Financial Guide for SMEs - SME Corporation Malaysia

FinancialGuide for SMEs

SME Corporation MalaysiaLevel 6, SME 1, Block B,Lot E, Jalan Stesen Sentral 2,Kuala Lumpur Sentral50470 Kuala LumpurGeneral Line : 03-2775 6000Fax Line : 03-2775 6001Info Line: 1-300-30-6000Website : www.smecorp.gov.myFirst published in 2011Printed by Percetakan Jiwabaru Sdn BhdLot 14, No 2, Jalan P/8 Kawasan MIEL FASA 2,Bandar Baru Bangi, 43650 Bangi Selangor Darul Ehsan

Financial Guide for SMEsAbout the GuideThis Guide has been adopted from the Australian version entitled “AchievingFinancial Success” (formerly known as the Financial Survival Guide) preparedby Jan Barned (CPA, FFTP), with the assistance of CPA Australia and SmallBusiness Victoria. Ms. Barned who is the principal of Financial ManagementTrainer (www.fmtrainer.com.au), has worked in the fi nance industry internationallyand in Australia for over twenty years.SME Corporation Malaysia and CPA Australia have been granted the copyrightto reproduce the Guide and to modify the content to suit the Malaysian context.The Guide will be a useful reference for entrepreneurs on fi nancial managementwhich is a key success factor to any SME business, particularly for newentrepreneurs with little fi nancial background.Copyright NoticeCopyright 2011 SME Corporation Malaysia and CPA Australia. All rightsreserved. Subject to Copyright Act 1987 (Malaysia) and Copyright Act 1968(Australia).No part of this publication, including the contents, trademarks and tradenames may be reproduced, stored in a retrieval system or transmitted in anyform by any means including in websites, for commercial or non-commercialmeans without prior written permission of SME Corporation Malaysia andCPA Australia. Application for these uses shall be made directly to the ChiefExecutive Offi cer of SME Corporation Malaysia.In reproducing or quoting the contents, acknowledgement of source is required.DisclaimerWhilst every effort has been made to ensure the accuracy of the informationcontained in this book, both SME Corporation Malaysia and CPA Australiaaccept no responsibility for any errors and / or inaccuracies it may contain, orfor any loss, fi nancial or otherwise sustained by any person using informationextracted from this book. All information and specifi cation are current at thetime of preparation and are subject to change as may be required.No part of this Product is intended to be treated as advice, whether legal orprofessional. You should not act solely on the basis of the information containedin the Product as parts may be generalised and may apply differently todifferent people and circumstances. Furthermore, as laws change frequently,all users are advised to undertake their own research or to seek professionaladvice to keep abreast of any reforms and developments in the law.1chapter 1 01-21 Eng.indd 18/27/11 11:15:00 AM

Financial Guide for SMEsTable of ContentsIntroduction.................................................................................5Glossary of Terms ......................................................................6Section I : Business Finance Basics.....................................9Chapter 1: Understanding Financial Statements .......................11Income Statement .................................................................12Balance Sheet .......................................................................16Statement of Cash Flows ......................................................19Chapter 2: Assessing the Financial Health of Your Business ...23Liquidity Ratios ......................................................................23Solvency Ratios .....................................................................25Profi tability Ratios..................................................................26Management Ratios ..............................................................27Balance Sheet Ratios............................................................28Chapter 3: Budgeting....................................................................31Profi t and Loss Budget ..........................................................32Assumptions ..........................................................................33Monitoring and Managing Your Profi t and Loss Budget ........36Section II : Improving Business Finances...........................37Chapter 4: Maintaining Profitability.............................................39Profi tability Measures ............................................................39Discounting Sales..................................................................43Expense Management ..........................................................45Chapter 5: Improving Cash Flow .................................................47Managing Inventory ...............................................................49Managing Payments to Suppliers ..........................................54Managing Work-in-progress ..................................................58Managing Receivables ..........................................................60Working Capital Cycle – Cash Conversion Rate ...................642chapter 1 01-21 Eng.indd 28/15/11 5:01:21 PM

Financial Guide for SMEsChapter6 : Managing Cash Flow............................................67Cash and Profi t ........................................................67Cash Flow Drivers in Your Business .............................69Cash Flow Forecasting ..................................................71Section IIIChapterChapterChapter: Financing Your Business .................................797 : Debt, Equity or Internal Funds? .................................81Comparing Debt Finance, Equity Investment and InternalFunds .............................................................................81Deciding Between Debt and Equity ....................................91Understanding the Debt Financing Options :Long-term versus Short-term .........................................938 : Transactional Banking to Suit Business Needs ..103Transactional Banking Products ........................................103Merchant Facilities .......................................................104Transactional Fees ............................................................1069 : Trade Financing ...........................................................109Foreign Currency Payments ..............................................109Alternative Methods to Manage Foreign CurrencyPayments ..........................................................111International Trade Finance ...............................................112Section IV : Managing Lenders ...................................................119Chapter 10 : Applying For a Loan ....................................................121Preparing for a Loan Application .......................................121Details of the Loan Required .............................................134Presentation of the Loan Application .................................139The Role of Advisers .........................................................140Conclusion ........................................................................1403chapter 1 01-21 Eng.indd 38/15/11 5:01:22 PM

Financial Guide for SMEsChapter 11 : Refinancing Your Debt .......................................143How Refi nancing Works? ..........................................144Benefi ts of Refi nancing ............................................145Common Dangers in Refi nancing ..................................146Switching Banks ................................................................148Chapter 12 : Managing Your Banking Relationships .................153Annual Review ..................................................................153Continuing Relationships ...................................................154Managing Diffi culties .........................................................155Section V : Better Business Financial Management .......157Chapter 13 : Financial Controls .......................................................159Benefi ts of Financial Controls ...........................................160Financial Controls Checklist ..........................................161Appendix .................................................................................168Acknowledgement.................................................................1814chapter 1 01-21 Eng.indd 48/15/11 5:01:22 PM

Financial Guide for SMEsIntroductionSmall and medium enterprises (SMEs) are often driven by the passion toachieve the owners’ desired outcomes. They may want to see a business growfrom the start, be keen to enter into an industry that provides great challenge,or be motivated by personal reasons such as wanting to turn a hobby into abusiness or develop a long-term retirement plan. Whatever their reasons, manySME owners do not have formal fi nancial management training (that is they arenot an accountant or bookkeeper) and usually have limited resources to pay forsuch services.For the success of any business, good fi nancial management is necessary.Good fi nancial management will go a long way to ensure that all the availablebusiness resources are used effi ciently and effectively to provide optimumreturn.This Guide has been designed to help SMEs to develop the fi nancialmanagement skills that are essential for business success. Presented in easyto-understandlanguage, this Guide discusses the key fi nancial aspects thatSMEs should focus on to ensure that good fi nancial management is in place.The areas discussed in the Guide address the fi nancial aspects that a businessshould consider and understand as part of good fi nancial management. Ifthese practices are implemented early, the business would benefi t from strongfi nancial management and the owner would be equipped with the fi nancial toolsto operate and grow a successful business.It should be noted that some of the areas may not be relevant for allbusinesses. For instance, if you are providing a service, discussion on inventorymanagement will not be relevant. Also, you have to keep in mind the typeof industry that you are in when considering good fi nancial management. Forexample, if you run a café, you would probably be reviewing inventory levelsevery week; however, a small retail toy shop may only do an inventory countonce a year.This Guide has fi ve sections, each with a number of chapters to furtherelaborate on the key topics. There are hints and tips along the way to help youfocus on the important messages and these are summarised in the Appendixfor easy reference.5chapter 1 01-21 Eng.indd 58/15/11 5:01:22 PM

Financial Guide for SMEsGlossary of TermsAs with any topic, there is a wealth of jargon and terminology associated withfi nancial management. It is helpful for you to understand these terms whenreading fi nancial statements or when talking to fi nance professionals such asbank managers. This will make you feel more confi dent and comfortable. Themost basic and useful of these terms are set out below.Accrual AccountingAccounting EntryAccounting PeriodAssetBreak-evenBudgetCapital ExpenditureCash AccountingCash Conversion RateCash FlowCost of Goods Sold(COGS)Recognising income and expenses when they occurrather than when they are received or paid forBasic recording of business transactions as debitsand creditsA period for which fi nancial statements are prepared(normally monthly and then annually)Anything having a commercial value that is owned bythe businessAmount (in either units or value), that the businessneeds to achieve before a profi t is generatedA fi nancial plan for a business (allocating money thatthe business forecasts it will receive and spend);typically done once a yearAmount of money that is allocated or spent onassetsAccounting for transactions as they are received orpaidOverall number of days to convert a trade from thecash outfl ow at the beginning of the working capitalcycle to cash received at the end of the cycleFlow of cash into and out of the businessTotal cost of all goods sold during the period6chapter 1 01-21 Eng.indd 68/15/11 5:01:22 PM

Financial Guide for SMEsCreditorsCurrent AssetsCurrent LiabilitiesDepreciationDrawingsEquityExpensesFinancial RatioFinancial StatementsForecastingInventoryIntangiblesLiabilityGross MarginMark-upAmount of money that the business owes thesuppliersAssets that are likely to be turned into cash within a12-month periodLiabilities that are due within a 12-month periodWriting-off of a portion of a fi xed asset’s value in afi nancial periodWhere the owner of the business takes something ofmonetary value permanently out of the business(can be in the form of cash or other assets)Amount that the business owes the ownerCosts associated with earning the business incomeMethod by which the business can measure thefi nancial health and compare their business operationsto similar businesses in the same industryRecord of the financial performance and health of abusiness for a given periodProcess of predicting the future financial performanceof a businessStock that a business holds to sellAssets that do not have a physical form e.g. patents,goodwill etc.Amount of money that the business owes its externalstakeholdersProfi t from sales before deducting overheadsPercentage by which the sales price exceeds the cost7chapter 1 01-21 Eng.indd 78/15/11 5:01:22 PM

Financial Guide for SMEsOwners’ EquityOverheadsProfitPurchase OrderReceivablesRevenueRetained ProfitReservesWorking CapitalWork-in-progressAmount of capital contributed to form the businessor added laterCosts that are not directly associated with theproducts or services sold by the businessIncome minus expensesA commercial document issued by a buyer to aseller, indicating the type, quantity and agreed pricesfor products or services the seller will provide to thebuyerAmount that are owed to a business (sometimesreferred to as debtors)Income that the business earns from its operationsProfi ts that have not been distributed to the ownersRetained profi ts that are held for a specifi c purpose orthe result of revaluation of assetsExcess of current assets over current liabilitiesWhere an order has been taken from the customerand the business is in the process of “working” tocomplete the order8chapter 1 01-21 Eng.indd 88/15/11 5:01:22 PM

Section I : Business Finance BasicsKeeping the book for your business canprovide valuable information to enable younot only to prepare the fi nancial statements,but also to gain a better understanding onthe financial position of your business andhave insights into how to improve businessoperations. Good fi nancial systems will assistin monitoring the fi nancial situation, managingthe fi nancial position and measuring thesuccess of your business.In this fi rst section, we will look at the threekey fi nancial statements and discuss onhow you can use this information to improvebusiness operations through ratio analysisand to prepare an operating budget.Financial Guide for SMEsImplementing goodfi nancial practices inyour businesswill providesound fi nancialinformation that canidentify currentissues and be usedto plan for thesuccessful fi nancialfuture of yourbusiness9chapter 1 01-21 Eng.indd 98/15/11 5:01:23 PM

Financial Guide for SMEsChapter 1Understanding FinancialStatements10chapter 1 01-21 Eng.indd 108/15/11 5:01:23 PM

Financial Guide for SMEsUnderstanding Financial StatementsPlease note that this chapter is not designedto assist you with the preparation of fi nancialstatements but to familiarise you with whatthey look like and how they can be used tobenefi t your business.Every business requires some assets to beable to run the operations and ultimately makea profi t. This could be as simple as having cashin the bank, but is more likely to be a numberof assets, such as inventory (only unsoldinventory is an asset), offi ce equipment andperhaps even commercial premises. Sinceall of these items need to be paid for whenstarting up a business, the owners will needto invest their own money or borrow from alender (e.g. bank) or investor.Financial statementsprovide information onhow the business isoperating financiallyand why. Ensuring thatthese statements areproduced regularlywill provide financialinformation forcontinuousimprovement ofbusiness operationsThere are three fi nancial statements that record fi nancial information of abusiness, which are:• Income Statement;• Balance Sheet; and• Statement of Cash Flows.The fi nancial statements record the performance of your business and allowyou and others to diagnose the strengths and weaknesses of your businessby providing a written summary of the fi nancial activities for a given period. Toproactively manage your business, you should plan to generate these fi nancialstatements on a monthly basis, review the results and analyse for improvement.Let’s look at the financial statements and see how they can assist inmonitoring your businesses fi nancial performance.11chapter 1 01-21 Eng.indd 118/15/11 5:01:23 PM

Financial Guide for SMEsIncome StatementThe income statement is a summary of income and expenses for abusiness over a specific period. It should be prepared at regular intervals(usually monthly and at fi nancial year-end) to show the results of operations fora given period. Profi t or loss is calculated in the following way:SalesLessSales Discounts /SalesCommissionsEqualsNet SalesLessCost of Goods SoldEqualsGross ProfitLessExpenses(Fixed & Variable)Net ProfitOnly those businessesthat have goods(products) to sell willuse the calculation ofcost of goods soldEqualsHINTOpeningInventoryPlusInventory PurchaseEqualsInventory availablefor saleLessClosing InventoryCalculating the costof goods sold variesdepending on whether thebusiness is retail, wholesale, manufacturing or aservice business. In retailand wholesale business,computing the cost ofgoods sold during thereporting period involvesbeginning and endinginventories includingpurchases made duringthe period.In manufacturing, itinvolves fi nished goodsinventories, plus rawmaterials inventories,work-in-progressinventories, direct labour,and direct factory overheadcosts.In the case of a servicebusiness, the revenue isbeing derived from theactivities of individualsrather than the sale ofa product. Hence, thecalculation of cost ofgoods sold is a smallertask due to the low level ofmaterials usedto earn the income.12chapter 1 01-21 Eng.indd 128/15/11 5:01:23 PM

Financial Guide for SMEsCase Study – Adam’s Computer BagsAdam has decided to start his own business and has been doing someresearch. He will sell computer bag to computer manufacturers. He is goingto leave his job and has saved some money to help him go through thestart-up phase. He has decided that in the fi rst year, he is going to focuson getting the business established, so he believes that a small profi t(before interest and tax) of RM5,000 should be achievable. His researchhas shown that the expenses to set up and operate the business will beapproximately RM15,600 for the year.Profi tRM5,000plus operating expensesRM15,600Total cash neededRM20,600From this information, Adam can see that he will need at least RM20,600 tocover the operating expenses and achieve his profit goal. Adam’s researchhas also highlighted that it is reasonable to expect to sell at least 1,000 bagsin the first year. Adam has negotiated with a supplier to provide the bags forthe cost price of RM31.20 each. Now we can work out according to Adam’sestimates, how much sales need to be made to reach the profit goal.Profi tRM5,000plus operating expensesRM15,600Plus cost of1,000 bagsRM31,200(cost of goods sold)Adam will needa total ofRM51,800to achieve his targeted profi tMinimum selling price (RM51,800 divided by the1,000 bags that he will sell)equals to RM51.80 per bag.Adam thinks that he will be able to sell the bag for RM52.00 each. So, at the endof the fi rst year, if all goes according to the plan, his income statement wouldlook like this:13chapter 1 01-21 Eng.indd 138/15/11 5:01:23 PM

Financial Guide for SMEsAdam’s Computer BagsIncome StatementFor the Year Ending Year OneRevenueSalesTotal SalesRMRM52,00052,000(1,000 bags @ RM52 each)Cost of Goods Sold (COGS)Opening InventoryInventory PurchasesLess Closing InventoryRMRMRM-34,3203,120Total Cost of Goods SoldRM31,200(See details on the next page)Gross ProfitRM20,800ExpensesAdvertisingBank Service ChargesInsurancePayrollProfessional Fees(Legal, Accounting)Utilities & TelephoneOthers:Computer SoftwareTotal ExpensesRMRMRMRMRMRMRMRM50012050013,00020080048015,600Net Profit Before TaxRM5,20014chapter 1 01-21 Eng.indd 148/15/11 5:01:24 PM

Financial Guide for SMEsTowards the end of the year, Adam managed to purchase 100 more bagson credit from his supplier for an order in the new year. This leaves him withRM3,120 of inventory on hand at the end of the year.Calculation for Adam’s Cost of Goods SoldOpening inventoryNilPlus inventory purchased during the year RM34,320(1,100 bags @ RM 31.20 each)Equals inventory available for saleRM34,320Less inventory on hand at the end of RM 3,120the year(100 bags @ RM 31.20 each)Cost of goods soldRM31,200For a service business, the income statement will usually not have a calculationof cost of goods sold. In some instances, where labour costs can be directlyattributed to sales, you may consider including these costs as the cost of goods(services) sold.TIPRegularly (monthly) produce profi t and loss information and compareagainst activities in the previous months to ensure that your profi texpectations are being met15chapter 1 01-21 Eng.indd 158/15/11 5:01:24 PM

Financial Guide for SMEsBalance SheetThe balance sheet refl ects the fi nancial health of a business at a given time(usually the end of a month or fi nancial year). It lists in detail the various assetsthat the business owns, the liabilities and the value of the shareholders’ equityor net worth of the business:• Assets are the items of value owned by the business;• Liabilities are the amount of money owed to external stakeholders of thebusiness; and• Shareholders‘ equity or shareholders’ fund is the amount that the businessowes the owner.HINTAssetsRM 54,820Fundedthrough:LiabilitiesRM 9,620Shareholders’EquityRM 45,200This diagrammeshows how thebalance sheetworks. The businessrequires assets tooperate and theseassets will be fundedfrom the equity in thebusiness, the profitfrom the operationsof the business or byborrowing moneyfrom external parties.The balance sheet can also be illustrated as:AssetsRM 54,820MinusLiabilitiesRM 9,620EqualsShareholders’EquityRM 45,200The diagramme above shows that the value of all assets owned by thebusiness less the value owed to external stakeholders (liabilities) will equal theshareholders’ fund of the business – that is, the value of the business after alldebts have been paid.16chapter 1 01-21 Eng.indd 168/15/11 5:01:24 PM

Financial Guide for SMEsBalance Sheet Categories• Assets may include cash, inventories, land, buildings, equipment, machinery,furniture, patents and trademarks, as well as money due from individuals orother businesses (known as debtors or receivables).• Liabilities may include funds made available to the business from externalstakeholders by way of loans, overdrafts and other credit used to fund theactivities of the business including the purchase of capital assets andinventory and for the payment of general business expenses.• Shareholders’ equity (or net worth or capital) is the money put into a businessby its owners for use by the business in acquiring assets and paying for thecash requirements of the business.Balance Sheet ClassificationsFor assets and liabilities, a further classification is made to assist in monitoring thefi nancial position of a business. These classifi cations are referred to as “current”and “non-current”. Current refers to a period of less than 12 months and noncurrentis any period greater than 12 months.The balance sheet will list non-current assets followed by current assets. Noncurrentassets are assets that will continue to exist in their current form for morethan 12 months. These can include furniture and fittings, office equipment,company vehicles etc. While current assets will include items that are likely to beturned into cash within a 12-month period such as cash in the bank, monies owedfrom customers (referred to as receivables), inventories and other assets.Similarly, the balance sheet will include non-current liabilities followed by currentliabilities. Non-current liabilities are all the loans from external stakeholders thatdo not have to be repaid within the next 12 months. Meanwhile, current liabilitiesare those monies that must be repaid within 12 months and would typically includebank overdrafts, credit card debt and monies owed to suppliers (referred to aspayables). These will be followed by shareholders’ fund or equity.TIPA prosperous business will have assets of the business funded by profi tsrather than being heavily dependent on funding from either external parties(liabilities) or continuous cash injections from the owner (equity)17chapter 1 01-21 Eng.indd 178/15/11 5:01:24 PM

Financial Guide for SMEsBased on the case study of Adam’s Computer Bags, his balance sheet at theend of year one would look like as follows:Adam’s Computer BagsBalance SheetFor the Year Ending Year OneTotal Non-Current AssetsTotal Current Assets0Total Non-Current Liabilities0TOTAL LIABILITIES AND EQUITYRM54,82018chapter 1 01-21 Eng.indd 188/15/11 5:01:24 PM

Financial Guide for SMEsStatement of Cash FlowsThe statement of cash fl ows is a summary of moneycoming into, and going out of, the business over aspecifi c period. It is also prepared at regular intervals(usually monthly and at fi nancial year-end) to show thesources and utilisation of cash for a given period.The cash fl ows (in and out) are summarised on thestatement into three categories: operating activities,investing activities and fi nancing activities.HINTStatement of cashfl ows only showsthe historical dataand differs from acash fl ow forecastOperating activities: These are the day-to-day activities that arise from theselling of goods and services and usually include:• Receipts from income;• Payments for expenses and employees;• Payments received from customers (receivables);• Payments made to suppliers (payables); and• Inventory movements.Investing activities: These are the investments in items that will support orpromote the future activities of the business. They are the purchase and sale offi xed assets, investments or other assets and can include items such as:• Payment for purchase of property, plant and equipment;• Proceeds from the sale of the property, plant and equipment;• Payment for new investments, such as shares or fi xed deposits; and• Proceeds from the sale of investments.Financing activities: These are the methods by which a business fi nances itsoperations through borrowings from external stakeholders and equity injections,the repayment of debt or equity, and the payment of dividends. Following areexamples of the types of cash fl ow included in fi nancing activities:• Proceeds from the additional injection of funds into the business from the owners;• Money received from borrowings;• Repayment of borrowings; and• Payment of drawings (payments taken by the owners).19chapter 1 01-21 Eng.indd 198/15/11 5:01:25 PM

Financial Guide for SMEsAs mentioned earlier, the statement of cash fl ows can be a useful tool tomeasure the fi nancial health of a business and can provide helpful warningsignals. Three potential warning signs which, in combination, can indicate thepotential for a business failure are:• Cash receipts are less than cash payments (i.e. you are running out of money);• Net operating cash flow is an “outflow” i.e. it is negative; and• Net operating cash flow is less than profit after tax (i.e. you are spending morethan you earn).TIPUse the Cash Flow Statement to analyse if you are spending more thanyou are earning or drawing out too much cash from the business20chapter 1 01-21 Eng.indd 208/15/11 5:01:25 PM

Financial Guide for SMEsHere is an example of Adam’s Statement of Cash Flows, showing the relationship between the Income Statementand the Balance Sheet.Adam’s Computer BagIncome StatementAs At End of Year OneAdam’s Computer BagStatement of Cash FlowsFor the Year OneAdam’s Computer BagBalance SheetFor the Year Ending Year OneCash flows from operating activitiesIncomeRM 52,000RM 52,000SalesRM 52,000RM 5,500RM 8,100RM15,000Non-Current AssetsComputerStore FirnishingOffice Equipment–RM 15,600–RM 18,000–RM 34,320RM 4,120Receipts from incomePayments of expensesFunding to DebtorsRM 28, 6 00Total SalesInventory MovementsCost of Goods SoldFunding from Creditors0RM 34,320RM 3,120Opening Inventory–RM 11,800Net cash from operating activitiesRM 26,220Stock PurchasesRM 54,820Total Non-Current AssetsCurrent AssetsCashRM 5,100DebtorsRM18,000Inventory RM 3,120Total Current AssetsTOTAL ASSETSLess Closing InventoryCash flows from investing activities0Non-current Liabilities–RM 28,600Payments for property, plantand equipmentFinancial Guide for SMEsRM 31,200Total Cost of GoodsSold (COGS)0Total-Non current Liabilities–RM 28,600Net cash from investing activitiesCurrent LiabilitiesRM 20,800Cash flows from financing activitiesRM5,500RM4,120Gross ProfitCredit CardCreditorsRM 5,500Increase in Short Term DebtIncrease in Long Term DebtTotal Current Liabilities RM 9,620RM 9,620TOTAL LIABILITIESRM 15,600Expenses TotalRM 40,000RM 45,500Proceeds from owners (equity)Net cash from financing activitiesRM 45,200NET ASSETSShareholder’s EquityRM 5,200Net Profit before TaxRM 5,1000Net increase in cashCash balance as at start of yearRM 40,000RM 5,200Owners FundsCurrent Year ProfitRM 45,200Total Shareholders’ EquityRM 5,100Cash balance as at end of yearRM 54,820TOTAL LIABILITIES AND EQUITY2121 22chapter 1 01-21 Eng.indd 218/27/11 11:15:40 AM

Financial Guide for SMEsChapter 2Assessing the Financial Healthof Your Business22Chapter 2-5 p22-65 Eng.indd 228/15/11 5:01:50 PM

