Alexis S. Becker
Strong governance can yield higher profits for SMEs
You probably already know that large, public companies with strong governance have higher profits. But were you aware that even small* and medium enterprises (SMEs) benefited from having formal governance in place? While the focus of most research on the subject is on large and publicly traded organizations, the broader business group that comprises small and medium-size companies is being studied more to discern the impact of good governance on their profitability and growth.
Small and mid-size companies may not see governance as an important or necessary function, but according to the International Finance Corporation, “Research and empirical evidence show that good governance improves (SME) business performance and increases the chances of a company’s long-term survival.”
What is Corporate Governance and Does it Apply to Small Business?
Corporate governance is “the system of rules, practices, and processes by which a firm is directed and controlled.” Through systems, process, procedures, and policies, management obtains more control and visibility over operations and financial performance. In large organizations, this makes sense as there are many moving parts and the return is palpable. For SME’s, the desired outcome is appealing, but the undertaking seems daunting.
Small Business Corporate Governance: It’s Not Just Red Tape
The inference of governance implies that accountability exists to the investors of publicly traded companies. Smaller businesses don’t view accountability beyond that to their owners, not always realizing the stake others have in their profitability.
In public companies, shareholders are not bound by the need for short-term returns, instead choosing to invest for a longer-term goal, like retirement. External auditors, engaged for impartial, third-party objectivity, rely on corporate governance to provide assurance of ethical accounting practices and accurate financial reports. This affirms to shareholders that their investment is sound.
Similarly, for SME’s, stakeholders include owners, employees, customers, and vendors, are reliant on income produced from the entity in the short term. It does not negate their interest in seeing the company prosper over the long run, with the desire to be invested in a growing and flourishing business. For these organizations, good governance assures stakeholders that measures are in place for sustainability — such as, but not limited to, a corporate strategy, timely monitoring of financial performance, delineation of roles and responsibilities, and dependable internal accountability measures.
A Small Business Governance Framework in Action
Let’s look at how governance can impact a small business.
A MAXIS® client is a profitable, multi-generational, family owned business. Candid in their contentment with operations and profit, the company is very successful by any measure. In order to access capital for major repairs and necessary upgrades to fund an expansion, they turned to their bank for a significant loan. When seeking to substantiate the level of risk, even though the bank had worked with them for years, the client was unable to provide adequate documentation to demonstrate adequate cash flow to sustain the investment.
The family felt strongly they all understood the purpose of the organization and their individual roles in contributing to it. It was a profitable venture, the informal “family like” culture resulted in little employee turnover, and the processes created by the founder seemingly led to consistent year-over-year growth. While stung by the rejection, their commitment to facilitating an enduring, thriving business for many generations superseded the frustration of the setback.
The bank recommended Freed Maxick to help create a more disciplined structure. (The client had outgrown the prior accountant, who recorded transactions but provided no advice, years ago, but felt too loyal to change.) While conducting an assessment , we discovered many weaknesses such as a lack of internal controls and accountability structure including:
- no strategic plan to guide the company’s growth
- no transactional protocols
- security vulnerabilities as a result of outdated software
- lack of documentation, primarily due to verbal requests
- incorrect cash flow analysis due to data not being input
- no accruals, all cash-based reporting
- family members multitasking roles without competence or oversight for accuracy
- over reliance on one person (bookkeeper, with a deep organization history of and institutional knowledge)
- no formal budget or forecasting process
In addition the assessment, Freed Maxick performed as a fractional CFO to develop and implement:
- the creation of a business plan that included short term and long term, operational and financial goals
- developed an organizational hierarchy, job descriptions and responsibilities commensurate with roles
- created a succession plan
- implemented separation of duties and authorization protocols for transactions
- upgraded software to create better accuracy and timeliness of data
- automated repetitive daily and weekly tasks
- increased security to safeguard information and assets
- currently assisting the client with the exploration of an outside advisory board to provide unbiased perspective and counsel
By prioritizing their commitment to small business corporate governance and a more disciplined process, the company was able to not only obtain the loan by demonstrating sound stewardship and transparency, but put the business before family, ensuring a stronger foundation for sustainable continuity.
While generally a function for publicly traded companies and organizations seeking an IPO, good corporate governance is an excellent practice for every enterprise. When applied, it provides a framework with which to manage the business that positively influences its performance and value regardless of its size.
* In the United States, the Small Business Administration “sets small business criteria based on industry, ownership structure, revenue, and number of employees” (Wikipedia). However, a general opinion is that small companies employ fewer than 250 employees, and medium, fewer than 500.
What Does Good Small Business Governance Look Like For Your Business?
Interested in learning more about how good governance can enhance your company’s performance and profitability? Contact Alexis Becker, accounting and advisory services practice leader, for a complimentary consultation at 716-332-2619 or email@example.com.