The Business Of SME Finance

Kristle Cortes  00:08

SMEs in the economy, we kind of consider them the backbone of economic growth. You want that layer of innovation and potential, and that always starts small.

Dr Juliet Bourke  00:26

A startling 99% of businesses in Australia are small to medium enterprises or SMEs. It's your hairdresser, your local fish and chip shop, or the real estate agent who rented you your house. 

It's a broad spectrum, a small business could have up to 19 employees, yet a medium one could have 199. If you're ready to start your own business, whether it's a full-time gig or a side hustle, you're going to need money. And you need to know how to manage your budget for business growth. And if you've never done this before, that might be pretty daunting. 

I'm Dr. Juliet Bourke. And this is The Business Of, a podcast from the University of New South Wales Business School. Dr. Kristle Cortes teaches people about the whole gamut of finance at the University of New South Wales. She's going to demystify concepts like market flows and cost of capital. But you might already have more experience in this area than you think. 

Kristle Cortes  01:27

So finance at its core is decision making. It's deciding whether or not to go ahead with a project on potentially deciding between two projects, we do that we typically talk about the value of money and the time value of money. So if you want to consume today, as we all do, and you can't, so you have to be given something in return such as interest, those are the decisions that go into making those investment. And whether or not, you're going to go ahead with something I feel is actually still accounting, right, because it's still based off of the numbers. Now the dream that you have, or what the goals you're trying to accomplish potentially, you can finance them in a myriad ways. But you probably a lot of your decisions come back to either having access to the credit, or getting access to the credit or ways that in the future, you'll be able to do projects, because you'll have improved access to credit. But I'm a bit of a captured audience on this right? Because I definitely think that that's how you move, you know, all the systems is that you have some funding behind it.

Dr Juliet Bourke  02:43

Let me just take you back to this language of SMEs. Is there a cut off point where you're small, medium large?

Kristle Cortes  02:53

That's an excellent question. We typically think of like the 500 employees as starting to get large, right, so but I feel like people can feel pretty fluid between the one to five that you can be considered small, and then around the 50. But these are all just a little bit detailed in the data and how we apply for them. So we'll punch them all together for the number of employees, typically, what are ways that we will interpret small or medium is the size of the loans that they're applying for. So if you're applying for a loan, that's less than a million dollars than then we consider that small. Right? So then if you can get up obviously into the 250-500 million, that starts to become large, I think that's because of the your horizon and your investment opportunities. And so they do bunch that in a little bit to give you that sense of where you would land on the bank's balance sheet. Right.

Dr Juliet Bourke  03:54

So does that mean when people are using this language of SME, that they could be talking in terms of employee or they could be talking in terms of loan size? And the two are not necessarily the same? 

Kristle Cortes  04:05

Yes, absolutely. Absolutely. And I think part of what we want to convey with some of that is that there is considered to be more risk for smaller or potentially younger, again, not necessarily the same thing, firms. And that's just because we don't know how your product is going to perform. Or we don't know what would happen if you're a one person job and all of a sudden you're not available, right? So because of that there's potentially more risk that's associated with that as a lending class overall. So it's different than the lending class like residential real estate, or commercial and investments. Those are different types of loan portfolios. But, and this goes on a little bit of why we want SMEs in the economy, we kind of consider them the backbone of economic growth. You want that layer of innovation and put essentially creative disruption, things that move where we are now to where we should be in that type that always start small. Right? So because of that, there's that element of they're a really special group. So I think we, we do talk about them a lot. But as we've touched on before, maybe we don't actually define what it is that we're talking about, specifically, yeah.

Dr Juliet Bourke  05:22

Thinking about that SME category and defining it either in terms of number of people or sort of loan size and risk. What are the common challenges that SMEs have from a financial perspective, as opposed to a large institution? 

Kristle Cortes  05:38

Look, there's a lot written in academic literature about something called relationship banking, what that really means is just that you have already established a relationship somehow, with your lender. It's also talked about a lot in the literature, that relationship banking exists because it can capture, quote, unquote, soft information. So I Kristle, I'm a potential borrower and I walk into a bank, and the bank first of all already knows I'm from a certain area, they know about that area, they maybe know about my profession at UNSW, they maybe have an appreciation for my background, all of that has some element of the softness, right? Because how would you capture that. And what will happen though, over time is most likely you will establish a relationship. And then the next round, it's slightly easier, because you've been able to show a history of what we've already received in investment, we've already received funding, this is what we've done with it. And you can kind of go from there. But I appreciate you, it's not trivial, kind of starting out, to be able to show that because a lot of this type of lending is based off of that, right? What is it that we're trying to show when we're making an investment? So I think those challenges are unique. 

