Studies on Working Capital Management in SMEs

Despite the increased attention paid to the SME sector both in developed and developing countries, there is comparatively little knowledge about the process of financial management and to what extent SMEs’ growth are being inhibited as a result of poor WCM practices. The research undertaken so far has increased our understanding with regards to the overall numbers of small firms, their characteristics, the number of jobs created, the number of small firms concerned with the take-up and use of support schemes, the number of firms that are using different forms of finance (Winborg, 1997) and which economies in the world have probably the most dynamic SME populations.  However our knowledge on process issues, such as financial management decisions in SME remains something of a ‘black box’ (Deakins et al., 2001). However, the biggest problem which most SMEs usually face is that of a lack of liquidity, which is often the result of late payment or poor credit management (Howorth and Wilson, 1998; Berry et al., 2002).   Ironically, their operations may turn out to be very profitable in the long run, but due to liquidity (cash flow) problems, they get into financial difficulties. On this note, Kolay (1991) highlighted  that firms need to systematically plan for adopting suitable short and long-term strategies to manage and avoid future working capital crisis.

Despite the increasing importance attached to small scale economic activities across the globe there appears to have little reported improvement in the financial management skills of small business owners (Jarvis et al., 1996). It is surprising to note that no specific research has been undertaken to tap the potential benefits that SMEs can reap by adopting a good framework of WCM routines. This area has not received the same consideration as the many other areas, ranging from start-ups to schemes promoting the growth of the sector (Dewhurst and Burns, 1989; Jarvis et al., 1996; Johnson and Soenen, 2003). There is a substantial amount of literature providing detailed and carefully tailored advice to small business owners on financial management. But none of them have specifically looked into the WCM of manufacturing firms, where working capital is expected to form a large share of total investment.

Importance of Working Capital Management

Managing cash flow and cash conversion cycle (CCC) is a critical component of overall financial management for all firms, especially those who are capital rationed and more reliant on short-term sources of finance (Walker and Petty, 1978; Cosh and Hughes, 1994; Banos-Caballero, Garcıa-Teruel and Martınez-Solano; 2011). The link between credit management/financial management and corporate performance was given as an area for further investigation in the study of Peel, Wilson and Howorth (2000).

Working capital represent that part of the firm’s investment which makes the business becomes operational. Thus, its management is crucial to ensure the continued flow of resources and for the survival of the firm. Kolay (1991) pointed out that systematic planning for adopting suitable short and long term strategies to manage and avoid future working capital crisis situation is crucial. A shortage of working capital usually forces organisations to take actions that might further aggravate the working capital position.

 A poor WCM can affect all areas of the firm’s operations, creating problems such as delay in production, accumulation of unpaid invoices, suppliers withholding delivery against payment of long outstanding bills, unable to meet interest charges, thereby escalating the level of outstanding debt, postponing major repairs and maintenance among others. According to Kolay (1991, p. 46) ‘this may affect the availability of inputs, thereby lowering capacity utilisation, worsening internal cash generation and, consequently, worsening working capital position’