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Emmanouil Schizas-3770

By Manos Schizas, senior economic analyst, ACCA

ACCA’s Beijing office recently teamed up with the China International Center for Economic and Technical Exchanges (CICETE) and the China Association of Microfinance (CAM) to hold an excellent event on the future of small business financing in the world’s second largest economy. It was a privilege for me to address this event and to learn first-hand from some of the pioneers of small business lending in China. It was also a great opportunity to meet a 50-strong delegation from ICBC, one of ACCA’s biggest employers in the region.

One question that came up as we were planning the event was this: What does the future hold for SME financing? More specifically, does Big Data have the potential to transform the industry and extend access to the large numbers of under-served small and micro-enterprises? It’s a reasonable question. After all, here at ACCA we stress that information is one of the four key inputs into business finance – alongside control, collateral, and risk appetite. It is, in fact, the most important one, as financial systems over-reliant on the other three can become unfair, unbalanced or unsustainable.

Unfortunately, I am no expert in Big Data. I was, however, able to fall back on the work of my colleague Faye Chua, our Head of Futures Research, as well as ACCA’s Accountancy Futures Academy, who are looking into this topic regularly and published an excellent review only a few months ago. Their report on the promise and perils of Big Data for the accountancy profession can be found here. What follows is a summary of what I told our audience in Beijing based on this reading, and although I must credit my colleagues for the insights, all errors and misunderstandings are entirely my own.

It’s good to start by defining what we mean by Big Data, because the term is often misused. My colleagues adhere to Gartner’s ‘Three Vs’ condition for Big Data, which says that ‘Bigness’ comes from the high Volume, Velocity and Variety of data. Gartner’s definition adds that Big Data “demand cost-effective, innovative forms of information processing for enhanced insight and decision making.”

Thus defined, what kind of Big Data are we seeing, and what could we soon see, in SME financing? The possibilities are significant – both for ‘soft’ and ‘hard’ data.

The easiest input imaginable is real-time transaction and payment data integrated from online payment systems, card terminals, accounting software, and credit databases. Finance providers such as Kabbage are already integrating this information to inform short-term lending decisions (more on this here).

More difficult to imagine, but still within the realm of ‘hard data’, would be trade credit data along supply chains – information about which businesses owe each potential borrower money, and how many sources of finance an SME is tapping at once. Mapping the web of trade credit flows makes it easier to spot vulnerabilities that wouldn’t show up in the financials of an individual business. Credit rating agencies are already able to provide some of this information, although mapping the web of business-to-business claims in real time could be many years away. You’ll know that day has arrived when governments start pre-emptively recapitalising corporate supply chains in the same way that they do banks today.

Finance providers could source almost real-time information about business’ capacity utilisation from utilities providers (electricity, water or telecoms) – giving them great insights into the business’ performance and potential finance needs. I recall that, in China, economists already used this method back in 2010 to estimate the effect of lending constraints on SMEs – they found at the time that electricity consumption by very small industrial users was down 40% year-on-year. Similarly, tracking data from logistics companies and GPS information could also provide a clue to the efficiency and capacity utilisation of a logistics-heavy business, helping direct finance to the right ones and making it much easier for providers to provide vehicle leasing or fleet insurance services.

In the realm of soft data, the possibilities are also substantial.

Integration with social media, family records, or the archives of large employers and educational institutions, could provide finance providers with a map of any entrepreneur’s social capital – who they know and who they can call on, as well who might be able to help them when in difficulty. Online crowdfunding would benefit strongly from this type of information, but credit providers could also use it as a measure of social capital when evaluating young businesses with no track record. Social media could also provide a tangible measure of a business’ ‘word of mouth’ – its stock of loyal customers, its reputation, and the uniqueness of its brand. Not all business models depend on this, but those that do can turn it into a tangible cash equivalent.

