Do Cash flow Constraints Stifle Innovation?

May 27th, 2016

Without a doubt, financing is extremely imperative for innovation and development, in particular at the seed and early stages of business development. In spite of the growing importance of entrepreneurial activities, innovative companies face several barriers for accessing finance, such as asymmetric information and financing gaps between investors and entrepreneurs. Indeed, access to finance is a central issue for both innovative entrepreneurs and policy makers alike.

Nonetheless, nusinesses that introduce innovation into their operations are more likely to experience business benefits compared with those that don’t. Benefits include increased revenue (39 per cent), reduced costs (19 per cent) and improved customer service (43 per cent). However, it is a widely held view that research and development (R&D) and innovative activities are difficult to finance in a freely competitive marketplace.

Indeed, the arguments of a link between financing constraints, R&D investments and innovative performances have been previously rooted in economic theory. Raising external funds for innovative investments is subject to difficulties that make firms mainly rely on their own internal finance, as in the pecking order theory of Myers and Majluf (1984). Because of this, financing constraints could end up thwarting profitable R&D investment opportunities when firms fall short of internal funds, leading to a market failure in innovation that adds to that created by the public good nature of R&D knowledge (Hall, 1992). In turn, by dampening R&D investments, financing constraints could be expected to reduce firms’ innovative activity and its impact on their economic performance, as opposed to the case of frictionless capital markets (Carpenter and Petersen, 2002; Brown et al., 2009).

In particular, in Australia, one in five (20.3 per cent) of businesses believe an inability to access funds is the biggest barrier to business growth and innovation, according to the Australian Bureau of Statistics (ABS). Despite these statistics, the fact remains that small businesses are actually some of the most progressive entities in Australia, with as many as 90 per cent looking to leverage innovative practices consistently.

However, many companies focused on innovation are missing out on ways they can boost their cash flow to provide money to meet expenses. One method of improving cash flow is through capitalising on government programs designed to foster new technologies. These are typically administered through the tax system, such as the R&D Tax Incentive, or as a grant scheme, such as the Accelerating Commercialisation (AC) grant.

If cash flow is impairing your ability to innovate, Swanson Reed has just introduced a new R&D tax refund financing service to our clients. With an R&D Tax Offset Financing service, companies undertaking R&D projects are able to receive the benefits of the AusIndustry R&D cash rebates prior to receipt from the Government. Fundamentally, this means that companies can access their R&D Rebates early, allowing businesses to fast-track their access to cash flow and further support their R&D Activities. See our service page for more information on this funding.

What do you think, does cash flow impact your innovative activities?


References:

Myers, S. C., and N. S. Majluf. 1984. “Corporate financing and investment decisions when firms have information that investors do not have.” Journal of Financial Economics 13 (2): 187–221. doi:10.1016/0304‐405X(84)90023‐0.

 

Hall, B. H. 1992. “Investment and research and development at the firm level: Does the source of financing matter?” NBER Working Paper No. 4096, National Bureau of Economic Research.

 

Carpenter, R. E., and B. C. Petersen. 2002. “Is the Growth of Small Firms Constrained by Internal Finance?” Review of Economics and Statistics 84 (2): 298–309. doi:10.1162/003465302317411541.

 

Brown, J. R., S. M. Fazzari, and B. C. Petersen. 2009. “Financing innovation and growth: Cash flow, external equity, and the 1990s R&D boom.” Journal of Finance 64 (1): 151‐185. Doi:10.1111/j.1540‐ 6261.2008.01431.x.

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