financial
modelling techniques to leverage their resources for enhancing shareholders’ value.

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Recommendations:
Certain recommendations can be put forward for SME financial planning:

 Manipulation of the financial report should be restricted to comply with ethical codes.
 Capital budgeting techniques should be applied before proceeding with any new SME
projects.
 Credit analysis should be carried on ensuring trade receivables balance does not
become a threat for the SME.

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References:
Beta.companieshouse.gov.uk. 2020. SOUTHERN BUSINESS TECHNOLOGIES LIMITED -
Overview (Free Company Information From Companies House). [online] Available at:
<https://beta.companieshouse.gov.uk/company/04323164> [Accessed 7 July 2020].

Rebellion. 2020. Homepage | Rebellion. [online] Available at: <https://rebellion.com/>

[Accessed 8 July 2020].

Gelders, P., 2020. Proven management models. European Journal of Operational Research,
110(2), p.407.

Dedoussis, E. and Papadaki, A. (2018). Corporate governance and investment: domestic and
foreign firms in Greece. Managerial Finance, 36(3), pp.174-200.

Business Case Studies. (2020). Ethical-business-practices - Business Case Studies. [online]

Available at: https://businesscasestudies.co.uk/ethical-business-practices/ [Accessed 15 Feb.
2020].

Kerzner, H., 2018. Project Management Best Practices. Hoboken: Wiley.

Lewis, M., 2019. Operations Strategy. 12th ed. London: Pearson Education UK.

Turban, E., 2018. Information Technology For Management. New York: Wiley.

TANDA, A., 2019. FINTECH, BIG TECH AND BANKS. SPRINGER NATURE.

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