Financial literacy plays a significant role in the survival and success of small and medium-sized enterprises (SMEs). Given the business dynamics and complexities today, entrepreneurs must enlighten themselves with basic financial knowledge, skills, and understanding of financial concepts to make informed decisions about managing personal and business finances.
According to Remund (2010), financial literacy can be summarized as:
(1) Knowledge of financial concepts;
(2) Ability to communicate about financial concepts
(3) Aptitude in managing personal finances
(4) Skill in making appropriate financial decisions
(5) Confidence in planning effectively for future financial needs.
For SMEs, financial literacy encompasses several key areas, such as understanding financial statements, cash flow management, budgeting, investment decisions, and access to financial markets. Research examining the impact of financial literacy on SMEs’ performance suggests that SMEs with higher levels of financial literacy tend to have better financial management practices, leading to improved profitability, liquidity, and solvency ratios. They are also better equipped to assess and manage risks, leading to a more stable financial position.
The positive effects of financial illiteracy include: spending more than their income; the lack of, or insufficient, record keeping; not planning and implementing a regular investment programme; and making incorrect financial decisions. Conversely, entrepreneurs with higher ex-ante financial literacy further exhibited some improvements in business performance and sales.
Moreover, financial literacy positively influences SMEs’ market share and growth rate. Entrepreneurs who possess a strong understanding of financial concepts are more likely to develop effective marketing strategies, identify growth opportunities, and allocate resources efficiently. Financially literate SMEs can secure funding for expansion, negotiate contracts with suppliers and customers, and navigate the complexities of competitive markets. Additionally, they are able to make better operational decisions, leading to increased productivity, cost savings, and overall efficiency. The lack of knowledge of financial management contributes to the low prevalence of new venture creation, and ultimately the high failure rate of SMEs. Such failures of SMEs would then create a negative impact on the economy as a whole.
The ability of entrepreneurs to understand and apply financial knowledge and skills directly influences their decision-making processes, financial management practices, and overall business performance.
Entrepreneurs, even if they are micro-business owners, must make an effort to learn and study the subject of Finance which will surely lead to improved profitability, liquidity, solvency, market share, growth rate, and operational efficiency. Policymakers and stakeholders should emphasize the importance of financial education programs tailored to SMEs’ needs to empower entrepreneurs with the necessary tools for success.
Learning to use debt the right way is one of the most important ways, while understanding the credit status and the credit score. Small businesses looking to borrow additional money need to understand how credit rating works and how their credit score can impact their loan limit, tenure, and interest rate.
Another way to increase financial literacy is by understanding new technologies, especially those which can be used to learn new financial literacy skills.
