Small and Medium-Sized Enterprises and the Risks They Face in an International Environment - Essay Example

?Small and Medium Sized Enterprises and the Risks they Face in an International Environment. Introduction: Small and Medium sized Enterprises or SMEsgenerally function in the economy’s formal sector, and it employs chiefly wage earning workforce, and involve in the organized markets. SME access to formal finance is an attractive possibility; and they have become competitive in domestic and international markets, and are more likely to grow further in future. The Small-Scale sectors add adequately to other aspects of socio-economic activities like reduction in inequalities of income, product diversification, isolated expansion of small scale industries, and relation with the other sectors of economy. In proportion to other trends of globalization, small and medium sized Enterprises are increasingly occupied in international businesses. “Foreign investments by small and medium scale enterprises have also increased” (Feyter 2011). SMEs account for a major share of exports and imports and go up to international network of production. “Small organizations have very little, if any, influence over the forces of external environment, and this can be attributed to the limited resource of the small firm” (Sha n.d). As SMEs try to internationalize, they frequently come across extensive hurdles. These hurdles are complex, and they can be from the larger, external, business environment of SMEs including barriers of trade policy; or from the internal environment of firms. “Currency fluctuations are the top concern for 49% of UK SMEs” (International Trade: Confidence Concerns and Risk for UK Smes). The various risks that small businesses face when they engage in the international trade include credit risk, interest rate risk, country risk, and currency issue. Credit Risk- SMEs regularly complain that their competitiveness and growth are restricted by lack of access to the financing and high cost of credit. The high cost of credit remains a major constraint in the development of SMEs, although there is proof that SMEs are more concerned about the access to credit than the cost of credit. Interest rate risk arises when the business depends more on borrowed funds, or revenue generated from savings. Fluctuations in interests rates affect the total profit of the business through reduction in income from the interest or by increases in the interest expenses. Country Risk The country risks in foreign exchange trading are connected with the intervention of government in foreign exchange market. Currency Issue- Most of the international trade is carried out in dollars. This has paved way to considerable exchange risks of currency. While taking SMEs in UK as an example, thirty six percent of SMEs  business leaders of UK  who carry out international business quote ‘currency fluctuations’ (Latest Market Research Surveys 2009) as their overruling concern. In spite of fluctuations in currency being their key concern, an astonishing fifty six per cent of SME leaders admit that they do not control their financial risk. UK SMEs on trading internationally, consider problems of currency fluctuations, legislation, problems in payment, pricing, language barrier, time limitations, and cultural differences. Aims and Objectives 1. To identify the risks faced by SMEs by way of international trading 2. To provide solutions to lessen the risks aroused from international trade Methodology The data for this business report is gathered from secondary sources like journals and articles published, and from different texts. “Research methodology is a way to systematically solve the research problem” (Research Methodology: An Introduction 1978). Primary sources are not used, as data collection from the SMEs of different countries as a whole is not possible. Secondary sources include data that are collected and gathered for a further purpose. The secondary sources include not only reports and records that are published, but also unpublished records, including different registers and records kept by organizations and firms like financial and personnel records, register of members, inventory records, minutes of meetings, etc. Literature Review Professor Ronald McQuaid says that there is no globally accepted definition for an SME. The two key approaches for defining an SME are: Quantitative and Qualitative approaches. The quantitative approach is based on the criteria of turnover, employment, and asset size. These may differ by country and industry. Qualitative approach to define small firms comprises activities like trying to understand the meanings, behavior and belief aspects, together with the issues facing the managers that differentiate small enterprises from that of large enterprise. Small firms are largely independent, and not mostly owned or directly controlled by larger firms. In defining activities like. “For the ILO, the rapidly changing global economy provides both challenges and opportunities” (Levin 2001). Gradually, more SMEs are seeking involvement in international markets as they think it is vital to their job creation, growth and survival. “International trade has become complex and highly demanding” (High-Growth Innovative Asian SMEs International trade and competitiveness: challenges and Solutions for APO Member Countries n.d). By now SMEs are major contributors to world economy, accounting for around 50 percent of the local and national GDP, 30 percent of the exports, and ten percent of the FDI. Although it is not possible to calculate the number of SMEs presently involved in the international markets accurately, it seems to be growing, mainly for SMEs in service sector. The opportunities