Entrepreneurs’ own personalities could become a target for data analysts, as it they are highly relevant to financing decisions. Not that long ago, ACCA’s own research demonstrated how executives’ personalities interact with business infrastructure to produce innovation. Forbes’ post on our findings is still ACCA’s most popular article ever, reaching about 800,000 people to date. The behaviour of entrepreneurs’ personal current accounts, for instance, can be correlated with anything from the way they speak on social media and the leisure activities they take part in, in order to populate a profile. Even language analysis could help. It’s already known, for instance, that CEOs’ and CFOs’ use of particular language on investor calls correlates with deceptive behaviour and through this to negative stock returns; or that the laughter of Federal Reserve interest-rate setters correlates with asset bubbles.

Realistically, the area most likely to see significant interest would be compliance, as Big Data is leveraged to allow easier identification of finance applicants and simplify due diligence. This can help control some of the most significant cost drivers in small business lending, especially in emerging markets. And given the small amounts involved, shaving off even a small percentage of the cost of due diligence can make a huge difference to financial inclusion.

That’s the potential.

However, as my colleagues pointed out in their review of Big Data, it’s easy to get caught up in the futurist dream and forget the reality. Big Data insights are expensive and the people that can help build them are few in number and increasingly well paid. The raw data that finance providers would need are not Open Data (indeed it helps to remember that most Big Data inputs are not); they are owned by providers with substantial bargaining power. Not to mention, their use will increasingly become heavily regulated as governments catch up with the industry.

Even then, my colleagues note that insights this tailored are bound to be short-lived. Big Data might be able to answer the question of ‘how likely is this person to need a business loan?’ very well, but only as long as the context has not materially changed. Meanwhile, competitors will each be building their own insights platforms, which other lenders will only be able to beat with even more investment. It will be undoubtedly progress, but not profitable progress.

Overall, it’s worth remembering the teachings of the Resource-Based View of the Firm. If you can’t own the raw data for your insights, or appropriate the gains from them, or if your competitors can replicate them, you have nothing of value in the long run. With no choice but to follow the leaders, many SME lenders will focus their energies on creating, buying in or replicating proprietary data.

Is this future imminent? Not as far as I’m concerned – SME lending will take a long time to catch up. The real reason for this, I think, is not cost; it is the fact that banks have such better uses for their money. I’m particularly thinking of a recent review of SME financing by uber-consultants McKinsey & Co. McKinsey found that the typical SME lender is already making really good risk-adjusted returns on equity, and they can double those by taking relatively simple analytical steps (see slide 13 on their deck), most of which don’t come close to using Big Data. If Small Data can double your returns, Big Data will almost certainly have to wait.


Emmanouil (Manos) Schizas

In our last blogpost for 2013, ACCA’s senior economic analyst, Manos Schizas, talks about trying his hand at lending directly to SMEs – and watches one of his borrowers fail.

I was extremely pleased to host ACCA’s Alternative Finance conference back in March 2013. It was an opportunity to showcase some of the most innovative finance providers in the UK, and it was exciting to see professional accountants work out the implications of their offering for themselves and the businesses they worked for.

But here at ACCA’s SME Unit we’d like to think we’re not all talk, so I have since opened accounts with a number of peer-to-peer consumer and business lending platforms, and have recently started to invest in the latter in earnest. As part of a wider portfolio of loans, I recently bought sixty pounds’ worth of the debt of a company that I shall call Space Odyssey Ltd (not their actual name of course). This may not sound like much but P2P platforms and elementary finance textbooks both stress that it’s important to diversify when investing, and I sure am glad I did in this case.

Looks good to me!

Seen from a policy wonk’s or a journalist’s perspective, Space Odyssey was precisely the kind of salt-of-the-earth business the banks ought to be lending to. It was a manufacturer with well-known big clients. At five years of age, Space Odyssey had managed to not only trade throughout the recession, but also grow by an average of 20% per year and consistently turn a profit. Now it needed to finance its working capital in order to continue growing. Its credit score was better than average for its sector, and indeed exceeded any other relevant benchmark. On top of that, the directors were willing to personally guarantee the loan and were prepared to pay more than the 6.8% average recorded by the SME Finance Monitor for fixed-rate loans of less than 100k. What’s not to like, right?