Dr Juliet Bourke  07:12

So how does the person themselves if it's all dependent upon them, they're in a small to medium enterprise? And I'm just thinking here, number of people? How do they make sure they have the capabilities to be able to present that information up? What human capital upgrade do people need so that they are financially fluent?

Kristle Cortes  07:29

You can absolutely upskill yourselves. This is available as education, you know, widely available education. And so I think the biggest thing is to start with your circle of people that you really trust, and you're trying to explain this. And whether or not that comes across already, that you understand you have a handle of what you're talking about. It may be, that's where you get the best feedback, and the constructive feedback to be able to go back to figure out what it is that you do have to upskill. Now, if I wanted to talk with my bank, I would ask them questions, and I would feel free, I would call them up, I would send an email, I want to stress that you do not want to be in a vulnerable position of necessarily only relying on someone else to be able to do these number crunching or decision making for you. And you have the capacity and the capability to be able to get there. If someone's going to teach you and show you perfect, you know, but as they say, you know, teach a person to fish and you get the fish for life, right?

Dr Juliet Bourke  08:40

Is there a sort of a 101 question that you think everyone should know the answer to before they progress in business? 

Kristle Cortes  08:48

I definitely think you should know why you're doing it. Yeah. Because we can get all caught up in the numbers. And it could be an incredible opportunity or extremely profitable. But definitely the why, because a lot of this will come down to late nights and frustration and points of pain or resistance. So if you know why you're doing something, it will make your life so much easier.

Dr Juliet Bourke  09:15

That doesn't sound like a finance question. That sounds like a purpose based question. 

Kristle Cortes  09:19

Yes. Well, I mean, people that work in banks are people to, it's truly the case that I want people to understand. You can know your numbers. But if someone's going to be on maybe Shark Tank, and you're going to have to pitch it to them, and you're going to need to be I guess versed in what the judges are going to ask you. They probably come after your ability to show your profit, or what is the expected turnover or the timeline. But I would suspect that every single one of them it's still wanting to why you're doing it. Yeah.

Dr Juliet Bourke  09:58

Is that because you talked before about relationship banking, that in effect, it's coming down to a human trusting and other human, not just a human trusting a spreadsheet, you could send a spreadsheet on your behalf. Sure. And you might not get the yes, the loan. 

Kristle Cortes  10:13

Yes, I believe that. We have seen a lot of that. 

Dr Juliet Bourke  10:17

Yeah, you come back a number of times to this idea of sort of agency and people sort of taking control, you know, through information or knocking on doors repetitively. Is that something that you think is important because people are not demonstrating that ownership of their financial, that they're outsourcing it to people? Why do you bring that up? 

Kristle Cortes  10:37

I think maybe that does come from the finance background. So there's something well known to be considered called, like, agency cost, right. So there's obviously some potential risks, if someone's doing something on your behalf, right, that there could be asymmetric information involved, which is that they don't understand everything that you know, you don't have access to all the same information, they can have moral hazard, which is if you don't bear the risk of something, maybe you'll take more risk, right. And then again, the actual agency costs itself. So it's true that I feel part of our education about finance, in general, is so that people can make these decisions based off of numbers, but an educated decision for themselves. And truth be told, I feel that there's a lot of sophistication in getting advice, and things that you don't know what you don't know. Right. So I'm a big proponent of education. And I feel like there is an element of that role could be a potential adviser or they can be, you know, an employee, or they can be their own background is specifically for this. But it's good if you can ask the questions. And when you get the answers that you feel like, yeah.

Dr Juliet Bourke  11:58

You actually understand the answers. Yeah. So let's just say that small to medium enterprise has moved up the ladder from small to medium, maybe even emerging into large and can afford to employ a CFO now, on maybe a financial advisor, what should they be looking for in that person to make sure they have that level of capability that you think is needed for that role? 