Financial Guide for SMEsAssessing the Financial Health of Your BusinessA helpful tool that can be used to predict thesuccess, potential failure and progress of yourbusiness is fi nancial ratio analysis. By spending timedoing fi nancial ratio analysis, you will be able to spottrends in your business and compare the fi nancialperformance and condition with the averageperformance of similar businesses in the sameindustry.Although there are many fi nancial ratios that youcan use to assess the health of your business, in thischapter we will focus on the main ones that can beeasily used. The ratios are grouped together underthe key areas that you should focus on.Liquidity RatiosThese ratios will assess the ability of your businessto pay its bills in due time. They indicate the easeof turning assets into cash and include the currentratio, quick ratio, and working capital (which arediscussed in detail in Chapter 5).Financial ratioanalysis willprovide theimportantwarning signs thatcould allow you tosolve yourbusinessproblems beforethey destroyyour businessHINTUse these ratios toassess if yourbusiness hasadequate cash to paydebts in due timeIn general, it is better to have higher ratios in this category, that is, more currentassets than current liabilities as an indication of sound business activitiesand an ability to withstand tight cash fl ow periods.Current ratio =Total current assetsTotal current liabilitiesOne of the most common measures of fi nancial strength, this ratio measureswhether the business has enough current assets to meet its debt obligationswith a margin of safety. A generally acceptable current ratio is 2 to 1; however,this will depend on the nature of the industry and the form of itscurrent assets and liabilities. For example, the business may have currentassets made up predominantly of cash and would therefore survive with arelatively lower ratio.23Chapter 2-5 p22-65 Eng.indd 238/15/11 5:01:51 PM

Financial Guide for SMEsQuick ratio =Current assets – inventoryCurrent liabilities – overdraftSometimes called the “acid test ratio”, this is one of the best measures ofliquidity. By excluding inventories which could take some time to turn into cashunless the price is ”knocked down,” it concentrates on real, liquid assets. Ithelps to answer the question: If the business does not receive income for aperiod, can it meet its current obligations with the readily convertible ”quick”funds on hand?TIPThe quick ratio will give you a good indication of the“readily” available cash to meet current debt obligations24Chapter 2-5 p22-65 Eng.indd 248/15/11 5:01:51 PM

Financial Guide for SMEsSolvency RatiosThese ratios indicate the extent to which thebusiness is able to meet all its debt obligationsfrom sources other than cash flow. In essence,it answers the question: If the business suffersfrom reduced cash flow, will it be able tocontinue to meet the debt and interest expenseobligations from other sources? Commonlyused solvency ratios are:HINTThese ratios measureif your business hasadequate long-term cashresources to cover alldebt obligationsLeverage ratio =Total liabilitiesEquityThe leverage (or gearing) ratio indicates the extent to which the business isdependent on debt fi nancing versus equity to fund the assets of the business.Generally speaking, the higher the ratio, the more diffi cult it will be to obtainfuture borrowings.Debt to assets =Total liabilitiesTotal assetsThis measures the percentage of assets being financed by liabilities. Generallyspeaking, this ratio should be less than 1, indicating adequacy of total assetsto fi nance all debt.TIPThese ratios indicate the extent to which the business isable to meet the debt obligations from all sources, otherthan just cash fl ow, as in the case with liquidity ratios25Chapter 2-5 p22-65 Eng.indd 258/15/11 5:01:51 PM

Financial Guide for SMEsProfitability RatiosThese ratios will measure your businessperformance and ultimately indicate the levelof success of your operations. More discussionon these measures is included in Chapter 4.HINTUse gross and netmargin calculationsto measure andmonitor theprofitability of yourbusiness operationsGross margin ratio =Gross profitRevenueThis measures the percentage of sales proceeds remaining (after obtainingor manufacturing the goods sold) to pay the overhead expenses of thebusiness.Net margin ratio =Net profitRevenueThis measures the percentage of sales proceeds left after all expenses(including inventories), except income taxes. It provides a good opportunityto compare the return on income of the business with the performance ofsimilar businesses.TIPComparing your net and gross margin calculations to businesseswithin the same industry will provide you with comparativeinformation and may highlight possible scope for improvementin your margins26Chapter 2-5 p22-65 Eng.indd 268/15/11 5:01:51 PM

Financial Guide for SMEsManagement RatiosManagement ratios monitor how effectively you aremanaging your working capital, that is, how quicklyyou are replacing your inventories, how often youare collecting debts outstanding from customers andhow often you are paying your suppliers. Thesecalculations provide an average that can be usedto improve business performance and measureyour business against the industry average (refer toChapter 5 for more details).HINTUse the number ofdays for inventory,debtors and creditorsto calculate the cashconversion rate foryour tradingactivitiesDays inventory = Inventory x 365Cost of goods soldThis ratio reveals how well your inventory is being managed. It is importantbecause it will indicate how fast inventory is being replaced. Usually, thehigher number of times the inventory can be turned in a given operating cycle,the greater the profi t.Days debtors = Accounts receivable x 365Net incomeThis ratio indicates how well the cash from customers is being collected -referred to as accounts receivable. If accounts receivable are excessivelyslow in being converted to cash, the liquidity of your business will be severelyaffected (accounts receivable is the total outstanding amount owed to you byyour customers).Days creditors = Accounts payable x 365Cost of goods soldThis ratio indicates how well accounts payable are being managed. Ifpayables are being paid on average before agreed payment terms or beforedebts are being collected, cash fl ow will be affected. If payments to suppliersare excessively slow, there is a possibility that relationship with thesupplier will be damaged.TIPComparing your management ratio calculations to businesses within thesame industry will provide you with comparative information that mayhighlight possible scope for improvement in your trading activities27Chapter 2-5 p22-65 Eng.indd 278/15/11 5:01:52 PM

Financial Guide for SMEsBalance Sheet RatiosThese ratios indicate how effi ciently your business isusing assets and equity to make a profi t.HINTUse the return onassets andinvestment ratios toassess the effi ciencyin the use of yourbusiness resourcesReturn on assets = Net profit before tax x 100Total assetsThis measures how effi ciently profi ts are being generated from the assetsused in the business. The ratio will only have meaning when compared withthe ratio of others in similar industry. A low ratio in comparison with the industryaverage indicates an ineffi cient use of business assets.Return on Investment = Net profit before tax x 100EquityThe return on investments (ROI) is perhaps the most important ratio of all asit tells you whether or not all the efforts put into the business is yielding anappropriate return on the equity generated, in addition to achieving the strategicobjective.TIPThese ratios will provide an indication of how effective is yourinvestment in the business28Chapter 2-5 p22-65 Eng.indd 288/15/11 5:01:52 PM

Financial Guide for SMEs29Chapter 2-5 p22-65 Eng.indd 298/15/11 5:01:52 PM

Financial Guide for SMEsChapter 3Budgeting30Chapter 2-5 p22-65 Eng.indd 308/15/11 5:01:52 PM

BudgetingBudgeting is the tool that develops thestrategic plans of the business into afinancial statement by setting out forecastedincome, expenses and investments for agiven period. The budget will enable you toevaluate and monitor the effectiveness ofthe strategic plans as they are implementedand to adjust the plan wherever necessary.Most SMEs operate without large cashreserves to draw on; therefore, budgetingwill provide the financial informationrequired to assess if the strategic planswill support the ongoing operations.In short, budgeting is the processFinancial Guide for SMEsof planning your fi nances over a period. Budgeting can also provide anopportunity to plan for several years ahead in an effort to identify changingconditions that may affect the business operations and lead to fi nancialdiffi culties.Good practice budgeting requires the following:A budget is the futurefi nancial plan of thebusiness. It is wherethe strategic plansare translated intofi nancial numbersto ensure that theseplans are fi nanciallyviable• Preparation of strategic goals;• Budgeted timeline that is aligned to the preparation of financial statements;• Regular comparison of budgets against actual financial results as disclosedin the financial statements; and• Scope for amending activities and targets.In short, budgets are one of the most important fi nancial statements, asthey provide information on the future fi nancial performance of the business.If the budgets are planned and managed well, they will be the centralfi nancial statement that allows you to monitor the fi nancial outcome of theimplementation of your strategic plans.31Chapter 2-5 p22-65 Eng.indd 318/15/11 5:01:52 PM

Financial Guide for SMEsProfit and Loss BudgetA profi t and loss budget is an important tool for allbusinesses because where activities can generateprofi t, your business will be less dependent onexternal funding. The budget is a summary ofexpected income and expenses set against thestrategic plans for the budget period. This is usuallyone year, although, in some cases, the period canbe shorter or longer, depending on the purpose ofthe budget.Although your accountant can be of assistance in thepreparation of this budget, it is important thatyou understand how it has been developed andknow how to monitor the outcomes against theprepared budget to ensure that your businesswill achieve the required fi nancial outcomes.HintBy preparing aprofi t and lossbudget annually,you will be in aposition todetermine if yourfuture businessplans willsupport theongoing activitiesof your businessPreparing Profit and Loss BudgetThe key to successful preparation of a profi t and loss budget is to undertake theprocess in an orderly manner, involving all key staff and ensuring that the goalsof the business are clearly understood prior to the preparation. There are twomethods of preparing a profi t and loss budget:• Incremental – where the activities carried out in the previous year are usedas the basis for budget preparation.• Zero-based – where the budget is prepared without consideration of pastactivities.For annual budgeting, the preferred method would be incremental, aszero-based budgeting would require an enormous amount of dedicatedresources and time. In the case of project-based or activity-based budgets,zero-based may be more suitable, particularly for new projects where there isno previous fi nancial data.32Chapter 2-5 p22-65 Eng.indd 328/15/11 5:01:53 PM

Financial Guide for SMEsAn annual budget preparation policy should be documented and followed, andcould include some or all of the following steps:1.2.3.4.5.Review the approved strategic plan and record all required activities for thebudget period.Separate activities into existing and new for the new budget period.Identify and document all assumptions that have been made for the budgetperiod.Review the income statement in the previous year by regular period (monthly,quarterly etc.).Prepare the profit and loss budget for the selected period using all the stepslisted above.TIPAn independent profi t and loss budget can be developed forseparate projects to assess the fi nancial viability of each projectAssumptionsTo ensure that your budget will be a useful tool, youneed to spend some time planning on what you thinkis going to happen in your business in the future.As you are preparing your estimates on incomeand expenditure, you will be estimating how yourbusiness will operate in the future and these arereferred to as assumptions. When determining yourassumptions, it would be best to use realistic targetsthat you believe will be achievable. Using your historicfi nancial information and looking for any trends in thisinformation is a good place to start. Also, any industryinformation provided by independent reputablecompanies will give your assumptions credibility. ThisHINTAll assumptionsmade during theplanning processof preparingbudgets should berealistic anddocumentedis particularly useful when you are going to provide your budget to a potentialor current lender or investor.Make sure you write down all the assumptions and then establish a fi nancialnumber that reflects the event. Once you have completed the table ofassumptions, attach them to the budget. This way, you will remember whatyou anticipated to happen and when reviewing your budget against the actualfi gures, this will help to determine why the actual results may not be the sameas your budgeted numbers.33Chapter 2-5 p22-65 Eng.indd 338/15/11 5:01:53 PM

Financial Guide for SMEsWhen listing your assumptions, if you believe there is some risk that theevent may not occur, include this detail, together with any actions you couldundertake if a particular assumption turns out to be incorrect so that you wouldalready have an action plan in place. Let us return to Adam’s Computer Bagsand see how he is going to set his budget for year two of his business.Using his fi rst year income statement, Adam is now going to set someassumptions for the second year of his business.Assumption TableAssumptionSalesForecast Source Risk ActionIncreaseby 50%ForwardordersSalesremainconstant ordecreaseReviewinventoryholdings andoperatingexpensesIntroducemarketingprogrammeCost ofgoodsRemain at60% ofsalesCurrentsuppliercontractStock pricesincreaseSource newsupplierSalariesIncrease toRM19,500In line withindustrystandardsCash fl owshortageReducesalaryexpenseVehicleexpensePurchasevehicleand includerunningexpensesRequired forsales andmarketingCash fl owshortageReviewoperationalactivities toidentifypossiblesavingsin expenditure34Chapter 2-5 p22-65 Eng.indd 348/15/11 5:01:53 PM

Financial Guide for SMEsWe can see Adam is now confident that, in the second year, he can increase hissales by 50%. Of course, with increased sales, comes an increase in expenditureto support the sales. Therefore, he has developed a plan of what the year twoincome statement will look like.RevenueSalesTotal SalesCost of Goods Sold (COGS)Opening inventoryInventory purchasesLess closing inventoryTotal Cost of Goods SoldGross ProfitExpensesAdvertisingBank service chargesInsurancePayrollProfessional fees (legal,accounting)StationeryUtilities & telephoneVehicle expensesOther: computer softwareExpenses totalAdam’s Computer BagsIncome StatementAs at end of Year OneRM 52,000RM 52,000RM -RM 34,320RM 3,120RM 31,200RM 20,800RM 15,600As at end of Year OneRM 78,000RM 78,000RM 3,120RM 49,920RM 6,240RM 46,800RM 31,200RM 500 RM 1,000RM 120 RM 200RM 500 RM 550RM 13,000 RM 19,500RM 200 RM 4200RM 250RM 800 RM 8800RM 2,450RM 480 RM 100RM 25,350Net Profit Before TaxRM 5,200 RM 5,850Adam will need to monitor his actual results, checking them against this budget,to ensure that his plan will be achieved.TIPWhen documenting your assumptions, include both the risk assessment ofeach assumption and the anticipated action required to match the risk. Bydoing this, you will be well prepared and have an action plan already in placeif the actual events do not match your assumptions35Chapter 2-5 p22-65 Eng.indd 358/15/11 5:01:53 PM

Financial Guide for SMEsMonitoring and Managing Your Profit and Loss BudgetThere are a number of ways in which the profit and lossbudget can be managed. As mentioned in Chapter 1,regular preparation of financial statements is important,particularly the income statements so that the actualactivities can be compared against the budget. Standardpractice would be to prepare monthly statements.However, for smaller businesses, quarterly preparationand comparison may be sufficient.Where the income statement is prepared on amonthly basis, the budget will need to be separatedinto months for the budget period. At the end of eachHINTRemember, the moreregular the reports,the fasteroperations can bereviewed for financialimpact and actioncan be implementedimmediatelywheneverrequiredmonth, the actual results are compared with the budgeted results to analyseany variances. Such variances should be highlighted on the reports andexplanations to be provided. All variances should be categorised as either a“timing” or “permanent” variance.A timing variance is where the estimated result did not occur but is stillexpected to happen at some point in the future.A permanent variance is where the expected event is not likely to occur atall.The power of this analysis is that each variance is documented for futurereference, and whenever required, actions can be taken to counteractfuture variances or implement new or improved activities to ensure that thestrategic goals underlying the budget can still be achieved.TIPRegular review of budget against actual results will provideinformation on whether your business is on track to achieve theplans formulated when you fi rst prepared your budget36Chapter 2-5 p22-65 Eng.indd 368/15/11 5:01:54 PM

Financial Guide for SMEsSection II : Improving Business FinancesNow that you have been introduced to thebasics of business fi nance, you can use thesetools to improve the fi nancial management ofyour business. Proactive management of thefi nancial position of your business would ensurethat any issues encountered will be identifi edearly so that appropriate actions to rectify thesituation can be taken in a timely manner.Through the use of the fi nancial informationdiscussed in the fi rst section of the Guide, andby implementing the processes introduced in thissection, you would be on the way to achievinggood fi nancial management for your business.Improving businessfi nances meansyou need to take apractical approachto implement newprocesses that allowyou to monitor thekey aspects of yourbusiness profi tabilityand cash fl owProfi tability and cash fl ow are the key areas that should be monitored on anongoing basis to help ensure that your business prospers. This section of theGuide presents a number of easy-to-understand procedures and tools that canassist you in maintaining profi tability and improving cash fl ow.Managing the business fi nances is all about taking a practical approach tomaintaining profi tability and improving cash fl ow, together with having thediscipline to continuously monitor and update the financial information ascircumstances change.37Chapter 2-5 p22-65 Eng.indd 378/15/11 5:01:54 PM

Financial Guide for SMEsChapter 4Maintaining Profitability38Chapter 2-5 p22-65 Eng.indd 388/15/11 5:01:54 PM

Financial Guide for SMEsMaintaining ProfitabilityOne of the most important issues forany business is maintaining profitability.A profi table business will ensure thatyou can manage your business in linewith your overall strategic objective,whether it is to grow the business, sellat a later date, or to achieve some otherobjective.In this chapter, we will be looking atthree useful tools that will help youmonitor the profi tability of your business.We will also discuss on how discountingcan affect your profi t, and how tomanage the expenses of the businessto maintain profi tability.It is very easy forprofi tability to be erodedif you do not measureand monitor on a regularbasis. Therefore, it isimportant to understandhow to use the toolsavailable to continuouslyevaluate the profi tabilityof your businessProfitability MeasuresOnce you have an income statement, you canuse the tools explained below to ensure that youknow:• Your profi ts are not being eroded byincreasing prices in inventories or expenses– Margin.•• How to set new selling price when inventorycosts increase – Mark-up.•• How much you need to sell before thebusiness is making a profi t – Break-evenanalysis.HINTUsing the profi tabilitymeasures provided willensure that you areaware of any reductionin profi t as it occurs andunderstand what levelof sales is required forthe business togenerate profi t39Chapter 2-5 p22-65 Eng.indd 398/15/11 5:01:54 PM

Financial Guide for SMEsMarginThere are two margins that need to be considered when monitoring yourprofi tability: gross and net. For a service business, only net margin would berelevant, as it is unlikely that there would be a direct cost of service provided.Gross margin is the sales proceed left after subtracting the cost of goods soldfrom net sales. What does it mean by “net sales”? This is all the sales amountless any discounts that have been given to customers and commissions paid tosales representatives. By knowing what your gross margin is, you can be surethat the price set for your goods will be higher than the cost incurred to buy ormanufacture the goods (gross margin is not commonly used for servicebusinesses, as they often do not have “cost of goods”) and you have enoughmoney left to pay expenses and hopefully, make some profi t.Gross margin can be expressed either in value (gross profit) or in a percentage,that measures the percentage of sales proceed remaining (after obtaining ormanufacturing the goods sold) to pay the overhead expenses of the company.The percentage value is particularly useful if you are comparing your businesswith other businesses in your industry or with past performance of yourbusiness.Gross profit (RM) = Net sales lesscost of goods soldGross profit valueGross margin (%) = Net sales value X 100Net Margin is the sales amount left after subtracting both the cost of goodssold and the overhead expenses. The net margin will tell you what is yourprofi t before you pay any tax. Tax is not included because tax rates and taxliabilities vary from business to business for a wide variety of reasons, whichmeans that making comparisons after taxes may not provide useful information.The margin can be expressed either in value (net profi t) or in percentage.The percentage value is particularly useful if you are comparing your businesswith other businesses in your industry or with past performance of your business.Net profit (RM) = Net sales lessgross profit lessoverhead expensesNet profit valueNet margin (%) = Net sales value X 10040Chapter 2-5 p22-65 Eng.indd 408/15/11 5:01:55 PM

Financial Guide for SMEsMark-upMark-up is the amount that you sell your goods above the cost to purchase ormanufacture those goods. It is generally only a meaningful figure when referringto the sale of products rather than services. It can be useful to use mark-upcalculation to ensure that you set the selling price at a level that covers all costsincurred with the sale.Mark-up is calculated as follows:Sales less cost of goods soldPercentage value = X 100Cost of goods soldBreak-even CalculationThe break-even calculation shows how much sales are required, in either value orunits, before all the expenses are covered and actual profit begins.This simple calculation is used to find where profit really starts. The break-evenpoint is calculated as follows:Break-even (RM) =[Expenses / 1 less (Cost of Goods Sold)](Net Sales)Break-even (%) = Expenses / (Unit selling price less Unit cost to produce)If we remember Adam’s income statement for year one (in Chapter 1), we canuse this to calculate the profi tability measures for his business.41Chapter 2-5 p22-65 Eng.indd 418/15/11 5:01:55 PM

Financial Guide for SMEsAdam’s Computer BagsIncome StatementFor the Year EndingYear One%Sales RM52,000 (100)Less cost ofgoods soldGross profitLess operatingexpensesRM31,200 (60)RM20,800 (40)RM15,600 (30)Net profit RM5,200 (10)Sales less cost of goods soldMark-up (%) = Cost of goods soldRM52,000 less RM31,200=RM31,200= 66.67%Net sales - cost of goods soldGross margin (%) = Net sales X 100RM52,000 less RM31,200=X 100RM52,000= 40%Net profi t (value)Net margin (%) =Net sales (value)RM5,200=RM52,000= 10%X 100X 100ExpensesBreak-even (RM) = 1 less (Cost of goods sold)(Net sales)RM15,600= 1 less (RM31,200)(RM52, 000)= RM15,6001 less 0.6= RM39,000 sales required before any profi ts can be madeSummary of Adam’s Computer BagsProfitability MeasuresMark-up 66.67%Gross margin 40 %Net margin 10 %Break-even RM39,000TIPCompare yourprofitability measures tothe businesses withinthe same industry toensure that you arebeing competitive andachieving maximumprofit potential42Chapter 2-5 p22-65 Eng.indd 428/17/11 1:34:38 PM

Financial Guide for SMEsDiscounting SalesDiscounting your goods or services toentice customers to purchase may erodeyour profi ts. Of course, some discounting canbe benefi cial; however, before you decide tooffer discounts, it is important to understandthe impact that discounting will have on yourprofi ts. Alternatives such as add-on productsor services may deliver more value of grossprofit to the business and should be consideredbefore deciding to offer discounts.HINTYou may want to consideroffering your customersadd-on services as analternative to offeringdiscountsIn the previous section, we discussed sales “net” of discounts. When you offerdiscounts you are effectively offering your goods or services at a reduced sellingprice. Where discounts are offered, you will need to sell more goods in order toachieve your gross margin.Let us return to Adam’s Computer Bags. He is considering offering a 5% discountto encourage more sales. Adam needs to keep his gross margin at 40% to ensurethat he reaches his profit goal. As the table below shows, if he decides to discounthis bags by 5%, he will need to increase his sales volume by 14.3%.If you cut yourprices by...5%The Effect of DiscountingAnd your present Gross Margin (%) is .......10%100%15%50%20%33.3%25%25%30%20%35%16.7%40%14.3%6%150%66.7%42.9%31.6%25%20.7%17.6%8%400% 114.3%66.7%47.1%36.4%29.6%25%10%200%100%66.7%50%40%33.3%12%400%150%92.3%66.7%52.2%42.9%15%300% 150% 100% 75% 60%43Chapter 2-5 p22-65 Eng.indd 438/15/11 5:01:55 PM

Financial Guide for SMEsIf we put some numbers to this, we can see the results in the box below:Adam’s Computer BagsAdam wants to discount his bags by 5%. To maintain gross margin of 40%, hewill need to increase sales units by 14.3%.Adam is currently selling1,000 bagsIncrease volume by 14.3% = 1,000 + (1,000 x 0.143) = 1,143 bagsTo maintain gross margin (and achieve target profit), Adam will need to sell1,143 bags if he sells at 5% discount.The same would apply to a service business; if selling price is cut by 5% and thenet margin is 30%, sales will need to increase by 20% to ensure all operatingcosts are covered.44Chapter 2-5 p22-65 Eng.indd 448/15/11 5:01:56 PM

Financial Guide for SMEsExpense ManagementGood management of general expenses by thebusiness will contribute to increasing profits. Bymonitoring business expenses, you may be able toidentify where costs are increasing and take action toensure that you maintain your net profi t margin.When monitoring expenses, do not forget to identifythe expenses that are important to your businessoperation (e.g. presentation of premises, marketing,staff training) and keep these at sustainable levels.HINTKeeping a close eyeon your expenseswill ensure that youmaintain theprofi tability of thebusinessTo maintain constant control on expenses, continuous review will help you toidentify where costs are getting out of hand. Do not forget to use the profi tabilitymeasures, as they are the simplest way to quickly identify if your profi ts arebeing eroded. Some other ideas to manage expenses are to consider joiningforces with other businesses to benefi t from group buying, investigate usingcompanies that provide access to discount services for bulk orders, and to seekquotes from different services to ensure that you are paying the best possibleprice for your expenses. Often, if you are a member of an industry association,the association may have established relationship with service providers suchas insurance companies and you may be able to access discounted services orproducts through your membership.However, be careful not to focus too much on individual expenses. Thevalue you may save from such an exercise may be outweighed by the cost ofyour time and the aggravation such a focus may cause your staff, suppliers orcustomers.TIPLook for opportunities to join with other businesses for “group” buyingthat can provide discounts on your expenses45Chapter 2-5 p22-65 Eng.indd 458/15/11 5:01:56 PM

Financial Guide for SMEsChapter 5Improving Cash Flow46Chapter 2-5 p22-65 Eng.indd 468/15/11 5:01:56 PM

Financial Guide for SMEsImproving Cash FlowOne of the most important aspects ofrunning a business is to ensure that thereis adequate cash fl ow to meet all of theshort-term obligations. The survival of yourbusiness will depend on this. Referred toas working capital management, this is allabout setting up strategies to ensure thatthere is enough cash in the business tooperate on a day-to-day basis withoutfacing a cash fl ow crisis.Working capital in business is made up ofthese core components:• Inventory management;• Work-in-progress;• Payment to suppliers (creditorpayments); and• Collection of cash from customers(debtor collection).Working capital is theshort-term capital thatworks for the business.This includes inventory,work-in-progress,payment to suppliersand receipt fromcustomers. By workingon your cycle moreeffi ciently, you wouldhave more readilyavailable cash to use inother parts of thebusinessOften referred to as “the working capital cycle”, this is really about the lengthof time it takes from using your cash to purchase inventory (or perhaps gettingit from a supplier on credit terms), and using the inventory, possibly for amanufacturing purpose (hence creating part of the cycle called “work-in-progress”),to securing the sales and receiving the cash.Here is a diagramme of the working capital cycle:Manufacturer or Product ProviderCASHDebtorsPurchaseInventoryService ProviderCASHSalesSupplierPaymentDebtorsSalesWork-inprogress47Chapter 2-5 p22-65 Eng.indd 478/15/11 5:01:56 PM

