Financial Guide for SMEs - SME Corporation Malaysia

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