By Chalerm Jaitang (Prince of Songkla University), Zhaohua Li and Christopher Gan (Lincoln University)
Introduction
Small and Medium-sized Enterprises (SMEs) are a cornerstone of Thailand’s economy, contributing significantly to employment and economic activity. In 2023, there were 486,213 SMEs, accounting for 15% of all enterprises and providing jobs for 40.86% of the workforce [1]. Despite their importance, Thai SMEs face numerous challenges, particularly insolvency risks. Given the substantial economic impact of SME insolvency, addressing these challenges is vital for maintaining economic stability and promoting growth.
Our study analyzes the factors contributing to insolvency risk among Thai firms by focusing on industry-relative (IR) financial ratios, firm characteristics, and local economic conditions. The unique aspect of the research lies in its application of IR financial ratios, which normalize financial performance across industries, ensuring uniform measurements and enhancing the robustness of the analysis. The financial variables in this analysis are categorized into four key areas: profitability, liquidity, operational efficiency, and leverage (financial position). By focusing on three crucial sectors—manufacturing, trading, and services—the empirical design identifies significant financial ratios that serve as key predictors of insolvency risk across different sectors.
Our recent study was published in the Asian Journal of Applied Economics [2]. This blog article provides a concise overview of the research and key findings.
The Data
The dataset for our study is obtained from the Department of Business Development (DBD) of Thailand [3] and includes a comprehensive sample of 5,150 Thai SMEs. These firms span 17 distinct industries and are categorized into three major sectors: manufacturing (807 firms), trading (1,692 firms) and service (2,651 firms). The dataset is constructed from the annual financial reports of these SMEs, covering a five-year period from 2017 to 2021, results in a total of 22,711 firm-year observations.
In our analysis of insolvency risk across different sectors, the dataset reveals notable variations in insolvency rates:
• Manufacturing Sector: Out of 3,584 firm-year observations, 15.62% of firms were insolvent.
• Trading Sector: With 7,765 firm-year observations, 16.07% of firms faced insolvency.
• Service Sector: Comprising 11,362 firm-year observations, the insolvency rate was the highest at 17.60%.
Conclusion
The empirical findings of our study emphasize the importance of key financial ratios in predicting insolvency among Thai SMEs. Several specific ratios consistently emerged as strong determinants of insolvency risk across the manufacturing, trading, and service sectors: inventory turnover, accounts payable turnover, assets to equity, and debt-to-assets. This indicates that regardless of industry, firms with poor performance in these areas face higher insolvency risks. The findings provide a clear framework for firms and policymakers to monitor financial health and implement risk mitigation strategies.
The sector-specific insights for the manufacturing sector provide valuable details on which financial ratios most significantly influence insolvency risk among Thai SMEs: returns on assets (ROA), gross profit margin, accounts receivable turnover, inventory turnover, accounts payable turnover, and assets to equity. These findings suggest that managing receivables efficiently, maintaining profitability, and limiting debt exposure are critical strategies for reducing insolvency risk in the manufacturing sector.
In the trading sector, our analysis reveals a distinct set of financial ratios that influence the probability of insolvency among Thai SMEs: ROA, returns on equity (ROE), inventory turnover, accounts payable turnover, total assets turnover, and assets to equity. On the other hand, two financial metrics are identified as increasing the likelihood of insolvency: operational expenses to total revenue and the debt-to-assets ratio. The total assets turnover ratio stands out as the most influential financial metric in determining insolvency risk in the trading sector. This highlights the importance of efficient asset utilization in this sector, where maximizing the generation of revenue from assets is critical for survival.
In the service sector, our analysis uncovers specific financial ratios that significantly affect the probability of insolvency among Thai SMEs, highlighting some unique dynamics within this sector: gross profit margin, inventory turnover, accounts payable turnover, total assets turnover, and assets to equity. Three financial metrics are identified as increasing the likelihood of insolvency: operational expenses to total revenue, debt-to-assets, and working capital to total assets. In the service sector, gross profit margin is the most significant factor in reducing insolvency risk, emphasizing the importance of cost management and profitability. The unique effect of working capital to total assets suggests that maintaining an optimal balance between current assets and liabilities is critical for avoiding financial trouble.
The empirical findings highlight important characteristics beyond financial ratios that influence insolvency risk among Thai SMEs. Medium-sized firms are found to have a significantly lower probability of insolvency compared to smaller firms. This is likely due to their greater resources, better access to capital, and more stable operations, which help them withstand financial difficulties more effectively than smaller businesses. Firms structured as juristic ordinary partnerships demonstrate a lower likelihood of insolvency than those operating as ordinary partnerships. The legal distinction likely provides more formal governance structures and risk management, contributing to reduced financial vulnerability. Firms with exclusively Thai ownership face a higher probability of insolvency compared to firms with mixed nationality or foreign direct investment (FDI). This might reflect greater financial stability, access to international resources, or management expertise in FDI firms, making them more resilient to insolvency risk. SMEs located in these regions show a lower likelihood of insolvency compared to those in the central region, which includes the capital city and metropolitan provinces. The central region's higher competition and potentially higher operational costs could increase financial pressure on firms, while firms in less competitive environments might face fewer challenges, such as lower costs and less market saturation, reducing their insolvency risk.
These results underline the importance of firm size, legal structure, ownership composition, and regional competitiveness in determining insolvency risk. Medium-sized firms, juristic ordinary partnerships, and firms with foreign investment, especially in less competitive regions, tend to be more resilient against financial distress.
Implications and Limitations
The findings from the study present several actionable insights that can inform policies and strategies aimed at supporting Thai SMEs and reducing their risk of insolvency. For example, policymakers could organize workshops that provide benchmarks for optimal payment collection periods. This could help SMEs assess their own collection practices and adjust them to minimize the risk of late payments and potential insolvency. Additionally, policymakers could create accessible online platforms or local consultation services where SMEs can receive expert advice on best practices in asset management and inventory control. This could include guidance on inventory turnover strategies and how to optimize stock levels to improve cash flow. Firm managers can leverage the insights gained from the study to enhance their operational practices and safeguard their businesses against insolvency.
Recognizing the limitations of a study is crucial for providing a balanced view of its findings and implications. The analysis is exclusively based on Thai SME juristic persons, which may not capture the complete landscape of SMEs in Thailand. Juristic persons are typically more formalized and may have different operational dynamics compared to non-registered firms or sole proprietorships (natural persons). This focus limits the generalizability of the findings to all SMEs.
The study uses data from the DBD of Thailand, which primarily includes registered firms. This exclusion of non-registered firms means that potential insights from a significant portion of the SME population may be overlooked. Non-registered firms often represent a substantial segment of the informal economy, which can differ greatly in terms of financial practices and vulnerability to insolvency.
* This blog article is an adapted version and was originally published in the Asian Journal of Applied Economics.
[1] https://www.sme.go.th/uploads/file/20240919-124025_SME_Annual_lowres_final.pdf
[2] https://so01.tci-thaijo.org/index.php/AEJ/article/view/274847