Financial Guide for SMEsBetween each stage of the working capital cycle, there is a time delay. Forsome businesses, there could be a substantial length of time to make and sellthe product. In these enterprises, a large amount of working capital will berequired to survive. Others may receive their cash very quickly after paying outfor inventory, perhaps even before paying their bills. Service businesses maynot be required to pay out cash for inventory and therefore, will need lessworking capital.The key to successful cash management is monitoring carefully all the stepsin the working capital cycle. The faster the cycle turns, the faster you haveconverted your trading operations back into available cash, which means youwould have increased the liquidity in your business and will be less dependenton cash or extended terms from external stakeholders such as banks, customersand suppliers.There are many ways you can make the working capital cycle move faster. Thefollowing sections provide information on how you can make the cycle movemore quickly and improve the cash fl ow in your business.48Chapter 2-5 p22-65 Eng.indd 488/15/11 5:01:56 PM

Financial Guide for SMEsManaging InventoryInventory management is about having the right level of inventory to satisfy theneeds of your customers and managing the inventory to identify excess or oldinventory. Of course, inventory has to be purchased, either from existing cashin the business or from borrowings, so it is important that the inventory levelsare managed so that they use minimum fi nancial resources as possible. Thisdoes not necessarily mean keeping low levels of inventory, but rather ensuringthat inventory is held for the shortest possible time, which means that it will beconverted into cash quickly (too little inventory can affect sales, so the key is tofi nd the appropriate level, which can change over time).However, maintaining inventory comes with a cost. Itis estimated that holding inventory can cost anythingbetween 10 to 30 percent of the value of the inventory.This includes storage, insurance, keeping accuratetracking records and proper controls to avoid theft.Effi cient inventory control involves three elements:• Inventory review;• Buying policy; and• Operational issues.HINTSetting up goodinventory controlprocedures willensure that cashis not tied upin holdingunnecessaryinventoryThe following checklist will help you to determine what measures for inventorycontrol you may need or can use to improve your existing procedures.Checklist for Managing Inventory1. Inventory ReviewActionDescriptionList all Determine the current level, what items are held and the valueinventory of inventory on hand.Reviewsalesof inventoryLook at the sales records to fi nd out which are the best sellingitems and which are slow moving. Do not forget to look atseasonal trends. A focus on the best selling items shouldincrease cash fl ow, if you manage your debtors well. Work outwhich items of inventory sold make the highest gross margin.This is important, as you may then be able to increase profi t byfocusing more energy on these sales.49Chapter 2-5 p22-65 Eng.indd 498/15/11 5:01:57 PM

Financial Guide for SMEsChecklist for Managing InventoryList slowmoving,old andexcessinventoryUpdateinventoryrecordsMake a list of slow-moving, old and excess inventory itemsand develop an action plan to move this inventoryimmediately, even if it is at lower price than the cost of theitem. This will generate cash to invest in new inventory thatwill move more quickly and make available display space forfaster moving inventory.Update your inventory records with the current levels andthen implement a policy to track all movements of inventory.This will help to ensure that inventory is re-ordered only whenneeded, and will highlight any theft or fraud that may occur.2. Buying PolicyActionUnderstandwhat is “core”inventoryDescriptionIdentify inventory that you simply must never run out of in orderto maintain sales momentum and ensure that customers wouldnot be disappointed over the basic products.Tighten thebuying ofinventoryNegotiatewithsuppliersBeware ofdiscountsofferedKnow the volume sales per inventory item. This will help youto buy the right amount. Carrying too little inventory maydiscourage customers, as you may not be able to satisfy theirneeds immediately, and carrying too much inventory meansyou are tying up cash that could be put to better use.Negotiate deals with suppliers, but avoid volume-baseddiscounts. When money is tight, there is no point investing innext month’s inventory without good reason. Instead of volumedicounts, try to negotiate discounts for prompt settlement(unless your cash position is poor) or negotiate for smaller andmore frequent deliveries from your suppliers to improve yourcash fl ow.Do not let discount prices determine your inventory-buyingdecisions. Buy inventory that you can sell at a profi t in areasonable time frame.50Chapter 2-5 p22-65 Eng.indd 508/15/11 5:01:57 PM

Financial Guide for SMEsChecklist for Managing Inventory3. Operational IssuesActionDescriptionSupplierserviceAdvertisingandpromotionSalespolicyCustomerdeliverySuppliers can assist in inventory management by providingaccess to inventory only when you need it (called JIT or justin-time)and by providing good delivery service. By orderingless inventory more frequently and arranging better deliveryschedules, you can reduce inventory quantities, savingvaluable cash resources and improving liquidity withoutreducing sales.Before launching a promotion, ensure that you have adequateinventory or can source for adequate inventory. If you havetaken on larger than normal quantities, make sure you have aback-up plan if they do not sell during the promotion.This can have a strong infl uence on inventory levels andshould be managed with a view not only to maximising sales,but also to minimising investment in working capital. This canbe achieved by directing policy towards a higher turnoverof goods, selling goods bought at bargain prices faster, andclearing slow-moving items.Ensuring that goods are delivered to the customer fastermeans the inventory is moved and the cash for the sale willcome in more quickly.51Chapter 2-5 p22-65 Eng.indd 518/15/11 5:01:57 PM

Financial Guide for SMEsTIPS FOR IMPROVING INVENTORY CONTROL• For fast-moving inventory, negotiate with suppliers for delivery whenrequired (JIT or just-in-time), eliminating the need to hold a largeamount of inventory to meet customer demand.• For old and excess inventory, either sell at whatever price to move it,or use as a donation to a charity or community group. (Do not forgetto advertise that you have made a donation!)• Keep accurate inventory records and match the records to a physicalcount regularly – at least once a year. However, if there are largevariances between the records and physical count, do the countmore regularly until the issues are identified and corrected.• Understand your inventory: which ones move quickly, which onescontribute the highest gross margin, and which ones are seasonaletc. This will help you know how much of each line of inventory tokeep on hand and when re-order is required.• Use your financial system to track inventory items. This will helpwith both:o Automating re-order requirementso Matching different inventory items to sales and easily identifyinghigh margin high sales. margin sales.• Keeping good control over your inventory holdings will ensure thatyou keep old and excess inventories to a minimum and reduce therisk of theft, while still having adequate inventory levels to meetyour customers’ needs.52Chapter 2-5 p22-65 Eng.indd 528/15/11 5:01:57 PM

Financial Guide for SMEsUsing Numbers to Manage InventoryDays Inventory RatioThis ratio reveals how well your inventory is being managed. It is important becauseit will indicate how quickly inventory is being replaced, and the more times inventorycan be “turned” (replaced) in a given operating cycle, the greater the profit.Days inventory ratio is calculated as follows:Days inventory =Inventory on handCost of Goods Soldx 365Adam’s Computer BagsDays inventory = RM 3,120 x 365 = 36.5 daysRM 31,200This calculation shows that, on average, Adam holds his inventory for 36.5 days.Inventory TurnoverThis calculation shows the effectiveness of your planning of inventory holdings. Alow inventory turnover rate will show that you are not moving inventory, which couldlead to excess or old inventory and, of course, higher holding costs. A high inventoryturnover rate could indicate that you run the risk of not having adequateinventory on hand to supply customers’ needs.Inventory turnover is calculated as follows:Inventory turnover =Cost of Goods SoldInventory on handAdam’s Computer BagsInventory turnover = RM31,200 = 10 timesRM 3,120This calculation shows that, on average, Adam turns his inventory over 10 timesper year.The days inventory and inventory turnover calculations should be comparedwith industry average to provide useful information. Comparing these measuresregularly with previous periods in your business will also provide information onthe effectiveness of inventory management within your business.53Chapter 2-5 p22-65 Eng.indd 538/15/11 5:01:57 PM

Financial Guide for SMEsManaging Payments to SuppliersThe payments to suppliers will affect your cash fl ow. Often, start-up businesseswill have to pay suppliers in cash on delivery of goods or services, becausethey do not have a trading history. The supplier will not be prepared to providethe goods or services on credit because they are not sure if the business will beprofi table or still operating in the future. Once your business is up and running,there is likely to be some basis to negotiate with your suppliers so that you canpay on credit and have more cash fl ow.Making full use of your payment terms with yoursupplier is effectively an interest free loan. Therefore,it is important to manage your suppliers and thepayments to them in the same way as you managethe other key components of the working capital cycle.Effective management of suppliers and the paymentsto them consists of three key elements:• Supplier selection• Payment terms• Managing relationshipsHINTSetting up goodmanagementprocedures willensure that you getthe most out of yourrelationship withsuppliersThe following checklist will help you review what procedures you may need toimprove your existing supplier procedures:Checklist for Managing Suppliers & Payments to Suppliers1. Supplier SelectionActionPrioritiesDescriptionDetermine your priorities in relation to your suppliers. Is itquality, reliability, returns policy, price, terms, or a combinationof some or all of these factors?DeterminepreferredsuppliersCheckreferencesSelectsupplier(s)Prepare a list of preferred suppliers.Undertake credit and trade reference checks for each supplieron the list.Select supplier(s) based on your priorities and results fromcredit and trade checks.54Chapter 2-5 p22-65 Eng.indd 548/15/11 5:01:58 PM

Financial Guide for SMEsChecklist for Managing Suppliers & Payments to SuppliersEstablishalternativesuppliersReviewregularlyIf you have one main supplier, make sure that you havean agreement in place with an alternative suppliers to coverany risk that the chosen supplier cannot provide the agreedservice at any time.Monitor the selected supplier(s) and regularly review theirperformance against your priorities (priorities may change asthe business grows).2. Payment TermsActionNegotiatetermsDescriptionAgree on the payment terms with suppliers before entering intoa transaction.Includeterms onthe orderConsiderdiscountbenefi tPay ontermsHavedamagedgoodsproceduresReviewtermsregularlyDocument standard payment terms on each purchase order.Calculate the benefi t of taking a discount for early payment.Ensure all suppliers are paid on agreed terms, not earlier andnot too late (check this on a regular basis).Have an agreed process in place for where damaged goodsor unsuitable goods are supplied. Do not withhold paymentwithout communicating to the supplier that there is an issue.Review the terms with each supplier regularly. If you fi nd analternative supplier that can provide better terms, fi rst discussthis with your existing supplier before changing over. They maybe able to match this offer and will appreciate the loyalty youhave shown.55Chapter 2-5 p22-65 Eng.indd 558/15/11 5:01:58 PM

Financial Guide for SMEsChecklist for Managing Suppliers & Payments to Suppliers3. Managing RelationshipsActionMeetregularlyDescriptionMeet regularly with your main suppliers to discuss the progressof your business (they are often able to assist with increasedcredit terms, new product etc.)Adhere topaymenttermsEnsure that agreed payment terms are adhered to.Have anon-paymentprocessCommunicateBe a goodcustomerEnsure that there are processes in place for when suppliersare not paid on time i.e. they can contact someone to discusson the situation.Communicate with suppliers when payment needs to bedelayed and, if possible, set up an agreed payment arrangement,and make sure you stick to it. Summarise this agreement inwriting and ensure that the senior fi nance person (or owneretc.) receives a copy.To maintain good relationship with key suppliers, be seen asa good, reliable customer.56Chapter 2-5 p22-65 Eng.indd 568/15/11 5:01:58 PM

Financial Guide for SMEsTIPS FOR IMPROVING SUPPLIER PAYMENTS•Extend payment terms. Extending the payment period from 30 to 45days may help to reduce fluctuations in cash flows.• Some larger companies may accept quarterly payments, which canhelp in forecasting cash flow requirements.• Payment terms should specify that payment terms commence fromcomplete delivery, as opposed to part delivery. This should also includegoods or services that have not been provided as agreed.••••Where goods are returned, either:o a new invoice should be produced, and this is the initiation ofthe payment terms; oro disputed invoices are held over until a credit note is received.Initiate a structured payment run, usually once a month (i.e. on thelast day of the month) and stick to it.Ensure that your systems have good controls so that suppliers are not:o paid early. Where financial systems are used, ensure paymentdate is automated from approved supplier details and no changeto the automated date is possible without authorisation.o over paid. All received goods must be checked against thepurchase orders and the totals on invoices checked.o paid twice. Pay only on statement.Continuously review supplier contracts for opportunities such as:o improved pricingo effective discountingo improved delivery (you will not need to order so early and hencewill be able to defer payment).57Chapter 2-5 p22-65 Eng.indd 578/15/11 5:01:58 PM

Financial Guide for SMEsUsing Numbers to Manage Payments to SuppliersDays Creditors RatioThis ratio indicates how well accounts payable (payments to suppliers) is beingmanaged. If these payments are being paid, on average, before agreed paymentterms, cash flow may be affected. If payments to suppliers are excessively slow,there is a possibility that relationship with your suppliers will be damaged.The days creditors ratio is calculated as follows:Accounts payableDays creditors = x 365Cost of goods soldNote: Accounts payable is the amount that is owed to your suppliers at the time ofthe calculation.Adam’s Computer BagsDays creditors = RM 4,120 x 365 = 48.20 daysRM31,200This calculation shows that on average, Adam pays his suppliers every48 days.Managing Work-in-progressWork-in-progress is where an order has been takenfrom the customer and you are in the process of“working” to complete the order. Of course, in mostcircumstances, there will be many orders in progress,so you will need good management systems in placefor effi cient execution of customer orders. Workin-progressis often thought to be only relevant inmanufacturing business; however, some retail andservice businesses will also have a form of work-inprogress– the time of order from customer to deliverymeans that the work is in progress.HINTThe key tomanaging workin-progressis tohave a goodrecord keepingsystemManaging work-in-progress is important because the faster the job can becompleted, the earlier the invoice can be issued and hence the cash receivedfor the job. The following checklist will assist you in comparing yourwork-in-progress procedures and may help to identify some improvements.58Chapter 2-5 p22-65 Eng.indd 588/15/11 5:01:58 PM

Financial Guide for SMEsChecklist for Managing Work-in-progressActionRecord alldetails atorderTrackprogress ofoutstandingordersInvoice ondeliveryUse recordsfor cash fl owforecastingDescriptionEnsure that all orders are recorded and all relevant detailsare noted, such as when the order is due, anypayment received (e.g. deposit), any progress paymentsto be invoiced, how long the job takes to complete, and anyadditional costs incurred in completing the job.Have procedures in place to track all outstanding orders andrank them by priority. The procedures should highlight anyactual or potential delays and have steps outlined for actionwhen delays occur.When an order is completed, ensure that the invoice is issuedand sent with the goods.The record-keeping system should provide details of expectedcompletion, delivery, and invoice date, and therefore provideinformation on cash receipt to assist in cash fl ow forecasting.TIPS FOR IMPROVING WORK-IN-PROGRESS• Only order inventory when you are ready to use it to effectivelyreduce the number of days held (and hence paid) before productionbegins.• Identify any bottlenecks in the production process and look forimprovements.• Look at the process, including the physical layout of goods, andidentify possible improvements to speed up the movement throughthe work-in-progress stage.• Before accepting the order, make sure that you know how muchinventory you need to have on hand to complete the order. Delay inreceiving goods is delay in preparing the sale.• Review work-in-progress procedures annually to identify possibleprocedures or technology that could improve the process.• Where specific materials are required for the customer order (e.g.fabric for covering a couch), include in your order agreement that thecustomer pays a deposit up front before the order is commenced.59Chapter 2-5 p22-65 Eng.indd 598/15/11 5:01:59 PM

Financial Guide for SMEsManaging ReceivablesSales income is a cash fl ow driver of all businesses and converting the salesinto cash is one of the most important processes in any business. Where salesare offered on credit, fi nancial systems will refer to the amount outstanding as“receivables”. Managing the payments due from receivables can consume alot of time and efforts if proper controls and procedures are not put in place atthe outset. Your customers are your key to business success; however, untilyou receive the cash for the sale, effectively you have given a donation to yourcustomers! So it is important to manage all outstanding payments from yourcustomers and ensure that you have good procedures in place to encourageyour customers to pay the right amount and on time.Effi cient receivables collection procedures includethe followings:• Set up credit control• Establish payment terms• Managing customer relationshipsHINTEnsure thatyou have goodprocedures inplace to encourageprompt paymentThe following checklist can be used to compare your existing proceduresfor collecting outstanding amounts from your customers and help to identifypossible improvements:1. Set up Credit ControlActionRecordcustomercredit checkChecklist for Managing ReceivablesDescriptionHave a system in place that record credit check for all newcustomers to ensure that the process has been properlyundertaken.Rank allcustomersaccording tocreditriskSet creditlimitsThis could be in terms of the time they have been in business,the quality of the credit check, the credit limit allowed for eachcustomer etc.Set appropriate credit limit for each customer. The limit shouldbe set in accordance with the credit-risk rating as set outabove.60Chapter 2-5 p22-65 Eng.indd 608/15/11 5:01:59 PM

Financial Guide for SMEsChecklist for Managing ReceivablesRegularlyreviewcredit checksRecordcustomers’limit usagePut policiesin place forexceededlimitsDuring tough times, the credit status of some customers maychange.Make sure your system tracks the outstanding credit ofcustomers and notifies relevant staff if the limit has beenexceeded (ensure that the notifi cation happens before thenext sales).Record procedures to be undertaken when a credit limit isexceeded and ensure that all relevant staff are aware of whatneeds to be done.2. Establish Payment TermsActionIncludeterms oninvoiceCommunicateterms to allstaffDescriptionRecord standard payment terms on each invoice.Ensure that all staff (including sales representatives) are awareof the payment terms and that they follow them.Have latepaymentproceduresManagereturnedgoodsImplement systems to ensure that all payment terms are met.Send out regular reminders and follow up on late payments.Have a policy and process in place for returned goods toensure that payment is not delayed for any length of time.61Chapter 2-5 p22-65 Eng.indd 618/15/11 5:01:59 PM

Financial Guide for SMEsChecklist for Managing Receivables3. Managing Customer RelationshipsActionMeetregularlyReviewpaymenttermsNonpaymentprocessDescriptionMeet regularly with your customers, particularly key customers.Sometimes, visiting their premises will help you to understandtheir business requirements and fi nancial position.Regularly review the actual payment and agreed terms for eachcustomer. If you fi nd a customer is continuously paying outsidethe agreed terms, meet and discuss on the issues.Ensure that there are processes in place for customers whenproducts or services are not provided as expected (returnedgoods). Have a policy that covers how to correct this type ofsituation.CommunicateWhere an order or delivery is going to be delayed, communicatewith the customer and discuss alternative solutions. Only agreeon a completion date with the customer if you are certain youcan meet the deadline.Be a goodsupplierBe seen as a good, dependable supplier to your customers.62Chapter 2-5 p22-65 Eng.indd 628/15/11 5:01:59 PM

Financial Guide for SMEsTIPS FOR IMPROVING RECEIVABLES COLLECTION•••Send out invoices as soon as work is completed, not at the end ofthe week or month.Provide incentives to pay early (e.g. a discount, but know the impacton profit margin).Make it easy to pay – direct credit arrangements or credit card.• Where commission is paid to sales staff, pay commission on amountscollected, rather than on total sales amount ordered.•Produce regular reports to identify when payments are due.• Identify slow paying customers and make contact early to discuss onany issues (e.g. faulty goods, inadequate service, inability to pay).•••Monitor non-paying customers and keep in regular contact.Make arrangements for non-paying customers (payment plan toclear the debt).Have a policy to stop supplying a customer until all debts arecleared.• Send letters of demand for long outstanding debts and if necessary,use a professional debt collector.• Remember, a good customer is only one that pays. If you are notcollecting the cash from your customer, then your organisation isfunding your customer’s business as well as your own.•Consider “terminating” a customer if they are unreliable in makingpayments63Chapter 2-5 p22-65 Eng.indd 638/15/11 5:01:59 PM

Financial Guide for SMEsUsing Numbers to Manage Payments from ReceivablesDays Debtors RatioThis ratio indicates how well the cash from receivables is being collected. Referredto as accounts receivable in accounting terms, this is the total outstanding amountowed to you by your customers. If these receivables are not collected reasonablyin accordance with their terms, you should reconsider the collection policy. Ifreceivables are excessively slow in being converted to cash, the liquidity of yourbusiness will be severely affected.The days debtors ratio is calculated as follows:Accounts receivableDays debtors = x 365Sales revenueAdam’s Computer BagsDays debtors = RM18,000 x 365 = 126 daysRM52,000This calculation shows that, on average, Adam collects from his debtors every126 days.Working Capital Cycle – Cash Conversion RateThe overall number of days to convert your trade fromthe cash outflow at the beginning of the working capitalcycle to cash received at the end of the cycle can becalculated through the cash conversion rate.DebtorsSalesCASHWork-inprogressPurchaseInventorySupplierPaymentHINTCalculate the cashconversion rate andcompare this with thestandards within yourindustry. Identify whichareas of the cycle areproblematic andprepare an action planto improve the cashconversion rate64Chapter 2-5 p22-65 Eng.indd 648/15/11 5:02:00 PM

Financial Guide for SMEsCash Conversion Rate CalculationThe cash conversion rate is calculated as:DaysInventoryPlus Days Debtors Less Days CreditorsDaysInventory36.5PlusAdam’s Computer BagsCash Conversion RateDays Debtors126LessDays Creditors48.2EqualsCashConversionRate114.3This calculation shows that for Adam’sComputer Bags the working capitalcycle takes 114.3 days from the startof the transaction to when thetransaction is completed and convertedback to cash.TIPCalculate your cash conversion rate regularly and implementimprovement to your working capital to release idle cash that is notbeing used within the business. This will reduce the need to borrowadditional funds to support the operations of the business, decreasedependency on funds from fi nanciers, and reduce any interestexpense incurred65Chapter 2-5 p22-65 Eng.indd 658/15/11 5:02:00 PM

Financial Guide for SMEsChapter 6Managing Cash Flow66Chapter 6 p66-78 Eng.indd 668/15/11 5:02:23 PM

Financial Guide for SMEsManaging Cash FlowCash and ProfitNow you know that profi t is made from sellingyour goods or services for a price higher thanwhat it costs to make or deliver to yourcustomers. Cash of course is generated fromthese transactions, as well as other activitiesthat the business may undertake (such asselling assets). The key to a successfulbusiness is good profi tability and adequatecash fl ow.This means that if you manage your marginsproperly, your trading should always beprofi table and hence have positive cash fl ow,right? Wrong! A business can be profi table butstill encounter cash fl ow issues. How doesthis happen? Well, it’s all about timing. Profi tof a transaction is calculated when the salesis made. If you are in a business that offersA business can beprofi table but stillhave cash fl owissues. It is importantto implementprocedures in yourbusiness that willensure cash fl ow isappropriatelymanagedHINTCASH DOES NOT EQUALPROFIT!goods or services on credit, then the profi t is generally assessed at the time ofthe sales; however, you may not receive the cash until sometime later.There are two ways in which the transaction can be recorded: either on thecash basis or accrual basis. When working out if your transaction is goingto be profi table, these are probably the questions you will need to answer:• How much will it cost you to buy or make the product, or provide the service(hours paid)?• What is a realistic price that your customer will be willing to pay?• What do your competitors charge for the same or similar products orservices?The next step is to compare the price you will receive with the cost paid, and ifthe price is higher than the cost, the transaction is profitable. Again, let us goback to Adam’s Computer Bags income statement, which we saw in Chapter 1.67Chapter 6 p66-78 Eng.indd 678/15/11 5:02:23 PM

Financial Guide for SMEsAdam’s Computer BagsIncome StatementFor the year ending Year OneSalesLess cost of goods soldGross profitLess operating expensesNet profitRM52,000RM31,200RM20,800RM15,600RM 5,200When we look at Adam’s incomestatement, we can see that he willmake RM20,800 in gross profit. Thisway of recording the transaction iscalled accrual accounting, that is,sales are recorded when made,rather than when cash is collected.This is the most effective way ofmatching all costs to the transactionand makes it easier to see clearlyhow much profit is generated fromthe transaction.Using Adam’s example, let us assume that he sells 500 bags at RM52 per bagto a computer manufacturer on thirty days’ credit, meaning that he will receiveRM26,000 from this customer at the end of month one. He is also able to export200 bags at RM52 each, which means that the payment of RM10,400 from theoverseas customer is not received until the second month from delivery. Thebalance of his inventory will be sold later in the year. All the bags have beenimported at the beginning of the year at the total cost of RM34,320, which waspaid at the end of the first month of trading.When we look at the cash flows from Adam’s sales, it becomes clear that thecash flows will not equal the profit until the total transaction is completed, that is,when all the money is received from all the sales.TransactionMonth 1Cash MovementMonth 2 Month 3 to 12Sales RM52,000 RM26,000 RM10,400 RM15,600Payment forinventoryGross profitCash balanceRM34,320 (RM34,320)0 0RM20,8000(RM8,320)(RM8,320)RM10,400RM 2,080RM15,600RM17,68068Chapter 6 p66-78 Eng.indd 688/15/11 5:02:24 PM

