USE OF SIMULATION METHODS IN A COMPANY’S SHORT-TERM FINANCIAL PLANNING: THE CASE OF SMEs
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INTRODUCTION 9
Chapter 1. FUNDAMENTALS OF FINANCIAL PLANNING IN SMES 13
1.1 The definition of “financial planning” 13
1.2 Academic studies on financial planning and performance of SMEs 16
1.3 Core elements of financial planning of SMEs 20
1.4 Principles and forms of financial planning 28
1.5 Characteristics of short-term financial planning 31
1.6 Methods of short-term financial planning 33
1.7 Research gap and formulation of hypotheses 44
1.8 Summary of Chapter 1 46
Chapter 2. RESEARCH METHODOLOGY AND DESIGN 47
2.1 Research methodology 47
2.2 Data collection procedures 49
2.3 Time horizons 56
2.4 Evaluation criteria and validity 56
2.5 Limitations of study 58
2.6 Summary of Chapter 2 59
Chapter 3. EMPIRICAL STUDY 60
3.1 Research design and operationalization of variables 60
3.2 Model specification 64
3.3 Descriptive statistics 65
3.4 Hypotheses testing and analysis 73
3.4.1 Base mode testing 73
3.4.2 Hypothesis 1 77
3.4.3 Hypothesis 2 79
CONCLUSIONS AND IMPLICATIONS 85
4.1 Conclusions 85
4.2 Theoretical contribution and managerial implications 88
4.3 Recommendation for future research and limitations 89
REFERENCES 91
Appendix 1. Survey 100
Chapter 1. FUNDAMENTALS OF FINANCIAL PLANNING IN SMES 13
1.1 The definition of “financial planning” 13
1.2 Academic studies on financial planning and performance of SMEs 16
1.3 Core elements of financial planning of SMEs 20
1.4 Principles and forms of financial planning 28
1.5 Characteristics of short-term financial planning 31
1.6 Methods of short-term financial planning 33
1.7 Research gap and formulation of hypotheses 44
1.8 Summary of Chapter 1 46
Chapter 2. RESEARCH METHODOLOGY AND DESIGN 47
2.1 Research methodology 47
2.2 Data collection procedures 49
2.3 Time horizons 56
2.4 Evaluation criteria and validity 56
2.5 Limitations of study 58
2.6 Summary of Chapter 2 59
Chapter 3. EMPIRICAL STUDY 60
3.1 Research design and operationalization of variables 60
3.2 Model specification 64
3.3 Descriptive statistics 65
3.4 Hypotheses testing and analysis 73
3.4.1 Base mode testing 73
3.4.2 Hypothesis 1 77
3.4.3 Hypothesis 2 79
CONCLUSIONS AND IMPLICATIONS 85
4.1 Conclusions 85
4.2 Theoretical contribution and managerial implications 88
4.3 Recommendation for future research and limitations 89
REFERENCES 91
Appendix 1. Survey 100
Financial planning is a key element of companies’ systems of planning. Good quality of financial planning is an essential of a company’s success, because it provides an ability to solve so strong issues such: effective cash flow management, optimal cash flow structure, minimizing of transactional costs and effective management in general. Planning as a whole and financial planning as a key interest for a company provides benefits for managers and shareholders of a company. Firstly, the good financial plan makes future finance more transparent and clear to understand. Secondly, perfect financial plan generates some opportunity for a company to be seen as a reliable and stable company that is extremely important for a company counterparties such as owners, bankers, potential investors, society. Also, the well-established planning system is a positive signal to the market that an enterprise is properly managing and risks of investment are low. Thirdly, high quality of financial planning enables a company to provide more accomplish financial control in order to overcome a crisis and lower financial risks. After all, allocation of some budget activities becomes more profitable due to decrease in money violation and lower tax payments. The last, but not the least benefit of a well-established financial planning is an opportunity to run a business successfully, to mitigate risk and cash flow violations. Successful companies are tending to extricate the maximum of financial resources and to provide extremely effective operations.
The main goal of development of short-term financial planning process for companies is to achieve investment targets, meet budget and reach projected financial results in the long run (for a long-term financial planning) and short-term period (for a planning within one fiscal year). Well established financial planning helps to control cash flows and to avoid a problem knows as “gap of liquidity”, where a company has positive effect of operations, but operations need more financial resources that a company has.
Scientific society started learning principles and mechanics of financial planning since the emersion of exchanges and broker’s boards, but despite of deep scientific studies this topic, in our fast-paced world, companies face those old requirements of a good financial planning don’t work in present conditions. Rules and requirements of successive financial planning become more tight and specific. Socio-economic relations in modern Russian society require being more qualified, more developed. In my opinion, such a development should be based on both theoretical and practical experience of international economic schools and businesses. Thus, in order to establish a good level of financial planning, we forced to analyze international experience and well-known scientific studies and implement modern techniques of financial planning.