Kristle Cortes  12:22

Well, there's definitely accreditations that could be something that you could first, you know, make sure they have. So something like the CFA or you know, a background in finance with some sort of bachelor or potentially advanced studies along those lines. So that really allows you to feel confident in the background and the basis for being able to do the calculations. And then if they don't have real world experience, if you're starting truly from scratch, I feel that there's a sense of they can still show you a little bit with what they envision for being able to keep the records for being able to appreciate some of the bigger questions for the markets and whatnot. And then if they do have experience, and you're able to kind of source this, it's curious, because some people feel like they, you know, maybe a CFO would need to have experience in their own field and only their own industry. I feel like a lot of our skills could apply to different industries. But it goes back to a little bit of what is it that you want that this role you're delegating to this role. And if it is that books are off your belt, you know, you're definitely able to make sure that someone else is in charge of these decisions, that you would want to make sure that they've maybe made some decisions in the past, and you would have agreed with how that went. But I feel like the accreditations help a lot. Because what that shown is not just that they can do it, but they want to do it right. So maybe I can embody the fact that there are definitely people out there that enjoy this that would want to do this, I would have fun doing this. And that would have fun sharing it with other people.

Dr Juliet Bourke  14:08

I wonder if people have the right skill base or the same attitude towards understanding the environment in which they're working, applying a financial lens to the market conditions. Do you think people traverse those two things? They know what they want their spreadsheet, but then they look at the big picture? Did they do tha and really evaluate the market opportunity in quite a precise financial way.

Kristle Cortes  14:31

There's something we call the cost of capital. Right. So this comes back to what effectively does it cost you to access capital in the market? Right. It is a good point that you bring up I think what you said is somewhat profound in that we’re often our world is our own little world. And so we have to look out beyond that. You actually also hit on something that's important but in our market well if you're interested in being funded In Australia, your market may be Australia or it may be the world. Right? So we've seen somewhat of a tendency even recently that some of our quote unquote local Australian firms were listed, NYSE. So because of that, there is a sense of definitely look up and see what else is out there. But a lot of what that is still comes back to. Okay, so what's the market cap? What are your goals to being able to achieve that? Are you planning on going public? Do you want to remain private? Alright, and that starts to become alright, what's the decision, you know, around this is it to be able to continue to grow is it to access or to be able to make it so more people can access your particular product, maybe what your product is, is yourself and your time constraint, right. So because of that, you would know kind of where you want to aim. But it's true that the market conditions are fundamental, because I think we're all aware that you don't get to launch something twice, right. So you definitely want to just be comfortable with what you're doing, and kind of make sure you set it up for success. 

Dr Juliet Bourke  16:13

And the people who can help you with that understanding of the bigger market, I often feel like people who are doing startups or even if you're in a mature business, and you're launching a new product line, a lot of it feels like hope and wish, rather than actually a good evaluation. What do you think?

Kristle Cortes  16:33

I go back to being a university professor. And so what I would most likely trust the most is truly in an academic setting, to be able to have the ability to learn to be able to read the popular press, and to be able to think about that and digest that information yourself. Understanding the market conditions cannot be boiled down to a tick tock video, it's just won't happen, right. But that being said, that doesn't mean you can't start there. And then kind of try to figure out, Okay, what's happening, maybe it's just that update that you needed, you already have a basis that you're working with. But if you read what is being reported, or what's being you know, the narrative that comes out, after central banks make their decisions on interest rates, all of this marking conditions are being reported on, it happens to from our big four banks, it happens from the consultants, agencies, there's a plethora of information. So being able to kind of make sure you understand what it's saying, is definitely your first go. And then if you appreciate the jargon around business cycles, or inflation, or you know, now, you can maybe read things more quickly, you can skim things you can get to where you need to be understanding today's headlines.

Dr Juliet Bourke  17:59

From what I've heard you say so far, Kristle, there is this sense that people need to own their own literacy, and need to keep on asking questions, so they get to a point of comfort, and then when they receive an answer, they can interrogate that answer. So what do you think is the state of people's financial literacy in Australia when they're going into business, do you think it is adequate? Are we coming out of school with 101?