Financial Guide for SMEsIn month 1, Adam only collects RM26,000 from sales, but he has to buy allthe computer bags in the same month. He only receives the cash for salesof another 200 bags in month 2 and the balance through the rest of the year.So the above table shows that at the end of month 1, he will need an extraRM8,320 to cover the purchase of the bags, and, by the end of the year, hisbank balance will match his gross profit. Of course, he will also haveto cover the operating expenses throughout the year, which have not beenincluded in the above table.TIPThe timing of when cash is received is the most important issue whenmanaging cash flowCash Flow Drivers in Your BusinessEven when your business is profitable,managing cash fl ow can be very important. Byidentifying what “drives” the cash fl ow in yourbusiness, it will be easier to manage your cashfl ow. What do we mean by “drivers” of cash fl ow?They are the things in your business that affectyour cash fl ow the most. For most businesses,this will be sales. However, for some businesses,it could be something else. Let us look at the mostcommon key drivers of cash fl ow and this will helpyou to determine the key drivers of cash fl ow inyour business.HINTCash fl ow is thelifeblood of everybusiness. A profi tablebusiness can stillsuffer from shortagesin cash, so it isimportant tounderstand what“drives” yourcash fl owAccounts Receivable (Debt Collection)Sales are important for all businesses. After all, this is what ultimately generatesprofi ts for your business. From Adam’s example on the previous page, it canbe seen that the collection of cash from sales is critical to ensuring that he hassuffi cient cash in the bank. So, if sales are the key issue for you to managecash fl ow, then you must have good procedures in place to ensure that you canconvert the sale to cash as quickly as possible. The best way to do this is tomanage the collection of cash from your customers using the checklist in theprevious chapter.69Chapter 6 p66-78 Eng.indd 698/15/11 5:02:24 PM

Financial Guide for SMEsAccounts Payable (Creditor Payments)Where the supply of inventories or services is critical to your business,managing your supplier relationships will be important. If you have only one ortwo suppliers that can provide the inventories or services for your business it iscritical that, you pay them on time and maintain a good relationship. If this is thecase, payments of accounts can be a key driver of your cash fl ow (for tips onmanaging supplier payments, refer to the previous chapter).InventoriesFor some businesses, the supply of goods is very important in ensuringthe supply of quality inventories in time to meet customer requirements. Todetermine if this is a key driver, you may want to consider whether the supplyof goods is critical to business operation. If it is, then maintaining the rightamount of inventories will have an impact on your cash fl ow.Capital ExpenditureWhere a business relies on having the most up-to-date technology to maintainmarket share, spending on capital expenditure can be a key driver of cashfl ow. An example may be a research and development company, where theyneed to keep the most up-to-date equipment to develop the latest products orservices. In this case, the business will require enough cash fl ow to supportthe capital expenditure.TIPThe importance of knowing what are the key drivers of your cash flowshould not be under-estimated. In order to maintain adequate cash flow,these drivers should be a priority for your business and be well managed70Chapter 6 p66-78 Eng.indd 708/15/11 5:02:24 PM

Financial Guide for SMEsCash Flow ForecastingA cash fl ow forecast is the most important tool forbusiness; cash flow planning is essential forbusiness success. The forecast will predict theability of your business to generate the cashnecessary for expansion or to support theoperations of the business. It will also indicate anycash fl ow gaps that the business may experience– periods when cash outflows exceed cashinflows. It uses estimated or real figures thatyou gather and add to a simple worksheet from theday you start the business. You can also developa cash fl ow forecast from existing information ifyou are already in business. After 12 months,you’ll have a good idea as to what your cashbalance will be, month by month for your next yearof operation.HINTRemember thatcash fl ow is all abouttiming and the fl owof cash, so whenpreparing your cashfl ow forecast, makesure you are asaccurate as possibleon the timing of thecash fl owsThere are a few ways to use a cash fl ow forecast as a planning tool:• In short-term planning, to identify when more cash is needed in a month,for example, when several large annual bills are due, and the cash in thebank is likely to be low.• In long-term planning, to fi nd where cash fl ow could affect the business,especially when you want to expand. For example, a school uniformretailer, after months of low trading volume with cash fl ow, has to buy newinventory, employ extra staff and advertise for back to school compaign.However they may also be planning to extend into the shop next door. Afterseveral lean months, the cash supply may be at its lowest, even withoutthe added expense of the new premises, so the cash fl ow would needcareful planning.The easiest way to prepare a cash fl ow forecast is to divide the forecast intosmaller areas and then bring all the information together at the end. The fi vesteps in preparing a cash fl ow forecast are:1.2.3.4.5.Prepare a list of assumptions.Prepare the anticipated income or sales for the business (called a salesforecast).Prepare details on any other estimated cash infl ows.Prepare details on all estimated cash outfl ows.Put all the gathered details together.71Chapter 6 p66-78 Eng.indd 718/15/11 5:02:24 PM

Financial Guide for SMEsStep 1: AssumptionsThe assumptions used in the cash flow forecast are the same as those used for theincome and expenditure budget process – refer to page 34.Step 2: Sales ForecastFor any business, sales are the key to business success. Whether you arestarting a new business or have an existing enterprise, estimating sales isoften one of the most difficult process in forecasting. If you think about it, yoursales will be dependent on many variables, such as the types of customersyou have, the terms you offer your customers, economic events such asincrease in the interest rate or competitive influences. It is not possible to predict allthe events that may occur and have an impact on your sales over the time frameof the forecast. This point is often the reason why many businesses do not doforecasts. However, if you accept that your forecast sales will most likely not matchyour actual sales, you can then focus on determining a ”realistic” figure for the salesof the business over the period for which the forecast will be prepared.For existing businesses, the best starting point will be to look at last year’s salesfigures. Do you believe that you will continue to achieve these figures, or have youenhanced your business operations to increase sales over the coming year? Onceyou have determined the likely adjustment needed to your historical sales figures,you can then estimate the forecast sales for the period.After you have determined the sales for the period, the next step is to break thesenumbers into ”sales receipts” – the actual timing of receipt of the cash from sales.Remember that we talked about the timing of cash as the key to the cash flowforecasts. Again, this information will be estimated, although existing businesseswill have some history to help estimate actual sales receipts.If the business is purely a cash business (for example a fruit stall at a market), thenthe sales will equal the ”sales receipts” number. However, as noted earlier, wherecredit terms are given to customers, there will be a delay in receiving the proceedsfrom the sale and this is where we need to estimate the timing of receipts. Applyingyour accounts receivable collection pattern from the past to your sales forecast isthe best way to predict your cash receipts from the collection of accounts receivable.To see how this is done, we have provided an example on how to calculate thetiming of cash receipts.After reviewing his sales collection history, Adam has determined that the followingsales receipt pattern had occurred in year one.Percentage of Cash Sales 40%Percentage of Credit Sales60%Applying these percentages to the estimated sales for year two, Adam completesthe following tables:72Chapter 6 p66-78 Eng.indd 728/15/11 5:02:24 PM

Financial Guide for SMEsFinancial Guide for SMEsNote: For cashflow forecasting,all estimatesshould includesales andservices taxOctoberYear OneMonthly Cash ReceiptsYear TwoNovember December January February March April May JuneJuly August September October November DecemberTotal Monthly SalesRM 4,056RM 4,300 RM 4,800 RM 5,500 RM 5,500 RM 6,050 RM 6,600 RM 6,930 RM 7,150 RM 7,700 RM 7,920 RM 8,030 RM 8,250 RM 8,470 RM 7,700Total Cash Sales40%Not RequiredRM 2,200 RM 2,200 RM 2,420 RM 2,640 RM 2,772 RM 2,860 RM 3,080 RM 3,168 RM 3,212 RM 3,300 RM 3,388 RM 3,080Total Credit Sales60%RM 2,434 RM 2,580 RM 2,880 RM 3,300 RM 3,300 RM 3,630 RM 3,960 RM 4,158 RM 4,290 RM 4,620 RM 4,752 RM 4,818 RM 4,950 RM 5,082 RM 4,620The next step is for Adam to complete a table that calculates the cash collections from his credit sales. From the sales madeon credit, Adam has worked out the average collection rate and has made a note in the following table:% of sales receipts collected in month following the sale% of sales receipts collected in 2nd month following the sale% of sales receipts collected in 3rd month following the sale60 %30 %10 %So, applying the above percentages to his estimated sales for year two, Adam has been able to calculate the estimated”actual” cash receipts from sales.7373Chapter 6 p66-78 Eng.indd 738/15/11 5:02:25 PM

Financial Guide for SMEsFinancial Guide for SMEsMonthly Credit Sales CollectedCredit Sales MadeYear OneYear TwoNovember December January February March April May June July August September October November DecemberOctober RM 2,434Year OneNovember RM 2,580 RM1,460 RM 730 RM 243December RM 2,880 RM 1,548 RM 774 RM 258Year TwoJanuary RM 3,300 RM 1,728 RM 864 RM 288February RM 3,300 RM 1,980 RM 990 RM 330March RM 3,630 RM 1,980 RM 990 RM 330April RM 3,960 RM 2,178 RM 1,089 RM 363May RM 4,158 RM 2,376 RM 1,188 RM 396June RM 4,290 RM 2,495 RM 1,247 RM 416July RM 4,620 RM 2,574 RM 1,287 RM 429August RM 4,752 RM 2,772 RM 1,386 RM 462September RM 4,818 RM 2,851 RM 1,426 RM 475October RM 4,950 RM 2,891 RM 1,445 RM 482November RM 5,082 RM 2,970 RM 1,485December RM 4,620 RM 3,049Total Monthly CreditSales CollectedRM2,745 RM 3,102 RM 3,258 RM 3,498 RM 3,795 RM 4,046 RM 4,217 RM 4,475 RM 4,666 RM 4,778 RM 4,891 RM 5,016Now that he has his monthly cash collections from credit sales, he adds these figures to his monthly cash sales to calculatethe total cash collected for each month.January February March April May June July August September October November DecemberTotal CashSales 40%Not RequiredTotal MonthlyCashCollectedNot Required7474Chapter 6 p66-78 Eng.indd 748/15/11 5:02:25 PM

Financial Guide for SMEsStep 3: Other Cash InflowsTo complete the cash infl ow information in the cash fl ow forecast, you will needto identify any additional cash coming into the business. Of course, the types ofcash infl ows for each business will vary, but the following list may help you torecognise other cash infl ows in your business:• Additional equity contribution;• Income tax refunds;• Grants;• Loan proceeds;• Other income sources not included in sales (e.g. royalties, franchise andlicense fees); and• Proceeds from sale of assets.If you are preparing a cash fl ow forecast for additional fi nancing, do not forgetto include the loan funds in your infl ows.Step 4: Cash OutflowsAs we have indicated earlier, one of the major inputs into the forecast is sales.Coupled with this infl ow is the cost of purchasing or manufacturing those goodsto sell. Therefore, when determining your cash outfl ows, it is suggested for youto calculate the cost of goods sold in line with your sales forecast. By doing this,if you need to change your sales numbers, an automatic change to the cost ofgoods sold fi gure should occur. Many computer programmes will allow you toset up a link between two items, such as your sales and cost of goods sold, tomake the process of forecasting easier. The calculation of cost of goods soldwas discussed in Chapter 1, so you may want to refer back to the section or usethe gross margin percentage discussed in Chapter 4 when estimating the costof goods sold for your forecast.ExpensesExpenses are those cash outfl ows relating to the operations of the businessand those that are not included in the cost of goods calculation. These are oftenreferred to as ”administration” or ”operational” expenditure. Again, the itemsof expense will depend on the type of business you are starting or currentlyoperating. One of the important areas to focus on when forecasting expensesis the classifi cation. Remember in Chapter 4, the difference between fi xed andvariable expenses was discussed. When putting together your forecast, thevariable expenses will be directly related to the forecast sales numbers. So ifyou adjust your sales, these expenses will need to be amended in line with thesales adjustment. Of course, the fi xed expenses will remain the same, althoughyou may need to consider adjusting these for increases (e.g. infl ation).75Chapter 6 p66-78 Eng.indd 758/15/11 5:02:25 PM

Financial Guide for SMEsOther Cash OutflowsIn addition to cost of goods sold and operational expenses, you may also haveother cash outfl ows during the operations of the business. Some examples ofcash outfl ows include:•••••Purchase of assets;One-off bank fees (i.e. establishment fees);Principal repayments of the loan;Payments to the shareholders (e.g. dividends); andInvestment of surplus funds.Step 5: Finalising the Cash Flow ForecastNow that all the relevant information has been gathered, it is time to prepare theforecast. At the beginning you would have determined the time period for theforecast. Remember, cash fl ows are all about timing and the fl ow of cash, soyou will need to have an opening bank balance, then add in all the cash infl owsand deduct the cash outfl ows for each period, usually by month. The numberat the end of each month is referred to as the ”closing” cash balance and thisnumber becomes the opening cash balance for the next month.An example of Adam’s cash fl ow forecast for year two has been provided onthe following page. This cash fl ow forecast shows that his business is goingto borrow RM20,000 to purchase a car to assist in his sales and marketing byvisiting his potential customers. Remember that Adam included this in hisassumptions (refer to page 34).The forecast shows that the RM20,000 is borrowed in February and the car ispaid for in the same month. The cash infl ows include anticipated sales receiptsas shown in the table on page 74. Remember, this is cash collected from sales,not the actual sales made. In the cash outfl ows section, all the monthly expensesas they are paid have been included and also cash outfl ows from expensesincurred for the loan (establishment fee etc.).By preparing the cash flow forecast, it can be easily seen that if Adam were toborrow the RM20,000 to purchase the car, he will still have not enough cash tocover all expenses for the period for which the forecast has been prepared. Themain reason for this is that a percentage of sales is made on credit. This meansthat while sales will increase after the purchase of the car, the time lag betweenbuying the car and increase in sales, and then the cash being collected meansthat his business will need an additional RM3,267 (maximum overdrawn amountas shown in month 5) to ensure that he has enough cash to cover the timingdifferences.76Chapter 6 p66-78 Eng.indd 768/15/11 5:02:25 PM

Financial Guide for SMEsAdam will have to consider how he is going to fund this cash shortage. Mostlikely, he will have to consider approaching his bank for additional funding. Inaddition, there are two important points to note here. Firstly, the bank is mostlikely to request details of the assumptions in the forecast. Secondly, if thebusiness were to request additional funds of only the extra RM3,267, therewould be no “buffer” in the event some of the anticipated cashfl ows changed(e.g. interest rates rose and the interest expense increased).TIPOnce the forecast is completed, you can run some “what if” scenarios tomeasure how reactive your business cash fl ows will be to certainchanges in events, such as decrease in sales or increase in fuel costs.This will show you how quickly you may run out of cash if any ofthese events occur77Chapter 6 p66-78 Eng.indd 778/15/11 5:02:25 PM

Financial Guide for SMEsAdam’s Cash Flow Forecast for Year TwoFinancial Guide for SMEspage page 74 74Sales & Service Tax335 435 1,180 4007878Chapter 6 p66-78 Eng.indd 788/15/11 5:02:26 PM

Section III : Financing Your BusinessFinancial Guide for SMEsJust as cash fl ow and profi t are importantto the business, ensuring that thebusiness is fi nanced appropriately isessential to achieving fi nancial success.Financing comes in many different formsand in this section, we will discuss onfunding a business with debt or equity,and the different types of loan productsthat can be considered. In addition, wewill look at the types of transactionalbanking available and specifi c types offi nancing for importers and exporters.Financing your businessis an important part ofgood fi nancialmanagement practice.Not only having accessto fi nance, but also beingable to choose the mostappropriate method offi nance for your businesswill result in continuedgrowth and profi tability79chapter 7-13 p79-181 Eng.indd 798/15/11 5:02:53 PM

Financial Guide for SMEsChapter 7Debt, Equity or Internal Funds?80chapter 7-13 p79-181 Eng.indd 808/15/11 5:02:53 PM

Financial Guide for SMEsDebt, Equity or Internal Funds?All businesses need finance to start operations and to grow. Finance can beobtained from the following sources:• Debt – this is fi nancing sourcedexternally, such as from banks.• Equity – this is fi nancing sourcedinternally, such as from an owner orinvestor.• Internal Funds – whereby profi ts andcash generated by the business areused to fund the ongoing operationsand expansion of the business.Comparing Debt Finance,Equity Investment and InternalFundsA key requirement toensure that you choosethe right funding is tomake certain that youfully understand thedifferences betweendebt and equity,and to consider theimplications of each onyour businessMany SMEs are faced with the dilemma to determine which type of funding isthe right option for them. The majority of SMEs look to raise debt fi nance orobtain funding support from a family member in order to expand. This is becauseit is often difficult to get an external investor interested in taking the risk of astart-up or SME business. Debt fi nance or using existing funds also enablesthe owner to maintain control over their business rather than having to give apercentage of ownership to an investor.Internally generated equity is the original funding provided by the owner and mayalso include any profi ts from the sale of an asset owned by the business orfunds generated through business trading each year that have not been drawn out(through dividends or drawings) by the owner. It could also be any additional equityfunds contributed by the owner.81chapter 7-13 p79-181 Eng.indd 818/15/11 5:02:53 PM

Financial Guide for SMEsThe assets of the business can also be funded froman investor who wishes to put permanent equity capitalinto the business. If the business is a company, theneither new shares are issued by the company or theinvestor may purchase some of the shares from theoriginal owner. You should seek advice from youraccountant regarding the capital gains, tax and cashfl ow implications of each of these choices in relation toyour specifi c circumstances.Utilising internal funds generated from the business is,in most circumstances, one of the more favourablealternatives. Most SMEs do not adequately assess thepotential ability to generate more cash fl ow throughHINTTo fully understandthe implicationsof choosing debt,equity or internalfunds to fund yourbusiness, askyourself what wouldhappen if somethinggoes wrong. Theanswer will help youto make the rightchoicegood management of working capital. Chapter 5 provides details on how this canbe achieved. Where additional cash can be sourced through good managementof working capital, this source of fi nancing can provide many advantages oversourcing of funding through debt or equity.The table on the next page outlines the key areas to consider when comparingdebt and equity. It shows the differences between those who have an interest inthe ownership of the business (equity party), such as yourself or a shareholder,and that of a party who has a debt fi nance relationship with your business(a bank).The comparison looks at:• Defi nitions and examples of each;• Level of risk for each financier / investor;• Types of security required;• How each funding party receives income on their funds;• Repayment of debt fi nance / investment capital;• Impact of financial structure on the financial statements of the business; and• Advantages and disadvantages of the alternatives.82chapter 7-13 p79-181 Eng.indd 828/15/11 5:02:53 PM

Financial Guide for SMEsDefinitions and ExamplesDEBT EQUITY INTERNAL FINANCEDebt funding can bedefi ned as:Equity fi nance can bedefi ned as:Internal finance can bedefi ned as:Funds or obligationsthat are owed to anexternal party basedon specific terms andconditions.Examples of debtfunding include:•••••••Bank overdraft;Mortgage loan;Fully drawn advance;Commercial bills;Trade creditors,accounts payable;Provisions fortaxation, employeeentitlements; andShareholder/benefi ciary loans.A form of investmentin the business, fromthe owner, partner orother people willingto take a portion ofownership in thebusiness.Examples of equityfunding include:• Issued shares/share capital(company);• Trust funds;• Partnership capital(partnership);• Owner’s capital(sole proprietor);• Retained/accumulated profits;and• Reserves – capital,profi t/sharepremium/revaluation.(Note: The nature of theinitial capital of an entitywill vary depending onthe structure, e.g. sharecapital is used if it is acompany, trust funds ifit is a trust, partnershipcapital for a partnership)Working capital, whichis cash used duringthe operating cycle ofthe business.Examples of workingcapital include:• Cash used topurchaseinventory;• Cash requiredto pay suppliers;and• Cashoutstandingfrom customers.83chapter 7-13 p79-181 Eng.indd 838/15/11 5:02:54 PM

Financial Guide for SMEsLevel of RiskDEBT EQUITY INTERNAL FINANCEFor a lender :The lender takes therisk that the businessmay be :• Unable to generatesuffi cient cash fl owto service the debt; or• Unable to repay theprincipal at the endof the loan period.The lender will generallyrequire a sufficient levelof security to cover theprincipal. However,the costs and timing ofenforcing this securityposes an additional risk.The risk for the businessis generally based on:• Changes in interestrates if exposed tovariable rates;• Cash fl ow risk ashigh growth requiresincreased workingcapital;• Ability to generatesuffi cient funds tofund principalrepayment; and• The proportion ofdebts to equity,(generally the higherthe proportion, thehigher the risk).For an investor :The equity investorbears the risk of thebusiness and its abilityto achieve the requiredlevel of growth.They also bear the riskof finding a willing buyerin order to exit theinvestment.The risk to the businessis reduced with equityfunding, as it does notimpose any significantcash fl ow requirementson the business.The ultimate risk forthe investor is that theycould lose their capitalif the company does notsurvive. Therefore, theirrisk is both a capitaland return-oninvestmentrisk.For the owner of thebusiness, bringing ininvestors usuallydecreases their controlof the business.For the owner:The owner of thebusiness takes therisk that cash usedfrom areas of workingcapital may affect thebusiness operations.For example, toincrease cash fl ow,the business mayreduce inventory level,which could result ininsuffi cient inventoryavailable for sale.84chapter 7-13 p79-181 Eng.indd 848/15/11 5:02:54 PM

Financial Guide for SMEsTypes of Security RequiredDEBT EQUITY INTERNAL FINANCELenders generallyrequire some form ofsecurity against thefunds that are lent to thebusiness. In the eventrepayment conditionsare not met, the lendercan call-up the loan andrealise the security.The level of fi nanceavailable is generallyrestricted or capped bythe level and quality ofsecurity available.Examples of commonsecurity required include:First or furthermortgages overproperty (this mayinvolve propertyowned by thebusiness or personalassets of the ownersor third parties);Fixed charge /debenture (coveringthe total assets of thebusiness); andSpecific assets (e.g.inventory / debtors,motor vehicle,equipment).Some lending can bedone without security,usually with a personalguarantee of the owners/directors. However, withhigher interest ratesrefl ecting the higher risk•••Equity investors donot require anysecurity against fundsinvested.The equity investor isproviding risk capitalbased on the potentialto achieve future profi tsand increased businessvalue.Equity investors rankbehind all otherunsecured creditorswhen the businesswinds up. For thisreason, they seek ahigh return on fundsinvested.Internal sources offinance do not requireany security as itis essentially usingcash held by thebusiness.85chapter 7-13 p79-181 Eng.indd 858/15/11 5:02:54 PM

Types of Security RequiredFinancial Guide for SMEsDEBT EQUITY INTERNAL FINANCEand the lender can thencall on other assets ofthe individual to meetbusiness debts, subjectto the terms of theguarantee.How Each Funding Party Receives Income on Their FundsDEBT EQUITY INTERNAL FINANCEA lender achieves areturn on their investedfunds through thepayment of interest.Interest terms can varysignificantly, based onthe terms and conditionsof the finance. In order tocompare the various debtproducts, you should beaware of:• The basis for calculationof the interest;• Exposure to interestrate changes;• The timing of interestpayments; and• Fees and charges.Debt finance often has arequirement to meet bothinterest and principalrepayments during theterm of the loan.Therefore, debt financehas an important cashflow impact on a growingbusiness.An equity investorreceives the return onfunds invested in twoways:• Profits from thebusiness (and whichcan be left in thebusiness to fundfuture growth); and• Increased value ofthe business (as thebusiness increasesin overall value, theequity investor’sinterest in thebusiness will increaseproportionately;however, this increasein value will not berealised until thebusiness or owner’sinterest is sold).It can be seen from theabove that the focusof the equity investoris on long-term growthof the business. As aresult, equity funds donot generally place cashflow pressures on thebusiness.Using internal sourcesof finance will notincur any fees orinterest payments.86chapter 7-13 p79-181 Eng.indd 868/15/11 5:02:54 PM

Repayment of Debt Finance/ Investment CapitalFinancial Guide for SMEsDEBT EQUITY INTERNAL FINANCEThe debt financeagreement provides theterms of repayment ofthe funds borrowed.The funds borrowed willbe repaid either ininstalments over the loanperiod or at the end of theperiod.The business will need togenerate suffi cient fundsfrom profi ts and cash fl owto meet these commitments.The equity investor hasacquired an interest inthe business. In orderto obtain return on thefunds invested, theinvestor will need tosell his/her interest inthe business.The return of the initialfunds invested willdepend on the changein value of the businessand the ability to finda willing buyer or anappropriate exit strategy.No repayment offunds is required.The lender does notshare the risk of thebusiness or the benefi t ofgrowth through increasedvalue.The equity investorshares both the risksof the business andthe benefits of growth.Hence, an investor mayreceive either more orless than what theyinitially invested.87chapter 7-13 p79-181 Eng.indd 878/15/11 5:02:55 PM

Financial Guide for SMEsImpact of Financial Structure on the Financial StatementsDEBT EQUITY INTERNAL FINANCEA significant relianceon debt fundingprovides a highergearing structure for abusiness.A higher gearing reflects ahigher risk as the businesshas more commitmentsto lenders than equity. Alower gearing reflects lesscommitment to externalfinanciers as comparedwith equity funds.The use of debt canalso result in reducedprofits through interestexpense, although debtcan be more tax effectivebecause interestpayments are deductedfrom assessable income.The injection ofadditional equitycapital can provide amore balanced debtto-equityratio,a common measure ofrisk.With additional capital,the owners may be in aposition to increase otherdebt finance, as thefinancial structure of thebusiness is much stronger.Equity capital injectionshould allow the businessto generate increasedprofits, as often it doesnot have to servicefunds raised (makerepayments, interestpayments etc).Utilising internalfinance can providea more balanceddebt-to-equity ratio,a common measureof risk.Through the use ofinternal finance asan alternative sourceof financing, thebusiness should beable to generate moreprofits, as it does nothave to service fundsraised.88chapter 7-13 p79-181 Eng.indd 888/15/11 5:02:55 PM

