Evaluating the independent review's impact on access to bank finance and consequent SME sustainability

Abstract

If asked to consider the contributions of business to socio-economic welfare, one’s thoughts inevitably wander in the direction of major, household name, corporations. The value-add of small and medium sized enterprises (SMEs) is often overlooked. The fact however, is that the SME business sector contributes substantially to global GDP and more than substantially to global job creation. The health and prosperity of all economies are thus directly dependent on a vibrant, expanding SME sector. It is therefore of crucial importance for global economic prosperity that the SME phenomenon is nurtured and supported to ensure the survival and sustainability thereof. As important as a healthy and growing SME sector may be, it is a commonly accepted truth that SMEs face a menagerie of challenges in their day to day business involvement, of which access to finance is one of the most commonly accepted, and potentially crippling. As such, SMEs regard banks as the go to provider of financing. Banks, on the other hand, have always regarded SMEs as higher risk lenders than bigger corporations. To abridge this risk, banks have historically relied on audited financial statements to mitigate the risk-related concerns they may have had. Audited financial statements gave banks the assurance, and peace of mind, that the information provided by SMEs during a loan application was at least a fair reflection of the position of the business at that point in time. Banks are more comfortable granting loans based on accurate and dependable financial information. The playing field in South Africa has however changed recently with the advent of the new Companies Act, No. 71 of 2008. The new act introduced the independent review as an alternative to the statutory audit. SMEs now have to choose between doing a less expensive independent review, while potentially sacrificing the goodwill banks have shown to audited financial statements during lending processes, or a full-fledged audit at a significantly higher cost, but with the benefit of keeping the banks positive during loan applications. This research paper delves into how much value SMEs should place on audited financial statements since the introduction of the new Act, when applying for bank financing. To address this predicament the research attempts to establish whether banks still place reliance on audited financial statements when evaluating loan applications. This is done by investigating the information banks require from SMEs when applying for financing. The research then compares these findings to the attitudes and perceptions of SME owners towards the requirements, in terms of audited financial statements, imposed on them by banks when applying for financing. As mentioned earlier, banks have historically relied on audited financial statements to provide reasonable assurance that financial information is accurate. The fact that audited financial statements have effectively fallen by the wayside, inevitably means that banks will start to view financial information provided by SMEs as opaque and asymmetrical. History shows us that accounting was born out of the need merchants had to record their transactional activities. As such, accounting has provided the solution the business domain requires, and to the extent that accounting has survived for centuries as the language of business. It then follows that a basic skillset in accounting, the language of business, may be what bridges the perception gap between perceived asymmetrical information and perceived accurate information. The research thus further investigates what SMEs can do to circumvent negative perceptions in terms of their financial information. This is done by investigating the attitudes of SME owners towards accounting as a more prolific tool by which the perception of asymmetrical information can be dispelled. The research will be of great value to SMEs by providing guidance concerning the decision between whether to audit or have an independent review done. It will further be of value in terms of investigating alternative ways of replacing the goodwill lost by potentially not providing banks with audited financial statements during loan applications. If this research can improve the success rate of SME bank loan applications in a small way, it will have accomplished much in the quest for economic sustainability of SMEs.