Modern Financial Management Theories & Small Businesses Joss Finance

The following are some examples of modern financial management theories formulated on principles considered as ‘a set of fundamental tenets that form the basis for financial theory and decision-making in finance’ (Emery et al.1991). An attempt would be made to relate the principles behind these concepts to small businesses’ financial management.

Agency Theory

Agency theory deals with the people who own a business enterprise and all others who have interests in it, for example managers, banks, creditors, family members, and employees. The agency theory postulates that the day to day running of a business enterprise is carried out by managers as agents who have been engaged by the owners of the business as principals who are also known as shareholders. The theory is on the notion of the principle of ‘two-sided transactions’ which holds that any financial transactions involve two parties, both acting in their own best interests, but with different expectations.

Problems usually identified with agency theory may include:

i. Information asymmetry- a situation in which agents have information on the financial circumstances and prospects of the enterprise that is not known to principals (Emery et al.1991). For example ‘The Business Roundtable’ emphasised that in planning communications with shareholders and investors, companies should consider never misleading or misinforming stockholders about the corporation’s operations or financial condition. In spite of this principle, there was lack of transparency from Enron’s management leading to its collapse;

ii. Moral hazard-a situation in which agents deliberately take advantage of information asymmetry to redistribute wealth to themselves in an unseen manner which is ultimately to the detriment of principals. A case in point is the failure of the Board of directors of Enron’s compensation committee to ask any question about the award of salaries, perks, annuities, life insurance and rewards to the executive members at a critical point in the life of Enron; with one executive on record to have received a share of ownership of a corporate jet as a reward and also a loan of $77m to the CEO even though the Sarbanes-Oxley Act in the US bans loans by companies to their executives; and

iii. Adverse selection-this concerns a situation in which agents misrepresent the skills or abilities they bring to an enterprise. As a result of that the principal’s wealth is not maximised (Emery et al.1991).

In response to the inherent risk posed by agents’ quest to make the most of their interests to the disadvantage of principals (i.e. all stakeholders), each stakeholder tries to increase the reward expected in return for participation in the enterprise. Creditors may increase the interest rates they get from the enterprise. Other responses are monitoring and bonding to improve principal’s access to reliable information and devising means to find a common ground for agents and principals respectively.

Emanating from the risks faced in agency theory, researchers on small business financial management contend that in many small enterprises the agency relationship between owners and managers may be absent because the owners are also managers; and that the predominantly nature of SMEs make the usual solutions to agency problems such as monitoring and bonding costly thereby increasing the cost of transactions between various stakeholders (Emery et al.1991).

Nevertheless, the theory provides useful knowledge into many matters in SMEs financial management and shows considerable avenues as to how SMEs financial management should be practiced and perceived. It also enables academic and practitioners to pursue strategies that could help sustain the growth of SMEs.

Signaling Theory

Signaling theory rests on the transfer and interpretation of information at hand about a business enterprise to the capital market, and the impounding of the resulting perceptions into the terms on which finance is made available to the enterprise. In other words, flows of funds between an enterprise and the capital market are dependent on the flow of information between them. (Emery et al, 1991). For example management’s decision to make an acquisition or divest; repurchase outstanding shares; as well as decisions by outsiders like for example an institutional investor deciding to withhold a certain amount of equity or debt finance. The emerging evidence on the relevance of signaling theory to small enterprise financial management is mixed. Until recently, there has been no substantial and reliable empirical evidence that signaling theory accurately represents particular situations in SME financial management, or that it adds insights that are not provided by modern theory (Emery et al.1991).

Keasey et al(1992) writes that of the ability of small enterprises to signal their value to potential investors, only the signal of the disclosure of an earnings forecast were found to be positively and significantly related to enterprise value amongst the following: percentage of equity retained by owners, the net proceeds raised by an equity issue, the choice of financial advisor to an issue (presuming that a more reputable accountant, banker or auditor may cause greater faith to be placed in the prospectus for the float), and the level of under pricing of an issue. Signaling theory is now considered to be more insightful for some aspects of small enterprise financial management than others (Emery et al 1991).

