Financial Management · Finance for small- and medium-sized entities (SMEs)

Assessing SME Funding Proposals and Cash Management

Updated 11 October 2026 · Fact-checked

Finance providers assess an SME funding request by judging whether the business can repay or earn a return, and what happens if it cannot. They review the business plan, management, ratios, cash flow forecasts, security and the amount asked for. SMEs must also manage working capital and cash tightly to survive.

Understand Assessing SME Funding Proposals and Cash Management

A small or medium-sized entity (SME) usually has little track record, few assets and a small owner team. A bank or investor cannot easily judge its risk. So the provider asks one core question: will this business generate enough cash to repay me, and what do I get if it fails?

Providers use a business plan to answer this. A good plan sets out the business and its market, the products, the management team and their experience, the amount of finance needed and what it is for, the forecast profit and cash flows, and the key risks. It should also state the repayment source and the security offered. A plan is weak if forecasts are unsupported or the assumptions are not stated.

Lenders often work through a checklist. Typical areas are the character and experience of management, how much the owners are investing themselves, the purpose and amount of the loan, how it will be repaid, the security available and the margin of safety if results fall short. Ratios support this. Gearing and interest cover show the debt burden. Liquidity ratios and the cash operating cycle show short-term strength. Profit margins and return on capital show earning power. Providers compare ratios with industry norms and with earlier years.

Cash is the main threat to small firms. Many profitable SMEs fail because cash runs out. Common causes are overtrading (growing sales faster than the finance available), slow-paying customers, too much inventory and weak credit control. SMEs often have less bargaining power with suppliers and customers and limited access to overdrafts.

A cash flow forecast is the main control. It shows expected receipts and payments by period, so you can see when a shortfall will arise and how large it will be. Management can then arrange an overdraft or loan in time, delay payments, speed up collections or cut spending. Lenders also like to see a forecast because it shows the borrower is in control.

Key rules to remember

Gearing (debt/equity): Debt ÷ Equity; Define debt consistently (long-term debt, or including overdraft). Say which version you use.
Interest cover: Profit before interest and tax ÷ Interest expense; Low cover means profit gives little protection for the lender.
Current ratio: Current assets ÷ Current liabilities; Compare with the industry norm rather than a fixed target.
Quick ratio: (Current assets − Inventory) ÷ Current liabilities; Removes inventory, which may be slow to turn into cash.
Receivables days: Trade receivables ÷ Credit sales × 365; Use credit sales if given, otherwise revenue.
Inventory days: Inventory ÷ Cost of sales × 365; Use cost of sales for inventory and payables.
Payables days: Trade payables ÷ Credit purchases × 365; Use cost of sales if purchases are not given.
Cash operating cycle: Inventory days + Receivables days − Payables days; A longer cycle means more finance is tied up in working capital.
Closing cash balance: Opening balance + Receipts − Payments; Carry each closing balance forward as the next opening balance.

How to solve Assessing SME Funding Proposals and Cash Management questions

Use this approach for written or objective questions on SME funding requests and cash management.

1Read the scenario and note the size, age and type of business, the finance requested and its purpose.
2Decide what the provider needs: ability to repay, return on investment, security and management quality.
3Pick the evidence that fits: business plan content, ratios, forecasts and security. Name each item.
4If numbers are given, calculate the relevant ratios or the cash forecast carefully and state the definitions used.
5Interpret every figure. Say what it means for risk, and compare it with a benchmark or a prior year.
6Spot cash and working capital problems such as overtrading, long receivable days or heavy inventory.
7Recommend actions: a suitable source of finance, tighter credit control, inventory reduction or negotiating payment terms.
8Finish with a clear conclusion that answers the exact question asked.

Quickest way: Repay, risk, plan, cash

When to use it: Use this when you have a few minutes for a written part or a short objective question.

Repay: Can the business service the debt from cash flow?
Risk: How much is the owners' own stake, and what security exists?
Plan: Is the business plan credible, with stated assumptions and a competent team?
Cash: Is there a forecast, and are working capital days under control?
Link each point to the facts in the scenario so it scores.

