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The vast majority of small and medium-sized enterprises (SMEs) operating in Hong Kong and on the Chinese mainland ultimately fail. The main reasons for their failure are not challenges posed by the external environment, but by deficiencies in their own internal strategies, management and operations.

One of the main internal challenges SMEs often face relates to financing operations and financial management. Because of the perceived higher risks involved, SMEs often have a difficult time obtaining financing for start-up, expansion and working capital. Moreover, many SMEs have primitive financial management that can cause problems.

To rectify the situation, SMEs should take some practical steps to improve their financial management.

First, they should develop good relationships with banks as lenders are the main source of finance, other than family funds and retained earnings. To this end, SMEs are advised to maintain regular contact with banks and the management could consider socializing with bankers as an opportunity to talk about the company's needs, future plans and get advice from bankers. The management could also consider contacting banks that they do not presently transact with to identify ways to work with those banks in the future and put in place contingency plans should the relationship with their present banks deteriorate.

SMEs need to establish adequate credit lines as well. Even though there is an expense to establishing credit lines, establishing them in advance of need is always better than waiting for the need to arise when terms will be tougher. The management should also consider talking to a range of banks, which includes those currently used and at least one other reputable bank that they do not to put credit facilities in place. The management could also take the opportunity to explain their future needs and plans to the banks and identify why the credit line might be needed. The main objective of this exercise is to negotiate with the banks for the best possible terms on establishing a credit facility.

In cases when the need arises, SMEs can also consider using asset-backed financing. Selling account receivables, and borrowing against assets like properties, plants and equipment are all potential sources of financing.

However this type of financing should be carefully calculated to ensure the interest payable, as well as other costs, are justified versus other financing options that are available.

In another sound financial-management practice, SMEs should formulate strong cash management policies. Weak cash management is the most common reason that many SMEs fail. The management should know their cash position on a daily basis by checking their cash and bank balance regularly. They should ask accountants to prepare regular cash flow statements and monitor cash inflows and outflows. Cash forecasts should be prepared to identify future cash needs and management must ensure that proper authorization is sought before cash commitments are made.

In any case, SMEs should ensure they keep enough cash in the business. In most situations, the primary source of income for the SME owner is profit. Sufficient profit, however, needs to be retained in the company to see it through difficult times.

The author is a partner at Grant Thornton Jingdu Tianhua, a tax and advisory services provider. The views expressed here are entirely his own.

(HK Edition 11/30/2011 page2)