At first glance, a couple of things were troubling. My own concerns centred on a directors’ loan that was larger than the loan Space Odyssey were seeking from the platform (why were these guys unwilling to put their own money into their own company as equity? Were we investors expected to bail the directors out?) Yet I also knew that this was a common arrangement among growing firms: back in 2009, when I modelled the UK SME population for the purposes of ACCA’s response to the Rowlands Review, I was surprised then to find that directors’ loans were five times more common among the businesses the Review was hoping to increase lending to than among other SMEs – 57% of consistently-profitable, fast-growing and cash-positive businesses were using them.

Other investors on the platform were also concerned about the directors’ insistence on anonymity, the pace at which they responded to questions on the platform, and most importantly their claim (probably in error) that the company had ‘no debt’, when in fact it had a bank loan and overdraft facility in place, and owed substantial amounts to directors and even more to trade creditors. Overall, however, investors welcomed Space Odyssey’s bid, and their loan was not particularly expensive by the platform’s standards.

The other side of the story

What I now know, but couldn’t have known at the time, was that Space Odyssey was already failing, despite what seemed like decent efforts by its management. Two of its major customers had gone bust, one in 2010, then another in 2012, pushing liquidity to the limit. Then earlier in 2013, a major supplier had halved Space Odyssey’s credit limit, pushing them properly over the edge. Yes, Space Odyssey’s top line was growing, and yes, it needed money to finance working capital; nobody had lied to investors. Nor were we bailing out the directors, who kept lending more of their own money to the company throughout the last year. But there was, clearly, more to the story than that. The P2P loan covered less than half of the liquidity shortfall; and even a larger loan, I now think, would have done little to help.

This is because loss of liquidity does not remain an abstract problem for long – it spreads throughout the business’ operations quickly and messily. When a business is unable to pay on time, suppliers don’t just sit there and take it. Space Odyssey’s suppliers refused to complete pending work and orders, derailing projects already in the pipeline. Similarly, clients withheld payments as projects were delivered late or to a less than satisfactory standard. The final blow came from Space Odyssey’s suppliers who secured County Court Judgements (CCJs) against the company. Who could blame them? Except the County Court had handed down a death sentence, making it nearly impossible for Space Odyssey to borrow formally or to secure credit from suppliers. By the time it was agreed the company was to be wound down, the cash shortfall had grown eight-fold.

Meanwhile, directors were scrambling to save a dying company. Just dealing with creditors must have been a nightmare; its own owners aside, Space Odyssey had nearly 70 creditors outstanding when it went out of business, including HMRC, their landlord, and their own staff. And here I was wondering, along with my fellow investors, why they weren’t responding to our questions in time.

Curtain call

Then on 15 November 2013, ironically one day before ACCA’s recent debate on Zombie Companies, I received notice that Space Odyssey was going into Creditors’ Voluntary Liquidation. While this process is decidedly an offline, face-to-face affair, it was related to me in the spirit of peer due diligence that is common in the p2p finance sector: I was invited, along with all other investors, to submit questions for the first creditors’ meeting, where the p2p platform would also be represented. I did, and my question was, in fact, asked on the day. My subsequent questions to the platform were answered promptly by their Head of Insolvency, who also forwarded the directors’ report to creditors as well as an attendance note from their own representative. It is from these documents that I pieced together the story of Space Odyssey, although even that is unlikely to be the whole truth.

And what about my money? It looks like the directors are going to honour their guarantees, keeping investors’ losses very low. They claim they will not go back into business together, or separately.

It’s not a good outcome of course, but it’s been reasonable and professionally managed. Space Odyssey’s failure is no doubt a personal tragedy for a number of people and I’m not entertained by it. I didn’t sign up to lend just so I could watch businesses being wound up or so I could help myself to guarantors’ hard-earned savings, but I always knew this was a possibility. More to the point, without a solid regime for business recovery and dealing with insolvent borrowers, I would not have had the confidence to invest in the first place.

This is not to say that I, or anyone else, should only lend if we can be assured we won’t lose money. They call it providing ‘credit’, for a reason. The P2P investor’s first and best line of defence is diversification, not recovery, and the sector’s strength is that it makes diversification possible even for small individual investors.