The Pecking-Order Theory or Framework (POF)

This is another financial theory, which is to be considered in relation to SMEs financial management. It is a finance theory which suggests that management prefers to finance first from retained earnings, then with debt, followed by hybrid forms of finance such as convertible loans, and last of all by using externally issued equity; with bankruptcy costs, agency costs, and information asymmetries playing little role in affecting the capital structure policy. A research study carried out by Norton (1991b) found out that 75% of the small enterprises used seemed to make financial structure decisions within a hierarchical or pecking order framework .Holmes et al. (1991) admitted that POF is consistent with small business sectors because they are owner-managed and do not want to dilute their ownership. Owner-managed businesses usually prefer retained profits because they want to maintain the control of assets and business operations.

This is not strange considering the fact that in Ghana, according to empirical evidence, SMEs funding is made up of about 86% of own equity as well as loans from family and friends(See Table 1). Losing this money is like losing one’s own reputation which is considered very serious customarily in Ghana.

Access to capital

The 1971 Bolton report on small firms outlined issues underlying the concept of ‘finance gap’ (this has two components-knowledge gap-debt is restricted due to lack of awareness of appropriate sources, advantages and disadvantages of finance; and supply gap-unavailability of funds or cost of debt to small enterprises exceeds the cost of debt for larger enterprises.) that: there are a set of difficulties which face a small company. Small companies are hit harder by taxation, face higher investigation costs for loans, are generally less well informed of sources of finance and are less able to satisfy loan requirements. Small firms have limited access to the capital and money markets and therefore suffer from chronic undercapitalization. As a result; they are likely to have excessive recourse to expensive funds which act as a brake on their economic development.

Leverage

This is the term used to describe the converse of gearing which is the proportion of total assets financed by equity and may be called equity to assets ratio. The studies under review in this section on leverage are focused on total debt as a percentage of equity or total assets. There are however, some studies on the relative proportions of different types of debt held by small and large enterprises.

Equity Funds

Equity is also known as owners’ equity, capital, or net worth.

Costand et al (1990) suggests that ‘larger firms will use greater levels of debt financing than small firms. This implies that larger firms will rely relatively less on equity financing than do smaller firms.’ According to the pecking order framework, the small enterprises have two problems when it comes to equity funding [McMahon et al. (1993, pp153)]:

1) Small enterprises usually do not have the option of issuing additional equity to the public.

2) Owner-managers are strongly averse to any dilution of their ownership interest and control. This way they are unlike the managers of large concerns who usually have only a limited degree of control and limited, if any, ownership interest, and are therefore prepared to recognise a broader range of funding options.

Financial Management in SME

With high spate of financial problems contributing to the high rate of failures in small medium enterprises, what do the literature on small business say on financial management in small businesses to combat such failures?

Osteryoung et al (1997) writes that “while financial management is a critical element of the management of a business as a whole, within this function the management of its assets is perhaps the most important. In the long term, the purchase of assets directs the course that the business will take during the life of these assets, but the business will never see the long term if it cannot plan an appropriate policy to effectively manage its working capital.” In effect the poor financial management of owner-managers or lack of financial management altogether is the main cause underlying the problems in SME financial management.

Hall and Young(1991) in a study in the UK of 3 samples of 100 small enterprises that were subject to involuntary liquidation in 1973,1978,and 1983 found out that the reasons given for failure,49.8% were of financial nature. On the perceptions of official receivers interviewed for the same small enterprises, 86.6% of the 247 reasons given were of a financial nature. The positive correlation between poor or nil financial management (including basic accounting) and business failure has well been documented in western countries according to Peacock (1985a).

It is gainsaying the fact that despite the need to manage every aspect of their small enterprises with very little internal and external support, it is often the case that owner-managers only have experience or training in some functional areas.

