Small and medium enterprises (SMEs) are supposed to play an important role in Sri Lankan economy as they are capable of generating employments, promoting the growth of Gross Domestic Product (GDP), embarking on innovations and stimulating of other economic activities. This sector is said to be the backbone of all developed and developing nations. According to a thesis by Shandong University of Technology in China, 60-80% of new jobs are created solely by the SME sector annually and in Europe, 75% of the workforce is employed by SMEs.
In Korea, SMEs represent 99% of the total number of companies and corresponded to 43% of the country’s exports. The development role of SME sector in developing countries has been highly recognized. They serve as engines through which the growth objectives of developing countries can be achieved. SMEs are necessary engines for achieving national development goals such as economic growth, poverty alleviation, democratization and economic participation, employment creation, strengthening the industrial base and local production structure (Abeygunasekera & Fonseka 2012). Thus the development of SME sector is paramount important for any country irrespective of their level of development, since this sector has great potential to generate maximum socio economic benefits to the country with minimum level of investment. Relatively labor intensive businesses coupled with regional dispersions of cottage and small scale industrial enterprises enable to create substantial employment opportunities. The SMEs have great potential to mobilize and divert financial resources in the economy, which would otherwise have been used for consumption purposes instead of investment purposes in rural economies. The development of SMEs can be an aid to promote balanced regional development.
Further the SME sector provides value addition in view of greater utilization of indigenous resources of the country. Hence SME sector would become an important aspect for developing countries as they are generally burdened by poverty and unemployment problems. Further, it has been noted that the SME sector has become a crucial as well as a major section of private sector in developing countries (MED 2002). Therefore, it could be argued that Sri Lanka can gain economic benefits by developing SME sector. Successive governments in Sri Lanka have taken various steps, to promote this sector since independence though the outcome has not been properly measured. With reference to the available information it is clear that the present contribution to the economy from SMEs is not at a satisfactory level. Thus there is a great need of study about the SME sector in developing arena and harness the full potential of the SME sector. SMEs make up a large part of Sri Lanka’s economy, accounting for 80% of all businesses. These are found in all sectors of the economy, primary, secondary and tertiary and provide employment for persons of different skills, skilled, semi-skilled and unskilled. It is noted that, 20% of industrial establishments fall into the SME group, while in the service sector their share is over 90%. And also SMEs are an essential source of employment opportunities and are estimated to contribute about 35% of employment (Secretariat 2012). The government budget 2016 has also proposed to provide relief to SMEs that were adversely affected during the global financial crisis (Annual report 2016).
Accordingly, significant tax exemptions and concessions were granted (PWC 2012). Except for the tax exemptions granted, recognizing the complexity of the problems faced by the SMEs, government has taken several supporting measures. Although SMEs role in the economy is substantial, many of them are plaque by management problems (Hashim and Wafa 2002). These management problems include financial management, human resource management, marketing management, operations management, strategic management etc. Given that financial management is one of the key aspects of the well-being and survival of a business and it is a managerial activity concerned with the planning and controlling of the firm’s financial resources (Pandey 2004). Small and medium scale entrepreneurs are often poor due to accounting and financial management challenges keeping records, making financial decisions, and using inefficient use of accounting information, and lower quality and reliability of financial data (Sarapaivanich2003). Appropriate accounting is also helpful in making small business decisions that are essential for making good decisions. Small and medium-sized financial institutions accurately assess their financial position and take weak financial decisions in a wrong and impartial, poorly reported and incorrect information. At a worst moment, small and medium-sized enterprises fail and possibly ultimately bankrupt (Stace et al 1999). These shortcomings can result in fund raising or cash collection or borrowing difficulties. Lack of bank facilities for banking facilities, lack of knowledge on banking procedures, long delays in loan issuance and failure to guarantee accountability, such as the lack of capital (Gamage 2000). Better reporting, better financial information, better opportunities to keep track of better performance and better record keeping, better data reporting and information management, can be linked with business success or other failures. Therefore, prudent accounting and financial management are important for the well-being of small and medium scale entrepreneurs.
Small and medium scale entrepreneurs play a very important role in developed and developing countries. They contribute to economic growth in many ways, such as job creation, new business development and the opening of new avenues for growth in the economy. However, the Central Bank of Sri Lanka (1998) noted that there are failures (no long term existence) in small and medium scale enterprises in Sri Lanka specially in Anuradhapura area, and insisted that adequate capital, adequate credit facilities, obsolete technology, inappropriate accounting systems, insufficient sales, SMEs The main problem faced is the lack of focus on small businesses. According to studies conducted by multilateral and bilateral agencies such as USAID, World Bank, JICA, ADB and UNIDO; it is found that high interest rates and the need of keeping collateral by the borrowers are common constraints faced by Sri Lankan SMEs (Gamage 2000).
Further, the financing has become a big challenge, even though the state owned banks and other development financial institutions have taken various measures to assist SMEs in providing finances (Appendix C) over the period of time (NEDA 2011). The inability of SMEs to find their counter funds requirement as a condition of financial arrangements creates another barrier for SMEs to enjoy the facilities offered in concessionary finances. Also the availability of detailed statements that are comparable among companies is a fundamental pre requisite for credit lenders to build a thorough and robust analysis of the creditworthiness of a business (Abeygunasekera & Fonseka 2012).
These obstacles are resulted from inefficient business administration, lack of experiences in some important business functions, especially accounting and finance. Several studies highlighted that, poor accounting practices as one of the factors contributing to the failure of SMEs. Huck & McEwen (1991) argue that, finance and accounting as one of the twelve competency areas for small business success. Having identified the importance of financial reporting, The Institute of Chartered Accountants of Sri Lanka introduced a separate standard and IFRS for SMEs with effect from 1St January 2012 with the intention of providing prudent financial information to the users of financial statements of SMEs (E&Y 2012). Thus prudent financial management practices could help Sri Lankan SMEs to plan and control their operations in order to achieve company goals and the long term success and survival of the businesses (Abeygunasekera & Fonseka 2012).
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