Lessons learned

As the p2p lending sector matures, stories such as Space Odyssey’s will naturally become more common. Major platforms also know this and are already citing estimated default rates much higher than their actual historical figures, precisely in order to avoid misleading investors.  Both the platforms and the Financial Conduct Authority (FCA) are stressing that p2p loans to businesses are not savings accounts and are not guaranteed by the government. Perhaps some investors still refuse to believe their borrowers can fail, but I suspect these are a minority.

Still, I think one group of people could do with a crash course in P2P default risk: us small business lobbyists. Until recently, newspaper headlines were screaming for governments around the world to force banks to lend based on politicised ‘common sense’ criteria. In the UK, the British Business Bank is still being urged to do the same. Wouldn’t it be nice if everyone making the case for such supposedly ‘common sense’ lending were also willing to try their hand at lending their own money? They might do no better than I did on this occasion, but at least it would be their own money they’d be losing instead of the taxpayer’s.

Reflecting further on Space Odyssey’s story, I can see one way in which the p2p sector needs to mature further. My father was a bank manager before he retired, and his stories, dating back to 1960s-70s Greece, all seem to revolve around tragic heroes like Space Odyssey’s directors. When their companies were in trouble, the market knew. The bank manager often dealt with their suppliers and their customers, and couldn’t help but notice a pattern.

On the one hand, I hope that one day the p2p sector will be able to reproduce this advantage of old-fashioned relationship banking. On the other hand, I think back to Space Odyssey’s early efforts to maintain anonymity and wonder whether they would ever have bothered with a close-knit p2p lender community like that. Even perfectly creditworthy businesses aren’t whiter-than-white, after all. Balancing crowd due diligence against inclusion will be a challenge for p2p lending platforms, and I look forward to seeing how they reconcile the two.

By Steve Rudaini, PR manager, ACCA

This is ACCA’s response to the UK Autumn Statement 2013:

The UK Economy

Manos Schizas, ACCA Senior Economic Analyst, said: “Unlike previous Budgets and Autumn Statements, or PBRs, this Statement is aimed squarely at high-street businesses with plans for slow, steady or no growth. There is an irony in how talk of ‘rebalancing’ the UK economy has disappeared now. Growth is now once again meant to be fuelled by consumption, retail spending, and housing rather than by investment.”

Sarah Hathaway, head of ACCA UK, said: “Businesses, now more than ever, are looking for long-term, sustainable measures that extend beyond the term of Parliament or government. Quick fix, sugar-coated initiatives are not what the City and the wider UK business community are looking for and create uncertainty at a time when UK plc is looking to build on firmer ground. While many announcements in the Autumn Statement are favourable to businesses, their life span and breadth of impact will be critical for the economy. This sentiment is true for other government policies, for example apprenticeship funding, so that businesses have the foundations of both finance and skills in place to grow.

“The Bank of England has shown its understanding of businesses needs for certainty, first through its introduction of forward guidance and, just last week, its decision to make the Funding for Lending Scheme a business initiative rather than the home loan vehicle it had become. Businesses need that level of certainty about the long-term from the Treasury as well as from Threadneedle Street.”

Small and Medium Sized Business

Rosana Mirkovic, ACCA Head of SME Policy, said: “The Government has moved away from the previous focus of encouraging growth in the more dynamic SMEs towards supporting smaller enterprises through business rate inflation caps and a further promise of reforms on this front in 2017. Various measures announced for supporting the bricks-and-mortar high-street businesses show a welcome move back to supporting the smallest and micro businesses. However, braver decisions could have been made – business rates reform has been put off for 2017, when it is clear from previous, recent budgets that the system was just not designed to take spikes in inflation into account.

“Reducing National Insurance contributions for young people could help small businesses, however, whether this is aimed at helping SMEs or get young people off benefits is an important distinction. SMEs in the UK are calling for a more skilled workforce, not an unskilled one.”

