Studies have shown that Small and Medium Enterprises (SMEs) are the backbone of Africa’s economy, accounting for approximately 90% of businesses and contributing over 50% of employment across the continent. Despite their huge significance, research reveals that over 60% of SMEs fail within the first three years, often due to financial mismanagement and inadequate access to resources.
If there is no money, there won’t be business, for in business, you need money to make money. Finances are the backbone of the business, sustaining, supporting, and sponsoring the business initiatives, daily operations, investing in growth, and basically everything else to ensure the smooth running of the business. As such, significant consideration of financial issues should be a top priority.
In this article, we will discuss the 7 top causes of financial challenges faced by SMEs and practical strategies to adopt for recovery and managing business finances.
What are the 7 Top Causes of Financial Challenges for SMEs
Here are the top seven reasons startups face financial challenges and practical actions to take to manage and recover financial stability.
1. Poor Cash Flow Management
Poor cash flow management happens when SMEs fail to adequately monitor their inflows and outflows of cash. This inadequacy in management can lead to liquidity crises, which makes it challenging to cover operational expenses, pay suppliers on time, or capitalize on growth opportunities.
Additionally, effective cash flow management includes predicting future inflows and outflows to plan finances effectively. When you lack such visibility, your preparation will be affected, and this will leave you unprepared for sudden financial demands.
Strategy for Recovery:
One of the major strategies is to implement regular cash flow analysis and forecasting to gain insights into the financial trends and to ensure adequate strategy is developed accordingly to ensure that the business maintains sufficient liquidity to meet obligations. Also, leverage modern accounting tools to track income and expenses in real-time, which will help to give you an accurate financial overview at all times.
2. Limited Access to Financing
One of the significant hurdles facing SMEs, especially in Africa, is access to adequate financing, as many lack the collateral or credit history required by traditional financial institutions. Lenders often view SMEs as high-risk borrowers, which has made it difficult for these businesses to secure loans or lines of credit. This limitation has affected their ability to invest in growth opportunities, upgrade infrastructure, or manage cash flow effectively.
Strategy for Recovery:
Explore alternative financing solutions, such as crowdfunding platforms or microloans. Also, you can seek out angel investors who are willing to provide funding in exchange for equity or convertible debt. Also, another practical strategy includes building a strong credit profile and improving business financial documentation that speaks transparency as it is essential for building trust with potential financiers.
3. High Operational Costs
High operational costs mostly stem from business processes, excessive staffing, or inflated overheads such as high rental expenses. These cause significant strain on a business’s financial resources and affect profitability, which can lead to the business running at on lose.
Strategy for Recovery:
Regularly assess and analyze all business expenses to identify areas where costs can be reduced. Cut off all unnecessary expenses and adopt lean principles to eliminate waste in operations, such as reducing excess inventory, optimizing production processes, or improving workflow efficiency. Additionally, negotiate favorable terms with suppliers and service providers for better terms, and consider outsourcing non-core functions.
4. Ineffective Pricing Strategy
Ineffective pricing strategy is one of the leading causes of financial challenges in SMEs. It refers to either underpricing or overpricing of products or services, which both are capable of affecting the business. Underpricing reduces the profit margins, which makes it difficult to cover costs or reinvest in the business. On the other hand, overpricing can affect customers’ demand, as the product or service might be perceived to be too expensive or not worth the value. Both issues, if not managed on time, can lead to lost revenue and hinder the ability to achieve financial stability.
Strategy for Recovery:
To remediate these issues, the first thing to do is to reevaluate the pricing strategy of your goods or services based on current market trends, competitor pricing, and the unique value proposition of your product or service. Also, introduce a tiered pricing structure to cater to different customer segments. This entails creating various levels of service or products that feature at different price points. For instance, if you are into services, you can have packages for basic and premium. For high-cost products or services, use a communication channel to reach out to the customers to educate them on the quality, value, and results your offerings deliver.
5. Poor Inventory Management
This is a common issue that can severely affect your business’s cash flow and profitability. To maximize profit and manage costs, you have to learn effective inventory management. A major causative effect of poor inventory management is overstocking, which ties up capital in unsold goods, and this prevents the money from being reinvested into the business or used for other critical business needs.
On the other hand, it can also lead to understocking, which can lead to lost sales, dissatisfied customers, and a tarnished reputation if products are unavailable when needed. Both extremes are determinantal to business growth and can affect the delicate balance between supply and demand.
Strategy for Recovery:
Invest in modern inventory management software to keep track of the stock levels in real-time and ensure that inventory is always aligned with demand patterns. Additionally, adopt the Just-in-Time (JIT) inventory practices to reduce storage costs and improve liquidity. This approach entails ordering inventory only when needed.
6. Weak Financial Planning
Most SMEs have weak financial planning structures due to a lack of a structured approach to budgeting and setting financial targets. This can be one of the major causes of financial challenges for SMEs because, without a clear understanding of your income, expenses, and financial goals, you might not know the right financial decisions to make steps to take and critical areas of the business to invest into.
Weak financial planning can lead to uncontrolled spending, cash flow problems and missed opportunities for growth, which have the potential of running down a business.
Strategy for Recovery:
Create a comprehensive budget that separates fixed costs (e.g., rent, utilities, salaries) from variable costs (e.g., raw materials, marketing, commissions) to give you a clearer understanding of the ongoing financial obligations of your business. Regularly update and keep track of your business budget. Also, clearly spell out your business financial goals. The goals should be specific, measurable, and time-bound to provide a sense of direction and accountability. Additionally, invest in financial literacy and financial business management.
7. Insufficient Revenue Diversification
When an SME relies too heavily on a single product, service, or client, it becomes vulnerable to fluctuations in demand or shifts in the market. Yes, it’s okay to have the major product you are known for, but it’s important you create supplement products or services so that when the key product or client faces a downturn, the business won’t be significantly affected.
Strategy for Recovery:
Expand your products or service offerings to appeal to different customer segments or complement existing offerings. This helps to spread the risk by generating multiple sources of revenue. For instance, if your business specializes in retail clothing, you might add accessories, beauty products, or home goods.
Also, you can build partnerships with businesses that are complementary to penetrate new markets or regions, which helps to reduce dependence on a single market. Furthermore, you can develop models that provide a steady income over time, such as subscription-based services or long-term contracts.
Final Words
At Mac Adebowale Professional Services, we provide expert solutions to help your business thrive. Our services include comprehensive financial audits and cash flow tools, custom strategies to secure funding and reduce costs and expert guidance on pricing, inventory, and revenue diversification. Contact us today at emails@macadebowale.com or macadebowaleadvisory@gmail.com; let us help you build a sustainable business model for long-term success.
