Financial Sustainability of Private Family SMEs

How to determine whether a family SME can sustain the family’s desired lifestyle

La sostenibilidad financiera de las pymes familiares privadas

When you are the owner-manager of a private family business (one which is not listed on the stock market), most likely you have experienced one of the following situations: the car or premises used by the company is owned by a family member; some relatives have a salary and it is above market value; or the company carries family’s expenses such as vacations, private schools or club memberships.

It is common for many family SMEs to share resources with the family and vice versa. Despite the fact that the company and the family are two different economic entities, some family businesses follow financial management policies based on the premise that the business is part of the family and the assets and profits generated by the company are at the disposal of the family.

Common as they are, these practices can distort the SME’s accounting records and impact the company’s strategic decisions, putting the financial sustainability of the business at risk and, therefore, the long-term sustainability of the family’s lifestyle.

Sustaining the family lifestyle

Many families start a business in order to achieve a certain standard of living, hoping that the business will provide sufficient income to distribute to family members on a sustained basis. It is possible that the distributable profits can enable a family to comfortably meet their material and status aspirations, but it may also be the case that family members withdraw more funds than profits generated by the company.

Therefore, it is extremely important to know to what extent the family business can sustain the desired standard of living. To analyze the business's ability to meet family goals, we published an article on our recent research titled “The Sustainability of Resource-Sharing Family Business in Relation to Family Non-Economic Goals” (International Journal of Project Management and Productivity Assessment, 2020 ), a topic that we also address in an expanded way in a chapter of a forthcoming book: Finances in private family companies: money management and the achievement of family objectives.

Our research methodology helps to understand the real financial position of the company, providing a measurement that links decision-making, long-term business sustainability and the achievement of family goals. As a result, the owner-managers of private family SMEs can enhance their decision-making capacity.

Correcting accounting

For our research, we studied a number of private family SMEs from three countries (Mexico, Italy and the United States). All of them are companies that share family resources and also cover some family expenses. However, their accounting does not properly reflect family expenses, nor company’s use of family assets. This has important consequences for strategic planning, with three cost effects to consider:

  • Costs are lower because payments for the use of family assets or royalties from intellectual property are not recognized.
  • Costs increase because there are payroll payments that are above fair value.
  • Costs increase because the company pays expenses that do not correspond to its economic activity.

To correct the effects of these distortions, the company must:

  • Register any payment for the use of assets owned by a family member (income, royalties, etc.) as an expense. Payment can be registered as an addition to  capital stock of the family member who owns the given asset.
  • Pay wages at fair value (market value) and any additional amount as dividends.
  • Register the expenses made by the company for family’s own expenses as dividends.

By making these adjustments, the financial indicators that depend on these items change, altering the measurement of the company’s performance, its competitiveness and its ability to grow. In our book, we make an in-depth analysis of the calculation of the business’s ability to grow and meet family goals. These are two essential indicators that must be evaluated as a preliminary step in determining the financial sustainability of the business-family system.

Towards the sustainability of family SMEs

After correcting the financial statements and determining the company’s net income, it is possible that dividends turn out to be larger than profits, which would indicate that the family is taking more than the company generates, leaving it in a very precarious position. As a result of our study, we identified five possible scenarios to describe the companies that were analyzed:

  1. Clear and imminent danger: The company is not able to support the family at its minimum level. If the business is to be profitable, the family should review their financial needs; however, the company should also review its strategy.
  2. Family at risk: The company satisfies the minimum level of profit retention to grow at the same rate as its industry, but the remaining profits do not cover the basic needs of the family.
  3. Basics: The family can receive dividends to cover their basic needs. Both business and family are sustainable, but aggressive strategic planning is required to grow above the industry and increase dividends.
  4. Comfort zone: The company allows the family to satisfy their needs at a satisfactory level. The company could grow more without jeopardizing the economic stability of the family.
  5. Achievement Zone: After growing to the desired level, the company generates the dividends that the family requires at its aspirational level. It is a stable situation and facilitates the growth of both the family and the company.

By determining in which of these scenarios the company falls, SME owner-managers will be able to guide their business strategy better, as we propose in our book. Finally, it must be remembered that, although this research focuses on the financial aspect of the company, the sustainability of a business does not depend only on its economic viability; this must also be balanced with its impact on the environment and society (other stakeholders).

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