Developing an optimisation model for the cost of working capital for SMEs

Ph.D. (Finance)Abstract: Small and Medium enterprises (SMEs) are at a considerable disadvantage when seeking finance for their businesses. They are at the mercy of both financiers and powerful trading partners who are able to impose stringent conditions on the terms of finance or trade. The impact is felt, mostly, on the working capital of the firms. This study seeks, firstly, to show that it is possible for firms, who collaborate financially, to optimise the cost of their working capital, at no net cost to any party and, secondly, to develop a model to measure the financial benefits that can be thus obtained. The literature argues that individual firms, who optimise their working capital, increase their profits. It is shown, however, that this is usually done at the expense of their trading partners. Research also shows why trade credit is used and how expensive it is. Both topics are developed to achieve the objectives of this study. It is shown that it is possible to optimise working capital in a supply chain. The Working Capital Cost Optimisation (WCCO) model is developed from a dyadic trading system to a full supply chain to calculate the benefit of financial collaboration. A supply chain is simulated from data obtained from a bank in SA and the WCCO model is tested. Three scenarios are considered 1) a benchmark scenario in which every firm trades with another, 2) a scenario in which SMEs and large enterprises (LEs) trade only with each other, and, 3) a scenario where the cost of trade credit is introduced to trade between SMEs and LEs. The output is analysed to determine the impact of the resulting financial benefits on key financial ratios of the firms. It is found that the financial benefit, especially for SMEs, increases as collaborative trade is focussed towards trade with LEs in a trade credit situation. The WCCO model can be applied to any situation where firms agree to collaborate using their financial resources. State-owned Enterprises (SOEs) and government departments who have a mandate to assist SOEs could be persuaded to implement the findings of this study to the benefit of SME suppliers