There is a school of thought that believes “a well-run business enterprise should be as unconscious of its finances as healthy a fit person is of his or her breathing”. It must be possible to undertake production, marketing, distribution and the like, without repeatedly causing, or being hindered by, financial pressures and strains. It does not mean, however, that financial management can be ignored by a small enterprise owner-manager; or as is often done, given to an accountant to take care of. Whether it is obvious or not to the casual observer, in prosperous small enterprises the owner-managers themselves have a firm grasp of the principles of financial management and are actively involved in applying them to their own situation.” McMahon et al. (1993).

Some researchers tried to predict small enterprise failure to mitigate the collapse of small businesses. McNamara et al (1988) developed a model to predict small enterprise failures giving the following four reasons:

– To enable management to respond quickly to changing conditions

– To train lenders in recognising the important factors involved in determining an enterprise’s likelihood of failing

– To assist lending organisations in their marketing by identifying their customer’s financial needs more effectively

– To act as a filter in the credit evaluation process.

They went on to argue that small enterprises are very different from large ones in the area of borrowing by small enterprises, lack of long-term debt finance and different taxation provisions.

For small private companies, these measures are unreliable and textbook methods for judging investment opportunities are not always useful in organisations that are privately owned to give a true and fair view of events taking place in the company.

Thus,modern financial management is not the ultimate answer to every business problem including both large and small businesses.However,it could be argued that there is some food for thought for SMEs concerning every concept considered in this study. For example it could be seen (from the literature reviewed )that, financial records are meant to examine and analyse corporate operations. Return on equity, return on assets, return on investment, and debt to equity ratios are useful yardsticks for measuring the performance of big business and SMEs as well.

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Defining Bad Credit: What You Need to Know to Get a Personal Loan

It is no secret that the economy is not doing too well these days. Both individuals and businesses are hurting. What is worse, if you were one of the unlucky ones caught in the bubble burst of the late 00’s, then likely your credit score went down the tube as well. As a result of this global financial mess, qualifying for credit cards is not as easy as it once was. Therefore, those in a hard spot in terms of money are often left with only one option: personal loans. The good news is that having bad credit does not automatically disqualify you from receiving this help.

Defining Bad Credit: What Is a “Bad” Credit Score?

An important fact to cover when it comes to lending these days is the definition of a bad credit score. Often, people get rejected for financing once and they automatically assume that they have “bad” credit. However, it is not that simple.

Most banks and private lenders will look at your FICO credit scores, which is reported by the big three agencies – Trans Union, Equifax, and Experian. FICO is short for the Fair Isaac Corporation. This is the financial agency that first came up with the credit scoring system as we know it in the United States. A FICO score can range anywhere between 330 and 850. The higher your score, the more creditworthy you are to lenders.

Technically speaking, a “bad” credit score is anything below 600. Those whose scores range from 601-640 have poor scores, but are generally still able to get loans at a high interest rate. A score from 641-680 is a medium score that will qualify you for most loans. Above 680 is the ideal and above 720 will get you the best rates offered.

How Is a Credit Score Calculated?

There are several different factors that go into the Fair Isaac system of credit calculation. These include:

1) The Length of Your Credit History

2) The Status of Your Accounts and History of Repayment

3) Total Debt

4) Types of Credit Used (Credit Cards, Student Loans, etc.)

5) Amount of New Credit Recently Sought (Inquiries into Your Credit Score)

Among the most important of these is your ability to show consistent, on-time payments to all debts you incur – the status of your accounts and history of repayment. In times of plenty, this is seldom a problem. What hit a lot of people the hardest in the financial bubble bust, however, was that due to lay-offs, ballooning interest rates and exorbitant fees, payments that were easy to make became impossible.

If you fell into a trap like this, your low credit score is not only understandable, but workable. In addition, other unforeseen expenses such as medical bills or family emergencies can create the same problems for people in terms of loan payback. If you want to get a personal loan now, as long as you have reformed and can prove your honest intent, then there are options out there.