Financial Guide for SMEsAdvantagesDEBT EQUITY INTERNAL FINANCE• Retain control over thebusiness.• Growth in value of thebusiness is retained bythe owner.• Debt repaymentcommitment can befixed.• Lower cost of capital.• Lower cost of raisingdebt finance.• Interest expense is taxdeductible.• Ability to raise fundsin excess of security.• No exposure tochanges in interestrates.• External resourcescould add strategicinput; and alliances.• Improved profile withlenders.• More stable financialstructure.• Possible mentoringsupport from theinvestor as wellas their funds.• Utilising internalfinance as analternative to debtfinance willpotentially increaseprofitability as thesefunds will not carryservice costs.• No exposure toexternal market,such as interestrates and investorappetite.• Retain control overthe business.• All growth in thebusiness is retainedby owners.• Better cash flowmanagement with nodebt / repaymentcommitment.• No exposure toexternalstakeholders suchas banks orinvestors.• No security overassets.89chapter 7-13 p79-181 Eng.indd 898/15/11 5:02:55 PM

Financial Guide for SMEsDisadvantagesDEBT EQUITY INTERNAL FINANCE• Ability to raise funds islimited by securityavailable.• Business may beexposed to financialrisks as a result ofinterest ratemovements.• Reduced opportunityto establish newexternal allianceswith potentialinvestors.• Loss of control andautonomy indecision-making(as other investorswill want a say in theoperation of thebusiness).• Greater pressurefrom other investorsto achieve growthand higher returns.• Need to identify exitstrategy.• Potential tighteningof operationalcash flow ifinternal finance isused for long-termasset purchases.• No credit history isdeveloped.• Potential loss ofmentoring frominvestor if equityfinance was analternative.• Liquidity exposure of ahighly geared structure.• Business opportunitiescan be lost throughtight cash flow.• Profitability can bereduced by highdebt-servicing costs.• Potential personalityconflict betweenowner and otherinvestors.• Additional costs ofequity process.• Greatermanagementreporting required.• Dividend paymentsby the business arenot tax deductible.• Length of time toraise equity canoften be lengthy.• Loss of income ifdividend paymentsare required.• No tax deductionsas no servicingcosts.90chapter 7-13 p79-181 Eng.indd 908/15/11 5:02:55 PM

Financial Guide for SMEsDeciding Between Debt and EquityDuring economic uncertainties, you may wish toreduce the financial risk of taking on significant debtfunding (it may also be difficult for you to raise debtfinance). Therefore, you may need to be preparedto share the ownership of your business to increasefunding.You may also want to consider a combination ofdebt and equity funding to meet the businessrequirements. An investor may be prepared toprovide both equity and debt finance.HINTIn deciding whetheror not to seek anequity party, youneed to considerboth the fi nancial andnon-fi nancialoutcomesConsiderations in selecting equity investment as your finance option mayinclude:• The ability to recognise an external investor’s interests in operating thebusiness;• Your attitude to losing a 100% control position and power to make alldecisions without consulting other owners;• Identification of skills of potential investors that would be advantageous tothe growth of the business;• The need to reduce the risk associated with the gearing level of the businessthrough lower interest and principal repayment commitments;• Long-term plans for succession and, if it is a family business, the impact onother family members;• Willingness to identify an appropriate exit strategy and its impact on you;• The opportunities equity funding will bring that could not be achieved withexisting debt available to the business;• Whether your business is attractive to an investor;• Whether you have prepared the necessary fi nancial statements andforecasts that a potential investor will want to see; and• How quickly you need the funding.91chapter 7-13 p79-181 Eng.indd 918/15/11 5:02:55 PM

Financial Guide for SMEsTIPGenerally, a business would aim to maximise the use of debt fi nance tofund its operations, as long as the business can service the level of debtand has enough security to support the funding. The business ownerwould retain the benefi ts of ownership in respect of growth andprofi tability of their businessThe choice between debt and equity is, therefore, a combination of:• Assessing the limitations that debt finance may bring;• Determining if your business has the growth potential to be attractive to anequity investor; and•Evaluating your willingness or preparedness for the changes equityinvestment will require.Many SME owners fi nd that the retention of majority control over their businessis important to them, and that their objectives are based on both lifestyle andfamily priorities. In these circumstances, debt will be their primary alternative forfunding their business, as they are unlikely to meet an investor’s objectives.TIPYou may find that your ability to raise debt improves with equityinvestment92chapter 7-13 p79-181 Eng.indd 928/15/11 5:02:56 PM

Financial Guide for SMEsUnderstanding the Debt Financing Options :Long-term versus Short-termIf you select debt as a financing option, you haveto consider which debt product (as there are many)will meet the needs of your business.In making this assessment, you will need to:• Understand the nature of alternative debtproducts in the market to make an informeddecision;• Identify the alternative features available foreach product;HINTIt is important toreview alternativefi nance productsfrom different lendersand ensure thatyou are comparingapples with apples• Have a common basis for comparing debt products;• Match the right debt product / features with your business circumstancesand requirements; and• Understand the tax implications of alternative products.To cater for your business needs, fi nancial institutions offer a wide range offi nancing products for SMEs under both conventional and Islamic banking. Youcan choose from a wide variety of products offered in the market, dependingon your fi nancing needs and the suitability of such fi nancing to your business.A list of different types of products available, its usage, features and benefi tsfor SMEs is provided on page 95.Evaluating Your Own CircumstancesIn matching a debt product and selecting the appropriate features to suit yourbusiness requirements, you need to determine the following about yourbusiness:• Types and purpose of the loan / funds and how long you would require them;• Whether they are for short-term funding of working capital or long-term funding,to fund a building extension or export market entry costs;• How much finance you need (be realistic about the amount of funds yourequire – do not underestimate).93chapter 7-13 p79-181 Eng.indd 938/15/11 5:02:56 PM

Financial Guide for SMEs• What level of security you can offer and how the lender will view the value ofthe security (real property security, compared with business assets, is likely toresult in a lower interest rate margin being charged); and• How the lender will assess ”risk” for your business.This evaluation will help you better match your requirements and limitations to thespecific “guidelines” for particular alternative debt funding.When choosing the appropriate fi nancial product for your business, it is importantto consider the impact of the features as well as the nature of the products. Insome circumstances, borrowers can structure their loan with a mix of fi xed/variable/capped and other variations of interest charges. If specifi c featuresare important to you based on your circumstances, you may need to look atalternative debt providers until you fi nd the right fi nance for you. You may fi nd,however, that your circumstances may limit the debt products available for yourbusiness.It can often be diffi cult for SME owners to evaluate debt product options.Lenders can have different names for similar products, and structure the terms,conditions and fees differently.TIPEnsure that the type of fi nancing undertaken matches the reason forseeking fi nance. A general rule of thumb is to match the term of the loanwith the length of the life of the asset you are funding94chapter 7-13 p79-181 Eng.indd 948/15/11 5:02:56 PM

Financial Guide for SMEsProducts for SMEs offered by Financial Institutions in MalaysiaPurpose Product Usage Features BenefitsFacilitate managementof funds, as repaymentamount ispredetermined.A loan granted for apredetermined lengthof time (tenure), withrepayments byinstalments.To aquire fixed assets(immovable propertiesi.e. land and buildings,as well as commercialvehicles).Term LoanAsset Acquisition /Business Expansion• Facilitatemanagement offunds, as leasinginstalments amountis predetermined:• For an operatinglease, maintenancecost is borne by thelessor (financialinstitution).• Instalments paid forleasing are eligiblefor full tax relief.• A facility which allowsSMEs to leaseequipment fromfinancial institutionswithout having topurchase theequipment.To acquire capitalassets such asequipmentand machineries.LeasingYour business requiresassets in order tooperate. These assetscould be immovableproperties such asfactories, shop housesand buildings, or otherassets such asvehicles, equipment,fixtures andmachineries.Financial Guide for SMEs• There are 2 typesof leasing facilitiesavailable:i. Operating LeaseOwnership is heldby the financialinstitutions.ii. Financial LeaseOwnership is heldby the financialinstitutions.However, thelessee has theoption to purchase9595chapter 7-13 p79-181 Eng.indd 958/15/11 5:02:56 PM

Financial Guide for SMEsPurpose Product Usage Features Benefitsthe asset at theend of the tenure.• Allow SMEs to ownequipment andmachineries withouthaving to pay thefull amount upfront.• Facilitatemanagement offunds, as repaymentamount ispredetermined.• Free up availablefunds for otherpurposes.• A form of financingwhereby the asset ispurchased by thefinancial institutionand hired to SMEs,with the ownershipbeing retained bythe financialinstitution until theloan is repaid.• SMEs make periodicrepayments to thefinancial institution.To acquire capitalassets such asequipment andmachineries.IndustrialHire -PurchaseFinancial Guide for SMEsFlexibility in fundsmanagement in viewthat the OD iscontinuously available,provided the facilitiesare properly conductedand the businesscontinues to operatesatisfactorily.• A revolving loanmade available to abusiness customervia a currentaccount, wherebythe borrower maywithdraw therequired amounteach time by issuingcheques, as long asthe OD limit is notexceeded.• A commitment fee of1% is charged on theTo meet workingcapital needs i.e.payment of salaries,purchases, utilities etc.Overdraft(OD)Working CapitalYour business needsworking capital for theday-to-day running ofthe business. Generally,the most convenientform of financing wouldbe an overdraft facilityfrom commercial banks.Although flexible,overdraft can be quitecostly. You may becharged commitment9696chapter 7-13 p79-181 Eng.indd 968/15/11 5:02:56 PM

Financial Guide for SMEsPurpose Product Usage Features Benefitsunutilised portionof the facility.fees for the unutilisedportion of the overdraftor revolving credit. • Interest is calculatedon a daily basisbased on theoutstanding balanceat the end of eachbusiness day.• Lower financingcosts compared toconventionalfinancinginstruments.• Continuousavailability of funds,as facility can berolled over.Similar to OD, it isshort-term in natureand is used to meetshort-term workingcapital requirements.Financial Guide for SMEs• A form of loangranted for a fixedperiod which can berolled over uponexpiry.• A convenient form ofshort term financingfor companies withgood financialstanding.• Drawdowns bymeans of a letterfrom the SME to thefinancial institutionstating the period ofthe loan required.RevolvingCredit• Cash advances areeasily and quicklyobtainable• No collateralrequired.A method of financing,where the financialinstitution purchasesthe client’s tradeinvoices at a discountTo obtain short termfinancing of tradedebts (sale of goodsto customers oncredit terms).Factoring9797chapter 7-13 p79-181 Eng.indd 978/15/11 5:02:57 PM

Financial Guide for SMEsPurpose Product Usage Features Benefits• Able to sell on morecompetitive terms tocredit customers.from the face value ofthe invoices, andprovide cashadvances for businesspurposes.• Buyer:i. A safe method ofpayment as thepayment can bedeferred by thebuyer until thegoods arrive oreven later ifdelayed paymentarrangementsare agreed toii. Customers willhave time toinspect thedocuments beforepaying/acceptingAssist customer inmaking paymentsfor trade transactions.Outward /InwardBills forCollection(OBC/IBC)Trade ServicesTo assist customers intrade transactions,financial institutionsalso provide paymentservices.Financial Guide for SMEs• Seller:i. Documents ofvalue, i.e. titlesdocuments, arenot released tothe buyer (drawee)• Documents arechanneled throughthe financialinstitution withspecific instructions.• Financial institutionshandle documentson instructionsreceived (fromcustomer or anotherbranch or financialinstitution) to:i. obtain acceptanceand/or payment;ii. deliver commercialdocumentsagainstacceptanceand/or againstpayment; andiii. deliver documentson other termsand conditions.9898chapter 7-13 p79-181 Eng.indd 988/15/11 5:02:57 PM

Financial Guide for SMEsPurpose Product Usage Features Benefitsuntil payment oracceptance hasbeen affected; andii. Once the bill isaccepted by thebuyer (drawee),the seller (drawer)can seek legalremedy in case ofnon-payment onmaturity date.Financial Guide for SMEs• Shows thecustomer’s/applicant’s capabilityto perform work asspecified in thecontract.• Able to obtain morefavourable tradeterms from thebeneficiary if a BG isproduced.• There is noneccessity to raisecash to meet thedeposit requirementsand funds could beused to support• Types ofguarantees:i. Tender Guaranteeor Bid Bond;ii. PerformanceGuarantee;iii. AdvancePaymentGuarantee;iv. Warranty ofMaintenanceGuarantee;v. RetentionGuarantee; andvi. SecurityGuarantee.• Commission is• Provides guaranteefavouring a thirdparty forperformance,payment etc.• Generally,businesses thathave a particularneed for BGs arecontractors, such asbuilding and suppliercontractors. On thecorporate side, BGscould also be givenfor the issuance ofprivate debtsecurities.BankGuarantee(BG)GuaranteesA guarantee is basicallya legal undertaking by afinancial institution onyour behalf (the thirdparty), where itguarantees thepayment of a certainsum of money up to acertain limit to abeneficiary, in the eventthat your business failsto settle a debt orperform a legalobligation. This ishowever subject to full9999chapter 7-13 p79-181 Eng.indd 998/15/11 5:02:57 PM

Financial Guide for SMEsPurpose Product Usage Features Benefitsworking capitalrequirements.• Allow customers tohave access to fundsespecially where BGis issued for advancepayment or releaseof retention fundsunder contracts.changed basedon the amount andperiod of theguarantee.• Maximum period ofguarantee isguided by the rulesof the Associationof Banks inMalaysia i.e.guarantee shouldnot be issued formore than 1 yearexcept forGovernmentcontracts. Theexpiry of theguarantee must notbe more than 12months after theexpiry of theoriginal contract.compliance of all termsspecified in the relevantguarantee. There areseveral types ofguarantees which canbe arranged by thefinancial institutiondepending on thespecific requirements ofthe borrower.A financial institutionmay take into account anumber of factorsbefore issuing aguarantee, such as, theextent of liability, periodand expiry, and creditstanding of thecustomer.Financial Guide for SMEsFacilitate meeting ofproduction or contractdeadlines.• Guarantee orundertaking by theissuing financialinstitution to theshipping agent torelease the goodswithout production ofTo expedite therelease of goodswhich have arrivedbefore the originaltransport documents.ShippingGuarantee(SG)100100chapter 7-13 p79-181 Eng.indd 1008/15/11 5:02:57 PM

Financial Guide for SMEsPurpose Product Usage Features Benefitsoriginal transportdocuments.• Usually issuedwhere the goodsare initiallyimported underLetter of Credit (LC)and is to beearmarked againstTrust Receipts (TR) /Banker’sAcceptance (BA)facilities.Financial Guide for SMEs101101chapter 7-13 p79-181 Eng.indd 1018/15/11 5:02:57 PM

Financial Guide for SMEsChapter 8Transactional Banking to SuitBusiness Needs102chapter 7-13 p79-181 Eng.indd 1028/15/11 5:02:57 PM

Financial Guide for SMEsTransactional Banking to Suit Business NeedsTransactional banking is the everyday bankingrequirements that your business needs tooperate effectively. Primarily, this will includeboth deposit accounts and payment of servicesprovided by your bank or other financialinstitutions (e.g. credit union, building society).All businesses need to have some transactionalbanking services. There are essentially twotypes of transaction banking groups:• Transaction Banking• Merchant FacilitiesTransactionalbanking forms part ofthe overall financingof your business. Theeveryday bankingrequirements shouldbe consideredcarefully to ensurethat the paymentsin your business areefficient and effectiveTransactional Banking ProductsWhen deciding what type of transactionbanking products your business will need, it isimportant to look at the type of business youare offering to your customers, the requirementsfrom your suppliers and how you want tomanage your cash flow. Although manybusinesses believe that paying by chequeoffers a few extra days before the funds arewithdrawn from the bank account, in reality,HINTChoosing the mostappropriate transactionalbanking products will assistin managing cash flow andimproving profitabilitypaying by cheque provides a level of uncertainty because you cannot be surewhen the cheque will be presented.With many options available to business today, it is wise to ask your bankaccount manager to assist in choosing the right products that will help managecash fl ow and reduce the need for time spent in managing all your bankingrequirements.The list below provides the most common transaction banking productscurrently available:• Electronic Desktop / Internet Banking;• Credits to accounts – electronically, manually or by direct credit;103chapter 7-13 p79-181 Eng.indd 1038/15/11 5:02:58 PM

Financial Guide for SMEs• Debits to accounts – electronically, by manual cheque, Electronic FundsTransfer (EFT) or overseas transactions;• Overdraft and other limit facilities;TIP• Cheque production or cashing facilities; and Your banker can assistyou in choosing the most• Payroll processing arrangements.appropriate transactionalbanking products for yourbusinessMerchant FacilitiesMerchant facilities provide your customers with various options to pay by eithera credit or debit card. These facilities enable you to process payments madeon these cards either manually or electronically.Some of the benefits of having merchant facilities include:• guaranteed payment within 48 hours of the purchase made;• improved cash fl ow and thus business performance;• reduced exposure to keeping cash on your premises;• reduced administration costs (you no longer have to wait for a purchaseorder, issue paper invoices or chase payment);• no need for establishing accounts for one-off or infrequent transactions; and• environmental protection (by reducing the useof paper).When considering merchant facilities, it is best tospeak to your bank account manager to discussthe best facilities for your business. Some of thequestions to consider before meeting with yourbank are:HINTMerchant facilitiesprovide a real benefi t toyour business cashfl ow: your customersdo not necessarilyneed to have cash inthe bank to pay foryour goods or services104chapter 7-13 p79-181 Eng.indd 1048/15/11 5:02:58 PM

Financial Guide for SMEs• Do you have a retail store where your customers walk in and pay for thegoods with their card? You may need an Electronic Funds Transfer at Pointof Sale (EFTPOS) terminal to swipe their cards.• Do you take the majority of your orders over the mail/phone/fax/internet?Do you need an EFTPOS terminal or is there an alternative method ofprocessing?• Do you need a combination of the two options above? Can you have anEFTPOS terminal to swipe the cards of walk-in clients but key-in the detailsof “remote” orders?• Would a mobile EFTPOS/ credit card machine assist with faster payments?• What volume of credit card, cash, or other payment methods are youexpecting?TIPBy introducing merchant facilities, your business would be able to benefi tfrom faster payment, signifi cant reduction in invoice queries and creditcontrol calls and improved cash fl ow105chapter 7-13 p79-181 Eng.indd 1058/15/11 5:02:58 PM

Financial Guide for SMEsTransactional FeesMost fi nancial institutions do not providetransactional services for free. In someinstances (particularly where your margins arevery small), the fees related to these servicescan substantially impact on the profi tabilityof your business. With so many fi nancialinstitutions providing these services, it wouldbe wise for you to consider the fee structurefrom a number of providers before decidingon the best provider (see the section on howto switch banks).HINTRegular review of yourtransactional bankingservices will guaranteethat you know how muchyou are paying for theseservices, and ensure thatyou are using transactionalservices that best suit yourbusinessIt is common knowledge that most SMEs do not know how much they are paying inbank fees. This can be attributed to the fact that they do not spend time reviewingthe transactional banking arrangements and some banks may not make it easy toclearly establish the total amount of fees being charged.TIPBy allocating all bank fees in a separate account, you would be able to clearlyidentify any increases in fees that could be affecting your profitability106chapter 7-13 p79-181 Eng.indd 1068/15/11 5:02:58 PM

Financial Guide for SMEs107chapter 7-13 p79-181 Eng.indd 1078/15/11 5:02:58 PM

Financial Guide for SMEsChapter 9Trade Financing108chapter 7-13 p79-181 Eng.indd 1088/15/11 5:02:59 PM

Financial Guide for SMEsTrade FinancingSMEs that import or export goods or servicesare often faced with additional challengesthat come from dealing with internationaltransactions. There are two importantareas that you should consider to help youmanage the risk and improve cash fl ow whenundertaking international trade:• Foreign Currency Payments; and• International Trade Finance.International tradefi nance products arespecifi cally designedto assist importersand exporters inmanaging risk andimproving cash fl owfor their businessForeign Currency PaymentsWhen importing or exporting goods orservices, you may need to pay or receivepayment in a foreign currency. Your bankcan help you to arrange payment in foreigncurrency or convert foreign currencypayments into Malaysian Ringgit.HINTBy hedging yourinternational currencypayments, you wouldreduce the risk of negativeimpact on profi tabilityOne of the main issues where the business isdealing in foreign currency payments is thatcurrencies fluctuate on a daily basis and business can be subject to afall in revenue (where foreign currency payments are being received) orincreased costs (where foreign currency payments are made) and have littlecontrol over this issue.However, there are various methods that can be used to assist business tominimise this impact. Essentially, the importer or exporter sets off the foreigncurrency risk by using one or more bank products – this is referred to asforeign currency hedging. Let us have a look at these various products andhow each one can be used.109chapter 7-13 p79-181 Eng.indd 1098/15/11 5:02:59 PM

Financial Guide for SMEsForward Foreign Currency AgreementTo minimise the impact on your profi t from foreign currency fl uctuations, it maybe possible to enter into a forward rate agreement with your bank. First, youneed to discuss with your bank to see if your business “qualifi es” for the bankto offer this product.How does this product work? The agreement between you and your bankallows you to lock in a pre-agreed exchange rate for a set date in the future.The agreed future exchange rate will be based on the current exchange rateand the fi nancial market’s view on where the exchange rate will be at the timeyou settle the transaction. The benefi t is that you then know exactly the amountyou will be either paying or receiving.It is important to note that once this transaction has been agreed with your bank,you will be required to “settle” the business transaction on the agreed date.This means you will need to ensure that you either have the foreign currency tobuy the Malaysian Ringgit (importer) or have received the foreign currency tosell for Malaysian Ringgit (exporter) on the settlement date of the transaction.Therefore, before entering into this type of transaction with the bank, you shouldmake sure your international trade transaction is confi rmed and payment dateis accurate.Foreign Currency OptionFor some business, locking in the foreign currency exposure may limit theirability to provide a competitive edge. How is this so? If, for example, an importeris importing goods denominated in US dollar for delivery in three monthsand enters into an agreement with their bank for a forward foreign currencyagreement, the importer is contractually bound to accept the US dollar he/shehas purchased at the agreed rate (for Malaysian Ringgit) on the agreed date. Ifthe Malaysian Ringgit strengthens, the importer must still honour the contracteven if it is less favourable than the current exchange rate.The importer can solve this problem bypurchasing a currency option, which issimilar to insurance. As with insurance, anoption requires payment of a premium, whichcan be relatively expensive.TIPOften using a combinationof hedging products wouldprovide the best protectionover fluctuations in foreigncurrency110chapter 7-13 p79-181 Eng.indd 1108/15/11 5:02:59 PM

Financial Guide for SMEsThe option will protect the importer from downward movements in thevalue of the Malaysian Ringgit, but allow the importer to benefit fromfavourable fluctuations in the Malaysian Ringgit.So if the Malaysian Ringgit increases in value, the importer can abandonthe option. If the Malaysian Ringgit diminishes in value, the importer canrely on the rate in the option. The maximum cost to the importer is thepremium. It is advisable to seek advice from your banker on which methodof hedging that will best suit your business needs.Alternative Methods to Manage Foreign Currency PaymentsIf your business has both cash inflows andoutflows, you can match these currencyexposures. The cash fl ows do not need to matchprecisely in terms of timing. The perfect hedge iswhere infl ows are received at the same time asoutfl ows are expected. However, this is rarely thecase. Where the timing of the infl ows and outfl owsdoes not match, then timing issue can beHINTForeign currencypayments can alsobe managed byimplementing alternativepayment methodsmanaged by depositing surplus foreign currency in a foreign currencybank account for later use, or by borrowing now to pay for foreign currencypurchases, and then using the foreign currency receipts to repay the loan.Negotiating to Pay or Receive in Malaysian RinggitThis means that the supplier or customer manages the foreign exchange risk.Be careful in this situation, as the supplier may increase the cost to coverthe possibility that the currency may move against them, or the customer mayexpect a reduced selling price to cover their risk.Goods Paid For at the Time the Agreement is MadeThis means that the goods will be paid for at the foreign currency rate at thetime of order; however, this also means that you will have to fund the goods fora longer period of time whilst waiting for the goods to arrive, and the exchangerate may be more favourable to you at a later date.TIPIt is advisable to speak to your banker to determine the best alternative tomanage your international trade payments111chapter 7-13 p79-181 Eng.indd 1118/15/11 5:02:59 PM

Financial Guide for SMEsInternational Trade FinanceIn addition to foreign currency payments,banks also provide fi nancing for SMEs thatare involved in domestic and internationaltrade. Some of the common trade fi nancingfacilities provided are listed on page 113.HINTTrading internationally canbe a real strain on cashflow. If you can negotiatewith your supplier orcustomer to use tradefinance products, you canrelease your cash flow forother parts of the business112chapter 7-13 p79-181 Eng.indd 1128/15/11 5:02:59 PM

