The Role Of Company Financial Characteristics

Published Date: 02 Nov 2017

MARNELAKIS EMMANOUIL (ID: 683684)

SME definition

According to the EU, "An enterprise is considered to be any entity engaged in an economic activity, irrespective of its legal form. This includes in particular, self-employed persons and family businesses engaged in craft or other activities, and partnerships or associations regularly engaged in an economic activity". Furthermore, an enterprise is considered to be an SME if it employs fewer than 250 persons and has an annual turnover not exceeding EUR 50 million and/or an annual balance sheet total not exceeding EUR 43 million (EU Research, 2013)

SME’s in Greece

SME’s in Greece cover an important part of the business sector compared with other European countries (60% of turnover, compared with 40% on average in Europe). This difference stems from the higher share that businesses with turnover up to € 2 million cover in Greece (40% versus 19% in Europe). The presence of SMEs is most apparent in the sectors of trade and construction, while smaller is their contribution to the manufacturing industry.

Greek SMEs are smaller than the corresponding ones in Europe (with an average turnover of around € 200 thousand, compared to € 400 thousand in Europe). The greatest difference lies in the industrial sector, where European SMEs are three times larger than the Greek (EC, 2012).

From all the above it is highlighted that this is a highly fragmented sector, which is dominated by micro-enterprises. However, it is important to emphasize that the small business sector (with turnover <€ 1 million.) shrinks over time - covering ¼ of the corporate sector in 2007, from 1/3 in 2002.

The role of company financial characteristics

Analysis of accounting statements

One of the purposes of finance as a science is the evaluation and optimization ofdata collected and recorded inbusiness books. These data are derived from dailybusiness transactions and canhelp any user of account statements, either internal or external, in orderto make a decision. The analysis of financial statements is an essentialtool for determining the financialcondition of financial institutions.This is made through the evaluation of the assets andcapital structure and analysis of aggregatesassociated with profitability, liquidity and solvency (Voulgari, Asteriou and Agiomirgianakis, 2000).

The analysis of financial statements is useful for various company stakeholders, such as:

The business owners

Company managers

Lenders

Prospective investor candidates

State authorities

The Chambers

Trade unions

The analysis of financial statements is usually subdivided into 2 categories, depending on the position of the analyst and depending on the stages of the analysis carried out.

Two types of analysis exist depending on the position of theanalyst, the internal analysis and the external analysis. The internal analysis is conducted byanalysts who have a direct relationship withthe financial institution and therefore havea direct access to books and recordsheld by the financial institution. The external analysis on the other hand is performed byanalysts who are not directly related to the financial institution ( Voulgari, Asteriou and Agiomirgianakis, 2000).

However in the case of the external analysis, several problems exist. The information they receive in order to conducttheir analysis is solely based onpublisheddata. For this reason the external analyzer has limitedinformation that can pose a greatdifficulty to him in articulating and demonstrating safeconclusions about the development of the economies of theorganization under review. Another problem that the outeranalyst is facing is "tampering the balance sheet andweaknesses of the controllers' to cope with it" (Gaganis and Zopounidis, 2008).

Financial statement analysis can also be categorized depending on the stages of the analysis. Standard analysis is the preparatory stageof the financial analysis. At this stage thestructure of the financial statements is controlled andthe appropriate changes are made (e.g. conversion of percentages, rounding, etc.). Effective analysis on the other hand, concerns the knowledge of any particularcharacteristics of the industry in which the economicorganization operates. It depends on the formal analysis andit specifies the criteria or ratios according tothe purpose of the analysis.

Financial Characteristics of SME’s in Greece

Almost 750.000 SME’s are active now in Greece. These companies contribute a yearly turnover of around € 150 billion.4/5 of SMEs represent individual companies covering the corresponding share in the totaldomestic corporate sector (compared to only ½ of the corporate sector in Europe).Although they are greater in number than individual companies, the largest share of turnover (over 60%) is produced by companies of various legal forms.

For companies (covering 62% of SMEs turnover), key financial indicators reveal that SMEsare in no worse position than the rest of the corporatesector, with smaller companies to exhibit the most intensefinancial problems.

The low ratio of debt to equity shows that small companieshave relatively lent less than they could. However, due to low profitability andasset velocity, small companies with stand more lending as loans already exceed sales (150% versus about 60% for medium sized companies) (Hyz, 2011).

While the Greek SMEs have profitability problems duringthe crisis, the respective European SMEs maintain their net margingain close to 5%. Furthermore, despite the lower (especially insmall companies) ratio of debt to equity, Greek companieshave a higher debt burden in relation to their sales (the ratio of loans to sales is touching 70% in Greececompared with 46% in Europe). As a result, the coverage of financialcosts is slowing due to recessionary situation for the SME companysector in Greece (coverage ratio at 0.3), while in Europecoveringthe SME’s financial costs remains easy (withcoverage ratio 2.7).