Getting a Personal Loan with Bad Credit

Your best option for getting the money that you need is to look online towards private lenders who specialize in working with those who have a history of bad credit. Private online lenders can sit down with you and review the circumstances that led to your credit score being where it is and can often help you by offering a lending package that is not only affordable, but will help improve your credit in the long run.

Mezzanine Financing Overview: What It Is, Pros and Cons, and Common Situations Joss Finance

If you’re raising growth capital to expand your business, you may want to consider using mezzanine financing as part of your funding solution.

Mezzanine financing is a form of debt that can be a great tool to fund specific initiatives like plant expansions or launching new product lines, as well as other major strategic initiatives like buying out a business partner, making an acquisition, financing a shareholder dividend payment or completing a financial restructuring to reduce debt payments.

It is commonly used in combination with bank provided term loans, revolving lines of credit and equity financing, or it can be used as a substitute for bank debt and equity financing.

This type of capital is considered “junior” capital in terms of its payment priority to senior secured debt, but it is senior to the equity or common stock of the company. In a capital structure, it sits below the senior bank debt, but above the equity.

Pros:

  1. Mezzanine Financing Lenders are Cash Flow, Not Collateral Focused: These lenders usually lend based on a company’s cash flow, not collateral (assets), so they will often lend money when banks won’t if a company lacks tangible collateral, so long as the business has enough cash flow available to service the interest and principal payments.
  2. It’s a Cheaper Financing Option than Raising Equity: Pricing is less expensive than raising equity from equity investors like family offices, venture capital firms or private equity firms – meaning owners give up less, if any, additional equity to fund their growth.
  3. Flexible, Non-Amortizing Capital: There are no immediate principal payments – it is usually interest only capital with a balloon payment due upon maturity, which allows the borrower to take the cash that would have gone to making principal payments and reinvest it back into the business.
  4. Long-Term Capital: It typically has a maturity of five years or more, so it’s a long term financing option that won’t need to be paid back in the short term – it’s not usually used as a bridge loan.
  5. Current Owners Maintain Control: It does not require a change in ownership or control – existing owners and shareholders remain in control, a key difference between raising mezzanine financing and raising equity from a private equity firm.

Con’s

  1. More Expensive than Bank Debt: Since junior capital is often unsecured and subordinate to senior loans provided by banks, and is inherently a riskier loan, it is more expensive than bank debt
  2. Warrants May be Included: For taking greater risk than most secured lenders, mezzanine lenders will often seek to participate in the success of those they lend money to and may include warrants that allow them to increase their return if a borrower performs very well

When to Use It

Common situations include:

  • Funding rapid organic growth or new growth initiatives
  • Financing new acquisitions
  • Buying out a business partner or shareholder
  • Generational transfers: source of capital allowing a family member to provide liquidity to the current business owner
  • Shareholder liquidity: financing a dividend payment to the shareholders
  • Funding new leveraged buyouts and management buyouts.

Great Capital Option for Asset-Light or Service Businesses

Since mezzanine lenders tendency is to lend against the cash flow of a business, not the collateral, mezzanine financing is a great solution for funding service business, like logistics companies, staffing firms and software companies, although it can also be a great solution for manufacturers or distributors, which tend to have a lot of assets.

What These Lenders Look For

While no single business funding option is suited for every situation, here are a few attributes cash flow lenders look for when evaluating new businesses:

  • Limited customer concentration
  • Consistent or growing cash flow profile
  • High free cash flow margins: strong gross margins, low capital expenditure requirements
  • Strong management team
  • Low business cyclicality that might result in volatile cash flows from year to year
  • Plenty of cash flow to support interest and principal payments
  • An enterprise value of the company well in excess of the debt level

Non-Bank Growth Capital Option

As bank lenders face increasing regulation on tangible collateral coverage requirements and leveraged lending limits, the use of alternative financing will likely increase, particularly in the middle market, filling the capital void for business owners seeking funds to grow.