Common mistakes in Assessing SME Funding Proposals and Cash Management

Listing generic loan criteria without using the scenario.
Students memorise a checklist and write it out.
Fix: Tie every point to a fact given, such as the firm's age, receivables days or lack of security.
Treating profit as if it were cash.
Profit and cash look similar in the income statement.
Fix: Remember depreciation is not a cash flow and credit sales are not yet received. Build the forecast from cash timing.
Calculating ratios but not interpreting them.
Students stop once the arithmetic is done.
Fix: Always add what the ratio means for the lender and compare it with a benchmark or trend.
Mixing up days calculations, for example using sales for inventory days.
The formulas look alike.
Fix: Inventory and payables relate to cost of sales or purchases. Receivables relate to credit sales.
Ignoring the timing of receipts and payments in a cash forecast.
Students enter figures in the month of the sale or cost.
Fix: Apply the credit terms first, then place each flow in the month cash actually moves.
Assuming overtrading is a sign of poor profitability.
Rapid growth seems positive.
Fix: Overtrading is a funding problem: sales rise faster than finance, so inventory and receivables grow and cash falls.

Worked examples

Example 1

A new SME, Kavya Ltd, asks a bank for a ₹10,00,000 loan. Profit before interest and tax is ₹3,00,000. Annual interest on the proposed loan and existing debt will be ₹1,00,000. Equity is ₹5,00,000 and total debt after the loan will be ₹10,00,000. Calculate interest cover and gearing (debt/equity) and comment briefly.

Show the solution

Interest cover = ₹3,00,000 ÷ ₹1,00,000 = 3 times.
Gearing = ₹10,00,000 ÷ ₹5,00,000 = 2, or 200%.
Interest cover of 3 times gives some protection, but a one-third fall in profit would leave cover at 2 times.
Gearing of 200% means debt is twice equity. The owners have a small stake, so the bank bears most of the risk.
The bank would probably want security, a lower loan or more owner equity, and would check the cash flow forecast.

Answer: Interest cover is 3 times and gearing is 200%. The cover is adequate but the gearing is high, so the bank will want security or more equity.

Example 2

A business has opening cash of ₹20,000 at 1 January. Credit sales are ₹60,000 in January, ₹80,000 in February and ₹90,000 in March. Customers pay in the month after sale. December sales were ₹50,000. Payments are ₹70,000 in January, ₹75,000 in February and ₹85,000 in March. Prepare the closing cash for each month.

Show the solution

January receipts = December sales ₹50,000. Closing = ₹20,000 + ₹50,000 − ₹70,000 = ₹0.
February receipts = January sales ₹60,000. Closing = ₹0 + ₹60,000 − ₹75,000 = −₹15,000.
March receipts = February sales ₹80,000. Closing = −₹15,000 + ₹80,000 − ₹85,000 = −₹20,000.
The business is overdrawn at the end of February and March, even though sales are rising.
Comment: it needs an overdraft of at least ₹20,000, or faster collections and delayed payments.

Answer: Closing cash is ₹0 in January, −₹15,000 in February and −₹20,000 in March. The firm needs short-term finance of at least ₹20,000.

Exam tips

In a written answer, name the provider's concerns (repayment, security, management, plan quality) and tie each to the scenario.
Show every cash forecast line and carry balances forward, so you earn marks for method even with an error.
In objective cases, check the definition used for ratios such as gearing and days, as options often differ by definition.
Recommend practical actions for cash problems, such as invoice discounting, tighter credit control or negotiating terms, and say why each suits the business.
Keep answers structured with short headed points, and always finish with a conclusion.

Practice questions from Finance for small- and medium-sized entities (SMEs)

Assessing SME Funding Proposals and Cash Management: frequently asked questions

How do banks assess SME loan applications?

They look at the business plan, management experience, the purpose and size of the loan, forecast cash flows and how repayment will be made. They also check ratios such as gearing and interest cover, and ask what security is offered. The aim is to judge the risk of non-payment.

What should a business plan include to raise finance?

It should describe the business, market, products and management team. It should state the finance needed and its use, forecast profit and cash flows with their assumptions, the key risks and the security or exit route. Credible, supported figures matter more than optimistic ones.

Why do small businesses have working capital problems?

They often have weak credit control, slow-paying customers, and limited power to negotiate with suppliers. Growth can cause overtrading, where inventory and receivables rise faster than finance. Limited access to overdrafts makes a shortfall hard to cover.

How do I approach an SME question in the ACCA FM exam?

Identify the provider's viewpoint, use the facts in the scenario, calculate any ratios or cash flows, and interpret them. Then recommend actions and give a conclusion. Apply the same method in objective cases and constructed response answers.