Taxation and State Retirement Age

Chas Roy-Chowdhury, ACCA’s Head of Taxation, said: “Families across Britain will need to look in detail at what the Autumn Statement means for them. The married persons tax allowance is a welcome move in principle, but not everyone benefits. In having an allowance restricted to those who are basic rate taxpayers creates an even more complex tax regime as well as confusion around couples who eventually become higher rate taxpayers. It should be possible for all taxpayers living with a partner to benefit from the allowance.

“There is logic in the government increasing the state retirement age to 68 by the mid-2030s, as people live longer, but at the same time families looking to save for retirement are being penalised. The annual pension contribution limit is set to drop from £50K to £40K and the total value of the pot people can have will also drop by quarter of a million pounds from next April, so those trying to be frugal and not be dependent on the state are being squeezed.

“ACCA welcomes the decision to exempt HMRC from further budget cuts. It is vital that it is properly resourced to keep the tax system running, and help give staff the promised crackdown on those who try to evade or exploit that system. However, ‘no further cuts’ actually means cuts in real terms, making life difficult for HMRC. The Government wants to tighten tax collection, but it needs to invest in HMRC to achieve it.”

The key points from the Autumn Statement can be found here

The live tweets from ACCA can be found at @ACCATaxation @ACCA_SME @ACCA_UK and @ACCANews

Emmanouil (Manos) Schizas

By Manos Schizas, senior economic analyst, ACCA

Late payment is, as I’ve written before (here and here), a significant problem for small businesses in the UK, indeed in many of ACCA’s major markets. For years successive UK governments have chiselled away at the problem with an array of tools but made relatively little progress.

Hence, it was encouraging to hear that the UK government is consulting on ways of reducing the incidence of late payment to SMEs. The government, we are told, will ask for views on (among other things):

  • How it can encourage greater responsibility for payment policies at senior management and board level
  • How it can make clear which firms are good payers and which aren’t
  • Whether there is a case for further legislation or penalties for firms which pay late.

Aren’t we forgetting something?

ACCA agrees with the PM that it is important that the Government signal in very clear terms that prompt payment is a significant element of corporate citizenship. Until last month, one of the ways it did so was to require that companies provide information on their record of prompt payment to suppliers.

I say ‘until last month’ because the Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013, which came into effect on 1 October, effectively scrapped this obligation; a change that has been two years in the making.

In September 2011, the UK Government launched a consultation on the future of narrative reporting in the UK. One of the proposals, inspired by a commitment to regulatory reform, was to scrap the prompt payment reporting requirement. BIS’ laconic justification reads as follows:

“Successive governments have attached a great deal of importance to prompt payment to creditors by business. However, we understand that the information this requirement provides is not considered useful for either creditors or shareholders so are removing this requirement.”

Now, I don’t doubt the outcome of the consultation was as reported by BIS. I’ve seen for myself responses from other influential stakeholders that ‘warmly welcome’ the removal of such ‘superfluous’ disclosures. I can say, however, that ACCA certainly did not share the majority view. In our response to the consultation, we argued that

Companies should continue to be subject to a requirement to disclose their policies and practices on payment of creditors. […] We would agree that the existing disclosure requirement does not appear to have impacted on the prevalence of the problem. But the ineffectiveness of the disclosure requirement can […] be attributed at least in part to the ease with which figures can be smoothed and to the absence of any sanction for non-disclosure. If the current requirement were to be removed, this would we fear send an unwelcome signal to companies that late payment is no longer seen as an important issue of public policy. […] Rather than abolish the disclosure requirement, therefore, it would be better to revisit the current requirement and refocus it so as to require the disclosure of more meaningful information.

Useful in principle

Long payment terms and late payment are, at the end of the day, cheap ways of ensuring liquidity. Investors, creditors, even a company’s own staff may benefit from them. But they may also want to know how much liquidity the company can draw on in this way; the amount is not infinite, and for a business plan to assume it is, is a major risk. It’s a matter of understanding the business model and its vulnerabilities. In a credit crunch, even small suppliers will become stricter creditors, as ACCA and CBI research has demonstrated. Some could fail altogether. An over-reliance on informal liquidity for the actual financing of the business could, in fact, signal trouble ahead.