Kristle Cortes  18:27

I believe so because we definitely need the basis on something like a pro forma income statement, or being able to do a discounted cash flow analysis. And that's what we expect our students to be able to really shine to be able to show that they can make these decisions using that as the background. If it's someone, though, that has not had that experience doing any sort of finance background, that's what I would recommend, I would recommend being able to do types of problems like I explained before to be able to calculate the present value or something of the future value, and to be able to do what is considered that discounted cash flow analysis and that your future profits or rents or whatever they're going to be, how do you capture what they're worth today? That means that once you've taken all of your cost benefit analysis, once you have all your benefits, and you subtract off your costs, Are you positive? Because if so then great, we can maybe go ahead with this, but maybe have two projects that are both positive and now you have to decide between the two, right? So that's, I think, a little bit of the actual literacy that you would want from just knowing what is kind of basic financial literacy.

Dr Juliet Bourke  19:56

So you feel like you've got the basics sorted. It's time to dive in and start your business, right? Well, maybe not just yet. Professor Frederik Anseel is a Senior Deputy Dean at the University of New South Wales Business School. And he's got a warning about confidence, and how too much of it can blow your judgement. There's decades of research on this phenomenon is called the Dunning Kruger effect.

Professor Frederik Anseel  20:21

If you're completely new in an area, and you have no skill whatsoever, you don't have a lot of confidence, you will not dare to make any decisions, you will probably rely on anyone else so you feel paralysed. But then the typical thing, what happens if you're a novice in a certain area, and you get a bit of experience, and you read a book on financial decision making on investment, and suddenly you're sort of scratching the surface a bit and you feel like you understand a few of the basics. And what we typically see is that you become overconfident. And you feel I noticed stuff, right? I know what to do. That is peak Dunning Kruger effect, right? You feel very confident in an area that actually you're not yet aware how little you know. And so that is probably for people who just start out in, in finance and financial decision making making their own investment decisions. That's the risky part, because you would discover Bitcoin, or anything else. And you would say, Oh, I'm following four accounts on social media that have said that Bitcoin will always go up. And this is the point to jump in. And that's where you make dumb mistakes, probably. 

I'm very sceptical that you can sort of protect yourself from Dunning Kruger effect, I think in every new area that you go in, people come with this sort of overestimation of their capabilities, people are most sort of susceptible for it, if you come from other areas where you were very good. And so you often see this that if people, entrepreneurs, business people, also academics, if they were very strong in one area, and they move to another area, they think, I have this expert level, I will not make all the rookie mistakes. And believe me, you do. So I think the best way is actually to sort of protect yourself from this Dunning Kruger phenomenon, if you move into a new area, like financial decision making is basically you need to tie your own hands behind your own back, which means that you need to involve somebody that knows what they're doing. Or you need to give the keys of the bank to someone else that protects you from making stupid mistakes. And for instance, you would say, only give me that sort of amount of money that I can freely invest, and all the rest, I will lock it up so that I'm protected from doing stupid things, because everyone is very likely to make the same type of mistakes. If we recommend people to seek external advice, where do you go, right? Because there's a lot of successful people in the business that sell their services and their advice. But success does not always mean that people are giving the best advice. 

Sometimes successful people have been become successful, for reasons that they don't know themselves. Right. Sometimes it's luck, right? There is something that we call survivorship bias, and that some people are successful, although they made a lot of mistakes. Other people who have failed, you never hear about, but they made the same mistakes as successful people, right? And you need to be very careful here. And so what I would say is try to understand where people come from, what is the basis for their advice, don't look too much about the stories about success, right? People like to tell stories about success. But what we know and what we discover is basically that the stories that are being told, often don't have a lot to do with the real reasons for success. I think it's wiser to look at the advice that is being given and trying to understand what are the sources of knowledge of expertise that are driving the advice, right? These are things that you can ask questions that you can ask from every advisor. So what is this based on? Is this just your intuition? Is this your gut feel? Is this something that maybe that you've done 100 times in the past and that you believe will always work? Or will you look at my specific case, and will you analyse my situation? And will you adjust your advice on the basis of my specific situation? So you need to be a bit of do a bit of work before you trust any external source. And so, expertise is a difficult sort of beast to understand as well.

Dr Juliet Bourke  24:52

We all have to start somewhere, and mistakes are inevitable, but they don't have to be disastrous. If you can get the basics of finance down, you'll save yourself some serious headaches and some serious cash. And if you can keep an open mind, you'll know when it's time to ask for help. 

The Business Of podcast is brought to you by the University of New South Wales Business School, produced with Deadset Studios.   

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