Small and Medium Enterprises (SMEs) form the backbone of Malaysia’s economy, contributing significantly to employment and economic growth. As of 2023, there are roughly 1.15 million SMEs in Malaysia. They account for 97.2% of total business establishments, generating 38.2% of GDP and providing employment for 7.3 million people. Balancing debt and risk management remains a constant challenge for many small and medium-sized enterprises (SMEs) in Malaysia. Traditionally, high debt was seen as a sign of high risk, possibly causing instability and business failure. However, recent research reveals that high SME debt in Malaysia does not necessarily make an SME riskier than its counterparts. 

In the last few decades, numerous financing ecosystems have emerged to provide diversified funding options for SMEs from both public and private institutions. Providing over 90% of total financing, banking institutions are the primary source of funding for SMEs in Malaysia. This has enabled Malaysian SMEs to continue having access to different financing sources to address their needs at various stages of development. 

Contrary to common belief, there are certain cases where debt may not be a significant risk factor. In fact, in 2023, overall business loan impairments remain low at just 1% of total banking system loans. Similarly, the proportion of SME loans classified as higher credit risk is relatively small, standing at 2.1% of total banking system loans. Moreover, there has been a decline in the share of SME loans under repayment assistance, now at 5.5% of total SME loans (equivalent to 0.9% of total loans from banking and development financial institutions). This decline indicates that SMEs have been able to sustain their loan repayments, showcasing their resilience despite economic challenges. 

However, there is a constant notion that debt inherently heightens risks.   Let’s look at these scenarios to debunk the notion surrounding SME debt and risk. 

Scenario 1: SMEs with stable and consistent revenue streams may not be at risk despite having a large debt. The predictability of their income can act as a mitigating factor, offering a safety net against the potential downsides of debt.

Scenario 2: When debt is strategically used to fuel growth initiatives, like expansion or technology adoption, it may not necessarily lead to increased risk. When done thoughtfully, this approach may not necessarily increase risk. Instead, it can lead to favourable returns that outweigh any associated risks.

Profitability’s pivotal role in SME risk dynamics

We all know that debt is the most discussed topic in risk assessment. However, another crucial key in managing risks for SMEs is profitability. Businesses must have healthy profit margins, creating a safety net against unforeseen circumstances. A healthy profit margin allows businesses to absorb financial shocks and navigate economic downturns more effectively.

Understanding how profit margins influence risk is crucial. A company with consistently thin margins operates on a tightrope, where even minor setbacks can trigger financial distress. Conversely, robust profitability provides breathing room for flexible responses to challenges and proactive risk mitigation strategies.

Let’s look further into how profitability affects a company’s risk management:

Scenario 1: Profit margins directly impact liquidity, affecting a company’s ability to meet short-term obligations. Businesses with healthy profit margins are better equipped to navigate unexpected challenges, reducing the likelihood of financial distress. 

Scenario 2: Profitable SMEs demonstrate higher resilience to economic downturns and reduce business failure. Profitability allows these businesses to weather uncertainties, ensuring continued operations even in challenging market conditions.

While businesses are anticipated to encounter challenges like rising costs, low foreign demand and  climate-related issues, most businesses are projected to be able to survive any new shocks as they strengthen their business leverage, build robust cash buffers, and adopt more agile business models.

For Malaysian SMEs, this translates into prioritising strategies that enhance profitability. Focusing on core competencies, optimising operational efficiency, and diversifying revenue streams are all ways to create a more resilient and risk-proof business model.

Reassessing traditional factors in SME risk assessment

Traditionally, SME risk assessment often relied on factors like size, firm age, and business ethnicity. However, recent research suggests these metrics might be one of many factors involved in SME risk assessment. While this doesn’t negate their relevance entirely, it highlights the necessity for a more comprehensive approach.

Instead of relying entirely on the firm’s size and age, one should consider the qualitative factors: financial performance, the team’s experience and capabilities, geographic location, the firm’s expansion plans, and the industry’s overall market potential. Geographic location plays a role by affecting proximity to critical resources like finance, suppliers, and customers. The industry itself can impact access to financing and inherent risk levels. The owner’s experience and education also contribute, as these factors influence business survival and success. Ultimately, financial performance ties everything together, as debt, access to capital, and overall performance all influence an SME’s risk profile and investment attractiveness.

Hence, businesses must reevaluate how to measure risks using empirical evidence and adapt strategies based on the SMEs’ specific needs. By moving away from one-size-fits-all models, stakeholders can create a more inclusive and effective financial ecosystem that supports sustainable growth for Malaysian businesses. With these insights, SMEs can develop tailored risk management strategies that enhance resilience and contribute to long-term success in the Malaysian business environment.