Moreover, investors, creditors and other stakeholders might well want to know whether the company’s bargaining power vis-a-vis suppliers is endangered by its payment policies. If the company is forcing its suppliers to underperform in the long term, they could refuse to do business with it in future. Alternatively, they or their assets could end up being acquired by their competitors. Either way, the remaining suppliers’ bargaining power would increase substantially, eating into the company’s profits. Why would anyone not want to know about this risk? Again, it’s a matter of assessing the viability of the business model.

The fact that a rather poor tool for delivering this valuable information did not seem to work does not mean stakeholders should forever give up on the information itself. This is a running theme whenever narrative reporting is discussed, and the solution is pursuing more integrated reporting, not giving up altogether.

I hope the UK Government’s consultation will provide an opportunity to reopen the discussion on this basis.

Finance For Growth: A Review

accapr —  23 September 2013 — 1 Comment

Emmanouil (Manos) Schizas

This is the first of a series of posts reviewing Finance For Growth, a recent report by Andrew Freeman, a director at the think tank, Demos Finance.

Published in September 2013, Finance for Growth took what some might consider a refreshing view of the problem of UK SMEs’ access to finance – by questioning whether a problem exists at all. It is a sign of the growing confidence in the UK’s economic recovery that such a question could be published; right or wrong, similar findings might have been circulated quietly or even shelved in 2010, to await better days.

ACCA’s SME experts delved into the report and found much that we could agree with; but we take issue with a great deal too. This series of posts reviews the fascinating debates behind and beyond the Demos report, and what they mean for accountants – the SME sector’s most trusted financial advisers.

Part I: Which SMEs don’t want to borrow – and why?

Part of Freeman’s argument is that incorrect and dangerous assumptions underlie the access to finance debate: that SMEs need credit, and more credit will deliver growth. The evidence, he insists, suggests nothing of the sort:

“most SMEs never borrow from a bank […] and they do their utmost not to get into debt, instead ploughing earnings back into the company or business so that they can remain debt-free. Which raises a question rarely asked and even more rarely answered. Why are we specifically concerned with SMEs and whether banks are lending to them? […] Why, in fact, do we assume that SMEs as a group want to grow, and that bank lending is the right way to fund that ambition?”

Plainly, Freeman is right about the SME sector’s active demand for credit. In Q1 2013, 61% of all UK SMEs used no external finance at all, and nearly half of all SMEs with employees didn’t either. Fewer than a third used any finance from banks. Only 4% of the sector actually applied for any bank finance at all in the 12 months to March. And 37% of SMEs had so few dealings with banks in the past and so little appetite for credit in the future they were classed by the independent authors of the survey as ‘disengaged’ or ‘permanent non-borrowers’ – businesses for whom the banks might as well not exist.

More curiously, the UK SME sector lends more money to the banks than vice versa, and has done so even in the boom times. By Q1 2013, SMEs had substantially more deposits in the UK’s banks (£125.9bn) than loans and overdrafts from them (£98.8bn), and only about 43% of agreed overdraft facilities were drawn. Even pre-crisis, the top short-term credit providers to SMEs were not banks, but their own suppliers. For every pound SMEs borrowed short-term from the banks, their suppliers put in two.

Where Freeman starts to take liberties with the data is in conflating (silently, for the most part), these ‘disengaged’ SMEs with SMEs uninterested in growth. Even that is not an unreasonable assumption. In the SME Finance Monitor’s massive dataset to Q1 2013 (40k observations), there were barely a handful of ‘disengaged’ businesses with 50 employees or more, almost none with turnover of more than £5m, and none (able? willing?) to report an annual profit of more than £500k. Clearly, a medium sized or large business cannot remain ‘disengaged’ from finance for long.

Taking calculated risks

But this does mean that these businesses have no growth prospects in the first place? No. If anything, the Finance Monitor figures suggest the opposite.

Ex ante, the ‘disengaged’ expect their turnover to grow less rapidly than the ‘engaged’ (data here). Ex post, the average permanent non-borrower is more likely to grow than the average ‘engaged’ business interested in external finance. The latter is true regardless of whether one looks at rapid growth (over 20% per year) or any growth at all. More importantly perhaps, the ‘disengaged’ are more likely to be profitable (comparison here), even though their profits are typically smaller.