Financial Guide for SMEsInternational Trade Financing FacilitiesProduct Usage Features BenefitsFinancial Guide for SMEs• Can assurepayment is madeto the beneficiary.• Able to obtain alower purchaseprice of the goodsand longerpayment terms, asthe LC provides anindication ofpaymentassurance, from thesellers’ perspective.• Documentspresented will beexamined by tradefinancing specialists.• Do not have tocommunicate withthe foreign seller sooften since thewhole transactionwill be routedthrough andhandled by thefinancial institution.A written undertakingby a financialinstitution to pay aseller a given amountof money subject tothe followingconditions:• On presentation ofspecified;documents as setout in the termsand conditions ofthe LC; and• Within a specifiedtime limit• At a specified place.For import or localpurchases of goods,materials or equipment.Letter ofCredit (LC) orDocumentary Credit (DC)113113chapter 7-13 p79-181 Eng.indd 1138/15/11 5:03:00 PM

Financial Guide for SMEsProduct Usage Features Benefits• Enables thecustomer to pay theseller promptly• Enables thecustomer to takedelivery of thegoods withoutpaying for itimmediately.• Able to easecashflow.A financing facilitythat enables acustomer to acceptdelivery of theirlocal/foreignpurchases prior topayment of the sightbills being made bythem.Trust Receipts (TR) Extends credit facility onbills drawn under thefinancial. institution’s ownLC. As such, customersdo not have to makeimmediate paymentson the LCs.Financing of a bonafide trade i.e. export.import or domestic tradetransaction.Banker’sAcceptance (BA)Financial Guide for SMEs• Provides cash flowbefore proceeds forsale of goods oncredit can becollected, or tofinance purchasesof raw materials forproduction.• Can always be soldat the prevailingmarket rate shouldthe customer needimmediate funds.• Provides two-wayfinancing as BAfinancing isapplicable for salesand purchases.• A draft (Bill ofExchange) drawnby customers totheir order, payableon a specific futuradate and acceptedby the financialinstitution for thepurpose offinancing a bonafide trade.• The minimumamount of financingis RM50,000 andin multiples ofRM1,000 (bunchingis allowed).114114chapter 7-13 p79-181 Eng.indd 1148/15/11 5:03:00 PM

Financial Guide for SMEsProduct Usage Features Benefits• Able to obtainimmediate fundsupon presentationof necessarydocuments.• Able to improvecash flow of thebusiness sinceSMEs can obtainimmediate fundsfrom the financialinstitution.A facility provided bythe financialinstitution forexporters, wherebythe financialinstitution maypurchase customers’outward bills forcollection and thecustomers’ account iscredited immediatelywith the proceeds.As a means of workingcapital financing forexporters.Bills of ExchangePurchased (BEP)The buying andselling of foreignexchange on a spotor forward basis, inrespect of foreignproceeds orpayments to be madeat sight or at a futuredeterminable date.Foreign ExchangeContracts (FEC)Financial Guide for SMEs• Customers areable to fit theirexchange rates forpurpose ofcosting/hedging.• No furtherexposure toexchange riskfluctuationsespecially in volatilemarkets orconditions.Generally forbusinesses, with thefollowing features:• Regularly importingor exporting inforeign currenciesof a sizeable level.• With credit standingthat is acceptableto the financialinstitution.115115chapter 7-13 p79-181 Eng.indd 1158/15/11 5:03:00 PM

Financial Guide for SMEsProduct Usage Features BenefitsCheap source offinancing exports.Financial Guide for SMEs• Administered bythe EXIM Bank.• 2 types of facilitiesavailable:i. Pre-shipmentAmount offinancing can becalculated using2 methods:Order Base80% of value ofexport order orsales contractrounded to thenearestthousand.Certificate ofPerformance(CP)Eligible amountspecified in theCP.ii. Post-shipmentAmount offinancing can beup to 100% ofthe export bill,rounded to thenearest• Commonly used byexporters with thefollowing criteria:i. Exportingproducts with avalue added ofat least 20%and uses aminimum of 30%domestic rawmaterials/inputcontent (atoleranceallowance of 2%is permitted) andnot in thenegative list asprovided byBank NegaraMalaysia.ii. Direct exportermust haveexported at leastRM3 million ofeligible goodsper annum in thelast financialyear and RM3million in theExport Credit Financing(ECR)116116chapter 7-13 p79-181 Eng.indd 1168/15/11 5:03:00 PM

Financial Guide for SMEsFinancial Guide for SMEsProduct Usage Features Benefitsthousand.preceding 12months.• For agriculturalproducts, theamount is aminimum of RM1million in the lastfinancial year andpreceding 12months.117117chapter 7-13 p79-181 Eng.indd 1178/15/11 5:03:00 PM

Financial Guide for SMEs118chapter 7-13 p79-181 Eng.indd 1188/15/11 5:03:00 PM

Section IV : Managing LendersBankers and other lenders are generallyvery good at providing assistance whenyou are looking for fi nance. However,you should remember that manyhave not run, or been involved in abusiness. While they may have someindustry knowledge, they are notbusiness owners. So if you are seekingdebt fi nance for your business, you needto educate a potential lender about yourbusiness and the industry you are in(in order to help them make a decisionon whether to lend to you and to helpyou decide whether you want to borrowfrom them).Financial Guide for SMEsMany people in businessover estimate how mucha banker knows abouttheir business or industry,and due to past actionsby some banks, they alsocan feel somewhatintimidated. However,if you take the time toeducate your banker, theycan be an asset to yourbusinessIf you take the time to discuss the keydrivers of your business - how sales aregenerated and how you manage yourbusiness on a day-to-day basis - your banker or alternative lender will be in abetter position to meet your needs and to act as an advocate on your behalfwhen you are applying for loans and other services offered.Do shop around. You are also trying to fi nd a lender that can fulfi ll your needs.By developing a solid relationship with your lender, you will benefi t from thesupport that they will provide to your business. Lenders and bankers can begreat sounding boards for new business ideas, and provide insight into whatis happening in your industry, as they will most likely have other customersthat are servicing your industry, region etc.119chapter 7-13 p79-181 Eng.indd 1198/15/11 5:03:01 PM

Financial Guide for SMEsChapter 10Applying For a Loan120chapter 7-13 p79-181 Eng.indd 1208/15/11 5:03:01 PM

Financial Guide for SMEsApplying For a LoanThe key to a successful loan application lies in the provision of all the requiredinformation. By providing the relevant information in your application, you canensure that the lender will have something tangible to review and pass on to thecredit manager and other key decision makers. In most cases, the loan offi cerprocesses the application and makes recommendations to the credit manageror loan committee.Preparing for a Loan ApplicationThe most important thing that you have to consider when preparing for a loanapplication is the requirements of the lender. Some lenders would require thatyou submit your loan application by completing a loan application form togetherwith the supporting documents, while some may require that you prepare adetailed proposal to demonstrate your thoughts and ideas in writing and latersupport them with the necessary fi nancial information. This Chapter will discussin detail the two loan application methods, followed by some tips on presentationof the loan application.Loan Application FormMost of the commercial banks already have their own application form whichcan be obtained from their branches or downloaded from their web-sites. Inan effort to enhance banking effi ciency and customer services for SMEs, theAssociation of Banks in Malaysia (ABM) in collaboration with its members,launched the PARTNER initiative in November 2010.The PARTNER initiative is implemented in phases. Phase 1 of PARTNERfocuses on streamlining and simplifying processes and procedures ofapplications for an SME loan. For this purpose, PARTNER has designed asimple loan application form that can be used in the event the bank that youwish to approach does not have its own. The form is designed to enable thebank to get to know you and is divided into seven main sections as follows:121chapter 7-13 p79-181 Eng.indd 1218/15/11 5:03:01 PM

Financial Guide for SMEs• Background Information – basic information about your business or you• Additional Information – contact information of your business or you• Facilities Required – type of facility or facilities you wish to apply for• Credit Facilities with other fi nancial institutions – information of existing creditfacility or facilities which your business or you may have with other fi nancialinstitutions• Supporting Documents – checklist of documents and/or information to besubmitted with the loan application• Start-Up – in the event your business has yet to commence or has commencedfor less than 12 months, please indicate the documents and/or informationthat cannot be provided in the application by crossing them out from thechecklist• Declaration – sign and confi rm that all information provided is true, correctand completePhase 2 of PARTNER will further refi ne or pursue other areas of improvementto the SME loan application process.122chapter 7-13 p79-181 Eng.indd 1228/15/11 5:03:01 PM

Financial Guide for SMEsSME FINANCINGAPPLICATION FORM(please use the Bank's own application form if there is one)BACKGROUND INFORMATIONName and Address of * Sole Proprietorship / Individual / Partnership / Corporation (or attach business card)Business Registration No /Certificate of Incorporation No* Please circle whichever is applicableSize of Business (tick where applicable)MicroSmallFor Primary Agriculture and Services Sector (including ICT)(Less than 5 employees or annual sales (Between 5 & 19 employees or annual salesturnover of less than RM200,000)turnover of between RM200,000 & less than RM1million)Medium(Between 20 & 50 employees or annual salesturnover of between RM1 million & RM5 million)For Manufacturing (including Agro-Based) and Manufacturing Related Services (MRS)(Less than 5 employees or annual sales (Between 5 & 50 employees or annual salesturnover of less than RM250,000)turnover of between RM250,000 & less than RM10million)N ature of BusinessYear of Commencement of Business(Between 51 & 150 employees or annual salesturnover of between RM10 million & RM25 million)Business Premise (tick where applicable)RentedOwnedNumber of EmployeesADDITIONAL INFORMATIONContact Person : Name and DesignationTelephone No / Fax NoHandphone NoE-mailFACILITIES REQUIREDTypeOverdraftTerm Loan (e.g. to finance purchase of factory, shoplots, etc)Trade Finance (please give details, e.g. Letter of Credit,Bills Negotiation, Trust Receipt, etc)Export Credit Insurance Trade FacilitiesForeign Exchange (Spot and Forward Contracts)Others (please specify)Please state the purpose of applying for the loanAmount (RM)Collateral to Offer (if any)CREDIT FACILITIES WITH OTHER FINANCIAL INSTITUTION(S) (please use a continuation sheet if necessary)Name of Financial Institution(s)Type of Facility(ies)Loan Amount (RM)SUPPORTING DOCUMENTSFor us to better consider your application, please provide the relevant documents.START-UPIn the event of a start-up (where the business has yet to commence or business has commenced for less than 12 months),please indicate which standard documents cannot be submitted by crossing them out from the checklist itself.DECLARATIONa) I / We hereby confirm that all information and supporting documents provided herein are true, correct and complete.b) I / We hereby give you my / our expressed consent to conduct any checking on my / our credit standing / financialstatus with any person /institutions/agencies that you may deem necessary including CCRIS, CTOS, SME/CentralCredit Bureau.c) I / We hereby agree the information relating to the facility may be forwarded by you to Central Credit Bureau and / orany other agencies / third party who may be entering into respective transactions with me / us.Authorised Signatory (Name & Position)NRIC No / Company ChopDate :123chapter 7-13 p79-181 Eng.indd 1238/15/11 5:03:01 PM

Financial Guide for SMEsThere are two sets of checklist under PARTNER. The fi rst details the generaltypes of documents or information required to be submitted with the applicationand the second sets out the more specifi c documents or information requiredfor various kinds of facilities. The checklist is further detailed to cater fordifferent forms of business establishments which include Sole Proprietorship orPartnership or Individual and Private Limited Company or Sdn Bhd. In this way,you can better anticipate supporting documents or information to be furnishedfor the purpose of a loan application and re-use the same if necessary. However,the checklists are not exhaustive as certain banks may have reasons to ask formore or other documents or information.Sole Proprietorship / Partnership / Individual(i) Standard / Common Documents - generally required by the banks tobe submitted in a SME loan applicationThe list is not exhaustive. Banks may require applicants to submit additionaldocuments on a case-to-case basis.Section 11.2.3.4.5.6.7.Section 21.Type of DocumentsCompany and Related Persons’ Background InformationCertified true copy of the business registration (Form A - soleproprietorship or Form B - partnership) and business license(Form D)Copy of partnership deed (where available)Photocopy of NRIC of proprietors (passport if foreigners)Photocopy of NRIC of partners (passport if foreigners)Photocopy of NRIC of the guarantors (third party), whereapplicableProfile of company and key managementInformation on other businesses (if any)Financial and Credit InformationPersonal information of relevant persons* in the business orotherwise (i.e. information relating to net worth and financialexposure) and evidence of income e.g. Form J / Form EA for thepast 2 years124chapter 7-13 p79-181 Eng.indd 1248/15/11 5:03:02 PM

Financial Guide for SMEs2.3.4.5.Section 31.Type of DocumentsAudited accounts for the last 3 years (last audited period shouldnot be more than 18 months from application date), whereapplicableManagement accounts for the last 3 yearsBank statements for the last 6 months (or more than 6 months atthe discretion of the bank)A list of facilities and securities arrangement from other financialinstitutionsSupplier / Competitor / Customer InformationCurrent debtors and creditors aging report (including informationrelating to credit limit and terms)2. List of top 10 suppliers / purchasers3. List of major competitors (where applicable)* Refers to Sole Proprietor / Partners / Guarantors (whichever shall be applicable)125chapter 7-13 p79-181 Eng.indd 1258/15/11 5:03:02 PM

Financial Guide for SMEs(ii) Additional documents that may be required by banks to support theapplicationThe list is not exhaustive. Banks may require applicants to submit additionaldocuments on a case-to-case basis.Section 11.2.3.4.Section 21.2.3.Section 31.Type of DocumentsAdditional Business and Financial InformationRelevant permits / licensesProjected cash flow for the next 3 years (where applicable)Product brochures (where required)For loans from the Credit Guarantee Corporation (CGC) - copy ofCGC application formSupporting Information for GuaranteesIf guaranteed by individual guarantors - supporting documents ofthe individual guarantor such as photocopy of guarantor’s NRIC,photocopy of guarantor’s evidence of income (Form J ) for last 2years, photocopy of the monthly salary slips for last 3 months andstatement of accounts with other financial institutions for past 6monthsIf guaranteed by corporate guarantors - supporting documentsof the corporate guarantor such as profile of company, profileof directors, key management personnel and all other relevantpersons*, business registration, Form 24 (Return on Allotment ofShares) and Form 49 (Return of Particulars of Directors), auditedand / or management accounts for the last 2 yearsRelevant tax returns and tax receipts of proprietors, partners andguarantors etc.Supporting Information for Property FinancingCopy of Sale and Purchase Agreement (SPA) or copy of bookingreceipt (if SPA is not available), copy of valuation report, copyof title deed and Power of Attorney (where applicable). A copyof location map and photos of the property may be required (forcases pending formal valuation report)2.Copy of insurance policy (where required)126chapter 7-13 p79-181 Eng.indd 1268/15/11 5:03:02 PM

Financial Guide for SMEs3.4.Section 41.Section 51.Section 61.2.3.4.5.6.7.8.Type of DocumentsCopy of latest quit rent and assessment (where required)Tenancy Agreements (where applicable)Supporting Information for Equipment / Machinery FinancingList and description of fixed assets and details on the equipment /machinery to be financedSupporting Information for Refinancing / RedemptionTo furnish copy of Letter Offer from existing Banker refl ectingdetails such as loan type / amount / securities / pricing / termsand conditions etc) and loan statements (if TL) and accountstatements (if OD)Supporting Information for Project / Construction / BridgingFinancingCopy of letter of awards / contract / dealership agreements /invoices / purchase ordersCopy of Project Paper, Joint Venture Agreement, TechnicalAssistance Agreement or Management Agreement (whereapplicable)Documentary Evidence / Confi rmation on Settlement of Debt (forapplicants with adverse CCRIS, CTOS & DCHEQ record)For applications from developer or contractor - list of completed,on-going projects and projects tenderedRelevant accreditations or certifi cations e.g CIDB, PKK, ISO etc(where applicable)Copy of construction costs / quotations from 2 contractors forcomparisonFor construction / bridging loans - copy of approvals fromrelevant authorities on building / layout plan, licences etc (whereavailable)For Bridging Loan - Feasibility Report (where applicable), projectcosting and location map. To provide projected cashfl ow forduration of the project/contract127chapter 7-13 p79-181 Eng.indd 1278/15/11 5:03:02 PM

Financial Guide for SMEsSection 71.Type of DocumentsSupporting Information for Contract FinancingA list of on-going projects with details like contract value,percentage of completion, remaining of work to be done (contractsum) etc. To provide projected cash fl ow for duration of theproject/contract* Refers to Directors / Shareholders (whichever shall be applicable)Private Limited Company or Sdn Bhd(i) Standard / Common Documents - generally required by the banks tobe submitted in a SME loan applicationThe list is not exhaustive. Banks may require applicants to submit additionaldocuments on a case-to-case basis.Section 11.2.3.4.5.6.7.Section 21.2.3.Type of DocumentsCompany and Related Persons’ Background InformationCertified true copy of the Certificate of IncorporationCertified true copy of Memorandum and Article of AssociationCopy of Form 24 (Return on Allotment of Shares) and Form 49(Return of Particulars of Directors)Photocopy of NRIC of directors (passport if foreigners)Photocopy of NRIC of the guarantors (third party), whereapplicableProfile of company and key management and company organizationchart (where required)Information on subsidiary / parent company(ies) (where applicable)Financial and Credit InformationPersonal information of relevant persons* in the company (i.e.information relating to net worth and financial exposure) andevidence of income e.g. Form J / Form EA for the past 2 yearsAudited accounts for the last 3 years (last audited period should notbe more than 18 months from application date)Management accounts (for period between last audited period upto current)128chapter 7-13 p79-181 Eng.indd 1288/15/11 5:03:02 PM

Financial Guide for SMEsType of Documents4.Bank Statements for the last 6 months (or more than 6 months atthe discretion of the bank)5.Section 31.2.3.A list of facilities and securities arrangement from other financialinstitutionsSupplier / Competitor / Customer InformationCurrent Debtors and Creditors Aging Report (including informationrelating to credit limit and terms)List of top 10 suppliers / purchasersList of major competitors (where applicable)* Refers to Directors / Shareholders / Guarantors (whichever shall be applicable)(ii) Additional documents that may be required by banks to support theapplicationThe list is not exhaustive. Banks may require applicants to submit additionaldocuments on a case-to-case basis.Section 11.2.3.4.5.Section 21.Type of DocumentsAdditional Business and Financial InformationProjected cash flow for the next 3 yearsRelevant tax returns and tax receipts of directors, guarantors etc.Product brochures (where required)For loans from the Credit Guarantee Corporation (CGC) - copy ofCGC application formMarket / industry profile (where required)Supporting Information for GuaranteesIf guaranteed by individual guarantors - supporting documents ofthe individual guarantor such as photocopy of guarantor’s NRIC ,photocopy of guarantor’s evidence of income (Form J ) for last 2years, photocopy of the monthly salary slips for last 3 months andstatement of accounts with other financial institutions for past 6months129chapter 7-13 p79-181 Eng.indd 1298/15/11 5:03:03 PM

Financial Guide for SMEs2.3.Section 31.2.3.4.Section 41.Section 51.Section 61.2.Type of DocumentsIf guaranteed by corporate guarantors - supporting documentsof the corporate guarantor such as profile of company, profileof directors, key management personnel and all other relevantpersons*, business registration, Form 24 (Return on Allotment ofShares) and Form 49 (Return of Particulars of Directors), auditedand / or management accounts for the last 3 yearsDirectors’ Resolution for proposed facility or where applicable,Shareholders’ Resolution for third party corporate guarantors /third party chargors (may be required only upon loan approval formore complex cases)Supporting Information for Property FinancingCopy of Sale and Purchase Agreement (SPA) or Copy of BookingReceipt (if SPA is not available), copy of valuation report, copyof title deed and Power of Attorney (where applicable). A copyof location map and photos of the property may be required (forcases pending formal valuation report)Copy of insurance policy (where required)Copy of latest quit rent and assessment (where required)Tenancy Agreements (where applicable)Supporting Information for Equipment / Machinery FinancingList and description of fixed assets and details on the equipment /machinery to be financedSupporting Information for Refinancing / RedemptionTo furnish copy of Letter Offer from existing Banker refl ectingdetails such as loan type / amount / securities / pricing / termsand conditions etc) and loan statements (if TL) and accountstatements (if OD)Supporting Information for Project / Construction / BridgingFinancingCopy of letter of awards / contract / dealership agreements /invoices / purchase ordersCopy of Project Paper, Joint Venture Agreement, TechnicalAssistance Agreement or Management Agreement (whereapplicable)130chapter 7-13 p79-181 Eng.indd 1308/15/11 5:03:03 PM

Financial Guide for SMEs3.4.5.6.7.8.Section 71.Type of DocumentsDocumentary Evidence / Confirmation on Settlement of Debt (forapplicants with adverse CCRIS, CTOS & DCHEQ record)For applications from developer or contractor - list of completed,on-going projects and projects tenderedRelevant accreditations or certifications eg CIDB,PKK,ISO etc(where applicable)Copy of construction costs/quotations from 2 contractors forcomparisonFor construction/bridging loans- copy of approvals from relevantauthorities on building/layout plan, licences etc (where available)For Bridging Loan - Feasibility Report (where applicable), projectcosting and location map. To provide projected cashflow forduration of the project/contractSupporting Information for Contract FinancingA list of on-going projects with details like contract value,percentage of completion, remaining of work to be done (contractsum) etc. To provide projected cashfl ow for duration of the project/contract* Refers to Directors / Shareholders (whichever shall be applicable)As part of the initiative, ABM and its members have also prepared a timelinewhich shows you the stages involved in the processing of a straight forwardloan application by a bank and the time to be expected. A straight forward loanapplication refers to one which is for a clean or unsecured loan, not subjectto consent from authorities, any third party or any other particular conditionsprecedent, for which specifi c approval requiring time has to be obtained.Last but not least, PARTNER has also included a comprehensive list of SMEcontact points of the banks for ease of reference. For more details, pleaserefer to www.abm.org.my or their toll-free hotline ABMConnect at 1-300-88-9980 from 9:00 am to 5:30 pm, Mondays to Fridays.131chapter 7-13 p79-181 Eng.indd 1318/15/11 5:03:03 PM

Financial Guide for SMEsCommon Timeline for SME Loan Application(straight-forward cases only*)Submission ofDocuments forSME LoanApplicationwithin 5working dayswithin 14 to21 days **within 3working daysYESwithin 14 to 30days (dependingon size of loans)within 5working daysYESLoanDrawdownPerfection ofLoanDocumentationfor DrawdownIssuance ofLetter ofOfferCompletereview andprocessing ofloan -Approved?To issue holdingreply to applicantthat documents arein order / completeand that applicationis being processedDocumentssubmitted inorder?NO NOReject application andinform applicantwithin 5working daysFinancial Guide for SMEs** Provided Letter of Offer is acceptedby applicant within the deadline andthere is no unforeseen delay and / orcomplication in the perfection of loandocumentationApplicant toresubmitoutstandingdocumentsTo inform applicantif documentssubmitted are not inorder / not complete* Note: The term “straight-forward cases” is used with reference to clean or unsecured SME loan application which are not subject to :- consent from authorities /any other 3rd party or; CGC approval or; any other particular conditions precedent, for which specific approval requiring time has to be obtained.132132chapter 7-13 p79-181 Eng.indd 1328/15/11 5:03:04 PM

Financial Guide for SMEsLoan Application ProposalThe objective of preparing a loan application proposal is to show the lender thatproviding you with a business loan is a worthwhile proposition. To increase yourchances of success, the loan application package should be comprehensive andeasy to review. A template for loan application proposal is as shown below:Template for Loan Application Proposal1. Summary of application information (often called an ExecutiveSummary)2. Short written information on:a. Company History;b. Industry information; danc. Ownership details / Management Team / Experience3. Details of the loan required4. Forecast fi nancial information5. Forecast assumptions including any independent information tosupport assumptions and any alternative plans that can beimplemented if events do not go according to plan (Refer toChapter 3)6. Details of any sensitivity outcomes and/or comments on fi nancialratio analysis of forecasts and budgets (Refer to Chapter 2)7. Personal information8. Historical fi nancial information9. Financiers loan application forms10. Other information required in the fi nancial checklist133chapter 7-13 p79-181 Eng.indd 1338/15/11 5:03:04 PM

Financial Guide for SMEsDetails of the Loan RequiredThe potential lender will need to review why you are applying for aloan. You would have identified the amount of the loan when preparingyour cash flow forecasts and now you need to provide a detaileddescription of the loan required. The application should contain all theinformation on the funding required and should include the following:• Purpose of the loan;• Amount of the loan required;• Duration of the loan;• The method that the loan will be serviced; and• The security that is available to support the loan.Each of these points will be discussed in detail in below.The Purpose of the LoanA detailed description of why the loan is required should be included in theapplication as it is very important to a potential lender. Most lenders will not bewilling to provide a loan to assist in funding operating losses or for purchaseof luxury assets for the business owner. The purpose should be set out simplyand clearly. This may include:• Funding capital expenditure such as plant, equipment, vehicles, property andrenovations;• Increased working capital resulting from growth or to support increasedinventory holding;• Replacement of existing equity with debt;• Succession planning to provide an exit strategy for family members;• Acquisition of another business or part of business;• Research and development or commercialisation stage; and• Expanding distribution or developing new markets.134chapter 7-13 p79-181 Eng.indd 1348/15/11 5:03:04 PM