One key problem for SMEs is that small businessesare the ones most affected by the crisis mainly because of economies of scale and high funding costs.

Small companies show greater decline in terms of activity and profitability.In addition, the growth of their trade cycle and the limited coverage oftheir financial costs create an increased need for working capital.While operating expenses as a percentage of sales arelower in small companies, this advantageis fully offset by the impact of anti-economies ofscale. Thus, while small companies achieved during the three years2008-2010 an operating margin of around11.5%, charges reduced the fixed costprofitability by nearly 18 percentage points, thus leading tocompanies to clearly detrimental effects (-6.4% forthe corresponding period) (EC, 2012).

The first reason for the high proportion of fixed cost for thesmall firms (and hence the large gap betweenoperating margin and net profit) is the lowvelocity assets (0.3 for small versus0.6 to 0.7 for medium and large companies). This parameteris reflected in the high rate of depreciation on sales (20% in very small companies, compared to about 5%in large).

The high fixed cost significantly limitsflexibility of small companies, making them morevulnerable to falling demand conditions.Beyond the high fixed costs, financialcosts are also a high percentage of sales forsmall companies (5% versus 2% for large companies for the period2008-2010). Basic causes for this are:

The high borrowing cost (morethan 8.5% for individualbusinesses as opposed to 6.5% -5.5% for companies)

The low asset velocity of smaller companies, which limitsthe capital efficiency capital and hence the potentialdebt (as reflected in a high rateloan-to-sales ratio while the ratio of foreign to self-fundsis low).

It is however important to note that the level of debtof the small Greek companies is lower than therespective European. Specifically, the ratio of foreign toequity for small businesses (with turnover <€ 2 million)is 1.1 in Greece compared to 1.4 in Europe and theloans to sales index is close to 100% for Greece andclose to 125% for Europe. Under these conditions, thefinancial expenses as a percentage of sales are lower on Greek small companies, in relation to theirEuropean counterparts (5% versus 8%).

The second basic problem of SMEs is that the credit reduction fromsuppliers leads to an imbalance of funding. Limiting the supply of credit from suppliers andthe difficulty of finding capital (partly because oflimited profitability) create a significant gapof liquidity to SMEs.

In particular, credit suppliers are an importantfunding source for Greek SMEs, as they cover23% of external funding versus 16% forEuropean SMEs.This important liquidity gap was covered at a large extent by increasing the loanable funds to the total financing of SMEs, by 7 percentage pointsfrom 2006to 2011 (from 26% to 33%). More specifically, there financing of loans of SMEs led to a reduction of short-term liabilities to banks and an increase of long-term debt, mainly bonds and syndicated loans. Borrowing before the crisis was more advantageous than supplier credit. Lastly, as a result of limited liquidity, an increase in late payments on othercreditors (such as rents) is observed.

Company performance measurement

Businesses operate in a highly competitive environmentas continued economic and political developments at an international level, the changes made in the business environment and the strongerpressure from customers to the company, have drastically affected theconduct and operational and strategic aspects of modernbusiness. The challenge for any business is competitiveness, productivity, quality and ultimately profitability (Neely, 2004).

Furthermore, the product life cycle has shrunk while differentiation has advanced too much, resulting inconstantly developed new products. Businesses prefer to lengthenthe maturity phase of their product life cycle, rather than enterin the process of developing new products that will follow the traditionallife cycle with the phases of introduction, growth, maturity and decline (Neely, 2004).

In this rapidly evolving environment the management of data and information from the business are keys to competitiveness and growth. Businesses adjust their strategy and structure, while investing in new technologies that will help them translate their needs and desires of customers in offered value, which in turn will yield them wealth.

Bearing in mind the challenges outlined above, it is clear thattraditional performance management systems fail to meetmodern requirements and in response it is proposed to businesses that (Neely, 2004):

1. They outlinea vision that will be shared in clear strategicgoals

2. The managers launch a series of actions in order toachievecompany objectives

3. They create a performance monitoring system for these objectives which will enable the achievement of their goals.

From the classic metrics of performance inPerformance cards

A company’s Performance Measurement Systems -PMS are crucial tools for its management.In addition they are a mechanism that increases the likelihood of successfulintroduction of strategy and the achievement of the objectives ofthe business entity.

Financial metrics were the dominant component ofa company’s performance measuring systems until the recent past. The liquidity ratios, traffic speed, leverage and profitability were the main instruments for measuring performance. But financial metrics reflect the resultsof management actions made in the past and provide the finalpicture of the performance of the business without the factors that created itinvolved. The exclusive use of financialmeasurements would risk the sacrificing of the long-term growth of the companyto achieve short-term financial goals (Kim, Suh and Hwang, 2003).

