Financial reporting: A challenge to SMEs

SUITS THE C-SUITE By Sherwin V. Yason

Business World (11/10/2014 – p.S1/4)

SMALL AND MEDIUM-sized enterprises (SMEs) vary in size and type across countries and industries; despite these differences, it is globally recognized that SMEs play a vital role in economic development.

Based on a report presented by R. Aldaba in August 2014, “Gearing Up SMEs for Association of South East Asian Nations (ASEAN) Economic Community 2015 (AEC 2015),” ASEAN SMEs account for about 99% of all registered businesses, employ more than 60% of the work force, and contribute 16% to 35% in exports.

These statistics explain why SME development is a significant component of AEC 2015, which will officially commence on December 31, 2015. In the Philippines alone, the latest data from the Department of Trade and Industry show that SMEs represent 99.6% of total registered enterprises, contribute 35% to the gross domestic product, and employ about 70% of the total Philippine work force.

SMEs are the lifeblood of our country’s economy. They stimulate economic activity, generate employment, prompt innovation, heighten competition and contribute largely to the country’s progress. However, Philippine SMEs continue to face serious difficulties and challenges in relation to their existence, development and competitiveness.

The reality is that most SMEs start small and generally remain small until liquidation or bankruptcy. Many research studies report that access to financing remains one of the most critical, if not the foremost, constraint facing Philippine SMEs.

This is despite the fact that, by law, all lending institutions are required to set aside and lend 6% of their total loan portfolio to small enterprises and 2% to medium enterprises. In addition, Government has also implemented plans and programs to support SME development and growth, such as the National SME Agenda, and the 2011 — 2016 Micro, Small and Medium Enterprises Development Plans.

Yet, many SMEs still find it very difficult to access funds due to the voluminous and stringent requirements (some of which are unfamiliar to them, including adequate financial statements) from the financial institutions and credit corporations or cooperatives.

As a result, SMEs tend to rely heavily on internally generated funds from operations and additional cash infusions from the personal savings of the owners. In a study, “SMEs’ Access to Finance: Philippines” conducted by R. Aldaba in 2012, it was revealed that SMEs, particularly the smaller ones, have been unable to access funds due to their limited track record, limited acceptable collateral and inadequate financial statements.

From a financial reporting perspective, it is clear that SMEs — despite having different products, services and business strategies — have a common and immediate need for an adequate accounting infrastructure that will provide them with timely and accurate financial statements. An adequate accounting structure will address the availability of financial information that is acceptable and useful for potential lenders or capitalists as they evaluate the SME’s true financial health and condition. With this information, lenders can evaluate the feasibility of extending a loan to the SME. A successful loan application will allow SMEs to build up their credit history and enhance the viability of its business, which are the essential requirements for SMEs when attempting to secure additional funding.

Beyond the issues of credit, having timely, accurate and consistent financial statements can help management and stakeholders make timely financial and investment decisions. However, considering the way most SMEs are structured, many do not prioritize their finance and accounting infrastructure, often due to cost considerations. They may also have insufficient finance personnel who are knowledgeable about the latest accounting standards and fast-changing tax regulations.

FINANCIAL REPORTING OF SMES

Philippine accounting standards have recognized the need of SMEs for simplified financial reporting tailored for the users of their financial statements (including investors, management and lenders). This is the reason why the Philippines Financial Reporting Standards (PFRS) Council and the Philippine Securities and Exchange Commission (SEC) adopted in 2010 the International Financial Reporting Standards (IFRS) for SMEs issued by the International Accounting Standards Board in 2009, to simplify the many complex and onerous accounting requirements required of large enterprises by full PFRS, and to reduce the SMEs’ cost and effort to produce financial statements that are consistent with internationally accepted standards.

However, despite the adoption of PFRS for SMEs four years ago, it seems that a big number of SMEs have yet to fully appreciate, maximize and realize the benefits of the accounting simplifications made available under PFRS for SMEs. Many SMEs still question and challenge sections of PFRS for SMEs, mainly: (i) the many simplified recognition and measurement principles, and (ii) the removal of accounting policy options and allowing a single generally simplified method.

Some hold the view that if certain recognition and measurement principles under full PFRS are useful to the users of financial statements of large enterprises, then these should be similarly allowed for SMEs. Others also prefer making accounting options available to, but not necessarily required of, SMEs if these will result in more useful financial information for financial statements users. While some points may be valid, SMEs should not forget that the ultimate objective of PFRS for SMEs is a simplified, independent and acceptable accounting framework specifically tailored to meet the specific needs of users of SMEs’ financial statements, such as lending institutions that are considering an SME for a loan.

NOW IS THE RIGHT TIME

With the mounting challenges SMEs are experiencing with their financial reporting, now is the right time for the SMEs to look into their accounting infrastructure and to commit to producing useful and reliable financial information. With the country’s improving economy and expected results of AEC 2015, such as the existence of a bigger ASEAN market of about 600 million people, the removal of trade and investment barriers, improvements in regional value chains and wider financing sources from integrated regional capital markets, SMEs should get ready to reap their share of the benefits within this highly anticipated competitive and beneficial business environment. Getting ready means having timely and adequate financial reports that, in turn, will translate into ready access to credit for the SMEs.

Sherwin V. Yason is a partner of SGV & Co.