Financial Guide for SMEsExample of Statement of PurposeAs a result of a new sales agreement with XYZ, our business will requirean increase in stock purchases to fulfil the contract requirements. Thefunding will support this business growth through the purchase ofadditional stock. This contract will increase annual revenue by a minimumof 20%.If the loan is to be used to purchase an asset (i.e. equipment or property), or for acontracted service, then provide the lender with all the important documentationthat you have gathered relating to the purchase. The important documentsshould include any agreement or contract to be signed, quotations for the assetor service, any specifi c requirements for the installation of the asset or provisionof the service etc.It is imperative to link the purpose of the loan to the overall business benefi tsthat will be achieved as a result of the additional funding. It is also importantat this point to state when the funds will be required. We often underestimatehow long it will take the bank or lender to process the loan application andthis can have an adverse effect on the business if the funds are not availablewhen required. Make sure you submit your application with plenty of time for theassessment to take place.The Amount of the LoanThe amount of funds required will be determined from your planning. Whetheryou are starting up a business, or funding an existing business, the planningstage will be the same. In a start-up scenario, the planning will be undertakenas part of the initial business planning process. For an existing business, a newbusiness plan should also be prepared. It is good fi nancial practice to revisityour business plan when key elements of your business change.In order to determine the total amount of funds required, you will need to preparea cash fl ow forecast. This forecast must be prepared as if the loan has beensuccessful and should cover the expected duration of the loan. All of thesedetails are covered in Chapter 6.135chapter 7-13 p79-181 Eng.indd 1358/15/11 5:03:04 PM

Financial Guide for SMEsIt is important to remember that there will be a number of costs that you willhave to pay when the lender provides the loan. Some of these costs will have tobe paid at the time the loan is made available; other costs will be incurred overthe loan period. Make sure these costs are included in your cashfl ow forecastto ensure that you would have adequate funds to cover all costs. Upfront costsmay include establishment fee, guarantee fee, legal fee or valuation fee whileongoing fee may include half-yearly loan charges, interest, transaction fee ordefault fee.When determining the amount of funds you would like to apply for, you shouldalso consider including a ”buffer” amount, in addition to the costs associated withthe loan funds. This is an amount above what your plan shows as the minimumamount required to fi nance your activities. Generally speaking, it is not possibleto forecast all events. A buffer will allow for any unexpected expenses or lowerthan expected income that is earned over the period of the loan. You will needto make an assessment of an adequate ‘buffer’ amount. Discuss this with thelender, as they may be able to assist in determining the level of contingencyrequired.Term of the LoanThrough your planning, it will become obvious how long you will need the funds.A cash fl ow forecast shows the movement of cash in and out of the business,and indicates when the business will be in a position to repay the funds. Anotherimportant factor in determining the term of the loan is the type of loan that youmay be seeking. Some types of debt fi nance have a maximum term available.For example, where funds are required to purchase an asset, a lease may bethe most appropriate debt product and the lease company may only providelease funds over a maximum of fi ve years. So again, the cashfl ow forecast willassist in determining what types of fi nance products you can consider.Servicing the LoanThe most important element of the loan application is to show the lender that thebusiness has suffi cient cash fl ow to make the regular loan repayment, includingall the associated costs of the loan, over the loan period, and ultimately repay theloan. This will entail having a good understanding of your fi nancial statements,most importantly the cash fl ow forecast. You must be in a position to make astrong justifi cation to the lender on how the forecast cash fl ow will adequatelysupport the repayment obligations of the loan within the allocated time frame.Reviewing the fi nancial ratios on your forecasted profi t and loss and balance136chapter 7-13 p79-181 Eng.indd 1368/15/11 5:03:04 PM

Financial Guide for SMEssheet will also provide information on the expected profi tability and fi nancialhealth of your future business operations.Security for the LoanFor most types of loans, lenders will require security (also known as “collateral”)over the loan. As part of your preparation, make sure you identify what securityyou are prepared to offer a lender. Appropriate security provides the lender withsome comfort that in the event the business is not able to repay the loan fundsborrowed, they can liquidate the security items to repay the outstanding funds.For a successful loan application, it is important that the security offeredmatches both the type of loan being made and the lender’s perception of therisk associated with the loan application. For example, where the loan is fora medium term of three years, inventory or customer receivables will not beacceptable as they are short-term assets. The lender will be looking for securitythat has value that exceeds the duration of the loan. Therefore, more appropriatesecurity would be equipment or property that has a valuation in excess of theloan over a lifespan of more than three years.It is recommended that you identify and provide details to the lender of thesecurity available, as part of your loan application. This way, you will be ableto present your preferred security prior to the lender nominating his or herpreferred security.Forecast Financial InformationA lender will pay particular attention to the budget and forecasts, as thesewill show how your business will operate during the period of the loan. It istherefore important to know how to prepare these forecasts in line with yourlender’s expectations. By preparing both a cash fl ow forecast and profi t andloss budget, you will have suffi cient information to prepare a balance sheetbudget. Remember, a balance sheet is fi nancial information ”at a point in time”;therefore, it has less importance to a potential lender when they are reviewingforecasts. This is because they are using the forecast information as a guide to“the continuing” operations of the business, rather than ”at a point in time.”137chapter 7-13 p79-181 Eng.indd 1378/15/11 5:03:05 PM

Cash Flow ForecastFinancial Guide for SMEsA cash fl ow forecast is probably the most important information for the lender. Itwill provide the necessary detail to a potential fi nancier on the cash available topay back the loan (refer to Chapter 6 for information on how to prepare a cashfl ow forecast).Profit and Loss BudgetA profi t and loss budget will indicate to the potential lender whether the newbusiness plan is profi table (refer to Chapter 3 on how to prepare a profi t andloss budget).Personal InformationAlthough lenders are in the business of lending funds to businesses, they like tomake sure that the funds will be repaid. One of the most important indicators forthem will be your own personal spending habit, which will show them how youmanage your own fi nances, and will be particularly important when the businessloan application is for a business start-up, where history of the business patternhas not yet been established.When you are applying for a loan, it is most likely the lender will undertake apersonal credit check and the authorisation to do so is usually included in yourapplication form. A clear report would indicate that you have not, in the past,defaulted on any payment obligations and this will impact positively on yourbusiness application. Therefore, maintaining a sound personal credit record orrating is very important. Paying your credit cards and personal loans on time willbe considered favourably by a lender, as it helps to prove that you are able tomeet your future debt obligations on time.The types of personal information the lender will be looking for can include:• Personal assets - purchase price and date, independent valuation ifavailable, ownership documents (i.e. mortgage or leasing agreements)and, for any policies, the most recent policy statements;• Tax returns - you may be required to supply supporting documentation tothe tax schedules such as proof of income from investments etc; and• Personal bank details - all statements issued from the bank or fi nancialinstitution. For bank loans, include the original loan agreement as well asthe statements.138chapter 7-13 p79-181 Eng.indd 1388/15/11 5:03:05 PM

Financial Guide for SMEsTo gain an understanding of your personal position, the lender will usuallyrequire the key fi nancial information for the past three years. This is to ensureany unusual circumstances are ”averaged” over the period.Historical Business InformationFor existing businesses, the lender wouldwant to review historical financial information.Typically, they would want at least three years’business records to give an indication of thebusiness operations. The financial informationthey require will be the statements outlined inChapter 1- balance sheet, income statement andcash flow statements. Ideally, this informationHINTMake sure you understandall the fi nancial informationthat has been preparedand is being presentedshould be either prepared and or reviewed by an accountant. This willgive comfort to the lender that all the information contained in the statements isaccurate, complete and correct. In addition to the financial statements, the lenderwould also most likely want to check the historical operating data of the business.This will provide an overview of the way the business is managed and some insightinto the character of the owner. Such information may include annual tax returns,current accounts receivable and payable schedules (debtors and creditors lists),bank statements for all bank accounts and loans for the past three years or detailsof any other type of financing such as leasing or hire purchase.Presentation of the Loan ApplicationThe most important asset of a business are the experience of the owners, thepotential value of prospective customers and other non-fi nancial items. It is forthis reason that some banks may require that you make a presentation to theloan approval committee. The committee will be looking at your confi dence,management style and capacity to understand fi nancial and other risksassociated with your business. In doing so, you will be able to present yourself,your business and your fi nancial needs in a manner that will convey a messageof confi dence and capability to the lender. This may well be the fi rst step indeveloping an ongoing relationship that will foster the growth of your businessin the future.To ensure that your presentation is successful, establish the expectations ofthe lender before you meet with him or her. This can be done by looking at thewebsite of the fi nancial institution or by contacting the institution and askingfor a checklist of the information that will be required. In addition to the loanapplication package, be prepared to discuss certain aspects of your business,competitors and industry. Be prepared for the lender to look at relevant financial139chapter 7-13 p79-181 Eng.indd 1398/15/11 5:03:05 PM

Financial Guide for SMEsratios. Make sure these ratios on your forecasts are within the acceptable levelsand that you understand what the ratios mean. Furthermore, a good presentationwill include discussion on the sensitivity of the ability to repay the loan. Thismeans you know where the risks in the forecast may be, and have thoughtabout potential fallback plans in the event the activities do not go according tothe plan.Be confi dent when you present your loan application. Dress for success. If youhave forgotten something, don’t get fl ustered. Explain to the lender that youhave forgotten the item and that you will deliver it later that day or the followingday. The same goes for any additional information that the lender may requestthat you have not included in your application.TIPWhen applying for a loan, always meet your banker in person to discussthe applicationThe Role of AdvisersAccountants and business advisers can assist in preparing a loan application.They are well versed in translating your future ideas into fi nancial forecasts andto emphasise the potential areas the lender will focus on. You may even wantto practise your presentation with them. However, it is important to rememberthat the fi nancier will be looking at your ability to manage the future growth ofyour business, so you must ensure that you fully understand the informationyou present.ConclusionIf your loan application is denied, fi nd out as much as you can about why it wasnot successful. This will assist you in any future loan applications that you mayconsider. Above all, remember that the lender is in the business of providingloans, and therefore will be looking for future business. Often loan applicationsfail not because the business is too high a risk, but more likely because theloan application was poorly prepared, indicating a lack of understanding, whichsends immediate warning signals to the lender.For more information on applying for a loan for your business, you can refer tothe respective web sites of potential lenders or www.bankinginfo.com.140chapter 7-13 p79-181 Eng.indd 1408/15/11 5:03:05 PM

Financial Guide for SMEs141chapter 7-13 p79-181 Eng.indd 1418/15/11 5:03:05 PM

Financial Guide for SMEsChapter 11Refinancing Your Debt142chapter 7-13 p79-181 Eng.indd 1428/15/11 5:03:05 PM

Financial Guide for SMEsRefinancing Your DebtFor many SMEs, the initial financingarrangements put in place at start-up stillremain in place for many years later. Forexample, a business starts off with a simpleoverdraft facility and just arranges forseveral modest increases in the facilitywithout considering the cost–benefi t of thefacility or the suitability of the debtarrangements to its needs.SME owners are encouraged to reviewexisting debt fi nance arrangements on aregular basis to ensure that the fi nancefacility and structure fi t the current needs ofthe business. You may fi nd that there is astrong case for refi nancing the business. Thisprocess should not be undertaken lightly, asthere are many pitfalls in changing lenders,all of which should be considered as part ofyour review.Refi nancing your debt fi nance may involve:• Changing lending institutions (but retainingthe same debt products);• Funding the business from different debtproducts (with the same or a different lender);Often SMEs havethe same bankingfacilities yearsafter they havestarted. A review ofexisting facilities mayhighlight that thecurrent facilitiesand structure needto be changed tomeet the change inbusiness operationsHINTRefinancing can involve anumber of alternatives. Toachieve the best outcome,ensure that you understandall the alternatives beforecommitting to anew lender• Combining debt into a single facility or product;• Increasing or decreasing the total amount of the borrowing as part of therefi nancing;• Changing the repayment amount or timing; and• Increasing or decreasing the security offered to the lender.143chapter 7-13 p79-181 Eng.indd 1438/15/11 5:03:06 PM

Financial Guide for SMEsHow Refinancing Works?Refi nancing involves taking a new debt facility where the new funds are used topay out your old debt facility. This is all done by the new lender. If the refi nancinginvolves an increase in debt, then additional funds would be available to drawon.The key reasons why you choose to refi nance may include:• Gaining a better interest rate from a different lender or from a different mix ofdebt products;• Switching to fi xed rates or back to variable rates;• Gaining more fl exible features in a facility to meet your business needs;• Increasing your overall borrowing with a new debt facility;• Changing the fi nancial cash fl ow commitment required to fund debt (e.g. fullydrawn advance to an overdraft);• Consolidating debts to minimise and simplify repayments; and• Releasing security over personal / specific assets as the business reaches alevel of continued profitability.TIPMake a list of the reasons why you might consider refi nancing your loan tocompare against the loan offer you receive144chapter 7-13 p79-181 Eng.indd 1448/15/11 5:03:06 PM

Financial Guide for SMEsBenefits of RefinancingMany benefits may be gained from refi nancing.Some of these are outlined below.A new perspective based on yourcurrent position and not the pastYou may find that a ”fresh start” with a newlender may not carry any of the long-termpre-conceptions which your previous lendermay be influenced by. These may have includedHINTAfter carefully undertakinga cost–benefi t evaluationof refi nancing, you mayfi nd it brings a range ofnew opportunities to yourbusinessa poor trading period in earlier years or a particular experience they have hadwith another customer in your industry, which has influenced their lending decisionmakingagainst your interests.Access to increase in debt financeRefi nancing may also result in increasing the funds available for businessgrowth. You should ensure that, in taking on additional debt, you can stillservice the higher debt commitment and that these funds are utilised to achievea higher return for the business.Consolidation of debt funding – cash flow savingsThere is often an opportunity to combine a number of ad-hoc debt fi nancearrangements into a single product to simplify repayments and to potentiallyreduce your monthly cash fl ow repayment.Restructuring security offeringRefi nancing may also provide the opportunity for a change in the security beingoffered to the new lender. You may fi nd that, over time, the value of securityoffered to the existing lender has increased at a far greater rate than the level ofborrowing. When you negotiate your refi nancing, review what is a reasonableoffer of security assets.TIPRefinancing a strong healthy business may also indicate that there is anopportunity to separate your personal assets from security offered if thevalue of the business assets (i.e. commercial land and building, debtors,fixed assets etc.) is sufficient to cover the borrowing145chapter 7-13 p79-181 Eng.indd 1458/15/11 5:03:06 PM

Financial Guide for SMEsCommon Dangers in RefinancingWhen considering refi nancing, make sureyou understand all the implications beforechanging your facilities.What is the cost of paying out yourexisting debt facility?HINTEnsure that you haveundertaken sufficient reviewof your circumstances priorto making any commitmentsfor refinancing, as there aremany pitfalls that mayimpact any perceivedbenefitYour existing facility may have an “early repaymentpenalty” clause, which could outweigh any futureinterest savings. Other exit fees may include discharge of mortgage costs ifproperty is involved as security. Deferred establishment fees may apply.What will be the ingoing costs of the new finance facility?Changing to a new lender (as opposed to a new product with the same lender)will require additional costs such as application, documentation, valuation (tovalue your security assets), mortgage fees, stamp duty on a new mortgage andsettlement fees. If your new lender is keen to get your business, you may beable to negotiate a waiver of some of the bank’s internal costs as part of thepackage.Impact of security assets used to support multiple borrowingsWhen you are refi nancing, you need to be aware of how your existing fi nancingis linked to your security assets. For example, your existing bank may providean overdraft facility, using security over your residential property, as well as anEFTPOS or credit card facility and access to an automated payroll system totransfer funds into employee bank accounts. If you change your debt facilitiesto a lender that does not have retail facilities such as EFTPOS and credit cardprocessing, you may fi nd that you need additional security to guarantee thesefacilities.146chapter 7-13 p79-181 Eng.indd 1468/15/11 5:03:06 PM

Financial Guide for SMEsChange in valuation of your securityBefore you commit to a change of lender or product, you need to ensure thatyou have a fi rm letter of offer in place and not one that is subject to satisfactoryvaluation or a third-party validation (such as a mortgage insurer) on the securityrequired. Different lenders can come back with lower or higher valuations ofyour property, depending on the value used or the current market conditions.Impact of leaving a long-term banking relationshipYou need to assess the strength of your long-term relationship with yourcurrent lender. Are there some intangible benefi ts that you have now, becausethe current lender knows your banking and business history, which you may notget in a new relationship?147chapter 7-13 p79-181 Eng.indd 1478/15/11 5:03:06 PM

Financial Guide for SMEsSwitching BanksA good banking relationship is crucial to your business operation and, in manycases, the fi nancial survival of your business. Banks are vital to the financing ofyour business operation and a good relationship with your bank can help younegotiate better terms for your banking needs. Even if you are satisfi ed withthe service quality of your bank, you should still meet with your bank at leastonce a year to discuss your banking requirements and areas of improvementsin products and services that your business could use.If you are not happy with the service of your bank, you should review your bankaccounts and facilities. You should not move to another bank without comparingthe services provided by your current bank with that of the new provider.Many businesses split their banking between two or more fi nancial institutionsto have more control over their fi nancial arrangements. These businessesusually have one main bank provider who does most of their banking transactions.If you are dissatisfi ed with the pricing or service levels of your main provider,you should compare its offer with those of other banks.TIPMake a list of all the points and note the pros and consfor each point to help assess whether to refi nance148chapter 7-13 p79-181 Eng.indd 1488/15/11 5:03:07 PM

Financial Guide for SMEsBanking ReviewYou can use the following checklist to help you review your bank accounts andfacilities:Item1. Create a listof all bankaccounts inyour company2. Obtain a letterof facilities3. Select your topthree preferredbanksDescriptionsYou should include what the account is used for; bankaccount details such as branch, account number,account name; and any special arrangements witheach account such as set-off arrangements. All socialaccounts, old companies, branch accounts, petty cashaccounts and special-purpose accounts should beincluded. This information can be obtained from yourbank statements or by asking your bank. You may besurprised at the number of accounts you have.Request a letter of facilities from all the banks you dealwith. The aim is to build a complete picture of all yourbanking arrangements with your fi nancial institutions.In your letter, you should ask your banks to ensure allfacilities are covered, including:• Credit or purchasing cards;• Merchant facilities;• Trade facilities;• Lease facilities;• Any information on loans that the bank provides;• Letter of credit;• Internet banking; and• Cheque cashing.How you select your top three preferred banks canbe based on any criteria, such as the bank you havethe most transactions with, the quality of their service,friendly staff, convenience, or pricing sensitivity.Knowing the existing or likely account manager (andhaving a favourable impression) is often a good reasonto include a bank in your list.149chapter 7-13 p79-181 Eng.indd 1498/15/11 5:03:07 PM

Financial Guide for SMEsItem4. Meet withyour currentbankDescriptionsOnce you have gathered the required information, youare ready to meet your bank. The aim here is to giveyour existing bank fi rst chance of improving the price orservice or any other criteria you have noted in step 2.When the bank has all your information, ask your bankerwhat will be the best package and fees available foryou. Usually, a bank will give you its best rates whenyou agree to do all transactional banking arrangementsthrough them.5. Review yourcurrent bank’sofferThe areas you should be reviewing are loan fees,interest margins, merchant facilities, and cash handling,if you are in a retail business or organisation. However,this will vary according to your business.If your current bank offers you improved pricing andservice levels, you may wish to stay with your currentbank and stop the review process. We recommendthat you ask your bank to detail a letter of agreementincluding the renegotiated fees, charges and servicelevels offered. If possible, negotiate for these revisedterms to apply for one to three years. If your bank doesnot offer a better deal in pricing, you should fi nd out whyand what is missing from the picture.6. Meet withalternativebanks onyour listIf you are not happy with your current bank’s offer, makean appointment with the next bank on your preferredbank list. If you disclose your current pricing, thesecond bank may only offer you a deal that is slightlybetter than that of your current bank. Due to the costand resources required to move to a new bank, it isgenerally not advisable to move banks unless the newbank offers substantially better pricing, product orservice.150chapter 7-13 p79-181 Eng.indd 1508/15/11 5:03:07 PM

Financial Guide for SMEsYou should consider the following factors before you change banks:• Will your business incur additional costs as a result of switching banks?(for example, costs in notifying customers and suppliers, changing depositand chequebooks).• Is the new bank’s service level good? You may be able to find out by talking tosome of their customers. You may have customers or suppliers who have anaccount with the new bank.• Give preference to the bank that allows you to meet with bank staff other thanyour account manager. This should include the bank manager and perhapseven the regional manager. Often, staff change on a regular basis withinbanks, so it is preferable that more than one staff member of the chosen bankhas an understanding of your business and the banking relationship.TIPComparative information on bank finance is available on theSME Info Portal at www.smeinfo.com.my orBanking Info at www.bankinginfo.com.my151chapter 7-13 p79-181 Eng.indd 1518/15/11 5:03:07 PM

Financial Guide for SMEsChapter 12Managing Your BankingRelationships152chapter 7-13 p79-181 Eng.indd 1528/15/11 5:03:07 PM

Financial Guide for SMEsManaging Your Banking RelationshipsAnnual ReviewWhen you arrange for a business loan orother fi nancing through a bank for the fi rsttime, you may think that the process ofproviding information and being interviewedby the bank is over. This is not always thecase. When they have provided fi nance,banks may also carry out annual review. Thisusually happens either when your annualaccounts are available or on the anniversaryof the borrowing.Annual reviews should be taken seriouslybecause banks always have far-reachingpower to cancel a loan that they havegranted. The review results in a submissionto the bank’s administration, with themanager recommending continuanceor withdrawal of the loan. Although a reviewof this kind may appear traumatic, there isnothing to worry about if your business isperforming well, and it may result in anoffer of additional fi nancing. If the businesshas been successful, the bank may also bewilling to reduce its costs, but most likelyonly if you ask. If your business has not beenGood relationshipswith your bankerswill ensure that theyunderstand yourbusiness and are inthe best possibleposition to provideadvice and supportwhen neededHINTBeing well prepared forthe annual review willshow the bank thatyou understand theirrequirements and indicategood managementpracticesperforming well, and you have not previously advised the bank, you should beopen about the situation.TIPDuring the annual review, the bank is likely to require up-to-datefinancial data and all other relevant information that summarisesyour business operations for the last 12 months153chapter 7-13 p79-181 Eng.indd 1538/15/11 5:03:07 PM

Financial Guide for SMEsContinuing RelationshipsBanking is essentially a hands-on type ofactivity. A good bank manager keeps awatchful eye over the businesses under his orher control, both evaluating the risks involvedand looking for new business opportunities.There are advantages in this for a business thatis well run. Besides maintaining an overviewthat is designed to protect the bank, thebank manager is also a salesman with salestargets. A business that is clearly performingHINTKeeping your bank wellinformed of your businessactivities and performancewill ensure that they areready to respond to anyadditional requestwell can therefore expect to be able to obtain increased bank assistance to matchany growth in requirements.For the relationship with the bank to develop well, there is one requirementthat must be observed: there must be an open approach that involves keepingthe bank properly informed. Any tendency to inform the good side and leavethe bad side unmentioned should be avoided. Any downward turn in eventsshould be discussed with the bank manager as soon as it is known, not whenthe overdraft limit is exceeded or loan repayments are late. Remember, whilethe bank is providing facilities, they are effectively in partnership with yourbusiness.One of the advantages of a well-developed banking relationship is that theexperienced bank manager can assume some of the role of an unpaid fi nancialadviser. Bank managers have experience with many types of businesses andcan give fair advice, since they are not closely involved in the business.TIPBank managers are often working with other businesses in similarindustries and can be a useful source of information for your business154chapter 7-13 p79-181 Eng.indd 1548/15/11 5:03:08 PM

Financial Guide for SMEsManaging DifficultiesBank loans usually have conditions of default,with the bank being able to demand paymentif one or more conditions are breached. Also,overdrafts are at call, with the bank being ableto ask for repayment on demand.Before a bank decides to call in a loan, therewould normally have been discussion or aletter expressing its concerns. If the bankdecides not to allow continuous default orescalation in borrowings, it must provideHINTIf your business is havingproblems such as difficultyin keeping up withrepayments, discuss themwith the bankimmediately so that theycan work with you to finda solutionwritten advice that banking facilities have been withdrawn, in which case it willask that all monies be repaid immediately.It is in your best interest to contact the bank immediately if your business isfacing difficulties, as there may be several ways that the bank can help you.They may:• Agree to change your borrowing arrangements to facilitate repayment;• Discuss with you, and if you wish, your accountant or advisers, the plans forimproving cash fl ow and profi ts; or• Recommend that you discuss the problem with your accountant or get in touchwith independent advisers, who can help you and possibly assist with yourbusiness problems. If there is no mutual agreement, then refer to BNMLINK(Bank Negara Malaysia Laman Informasi Nasihat dan Khidmat) atwww.bnm.gov.my/bnmlink.TIPBank managers are more ready to provide any assistance required, suchas a negotiation of repayments, if they are told about a deterioratingposition rather than having to fi nd out about it themselves155chapter 7-13 p79-181 Eng.indd 1558/16/11 1:09:49 PM

Financial Guide for SMEs156chapter 7-13 p79-181 Eng.indd 1568/15/11 5:03:08 PM

Section V : Better Business FinancialManagementFinancial Guide for SMEsFinancial management is not only aboutunderstanding the fi nancial information inyour business and using this informationto improve your business operations. Itis also to ensure that you have the rightpolicies and procedures in place to makesure that the fi nancial information youare using is accurate and that you canprotect your investment in the business.For complete fi nancial management ofyour business, you need to considerimplementing good fi nancial controls.When you are usingfi nancial informationto make decisions,it is important thatpolicies andprocedures are inplace to ensurethat the informationis complete andaccurate and willlead to correctdecisions157chapter 7-13 p79-181 Eng.indd 1578/15/11 5:03:08 PM

