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Home > Balance Sheets Best Practice > Corporate Finance for SMEs

Balance Sheets Best Practice

Corporate Finance for SMEs

by Terry Carroll
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Executive Summary

  • Corporate finance has evolved over many years to become a sophisticated specialism, for which the fees may be substantial.

  • The principles are the same for SMEs (small and medium enterprises) as for any larger company.

  • Often transaction-led, it is recommended that a wider full balance sheet approach be adopted because of the strategic financial significance.

  • SMEs often originate as owner/proprietor businesses, and this structure can often trigger transactions such as change of ownership or disposal for tax purposes.

  • By applying the same basic principles, there is no reason why similar sophistication should not be available to SMEs at affordable rates.

  • Working capital is a fundamental need in a recession. In order to survive, SMEs should strategically review and simplify the business, exploring all available sources of capital.

Introduction

The term “corporate finance” is widely, and sometimes loosely, used in business. In accounting firms it typically relates to a department or function that primarily deals with:

  • mergers, acquisitions, and disposals (M&A);

  • raising finance (early stage through to mature businesses);

  • flotations;

  • management buyouts and buy-ins;

  • business valuations;

  • due diligence;

  • succession planning and exit strategies.

These might represent the practical application of corporate finance. In theory, however, its primary role is to maximize the value of the business while minimizing the financial risks. The essence of the present article is that the practice of corporate finance has become oversimplified—potentially to the detriment of the business.

Furthermore, while corporate finance is usually a specialized department in larger accounting firms and in some smaller ones, its application in SMEs can often be quite different. Here, accessing and managing sources of working capital becomes a fundamental need, especially in a recession.

We shall propose a wider approach to corporate finance, based on asset/liability management principles and the full balance sheet approach, that is just as applicable to SMEs as it is to larger, more sophisticated companies.

A Full Balance Sheet Approach

A full balance sheet approach is recommended as the underlying principle of applying corporate finance. This involves looking at each and every asset in the context of the liabilities that actually or notionally finance them. Two key measures are:

  • The amount by which the profit would increase or decrease as the overall result of a 1% change in interest rates.

  • The difference between the average duration (i.e. asset life weighted by value) of the assets and the average duration of the liabilities that fund them. The importance of this is that, if the duration of the liabilities is shorter than that of the assets and, for example, interest rates rise, there will be an additional cost to the profit and loss account that cannot be recovered by the assets.

A More Sophisticated Approach to Corporate Finance for SMEs

SMEs are often started and/or owned by owner/entrepreneurs. Corporate finance transactions may be precipitated by owners, their bankers, accountants, or lawyers, or by approaches from elsewhere. For example, two sets of circumstances have recently led to a flurry of transactions:

  1. The British Government changed the capital gains tax (CGT) arrangements for businesses from April 6, 2008, ending taper relief. One result was that, leading up to this date, accounting and law firms were deluged by a spate of entrepreneurs seeking advice on financial restructuring or sale of their businesses to children, managers, and other interested parties so as to minimize CGT.

  2. A growing number of owner/entrepreneurs are approaching retirement age and want to pass their businesses on to their children or managers.

Both of these typical situations create the need for advice and support on corporate finance, funding, and tax and legal advice.

The transactions referred to in points 1 and 2 are circumstantial. Other typical examples are refinancing the business, management buyouts and buy-ins, and M&A. These are routine corporate finance transactions, but if we return to the theory and apply it there are many more sophisticated possibilities which can be more appropriately driven by business or financial strategy, rather than circumstance. One of the less obvious times to consider these is during a recession or economic slowdown.

Business in Three Boxes

Entrepreneurs who have started their own business often end up trying to juggle all of what are known as the “three boxes,” though such a simplified approach is entirely appropriate in a recession. The three boxes are:

  • business development, which includes both sales and marketing and the development of the business itself, whether organically or by acquisition;

  • operations, including delivery;

  • finance and administration.

It has been possible to outsource the last of these for at least 20 years. Not every business can afford or justify the appointment of a full-time finance director, but even that function can be contracted out these days at an economic cost—creating the “virtual F.D.”. By doing so, the entrepreneur is able to focus on those aspects where his or her skills and experience are usually best applied—in the first two boxes. These should go hand in glove, as together they represent the “end to end” customer-focused processes.

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