7 Tips to Help You Profit More From Your Online Business

Business owners always want to earn profits. It’s always the goal, no matter how big or small your business is. Earning good profits can be a challenge, but it’s very possible. Just be willing to study the tactics to earn good profits online. With that in mind, here are 7 tips to kickstart your profit-earning from your online business.

1. Give Back to Your Customers

Your customers will surely feel valued if your business has a loyalty or rewards programme. Giving back to your customers builds loyalty with them, and so they will keep on buying and buying your products in the long term. Maybe you can reward your customers every time they buy, say, more than £100 worth of your products. Alternatively, you could give bonuses to customers who refer your business to other people they know.

2. Hold a Christmas / Holiday Term Sale

Holding a sale for holiday seasons like Christmas is one of the best ways to make money online. Don’t worry about selling your products at a discount, because in the end you’ll drive traffic to your site, attract more customers, and make more sales. It’s also a good way to promote your business to others, as people are always attracted to products sold at cheaper prices.

3. Talk to Your Customers (via Chat Room)

Put up a chat room on your website, where your customers can talk to you, ask questions, and voice their concerns. It gives them the chance to get their questions answered immediately. As a result, your clients will feel that your business is always accessible. This way, they will trust your business even more.

4. Be Sociable (in Social Media)

Of course, having an online business means having social media accounts. Get comfortable with Twitter, Facebook, Instagram, Pinterest, and other social networks. Use these tools to market your products. Leverage the power of crowdsourcing: allow your followers to do the advertising for you! Your followers will make your product known through shares, retweets, and reviews on their personal accounts. The further your reach in social media, the more products you’ll sell, and the more money you’ll make. And if you get lucky, next thing you know a celebrity is already endorsing your product through their social media accounts!

5. Welcome Media Exposure

Don’t pass up any opportunity to get interviewed. This way, you can show people your expertise in your field, especially if you’re running a consulting business. Once people know you as someone who is very good at what you do, they will look up to you and trust your business. This will surely build up your customer base quickly.

6. Make Use of Webinars

Webinars are great sources of passive income. Take advantage of this and sell your products online through live webinars, where many people are listening. And if you’re in a webinar with trusted people, just like #5, people will likely trust you as well. Thus, this is another great way to expand the reach of your business.

7. Advertise on Google

You’ll have the whole world as your audience when you run an ad on Google. Nearly everyone uses Google daily, and people use Google more than any other site. Your reach will be massive!

Follow these top 7 tips to boost your earnings from your online business now! You’ll never regret them.

Need a Financial Breakthrough? Access the Power of Prayer! Joss Finance

When they need a financial breakthrough, most people have no trouble asking God for help. As Christians, we are taught to “make our requests known” through prayer. We understand that there is power in prayer. We understand that there is power in prayer. And when you have an urgent financial need, you don’t have time to wait. You need all the power you can get and you need it fast! Right?

Unfortunately, too often, we fail to see that power work in a timely manner-if at all. But how can that be? Scripture assures us that God hears our prayers and is faithful to answer, right? So what’s the problem? Why don’t we get what we’re asking God for-when we need it?

To achieve your financial breakthrough you must effectively using the power of prayer!! That’s why! You see, the power of prayer is not found solely during time on your knees. This is just the beginning-it’s like flipping the switch that sets a series of events in motion. It’s the completion of those events that produces the results you desire. So here are four series of events that ignite the power of prayer and expedite your financial breakthrough.

#1: The Word As The Foundation For Your Financial Breakthrough.

For your prayers to lead to quick results you have to know what to pray. God doesn’t honor just any old request. This means you have to find the word on your particular situation. So, the first thing to do is answer the question, “God, what does your word say about how my situation is supposed to be? To help you out, here are a few examples.