Financial Guide for SMEsChapter 13Financial Controls158chapter 7-13 p79-181 Eng.indd 1588/15/11 5:03:08 PM

Financial Guide for SMEsFinancial ControlsFinancial control is a procedure implementedto detect or prevent errors, theft or fraud,or policy non-compliance in a fi nancialtransaction process.Financial control procedures can beimplemented by either an individual or aspart of an automated process within afi nancial system.Financial controlsare policies andprocedures usedin your business toprotect your assetsand to support goodfi nancial reportingEach fi nancial control procedure is designedto fulfi l at least one of the following eightcriteria:CompletenessAccuracyAuthorisationValidityCriteriaExistenceHandling errorsSegregation ofdutiesPresentation anddisclosureDescriptionsAll records and transactions are included in thereports of the business.The right amounts are recorded in the correctaccounts.Approved authorisation levels are in place to coversuch things as approval, payments, data entry andcomputer access.The invoice is for work performed or productsreceived and the business has incurred the liabilityproperly.All assets and liabilities recorded in the booksactually exist. Has a purchase been recorded forgoods or services that have not yet been received?Is there correct documentation to support the item?Procedures ensure that errors in the system havebeen identifi ed and corrected.Certain functions are separated. For example, theperson taking cash receipts does not also do thebanking.There is timely preparation of reports forcompliance or review.159chapter 7-13 p79-181 Eng.indd 1598/15/11 5:03:09 PM

Financial Guide for SMEsBenefits of Financial ControlsFinancial control procedures ensure that allfinancial information is recorded andaccurate.Some of the benefi ts of implementing fi nancialcontrols are:HINTIf you are using inaccuratefi nancial information fordecision-making, you couldbe making the wrongdecisions• Regular reporting will provide accuratefi nancial information that can be usedby those responsible for the operations of the business (for example,sales numbers can be provided to sales representatives to monitor targetsand budgets);• Business can make informed decisions on budgets and spending;• Controls provide documentary proof for compliance requirements; and• Business standards are set and every person within the business is informedof these standards through reporting.Good fi nancial control procedures will:ProcedureAlign objectivesof the businessSafeguard assetsPrevent anddetect fraud anderrorEncourage goodmanagementDescriptionsEnsure that reporting procedures and the activitiescarried out by the business are in line with theobjectives of the business.Ensure that the physical and monetary assets of thebusiness are protected from fraud, theft and errors.Ensure that the systems can quickly identify errorsand fraud as and when they occur.Allow the manager to receive timely and relevantinformation on performance against targets, as wellas key fi gures that can indicate variances fromtarget.160chapter 7-13 p79-181 Eng.indd 1608/15/11 5:03:09 PM

Financial Guide for SMEsProcedureAct againstundesirableperformanceReduce exposureto risksEnsure properfinancial reportingDescriptionsAuthorise a formal method of dealing with fraud,dishonesty or incompetence when detected.Minimise the chance of unexpected events.Maintain accurate and complete reports, andminimise time lost correcting errors and ensuringresources are correctly and effi ciently allocated.TIPGood fi nancial controls will protect your investment in the business andensure that the business runs more effi ciently, resources are not lost andthere are fewer unpleasant surprisesFinancial Controls ChecklistTo manage the risk of a fi nancial transactionprocessing failure, manual or automatedcontrol procedures should be implemented atkey stages of the process.Some of the questions that can be asked are:• How well are the fi nancial aspects of thebusiness managed?HINTUsing the checklists willhelp you to determinewhich fi nancial controls arerelevant for your business,and highlight the areaswhere you can improveyour fi nancial controls• Are the business operations protecting theorganisation against disasters, internal theft and unfavourable external audits?• How comprehensive are the management practices?• Are the fi nancial records truly accurate?161chapter 7-13 p79-181 Eng.indd 1618/15/11 5:03:09 PM

Financial Guide for SMEsThis checklist will help you to review your business’s fi nancial controls.A business with good fi nancial management practices would answer "yes" tomost of the following questions:GeneralIs a chart of accounts used?YES/NOIs it detailed enough to give adequate managementinformation?Is a double-entry bookkeeping system used?Are journal entries used?Are journal entries approved?Do you use budgets and cash projections which are:• compared to actual results?• investigated if there are major discrepancies?Do you understand the form and contents of the fi nancialstatements?Are comparative financial statements produced andreviewed?Are the books and records kept up to date and balanced?Is fi nancial information produced regularly?Are reasonable due dates imposed for preparation offi nancial information?Are storage facilities safe from fi re etc.?Is insurance coverage regularly reviewed?Is there a records-retention schedule used?162chapter 7-13 p79-181 Eng.indd 1628/15/11 5:03:09 PM

Financial Guide for SMEsSalesIs there a policy for credit approval for customers?YES/NOAre credit fi les kept current?Are credit checks on customers done regularly?Are sales orders approved for price, terms, credit andaccount balance?Are all sales orders recorded on pre-numbered forms and areall numbers accounted for?Do you review the monthly debtors’ statements for outstandingbalances?Is accounts receivable subsidiary ledger balanced monthly tocontrol account?Is an aging schedule of customers’ accounts prepared monthly?Are write-offs and other adjustments to customer accountsapproved?Cash ReceiptsYES/NODo you, or a responsible employee other than the bookkeeperor person who maintains accounts receivable:• Open the mail and pre-list all cash receipts before turningthem over to the bookkeeper?• Stamp all cheques with restrictive endorsement “for depositonly” before turning them over to the bookkeeper?• Compare daily pre-listing of cash receipts with the cashreceipts journal and the duplicate deposit slip?Are cash receipts deposited intact on a daily basis?Are cash receipts posted promptly to appropriate journals?Are cash sales controlled by cash registers or pre-numberedcash receipts forms?163chapter 7-13 p79-181 Eng.indd 1638/15/11 5:03:09 PM

Financial Guide for SMEsCash Used (disbursements)Are all disbursements, except for petty cash, made by chequeor Internet payments?YES/NOAre cheques pre-numbered and all numbers accounted for?Are all cheques recorded when issued?Are all unused cheques safeguarded, with access limited?Is a mechanical cheque protector used to inscribe amountsas a precaution against alteration?Are voided cheques retained and destroyed?Do you sign or view all cheques and Internet payments?If a signature plate is used, do you have sole control?Are supporting documents, processed invoices, receivingreports and purchase orders presented with the cheques andreviewed by you before you sign the cheques?Are supporting documents for payments properly cancelledto avoid duplicate payment?Are cheques payable to cash prohibited?Are signed cheques mailed by someone other than theperson who writes the cheques?Are bank statements and cancelled cheques:• Received directly by you?• Reviewed by you before they are given to the bookkeeper?164chapter 7-13 p79-181 Eng.indd 1648/15/11 5:03:10 PM

Financial Guide for SMEsBank Reconciliation StatementsAre bank reconciliations prepared:• At least monthly for all accounts?• By someone other than the person authorised to signcheques or use a signature plate?YES/NOAre bank reconciliations reviewed and adjustments of thecash accounts approved by a responsible person other thanthe bookkeeper?Petty CashAre all disbursements from petty cash funds supported byapproved vouchers?YES/NOIs there a pre-determined maximum dollar limit on the amountsof individual petty cash disbursements?Are petty cash funds set on an imprest basis (i.e. if the totalamount is RM100, you can only spend what you have and itis only replenished by the amount spent)?Are petty cash funds:• Kept in a safe place?• Reasonable in amount so that the fund ordinarily requiresreimbursement at least monthly?• Controlled by one person?• Periodically counted by someone other than the custodian?Accounts PayableAre supplier invoices matched with applicable purchase ordersand receiving reports?YES/NOAre all available discounts taken?Is there written evidence that invoices have been properlyprocessed before payment, e.g. stamped?165chapter 7-13 p79-181 Eng.indd 1658/15/11 5:03:10 PM

Financial Guide for SMEsAccounts PayableAre there procedures that ensure any direct shipments tocustomers are properly billed to them?YES/NODo you verify that the trial balance of accounts payablematches with the general ledger control account?Are expense reimbursement requests submitted properly andapproved before payment?Goods ReceivedAre all materials inspected for condition and independentlycounted, measured, or weighed when received?YES/NOAre receiving reports used and prepared promptly?Are receiving reports subjected to the following:• Pre-numbering and accounting for the sequence of allnumbers?• Copies promptly provided to those who perform thepurchasing and accounts payable function?• Controlled so that liability may be determined for materialsreceived but not yet invoiced?EmployeesAre all employees’ job references checked?YES/NOAre individual personnel fi les maintained?Is access to personnel files limited to a person who isindependent of the payroll or cash functions?Are wages, salaries, commission and piece rates approved?Is proper authorisation obtained for payroll deductions?166chapter 7-13 p79-181 Eng.indd 1668/15/11 5:03:10 PM

Financial Guide for SMEsEmployeesAre there adequate time records for employees paid by thehour?YES/NODoes the sales people’s commission records reconcile withsales records?If employees punch time clocks, are the clocks located sothat they may be watched by someone in authority?Are time records for hourly employees approved by asupervisor?Are there appropriate controls in place to ensure that theabsence of any employee is noted?Is the clerical accuracy of the payroll checked?Are payroll registers reviewed by a responsible person?If employees are paid in cash, is the cash requisitioncompared to the net payroll?Is there control over unclaimed payroll cheques?Do you cross-train staff in accounting functions?TIPFor all those questions in the checklist that have not been answered with“yes”, review which ones are applicable to your company. Then make anaction plan that includes who will be responsible for implementing eachpolicy and procedure and give a due date for completionReviewing this checklist and taking appropriate action will ensure that you havegood fi nancial controls in place for your business.167chapter 7-13 p79-181 Eng.indd 1678/15/11 5:03:10 PM

Financial Guide for SMEsFinancial Guide for SMEsAppendixSummary of Tips and HintsImplementing good financial practices in your business will provide soundfinancial information that can identify current issues and be used to planfor the successful financial future of your businessSection I : Business Finance BasicsFinancial statements provide information on how the business is operatingfinancially and why. Ensuring if these statements are produced regularlywill provide financial information for continuos improvement of businessoperationsChapter One - Understanding FinancialStatementsTopic Hint TipRegularly (monthly) produce profit and lossinformation and compare against activities inthe previous months to ensure that yourprofit expectations are being metOnly those businesses that have goods (products)to sell will use the calculation of cost of goodssoldIncomeStatementA prosperous business will have assets of thebusiness funded by profits rather than beingheavily dependent of funding from either externalparties (liabilities) or continuous cash injectionsfrom the owner (equity)Balance Sheet The diagramme shows how the balance sheetworks. The business requires assets to operateand these assets will be funded from the equityin the business, the profit from the operations ofthe business or by borrowing money fromexternal partiesUse the Cash Flow Statement to analyse if youare spending more than you are earning ordrawing out too much cash from the businessStatement of cash flows only shows the historicaldata and differs from a cash flow forecastStatement ofCash Flows168168 155chapter 7-13 p79-181 Eng.indd 1688/15/11 5:03:10 PM

Financial Guide for SMEsFinancial Guide for SMEsChapter Two - Assessing the FinancialHealth of Your BusinessFinancial ratio analysis will provide the important warning signs thatcould allow you to solve your business problems before they destroy yourbusinessTopic Hint TipLiquidity RatiosUse these ratios to assess if yourbusiness has adequate cash to paydebts in due timeThe quick ratio will give you a good indicationof the “readily” available cash to meet currentdebt obligationsSolvency RatiosThese ratios measure if your businesshas adequate long-term cash resourcesto cover all debt obligationsThese ratios indicate the extent to which thebusiness is able to meet the debt obligations fromall sources, other than just cash flow, as in thecase with liquidity ratiosProfitability RatiosUse gross and net margin calculationsto measure an monitor the profitabilityof your business operationsComparing your net and gross margin calculationsto businesses within the same industry willprovide you with comparative information andmay highlight possible scope for improvement inyour marginsManagement RatiosUse the number of days for inventory,debtors and creditors to calculate thecash conversion rate for your tradingactivitiesComparing your management ratio calculationsto businesses within the same industry willprovide you with comparative information thatmay highlight possible scope for improvement inyour trading activitiesBalance Sheet RatiosUse the return on assets and investmentratios to assess the efficiency of theuse of your business resourcesThese ratios will provide an indication of howeffective is your investment in the business169156 169chapter 7-13 p79-181 Eng.indd 1698/15/11 5:03:10 PM

Financial Guide for SMEsFinancial Guide for SMEsChapter Three - BudgetingA budget is the future financial plan of the business. It is where the strategicplans are translated into financial numbers to ensure that these plans arefinancially viableTopic Hint TipProfit and Loss Budget By preparing a profit and loss budget annually, you will be in a An independent profit and loss budget can bedeveloped for separate projects to assess theposition to determine if your future financial viability of each projectbusiness plans will support theongoing activities of your businessAssumptionsAll assumptions made during theplanning process of preparingbudgets should be realistic anddocumentedWhen documenting your assumptions, includeboth the risk assessment of each assumption andthe anticipated action required to match the risk.By doing this, you will be well prepared and havean action plan already in place if the actual eventsdo not match your assumptionsMonitoring andManaging Your Profitand Loss BudgetRemember, the more regular thereports, the faster operations canbe reviewed for financial impactand action can be implementedimmediately whenever requiredRegular review of budget against actual resultswill provide information on whether your businessis on track to achieve the plans formulated whenyou first prepared your budget170170 157chapter 7-13 p79-181 Eng.indd 1708/15/11 5:03:11 PM

Financial Guide for SMEsFinancial Guide for SMEsSection II : Improving Business FinancesImproving business finances means you need to take a practicalapproach to implement new processes that allow you to monitor thekey aspects of your business profitability and cash flowChapter Four – Maintaining ProfitabilityIt is very easy for profitability to be eroded if you do not measure andmonitor on a regular basis. Therefore, it is important to understandhow to use the tools available to continuosly evaluate the profitability ofyour businessTopic Hint TipProfitability MeasuresUsing the profitability measures providedwill ensure that you are aware of anyreduction in profit as it occurs andunderstand what level of sales isrequired for the business to generateprofitCompare your profitability measures to thebusinesses within the same industry to ensurethat you are being competitive and achievingmaximum profit potentialDiscounting SalesYou may want to consider offeringyour customers add-on services asan alternative to offering discountsExpense ManagementKeeping a close eye on your expenseswill ensure that you maintain theprofitability of the business your expensesLook for opportunities to join with other businessesfor “group” buying that can provide discounts on171171chapter 7-13 p79-181 Eng.indd 1718/15/11 5:03:11 PM

Financial Guide for SMEsFinancial Guide for SMEsChapter Five – Improving Cash FlowWorking capital is the short-term capital that works for the business. Thisincludes inventory, work-in-progress, payments to suppliers and receiptsfrom customers. By working on your cycle more efficiently, you wouldhave more readily available cash to use in other parts of the businessTopicHint TipManaging Inventory Setting up good inventory controlprocedures will ensure that cash is not tiedup in holding unnecessary inventorySee page 52 for complete listof tipsManaging Paymentsto SuppliersSetting up good management procedureswill ensure that you get the most out ofyour relationship with suppliersSee page 57 for complete listof tipsManaging Work- in -progressThe key to managing work-in-progress isto have a good record keeping systemSee page 59 for complete listof tipsManaging ReceivablesEnsure that you have good procedures inplace to encourage prompt paymentSee page 63 for complete listof tipsWorking CapitalCycle – CashConversion RateCalculate the cash conversion rate andcompare this to the standards within yourindustry. Identify which areas of the cycleare problematic and prepare an actionplan to improve the cash conversion rateCalculate your cash conversion rate regularlyand implement improvement to your workingcapital to release idle cash that is not beingused within the business. This will reducethe need to borrow additional funds tosupport the operations of the business,decrease dependency on funds from financiers,and reduce any interest expense incurred172172 159chapter 7-13 p79-181 Eng.indd 1728/15/11 5:03:11 PM

ChapterSix–Cash and ProfitCashYouropicFlow DriversBusinessManaging Cash FlowinCash Flow ForecastingCash flow is the lifeblood of everybusiness. A profitable business can stillsuffer from shortages in cash, so it isimportant to understand what “drives”y ou r cash flo wRemember that cash flow is all abouttiming and the flow of cash, so whenpreparing your cash flow forecast,make sure you are as accurate aspossible on the timing of the cashflowsinTiFinancial Guide for SMEsFinancial Guide for SMEsA business can be profitable but still have cash flow issues. It isimportant to implement procedures in your business that will ensurethat cash flow is appropriately managedT tH pCASH DOES NOT EQUAL PROFIT! The timing of when cash is received is the mostimportant issue when managing cash flowThe importance of knowing what are the keydrivers of your cash flow should not beunder-estimated. In order to maintain adequatecash flow, these drivers should be a priority foryour business and be well managedOnce the forecast is completed, you can run some“what if” scenarios to measure how reactive yourbusiness cash flows will be to certain changes inevents, such as decrease in sales or increase infuel costs. This will show you how quickly you mayrun out of cash if any of these events occur173160 173chapter 7-13 p79-181 Eng.indd 1738/15/11 5:03:11 PM

Financial Guide for SMEsFinancial Guide for SMEsSection III : Financing Your BusinessFinancing your business is an important part of good financialmanagement practice. Not only having access to finance, but alsobeing able to choose the most appropriate method of finance for yourbusiness will result in continued growth and profitabilityChapter Seven – Debt, Equity orInternal Funds?A key requirement to ensure that you choose the right funding is tomake certain that you fully understand the differences between debtand equity, and to consider the implications of each on your businessTopic Hint TipComparing DebtFinance, EquityInvestment andInternal FundsTo fully understand the implications ofchoosing debt, equity or internal fundsto fund your business, ask yourselfwhat would happen if something goeswrong. The answer will help you tomake the right choiceGenerally, a business would aim to maximise theuse of debt finance to fund its operations, as longas the business can service the level of debt andhas enough security to support the funding. Thebusiness owner would retain the benefits ofownership in respect of growth and profitability oftheir businessDeciding BetweenDebt and EquityIn deciding whether or not to seekan equity party, you need to considerboth the financial and non-financialoutcomesYou may find that your ability to raise debt improveswith equity investmentUnderstanding theDebt Financing OptionsLong-term versusShort-termIt is important to review alternative Ensure that the type of financing undertakenfinance products from different matches the reason for seeking finance. A generallenders and ensure that you are rule of thumb is to match the term of the loan withcomparing apples with apples the length of the life of the asset you are funding174174chapter 7-13 p79-181 Eng.indd 1748/15/11 5:03:11 PM

Financial Guide for SMEsFinancial Guide for SMEsChapter Eight – Transactional Banking toSuit Business NeedsTransactional banking forms part of the overall financing of yourbusiness. The everyday banking requirements should beconsidered carefully to ensure that the payments in your businessare efficient and effectiveTopic Hint TipTransactional BankingProductsChoosing the most appropriatetransactional banking products willassist in managing cash flow andimproving profitabilityYour banker can assist you in choosing the mostappropriate transactional banking products foryour businessMerchant FacilitiesMerchant facilities provide a realbenefit to your business cash flow: yourcustomers do not necessarily need tohave cash in the bank to pay for yourgoods or servicesBy introducing merchant facilities, your businesswould be able to benefit from faster payment,significant reduction in invoice queries and creditcontrol calls and improved cash flowTransactional FeesRegular review of your transactionalbanking services will guarantee thatyou know how much you are paying forthese services, and ensure that you areusing transactional services that bestsuit your businessBy allocating all bank fees in a separate account,you will be able to clearly identify any increasesin fees that could be impacting your profitability175162 175chapter 7-13 p79-181 Eng.indd 1758/15/11 5:03:12 PM

Financial Guide for SMEsFinancial Guide for SMEsChapter Nine – Trade Financing International trade finance products are specifically designed toassist importers and exporters in managing risk and improvingcash flow for their businessTopic Hint TipForeign CurrencyPaymentsBy hedging your international currencypayments, you would reduce the riskof negative impact on profitabilityOften using a combination of hedging productsworld provide the best protection over fluctuationsin foreign currencyAlternative Methodsto Manage ForeignCurrency PaymentsForeign currency payments can alsobe managed by implementing alternativepayment methodsIt is advisable to speak to your banker to determinethe best alternative to manage your internationaltrade paymentsInternationalTrade FinanceTrading internationally can be a realstrain on cash flow. If you can negotiatewith your supplier or customer to usetrade finance products, you can releaseyour cash flow for other parts of thebusiness176176chapter 7-13 p79-181 Eng.indd 1768/15/11 5:03:12 PM

Financial Guide for SMEsFinancial Guide for SMEsSection IV : Managing LendersMany people in business over estimate how much a banker knows abouttheir business or industry, and due to past actions by some banks, theyalso can feel somewhat intimidated. However, if you take the time toeducate your banker, they can be an asset to your businessChapter Ten – Applying For a LoanTopic Hint TipPresentation of theLoan ApplicationMake sure you understand all thefinancial information that has beenprepared and is being presentedWhen applying for a loan, always meet yourbanker in person to discuss the application177164 177chapter 7-13 p79-181 Eng.indd 1778/15/11 5:03:12 PM

Financial Guide for SMEsOften SMEs have the same banking facilities years after they have started.A review of existing facilities may highlight that the current facilities andstructure need to be changed to meet the change in business operationsChapter Eleven – RefinancingYour DebtTopic Hint TipMake a list of the reasons why you might considerrefinancing your loan to compare against the loanoffer you receiveRefinancing can involve a number ofalternatives. To achieve the best outcome,ensure that you understand all the alternativesbefore committing to a new lenderRefinancingYour DebtRefinancing a strong healthy business may alsoindicate that there is an opportunity to separate yourpersonal assets from security offered if the valueof the business assets (i.e. commercial land andbuilding, debtors, fixed assets etc) is sufficient tocover the borrowingAfter carefully undertaking a cost–benefitevaluation of refinancing, you may find itbrings a range of new opportunities to yourbusinessBenefits ofRefinancingCommon Dangersin RefinancingFinancial Guide for SMEsEnsure you have undertaken sufficientreview of your circumstances prior to makingany commitments for refinancing, as there aremany pitfalls that may impact any perceivedbenefitSwitching Banks Make a list of all the points and note the prosand cons for each point to help assess whetherto refinanceBanking Review Comparative information on bank finance isavailable on the SME Portal atwww.smeinfo.com.my or Banking Info atwww.bankinginfo.com.my178165 178chapter 7-13 p79-181 Eng.indd 1788/15/11 5:03:12 PM

Financial Guide for SMEsFinancial Guide for SMEsChapter Twelve – Managing Your BankingRelationshipsGood relationships with your bankers will ensure that theyunderstand your business and are in the best possible position toprovide advice and support when neededTopic Hint TipAnnual ReviewBeing well prepared for the annual reviewwill show the bank that you understand theirrequirements and indicate good managementpracticesDuring the annual review, the bank is likely torequire up-to-date financial data and all otherrelevant information that summarises your businessoperations for the last 12 monthsContinuingRelationshipsKeeping your bank well informed of yourbusiness activities and performance willensure that they are ready to respond toany additional requestBank managers are often working with otherbusinesses in similar industries and can be auseful source of information for your businessManagingDifficultiesIf your business is having problems, suchas difficulty in keeping up with repayments,discuss them with the bank immediately sothat they can work with you to find asolutionBank managers are more ready to provide anyassistance required, such as a negotiation ofrepayments, if they are told about a deterioratingposition rather than having to find out about itthemselves179179chapter 7-13 p79-181 Eng.indd 1798/15/11 5:03:12 PM

Financial Guide for SMEsFinancial Guide for SMEsSection V : Better Business FinancialManagementWhen you are using financial information to make decisions, it is importantthat policies and procedures are in place to ensure that the information iscomplete and accurate and will lead to correct decisionsChapter Thirteen – Financial Controls Financial controls are policies and procedures used in yourbusiness to protect your assets and to support good financialreportingTopic Hint TipBenefits ofFinancial ControlsIf you are using inaccurate financialinformation for decision-making, you couldbe making the wrong decisionsGood financial controls will protect your investmentin the business and ensure that the business runsmore efficiently, resources are not lost and thereare fewer unpleasant surprisesFinancialControlsChecklistUsing the checklists will help you determinewhich financial controls are relevant for yourbusiness, and highlight the areas where youcan improve your financial controlsFor all those questions in the checklist that havenot been answered with “yes”, review which onesare applicable to your company. Then make anaction plan that includes who will be responsible forimplementing each policy and procedure andgive a due date for completion180180chapter 7-13 p79-181 Eng.indd 1808/15/11 5:03:13 PM

Financial Guide for SMEsACKNOWLEDGEMENTThe Financial Guide for SMEs reproduces sections of Achieving FinancialSuccess (a publication co-owned by CPA Australia and the State of Victoria,Australia through the Department of Business and Innovation). The State ofVictoria and CPA Australia have granted permission for such reproduction.SME Corporation Malaysia and CPA Australia wish to acknowledge thesupport the State of Victoria provided for this publication.SME Corporation Malaysia and CPA Australia also wish to record our deepestappreciation to the following institutians who have assisted to verify theinformation contained in this Guide to ensure that it is relevant to the Malaysiancontext, and hence making the production of the Financial Guide for SMEs areality.1. Association of Banks in Malaysia2. Malaysia Institute of Accountants3. Bank Negara Malaysia4. EXIM Bank Berhad181chapter 7-13 p79-181 Eng.indd 1818/15/11 5:03:13 PM

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