We’ve found a lot of researches are devoted to study the subject of financial planning, but only a small share of these researches dedicated to studying specifics of short-term financial planning. It seems very interesting, because exactly short-term financial planning is a key to successful implementation of a company’s strategic goals. Surprisingly, but prevailing majority of researchers are conducted to study long-term planning instead of short-term. In the author’s point of view, this situation occurs due to peculiarities of short-term financial planning, such as: short time period, big volatility, and instability of results, low level of predictability and limitations of planning based on historical dynamics.
In borders of modern conditions, it is extremely important to raise the quality of financial planning in order to optimize cash flows, make managerial decisions and predict financial results. There is a commonly known fact that traditional approaches to financial planning are not ready to work properly in a fast-paced business world, therefore, companies can make only a few decisions, because of a low probability of forecasts. What is a solution? The best solution is to use simulation methods to provide financial planning. These methods have as advantages as disadvantages, but their aim is to increase the quality of forecasts.
Use of modern methods in a company’s short-term planning enables management to provide decision at a qualitatively much higher level. Simulation methods could be used for large-scale analysis and for analysis of many alternatives, therefore the quality of forecasts and managerial decision become well. Due to use of statistical methods, results of a simulation are much more detailed and show a greater accuracy of predictions. However, these methods are quite complicated to implement and require special knowledge and skills that often go beyond traditional requirements for accounting or planning.
Simulation methods (e.g. Monte Carlo simulation) have been studying since 1950. Thus, databases of international work papers conducted to simulation methods contain about 2000 of studies, whereas among Russian authors we’ve found about 25. The most interesting in our point of view are studies which represent practical effectiveness of simulation methods (Vershinina, 2012; Goroshnikova, 2011; Zholudeva, 2011). This illustrates that modern methods of financial planning are not well-known in Russian scientific society. One of the aims of my Master Thesis is to cover this lack of knowledge.
One of the ways to address this research gap is to investigate the quality of short-term financial planning in everyday practices of Russian companies and built regression model in order to find out whether it is more beneficial for a company to use simulation methods of planning than traditional ones. Based on analysis and comparison of Russian companies’ approaches to short-term financial planning, especially analysis of internal effectiveness, an accuracy of predictions and the level of cash gaps, and open discussion within the professional community, were developed research goal and research objectives.
The main goal of development of short-term financial planning process for companies is to achieve investment targets, meet budget and reach projected financial results in the long run (for a long-term financial planning) and short-term period (for a planning within one fiscal year). Well established financial planning helps to control cash flows and to avoid a problem knows as “gap of liquidity”, where a company has positive effect of operations, but operations need more financial resources that a company has.
Scientific society started learning principles and mechanics of financial planning since the emersion of exchanges and broker’s boards, but despite of deep scientific studies this topic, in our fast-paced world, companies face those old requirements of a good financial planning don’t work in present conditions. Rules and requirements of successive financial planning become more tight and specific. Socio-economic relations in modern Russian society require being more qualified, more developed. In my opinion, such a development should be based on both theoretical and practical experience of international economic schools and businesses. Thus, in order to establish a good level of financial planning, we forced to analyze international experience and well-known scientific studies and implement modern techniques of financial planning.
We’ve found a lot of researches are devoted to study the subject of financial planning, but only a small share of these researches dedicated to studying specifics of short-term financial planning. It seems very interesting, because exactly short-term financial planning is a key to successful implementation of a company’s strategic goals. Surprisingly, but prevailing majority of researchers are conducted to study long-term planning instead of short-term. In the author’s point of view, this situation occurs due to peculiarities of short-term financial planning, such as: short time period, big volatility, and instability of results, low level of predictability and limitations of planning based on historical dynamics.
In borders of modern conditions, it is extremely important to raise the quality of financial planning in order to optimize cash flows, make managerial decisions and predict financial results. There is a commonly known fact that traditional approaches to financial planning are not ready to work properly in a fast-paced business world, therefore, companies can make only a few decisions, because of a low probability of forecasts. What is a solution? The best solution is to use simulation methods to provide financial planning. These methods have as advantages as disadvantages, but their aim is to increase the quality of forecasts.
Use of modern methods in a company’s short-term planning enables management to provide decision at a qualitatively much higher level. Simulation methods could be used for large-scale analysis and for analysis of many alternatives, therefore the quality of forecasts and managerial decision become well. Due to use of statistical methods, results of a simulation are much more detailed and show a greater accuracy of predictions. However, these methods are quite complicated to implement and require special knowledge and skills that often go beyond traditional requirements for accounting or planning.
Simulation methods (e.g. Monte Carlo simulation) have been studying since 1950. Thus, databases of international work papers conducted to simulation methods contain about 2000 of studies, whereas among Russian authors we’ve found about 25. The most interesting in our point of view are studies which represent practical effectiveness of simulation methods (Vershinina, 2012; Goroshnikova, 2011; Zholudeva, 2011). This illustrates that modern methods of financial planning are not well-known in Russian scientific society. One of the aims of my Master Thesis is to cover this lack of knowledge.