If you need money for a basic need like buying food and paying the rent or mortgage, utilities, or for an urgent medical procedure:

Why be like the pagans who are so deeply concerned about these things? Your heavenly Father already knows all your needs, and he will give you all you need from day to day if you live for him and make the Kingdom of God your primary concern. (Matthew 6:32-33 NLT)

For money to pay creditors to avoid losing your car, house, or business:

The Lord says, “I will rescue those who love me. I will protect those who trust in my name. (Psalm 91:14 NLT)

Or to overcome poverty or lack and get on the road to prosperity:

Study this Book of the Law continually. Meditate on it day and night so you may be sure to obey all that is written in it. Only then will you succeed. I command you-be strong and courageous! Do not be afraid or discouraged. For the Lord your God is with you wherever you go. (Joshua 1:8-9 NLT)

Okay, so now you’re armed with a few scriptures, now what? How do I use this to help me get what I need?

#2: A Strong Belief That God Will Provide Your Financial Breakthrough.

Most of the time we believe the word is true for someone else but not for ourselves. You must convince yourself that His word is true not just for your family member, friend or neighbor but that it’s true for you! There are two things to do to convince your brain that the word works!

Number one, you must constantly confess the word. Speak these scriptures over and over and over and over. Every time you have a thought contrary to His word, counter that thought by speaking the word out loud. Don’t be afraid if others hear you.

Number two, visualize that word being true. You have to see that financial breakthrough happening in your life. As you confess the word, picture it coming true. Engross yourself in that image as if you’re already there. Feel every emotion that you’ll experience when your breakthrough arrives. Heck! In your mind, go ahead and start planning the party!!!

Okay, got the word, and I’m convinced that it’s going to happen for me-not just someone else but me! Now what?

#3: Actions That Back Up The Belief For Your Financial Breakthrough!

Notice in the scriptures above God says, I will do this if you do that. The biggest mistake that limits the power of prayer and delays your financial breakthrough is lack of proper action after the prayer. We know that without faith it is impossible to please God. And, we know that faith is believing His word. What we forget or tend to discount is that there is work involved in having faith-without works faith is dead. So now it’s time to act like the word is true. How do you do that? If God say’s that he has provided for your needs then get busy finding out where he’s keeping that provision.

But, Arica, you say, what about waiting on the Lord? What about it? When your house is on fire do you sit in the living room waiting for God to put the fire out? Of course not! Then why sit around waiting on a miracle when your lights are about to get cut off or you’re about to lose your home? Just because I’m busy doing what I can doesn’t mean that I’m not waiting on God. I’ll be right where I’m supposed to be when he needs to get my miracle to me. In the meantime, I’m going to do what he says in Matthew 7:7.

Ask

If you need money for basic needs or to keep from losing your car or house ask yourself, “What programs, services, etc. are available to people in this situation?” If you need a job ask, “What must I do get a job?”

Seek

Seek out those who can lead you to or provide your financial breakthrough by asking, “What individuals, companies, or government agencies can provide me with all or part of what I need?” “Where are they located?” “How do I get in touch with them?”

Knock

Knock on the doors of those that can possibly help you and ask for your financial breakthrough. Find out, “Can you help me?” “Do I qualify?” If not, “Do you know someone who can?” Don’t wait for God to magically drop the answer to your prayer in your lap. Get out of the house and find out where he’s keeping your financial breakthrough!

And lastly,

#4: Persistence In Faith For Your Financial Breakthrough.

Now of course there are times when you’ve done everything you know to do and still don’t see your financial breakthrough. What do you do?

Persist in faith-that is, in believing and doing. No matter what it looks like keep using the word of God to combat every thought, emotion or feeling that tries to convince you that your financial breakthrough isn’t coming. Keep asking, “What else can be done? Keep seeking, “Who else can help?” And keep knocking, “Where else can I go?” Before you know it, you’ll have your breakthrough and a whole lot more!