for dealings in international business have developed noticeably, as conventional barriers related with distance and cross border deals have been reduced by way of new technology and negotiations of trade. But the growth of a rapid changing and ever more complex international marketplace has created significant pressures on the firms, especially SMEs. As per the discussion of OECD (Organization for Economic Cooperation and Development) APEC (Asia Pacific Economic Cooperation) Global Conference in Athens, SMEs “may also lack awareness of how their capabilities match the challenges of operating in international markets and also the knowledge about how to evaluate their capabilities in this respect” (Removing Barriers to Sme Access to International Markets 2008). The key challenges that are faced by the SMEs in global markets are as follows: 1. Recognizing global business opportunities, analyzing and locating appropriate markets: Due to limited time, less financial resources and competency are available for SMEs They are unable to recognize and grab new global market opportunities. 2. Communicating prospective foreign clients: The firms that are new to internationalizing, lack knowledge especially on how to enter and make the best use of profitable engagement in that particular market. They also do not have the skill to understand prospective customers in the new markets. 3. Acquire dependable foreign representation: The skill to obtain access to exact customers is a difficult task for any business that seeks to penetrate into an unknown market. Several firms require appointing agents to represent and forward their interests in the target market. Huge firms force their existing global staff to access new markets, but this is seldom a choice for SMEs. However, managing overseas representation is a talent that can be developed by experience with SMEs. 4. Firms searching to enter new markets may face scarcity of working capital. This can be due to the difficulties that exist in acquiring finance, fund provider’s perception of risks regarding exchange rate instability, difference in the regulatory environment of the target market, and sometimes political risks. Access to finance seems to become less of a trouble for SMEs’ subsequent to their active participation in international markets. 5. By way of SME’s internationalization, they face costs of transportation or difficulties in delivering goods to market, which are not faced by the local rivals. 6. SMEs have to face the anti-competitive behavior of governments or that of local firms which include levying overseas firms charges that are not levied on local manufacturer, particular licensing for the overseas service providers, or by the competing with foreign firms. Analysis “SMEs are defined as non-subsidiary, independent firms which employ fewer than a given number of employees” (Small and Medium -Sized Enterprises: Local Strength global Reach 2000). The existence of SMEs also correlate with a number of economic factors, including the nation's growth, and the gross domestic product (GDP). The energetic SME segments can bring great benefits to developing countries. However, the emerging private economy sectors are likely to be dominated by micro-enterprises or large corporations that often employ less number of workers, creating barriers to the growth of SME. There are several risks which are faced by small and medium sized enterprises in an international level. They include reducing the demand for SME products and services, financial risks, legislation and regulations, technology risks, energy costs, foreign exchange risk etc. This study mainly focuses on the foreign exchange risks that small and medium sized enterprises face in an international environment. Foreign exchange risks can be defined in there terms “foreign exchange risk is the exposure of an institution to the potential impact of movements in foreign exchange rates” (Foreign Exchange of Risk management 1996). The small and medium sized enterprises in international environment, face foreign exchange risk. The emerging SMEs mainly focus their business on international level. The businesses which enter global markets face currency exchange risks the large extent. Foreign currency trading is a lucrative option to earn high profit though it involves huge risk; the SMEs need to understand clearly such risks before entering the foreign exchange. As the business is trading in foreign exchange, faces four important foreign exchange risks. They are exchange rate risks, interest rate risks, credit risks and country risks. “SME’s are considered to have a crucial role in an economy and are a key source of economic growth, dynamism and flexibility and can adapt quickly to changing market demand and supply situation. They are also deemed to generate employment, help diversifying economic and make a significant contribution to exports and trade” (Ganbold 2008). Exchange Rate Risks In recent times, every small and medium sized enterprise has the urge to enter international market. It involves lot of risks and high profit possibility. The exchange rates risks in SMEs are due to the processes involved in importing and exporting. The currency rate of each country is entirely different. Exchange rate risks can be defined “as the possible direct loss (as a result of an unhedged exposure) or indirect loss in the firm’s cash flows, assets and liabilities, net profit and, in turn, its stock market value from an exchange rate moves”(Papaioannou 2006). The exchange rate risks in SMEs and the exchange rate risks in foreign exchange trading occur due to the constant ongoing demand, and supply balance change in the worldwide foreign exchange market. Exchange rate position is a topic of