Strengths of small and medium-sized enterprises in Ger­many and the consequences for Financial Management

last updated on 22 February 2022 | reading time approx. 3 minutes
 

SMEs are the “backbone” of the German economy. Until now, many SMEs have closed their doors to capital market financing or financing from investors. International investments are facing fundamental changes in financing behaviour.

Crucial role of small and medium-sized enterprises (SMEs) in the economy

Germany is the largest European economy in terms of gross domestic product. This established success arouses interest of renowned foreign investors who are interested in making capital investments in Germany or in acquiring German companies. In this respect it is worth noting that according to the Institute for SME Research 99.5 of all German companies generating sales from goods and services and/or having employees subject to social security contributions are small and medium-sized enterprises (SMEs)¹. This composition, which is characteristic of the German economy, is a particularly relevant aspect for the aforementioned large share of SMEs compared to the rest of the European economies.

Performance capabilities of German SMEs

German SMEs are characterised by a remarkable crisis resistance – despite more difficult environment compared to large corporations. The average number of employees at German SMEs has risen over the past decade. Furthermore, they were also much less affected by economic downturns, such as during the financial crisis of 2008 and 2009. By contrast, according to a study by the IfM, large corporations have reduced their average employment rate during this period. Despite its resistance to crises, the coronavirus pandemic also severely hit Germany's SME sector. Nevertheless, companies have come through the crisis year 2020 relatively unscathed. As indicated in the KfW SME Panel 2021, small and medium-sized enterprises suffered sales losses of 277 billion euros last year². Thanks to enormous adaptability of SMEs worse could be prevented from happening, and despite tough shortfalls in sales, they remained profitable. The average return on sales fell only slightly, from 7.5 per cent  to 7.3 per cent. German medium-sized companies have thus once again proven to be crisis-proof.
 
Another strength that sets German SMEs apart from large corporations is their high degree of flexibility with regard to customers and the market. SMEs can switch production more quickly because, among other things, they have smaller batch sizes. They are thus more capable of meeting specific customer requirements. Also in the future this will remain the characteristic strength of SMEs and thus of the German economy.
 
Worth noting here is also another characteristic feature of German SMEs, namely their unique way in which they treat their staff and the related higher productivity of their employees. Job enrichment, job enlargement and participation are an essential element of the employees' activities, and this helps avoid monotonous work. While large corporations are characterised by bureaucratic standardisation and regulatory framework due to the size-related organisational complexity, the structure of SMEs seems to be more advantageous due to the lower degree of differentiation in the workplace organisation. This avoidance of monotonous work increases motivation and thus productivity of the staff.

Financing behaviour of German SMEs

The current financing behaviour of German SMEs is dominated by classic financing instruments such as internal financing, bank loans and shareholder deposits or loans. The financing instruments IPO and capital market-oriented debt financing are of least importance for German SMEs. One of the main reasons for this is the misconception of most of the companies concerned that they are not ready for the capital market due to their size. However, based on historical values it can be concluded that procuring financing via the capital market is also feasible and reasonable for small and medium-sized enterprises. In this respect, it is indeed possible to further improve the performance capabilities of German SMEs by utilising these previously rather undiscovered financing alternatives.

Consequences for Financial Management in German SMEs

Due to the above-mentioned specific environment in which German SMEs operate, it is essential that Financial Management is adequately geared to these circumstances. Appropriate corporate planning is of particular importance in this context: In order to retain and improve the aforementioned flexibility with regard to customers and markets as well as the aforementioned crisis resistance, quantitative areas such as cost, investment and liquidity planning take on a very special significance.
 
Cost Management of SMEs must first ensure that fixed costs can be identified and reduced as far as possible on the basis of a cost structure that is as transparent as possible. By making total costs more flexible in the said manner, any decline in sales can be counteracted by an immediate reduction in costs, thus promoting the aforementioned crisis resistance.
 
Continuous investment planning is essential for maintaining the above-mentioned flexibility  which is so typical of German SMEs. In order to be able to respond quickly to significantly increasing demand, the company must always be able to finance new acquisitions. If the company does not consider this flexibility, which represents a pivotal source of  potential for strategic success, in its corporate planning, it will lose its greatest strength in the long term and will not keep its head above water.
 
Liquidity planning must ensure adequate working capital management and thus guarantee the company's continued solvency.
 
In addition, a full understanding of all financing alternatives – including opportunities and risks – is necessary to take advantage of the lowest possible financing interest rates.
 

Conclusion

The German economy, which is the leading economy in Europe, is shaped by small and medium-sized enterprises. German SMEs are characterised above all by particular crisis resistance and pronounced flexibility with regard to changes in demand. In order to retain these sources of strategic success potential, it is essential to adequately align Financial Management with the aforementioned strengths.
 
The financing instruments IPO and capital market-oriented debt financing are noticeably of minor significance for German SMEs due to misconceptions. In this context, Financial Management must have the professional expertise and also the courage to use the capital market-oriented sources of financing to take advantage of the most favourable capital procurement possible.