Risk Management in Small-medium Enterprises (SMEs)

TABLE OF CONTENT

ABSTRACT

1. BACKGROUND OF PROBLEM

2. LITERATURE REVIEW
2.1 SME
2.2 Expenditures of SMEs in Risk Managements
2.3 Risk Management in SMEs
2.4 Selection of Technique and Implementation
2.5 People point of view on the Impacts of Risk Management in SMEs

3. RESEARCH QUESTIONS AND OBJECTIVES

4. RESEARCH METHODOLOGY
4.1 Limitations

5. TIMESCALE

6. CONCLUSION AND RECOMMENDATIONS

7. REFERENCE LIST

ABSTRACT

This paper is proposing to research the influence of risk management on the financial performance of small-medium-sized enterprise (SME) in West Midlands, UK. SMEs expose many risks in their ordinary course of business, such as interest rate risk and foreign exchange risk, natural disasters and so on, that could minimize their profit by increasing their financial loss. This paper shows that how could SMEs reduce its financial loss from risk exposure by having proper risk management tools in place, by interviewing the SMEs' risk managers. The interview generally focuses on the risk management process in SMEs accompany with their annual spending on it, and examines how these risk managements in company are used to overcome the risks. In addition, different perspectives on the impacts of the risk management to company’s financial performance, research methodology, research limitations, and research timescale are discussed and presented.

1. BACKGROUND OF PROBLEM

Many small businesses operate on a very tight budget. Figures published by the Insolvency Service during 2005 show that 12,893 companies went into liquidation and 10,839 self-employed people were declared bankrupt (Small Business, 2006)

Every business will exposes to risk, not matter internal or external that can directly or indirectly resulted loss to the company, particularly to the small business which doesn’t have the strong capital background. Hollman and Mohammad-Zadek (1999 ) found that every small enterprise face loss exposures due to unforeseen circumstances that can reduce projected profits or impair operating efficiency. The study reveals that items subject to loss may be classified under property and its uses, freedom from legal obligations, and personal health or earning capacity.

Therefore, managing the risk to minimize the loss exposures in today becomes the essential issues for every small enterprise. But, many of the self-employed failed to do so. Research by the Institute of Chartered Accountants in England and Wales (ICAEW) revealed that SMEs are only discussing how to handle general business risk once a year (Credit Control News, 2005).

Besides, as the credit crunch continues to bite, driving down revenue and squeezing margins, many small firms could well be staring bankruptcy in the face. The fluctuation of interest rate, foreign exchange rate, and inflation rate has seriously impact their operating efficiency, loss incurred from foreign trade or foreign assets, or even late payments from large customers have also resulting many small firms encounter a massive debt. Despite it, many small businesses are still having few effective policy tools to deal with risks (Schweser and Peterson, 1980).

Global warming has arrived at a time where only 25% of our small-to-medium businesses carry adequate business interruption cover (Kevany, 2007). The more worrying report is that the IAG research shows that half the SMEs in Australia that sustain a major loss or catastrophe go out of business (Kevany, 2007). The natural disasters have caused many small companies losing stock, having damaged equipment, and their major customers shutting down (Bell, R. in NZB, 2007). In addition, major health risks like H1N1, SARS, and so on spread around the world. War in Afghanistan and Iraq has also impacted on the global business. Forest fires in the US and Australia, and a growing number of computer viruses have further raised awareness of effective crisis management in small-medium sized enterprise (Kevany, 2007).

However, engaging in the risk management could increase the company’s expenditures which may not affordable for the small business, as they normally operate in a very tight budget. For example, companies not only contributes lot of money in developing the risk management program, but also the invisible cost such as time in developing the risk management process, and cost of recruiting or training the employees to get use on it. Alquier and Tignol (2006) also point that risk and risk management are at present ill-defined, which cause difficulties to companies, and specifically small- and medium-sized enterprises (SMEs) which are particularly sensitive to business risk and competition.

Lastly, company’s decision on whether what should invest, how much should invest in, and it is worth to invest to against the risk of accidental loss, yet, those are still depending heavily on the company’s financial status and its financial returns. Nevertheless, shareholders and customers would expect business to continue no matter what and require losses to be minimized when disaster or unforeseen circumstances strike to ensure their profit and returns. Therefore, there is a scope for an exploratory study to research on whether the structured risk management help SMEs to minimize their loss exposures, thus, providing better financial performance. In the rest of the paper, we briefly review the proper risk management process in SMEs, discuss the research objective and questions, and describe the research methodology and limitations.

2. LITERATURE REVIEW

2.1 SME

Small and medium-sized enterprises (SMEs) are non-subsidiary, independent firms which employ less than a given number of employees. This number, however, varies across countries. (William, 2000, in Bakare, 2009)

Below is the definition of SMEs in UK,

illustration not visible in this excerpt

(Sources: University of Strathclyde Library, 2009) <http://www.lib.strath.ac.uk/busweb/guides/smedefine.htm>

According to Department for Business Innovation & Skills (2009), In UK, there were an estimated 4.81 million private sector enterprises at the start of 2008, an increase of 104,0003 (2.2%) since the start of 2007. These enterprises employed an estimated 23.1 million people, and had an estimated combined annual turnover of £3,000 billion. SMEs together accounted for 99.9% of all enterprises, 59.4% of private sector employment and 50.1% of private sector turnover. In many sectors, SMEs are also responsible for driving innovation and competition. Globally SMEs account for 99% of business numbers and 40% to 50% of GDP (Wikipedia, 2009)1.

2.2 Expenditures of SMEs in Risk Managements

According to Credit Control News (2005), the survey of Institute of Chartered Accountants in England and Wales (ICAEW) revealed that SMEs do spend on risk management, included

- the costs of insurance,
- management and staff time,
- security and internal and external audits.

The findings shows that the amount spent varied, which the annual spending of small businesses is an average of £44,000, but medium-sized businesses spend an average of £150,000. Although 39% and 41% of small and medium companies respectively spent less than 0.5% of company turnover on risk management, the spend did vary substantially among all businesses. The study revealed that spend on risk management was expected to rise over the next two years, with 51% of respondents believing that budgets would increase.

2.3 Risk Management in SMEs

Hollman and Mohammad-Zadek (1984) state risk management is a systematic method of using a firm's physical, financial, and human resources to attain certain objectives concerning most pure loss exposures. They added a pure loss exposure only provides two prospective outcomes—loss or no loss. There is no possibility of a gain. In smaller firms, owner is likely to bear the responsibility for management, perhaps in conjunction with a top staff officer who is assigned the duty on a part-time basis (Hollman and Mohammad-Zadek, 1984)

Hollman and Mohammad-Zadek (1984) added the effective functioning of SMEs requires that loss exposures be identified, measured, and treated. They defined that the way these exposures are handled is called “risk management”, and the decision-making process that is followed in finding the least costly way of protecting the firm against accidental losses is called the “risk management process”

[...]