One of the ways to address this research gap is to investigate the quality of short-term financial planning in everyday practices of Russian companies and built regression model in order to find out whether it is more beneficial for a company to use simulation methods of planning than traditional ones. Based on analysis and comparison of Russian companies’ approaches to short-term financial planning, especially analysis of internal effectiveness, an accuracy of predictions and the level of cash gaps, and open discussion within the professional community, were developed research goal and research objectives.
While discussing both theoretical and practical contributions of the research conducted, it is worth to mention that there are certain limitations of the study, that were unavoidable during the process of conducting the empirical research.
Firstly, the limitation might be presented with design of the study, as the innovative performance outcomes might not be able to transform into financial ones immediate^. Thus, introduction of 5+ years longitude research might eliminate this limitation, as it can capture the time-lagged nature of this translation.
Secondly, the generalizability of the results is under question. The results cannot be generalized to all the emerging markets due to the specific features of the environment of Russian Federation. Several financial non-financial parameters, such as the level of innovations, the number of talents in the company and ease of financing proved to be statistically insignificant being tested on the sample of Russian SMEs. On the contrary, studies based on samples of SMEs from other countries (both developed and developing) showed statistical significance of these factors. The author concludes that the reasons of such a difference could be described by the structure of sample as well as specific features of Russian SMEs and Russian business environment, which in general effect on managerial decisions and financial results.
Thirdly, due to academic reasons this research is limited, thus we should account for some specific limitations of this analysis. To start out, we should mention limitation of time and the size of the sample. Academic schedule affected the research in terms of limited time for data collection and research execution. Limited time lead to limited number of respondents, shortened amount of observed companies and short duration of qualitative study. Strict deadlines limited our possibilities to collect and observe more data and if there was not so short time for research, we could even extend the scope of our study and analyze more industries and reveal regional specifics and season dynamics.
Finally, regarding the specifics of survey, some factors were estimated by companies and cannot be measured by the author to prove their validity and objectivity. For factors, such as number of talents, level of competition and ease of financing, which were estimated judgmentally, we should be accurate in conclusions. The author proposes to provide deep analysis of effects of these factors on financial performance of companies in future, but in terms of current study this analysis is out of scope. The author has an optimistic view on results of the study, which supported by high R-squared of final model, however, the set of financial and non- financial parameters that were chosen for this study could be developed. The author has a belief that out of dozens of criteria, there are several factors of success which should be tested to develop the model and expand our understanding of grass roots of success of SMEs.
Despite the limitations described above, empirical results are not compromised and can be used in order to further investigate the discovered phenomenon. All in all, future research may confirm the results of this study on the other emerging markets and compare them to those of Russia.
Firstly, the limitation might be presented with design of the study, as the innovative performance outcomes might not be able to transform into financial ones immediate^. Thus, introduction of 5+ years longitude research might eliminate this limitation, as it can capture the time-lagged nature of this translation.
Secondly, the generalizability of the results is under question. The results cannot be generalized to all the emerging markets due to the specific features of the environment of Russian Federation. Several financial non-financial parameters, such as the level of innovations, the number of talents in the company and ease of financing proved to be statistically insignificant being tested on the sample of Russian SMEs. On the contrary, studies based on samples of SMEs from other countries (both developed and developing) showed statistical significance of these factors. The author concludes that the reasons of such a difference could be described by the structure of sample as well as specific features of Russian SMEs and Russian business environment, which in general effect on managerial decisions and financial results.
Thirdly, due to academic reasons this research is limited, thus we should account for some specific limitations of this analysis. To start out, we should mention limitation of time and the size of the sample. Academic schedule affected the research in terms of limited time for data collection and research execution. Limited time lead to limited number of respondents, shortened amount of observed companies and short duration of qualitative study. Strict deadlines limited our possibilities to collect and observe more data and if there was not so short time for research, we could even extend the scope of our study and analyze more industries and reveal regional specifics and season dynamics.
Finally, regarding the specifics of survey, some factors were estimated by companies and cannot be measured by the author to prove their validity and objectivity. For factors, such as number of talents, level of competition and ease of financing, which were estimated judgmentally, we should be accurate in conclusions. The author proposes to provide deep analysis of effects of these factors on financial performance of companies in future, but in terms of current study this analysis is out of scope. The author has an optimistic view on results of the study, which supported by high R-squared of final model, however, the set of financial and non- financial parameters that were chosen for this study could be developed. The author has a belief that out of dozens of criteria, there are several factors of success which should be tested to develop the model and expand our understanding of grass roots of success of SMEs.
Despite the limitations described above, empirical results are not compromised and can be used in order to further investigate the discovered phenomenon. All in all, future research may confirm the results of this study on the other emerging markets and compare them to those of Russia.