Small firms' finances in weak state

THE FINANCES of small businesses suffer from serious structural weaknesses, according to a report by the 3i Cranfield European Business Centre, writes Mary Fagan. The report, based on an analysis of 3,000 firms that have registered with Companies House, paints a 'worrying picture' of small business finance in the UK that requires action from the Government and from banks.

The report shows that, compared with large companies, small firms have weak liquidity and a much lower ratio of fixed assets, making it difficult to raise finance from banks wanting security on loans. The companies typically have lower levels of profitability and face more profit volatility, which acts as a deterrent to lenders and providers of equity.

In general, small firms appear to depend on trade credit as the main source of finance. While they have approximately the same gearing as larger companies, their borrowings are mainly overdrafts and short-term loans. The report warns that these financing options may be relatively cheap to obtain but are risky and vulnerable to economic fluctuations.

The 3i study says small companies have insufficent shareholder funds and calls for government policies including the reintroduction of accelerated capital allowances on plant and equipment to encourage retention of earnings.

Because lack of security results in high interest rates for small firms, the report says the Government should consider a direct subsidy to banks with a view to them bringing down interest rates. Small firms and banks should be more wary of the risks of over-reliance on short- term finance and any government subsidy should be offered only on long-term loans.

The report urges companies to place greater emphasis on financial control.

Paul Burns, director of the 3i Cranfield Centre, said: 'It cannot be good for the UK that such a substantial element of its wealth-creating capacity is built on shaky foundations.'

The Instititute of Directors has called for tax reforms to help small businesses. An IoD survey shows a 'severe' lack of funds for people starting a business and for small firms trying to expand.