Company management in order to address the lack of financial measurements introduced new additionalmeasurements which are related to the operating performance of the business. Thesenew evaluation systems were more of simple measurementlistsand not an integrated system with interlinkedperformance indicators. But the choice of various unrelated measurementswas not the solution to the fairness of the performance of the company (Smith1998).

The answer to the problem of good imaging of company performance was given by Kaplan and Norton in the early '90’s, by presenting a new approach to evaluation systemsfor business performance, which they called Balanced Scorecard - BSC. Their approach is a well-weighted group of key performance indicators, which assesses companyperformance in specific areas that are crucial for the further development offirm (Kaplan and Norton 1997).

Tables of balanced targeting or balanced scorecards orbalanced performance cards are some of the most innovativetools for measuring business performance. From 1990 onwards,they appear in case studies which approach the issue of measuringthe pace of continuous improvement of business operations.These cases showed the use of a newly created artthe "Combined Card-Combined balanced boardof Targeting », or else the Corporate Scorecard, which contained among differenttraditional economic indicators, other performance indicatorsas well, which were associated with the delivery times to customers, quality,completion times of the processes and effectivenessof development of new products. The experience of senior management withspecific tables appeared positive results and thereforestakeholders focused on the design of multidimensional targetingtables, since the latter promised, it would seem, out-performance needs of the organization (Kim et al., 2003).

Thus, the simple balances scorecards were expanded tothe "Balanced Target Tables", which are organized aroundfour separate dimensions - financial, customer, internal and innovation / learning. The name reflects the balance that must exist between short and long term objectives, betweeneconomic and non-economic indicators, including indicators of economic progressand headline indicators, and between external and internal dimensionsof efficiency. Pilot testing of prototypes of balanced target tables in specific company areas led toidentifying opportunities, feasibility, advantages, and ultimately, acceptance (Kaplan and Norton, 1992).

The use of balanced scorecards

Managers need guidance on many issues that arise in their environment and affect their performance. The balanced score card enables managers by giving them the necessary tools to navigate in future competitive success. The balanced scorecard emphasizesachieving economic goals but also includes performance drivers for these financial goals. It also enables a firm to monitor its financial resultsand at the same time the progress in building its capabilities. Henceit contributes to the acquisition of intangible assets that will be needed forpotential growth, and intangible assets became a key source of competitive advantage of a company. This resulted in a change from the business strategy ofmeasurable resource management to the creation and management of intangibleassets.

The balanced scorecard is a general framework, composed by the four aspectsmentioned above, but the implementation is as unique as thecompany in which it applies. That is because each business unit has itsown vision, mission and strategy, its own unique competitiveadvantages and manages physical and intangible resources in its ownunique way (Epstein and Manzoni 1997). So there should be a clear link between the balanced score card with the business strategy. The balanced scorecardis thetable derived by multiplying the selected specific indicators -Key Performance Indicators – KPI – of the performance of every aspect of thecorresponding statistical weights. Obviously, the success in using the balanced score cards depends on the appropriate selection of indicatorsof performance for each aspect, and the correct determination of the ratewith which each index participates in the total balanced scorecard. The balanced score card is primarily a mechanism for strategy implementation and not for configuration and strategy formulation.

REFERNCES

Epstein M.J. and Manzoni J.F. (1997).The Balanced Scorecard and Tableux de Bord :Translating Strategy into Action, Management Accounting. Vol August

European Commission (2012).SBA Fact Sheet, 2012, Greece. Retrieved from http://ec.europa.eu/enterprise/policies/sme/facts-figures-analysis/performance-review/files/countries-sheets/2012/greece_en.pdf

Gaganis, C. and Zoupounidis, K. (2008).Identifying counterfeit accounting statements: Methodological Framework and Applications. Klidarithmos: Athens

Hyz, A.b. (2011). Small and Medium Enterprises (SMEs) in Greece - Barriers in Access to Banking Services.An Empirical Investigation.International Journal of Business and Social Science. 2:2, pp. 161-165

Kaplan R.S. and Norton,D.P. (1992).The Balanced Scorecard : Measures that drive performance. Harvard Business Review, Vol. January-February

Kaplan R.S. and. Norton,D.P (1997).Why does business need a Balanced Scorecard?.Journal of cost management, Vol. May-June

Kim, J., Suh, E. and H. Hwang.(2003). A Model for Evaluating the Effectiveness ofCRM Using the Balanced Scorecard, Journal of Interactive Marketing. 17:2, 5-19.

Neely,A. (2002). Business performance measurement, Theory and practice.Cambridge University Press. p. 22-40

Smith M. (1998).Measuring organizational effectiveness, Management Accounting, Vol. October

Voulgari, F., Asteriou, D. Agiomirgianakis, G.M. (2000).Financial Development and Financial Structure of Industrial SMEs: The Case Of Greece. European Research Studies Journal, vol. III, issue 3-4, pages 95-110