Perhaps, then, the ‘disengaged’ are better at assessing their prospects and hence less prone to over-optimism? It’s possible to test this, too, by looking at what share of each group report growth over the last year and comparing them to the share that expected growth a year earlier. Turns out the expectations of the ‘disengaged’ as a whole are almost exactly in line (we’re talking just decimal points of a percentage off!) with their subsequent performance, while the ‘engaged’ group’s expectations are way off. You can see the comparison for yourselves here.

I should note here that the Finance Monitor is not a panel survey – so comparing expectations with outcomes tells us nothing about the prescience of individual businesspeople. But the fact that the group’s expectations are such a good predictor of its subsequent performance cannot be entirely meaningless, either.

But even this doesn’t tell us everything we need to know. What if the ‘disengaged’ are simply afraid of taking risks? That could explain both their poor appetite for finance and their spot-on record in anticipating growth.

You guessed right. We can test that too, by looking at what their growth plans tend to be and what their owners and managers are willing to do with their own money.

Turns out, the ‘disengaged’ that intend to grow are less likely to want to introduce new products and services, to enter new markets and especially hire new members of staff than the ‘engaged’. So it’s fair to say their plans are less risky, but is it fair to say their owners don’t like taking on risk?

I insist on this question because owners of ‘disengaged’ SMEs have big personal stakes in their businesses. In any 12-month period between mid-2011 and mid-2013, 20% of ‘disengaged’ SMEs received cash (i.e. equity) injections from their owners or directors as a matter of choice rather than necessity (see graph here), easily more than the figure for ‘engaged’ businesses, whose owners were more much likely to inject funds just to keep them afloat. These emergency finance needs are probably tied to the overconfidence issues we discussed earlier. Finally, owners and directors of non-borrowers were exactly as likely to inject cash as a long-term investment as their ‘engaged’ counterparts.

I think it’s fair to say, then, that non-borrowers are not afraid of risk – their owners, if anything, are more willing to put their own money at risk – but they want more control over the investment in return. That sounds pretty entrepreneurial to us, and ACCA’s research shows that the degree of SME self-financing is very strongly correlated with high growth.

Accountants can bring the ‘disengaged’ into the fold

One could argue that there is an equilibrium of sorts here. Non-borrowing entrepreneurs make a rational choice to take only moderate, carefully calculated risks which will keep decision-making simple, cheap, and ‘in the family.’ So they shun the banks and rely on their savings, suppliers and retained earnings. Except, of course, this would only be one of many possible equilibria, and one consistent at the macro level with low growth and rising inequality. Not everyone can tap into their savings to finance their business, and some investments, even of the moderately risky variety, are not efficient at a small scale.

But the Finance Monitor data hint at a different compromise at play. One thing does distinguish non-borrowers from other businesses: financial capability. The average disengaged SME is much less likely to produce regular management accounts, and less likely have a business plan or a financially trained person looking after its finances (data here). Even after accounting for size (larger businesses tend to have more professional finance functions), the difference persists – particularly when it comes to management accounts.

These figures on turnover x capability have a lot more to say. They show, for instance, how a business with more than £500k in turnover needs a properly trained person in charge of their finances and a proper business plan. Those that fail to put these resources into place become ‘disengaged’ by default – suffering the lower ambition and growth that comes with disengagement.

Second, it’s worth looking at the higher turnover size bands (£5m+) where ‘disengaged’ businesses are very rare. It’s clear from the analysis so far that at turnover levels of £2m-£5m, being ‘disengaged’ starts to become unsustainable. Only the very best-run businesses can continue to finance themselves from retained earnings and trade credit after this point – a very small, elite group of ‘luxury non-borrowers’. Unsurprisingly, their financial capabilities are top-notch.

There may be other variables we are missing here – a lack of confidence perhaps, or a mistrust of accountants and other numerate professionals. The ‘disengaged’ businesses are more likely to be owned by older entrepreneurs, women and people without a university education, and it’s likely that these factors influence the way they are run.