all price changes, as long as it is exceptional. In order to cut short these rates of exchange risks and to have a profitable position, business trading should be done within the manageable limits. It is one of the important risks that small and medium sized enterprises face. Interest Rate Risks SMEs face interest rate risks in international environment. These risks in foreign exchange trading are linked to the features, currency swaps, options, and forward out rights in currency exchange trading. The interest rate risk is one of the important foreign exchange trading risks. “Interest rate risk is the risk to earnings or capital arising from movement of interest rates” (Interest Rate Risk 1997). It arises from differences between the timing of cash flows, and the timing of rate changes. The interest rate largely affects the international trading of SMEs. Credit Risks Credit risk is one of the significant risks involved in foreign exchange trading. These are connected with the idea that an excellent currency position might not repay as decided upon, because of the involuntary or voluntary action caused by the other party. In these types of foreign exchanges, investors of small and medium size business as well as that of and large size business can deal without any credit concern. “The banks should carefully consider the results of this study when setting their internal systems and procedures to manage credit risk for SMEs” (Sabato n.d). The following types of credit risks are well understood. There are mainly two types of credit risks involved in foreign exchange trading; they are replacement risks and settlement risks. The higher the supposed credit risk, the higher the rate of interest that the investors insist for bending their capital. In small and medium sized enterprises, the credit risks are calculated on the basis of the borrowers' overall capability to repay. Credit risk defined as “the potential for loss due to failure of a borrower to meet its contractual obligation to repay a debt in accordance with the agreed terms” (Credit Risk Management n.d). Country Risk The country risks in SMEs’ foreign trading occur in case is a party is unable to obtain a usual amount of payment because of government intervention (in the light of insolvency related to an individual institution or bank). The country risks are concerned with the interference of government in foreign exchange markets. It is the mutual responsibility of the credit department and the treasurer to interfere in foreign exchange market. The control of government on foreign exchange actions still operates and it is implemented actively. It is important for small and medium sized enterprises is important to know or be capable of anticipating the restrictive changes related to the free flow of currencies. The SME foreign exchange trading process is a difficult process. Recommendation To create and manage a foreign exchange risk specific guidelines in the management of SME business should be instituted. SME should research on consumer tastes, trends and preference so that the SME’s business can react to changes that occur in the market frequently. It would be ideal for SMEs check continually testing the international market environment, to observe what types of products and services are preferred by consumers. This observation provides a better understanding of the changing consumer sentiments in the monetary cycle. SMEs promoting their products and services in international level improves during an economic slump. SMEs face so many risks, but if they promote their products or services effectively, they can withstand the challenges in the market. SMEs can using their financial position as a benchmark for operational and financial performance against the industry averages. Deeply observe international foreign exchange market, and foreign exchange procedure, policies etc. Consulting regularly the bank on how can support in managing the goods price exposure Properly using a number of instruments in financial market, provide by the financial institutions SMEs should consult banks for their support in managing the interest rate exposure SMEs should continue to establish relationships with their clients and local community. Conclusion The findings associated with foreign exchange risks and managing credit risk for small and medium sized enterprises requires certain procedures and models particularly focused on the segment of SME. The SMEs’ international environment face severe foreign exchange risks, interest rate risks, credit risks and country risks. These are the common risks, in foreign exchange trading. As small and medium sized enterprises have entered the international market they have to follow the several procedures and policies strictly. Unfortunately these policies are not clearly understood by the SMEs resulting in increased risks. Foreign exchange risk is one of the important barriers in international business. Globalization has encouraged s lot of SMEs is to enter global market. The main issues of entering the global market are related with exchange rate, currency value etc. The small businesses face these types of risks in international environment. It is necessary to build a favorable business environment through rules and regulations, standardization of products and services, and a flawless market infrastructure in the international environment. Reference List Credit Risk Management (n.d). Global Association of Risk Professionals. [Online] Available at [Accessed on 07 May 2012] Feuter, KD (2011). Handleiding Volkenrecht. Foreign Exchange of Risk management (1996). Bank of Jamaica. [Online] Available at [Accessed on 07 May 2012] Ganbold, B (2008). 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