Without strong finances, SMEs cannot deliver on sustainability goals

New research published in the journal Sustainability shows that for most small and medium-sized enterprises (SMEs), the ability to innovate or pursue sustainable development is not primarily a question of vision or entrepreneurship, but of financial health.

Titled Innovation for Sustainable SMEs: How Financial Health Drives Resilience and Long-Term Performance in a Transition Economy, the research provides empirical evidence that liquidity, capital structure, and profitability are the decisive foundations that determine whether SMEs can remain resilient and create the conditions needed for innovation and sustainability. The study reframes financial performance indicators as structural enablers rather than short-term outcomes, with direct implications for policy design and SME support frameworks.

Based on a detailed analysis of financial data from 345 SMEs operating across manufacturing, services, trade, construction, and tourism, the study identifies specific financial mechanisms that either strengthen or undermine SME resilience, offering a grounded view of why sustainability ambitions often stall at the firm level.

Liquidity and capital structure define SME resilience

The research identifies liquidity as one of the most critical determinants of SME stability. Firms with stronger cash positions relative to revenue consistently show better financial performance and lower exposure to operational risk. Cash reserves allow SMEs to absorb delayed payments, sudden demand fluctuations, and rising input costs without resorting to high-cost borrowing or emergency financing. In an environment marked by inflationary pressures and supply chain disruptions, this buffer becomes essential for survival.

Capital structure emerges as an equally decisive factor. The study finds that SMEs with higher equity shares in their financing mix tend to achieve higher profitability and stronger financial resilience. Equity financing reduces dependency on debt servicing and interest obligations, giving firms greater flexibility to adjust to market changes. By contrast, excessive reliance on debt is shown to undermine both profitability and liquidity, increasing vulnerability during economic downturns.

The analysis also highlights the role of working capital management. Longer receivables collection periods and extended payment cycles place significant strain on liquidity, especially for firms with limited cash buffers. Inefficient working capital practices amplify financial stress and can quickly push otherwise viable SMEs into liquidity crises. These dynamics are particularly pronounced in transition economies, where payment discipline across supply chains remains uneven.

Rather than treating profitability and liquidity as performance results, the study positions them as prerequisites. Firms that maintain financial stability are better equipped to plan, invest, and adapt. Those operating under constant financial pressure tend to focus on short-term survival, leaving little room for strategic initiatives or sustainable transformation.

Sectoral exposure reveals unequal financial risks

The study’s sectoral breakdown reveals that SME financial resilience varies sharply across industries. Manufacturing and construction firms are identified as especially exposed to financial stress due to their capital-intensive operations and longer cash conversion cycles. These firms often require substantial upfront investment in machinery, materials, and labor, while revenue realization may be delayed by project timelines and contractual payment structures.

Service-oriented and trade SMEs generally exhibit greater financial flexibility. Faster cash turnover and lower fixed costs allow these firms to adjust more rapidly to demand changes. While not immune to economic shocks, they tend to face fewer liquidity constraints compared to capital-intensive sectors. Tourism-related SMEs occupy an intermediate position, benefiting from strong seasonal demand but remaining highly sensitive to external disruptions such as travel restrictions or macroeconomic instability.

Across all sectors, the negative effects of excessive leverage are consistent. Higher debt levels are associated with reduced liquidity and weaker profitability, regardless of industry. This finding challenges growth strategies that rely heavily on borrowing, particularly in environments where interest rates are rising and access to refinancing is uncertain.

The sectoral differences highlighted in the study point to the limits of one-size-fits-all SME policies. Financial instruments, credit guarantees, and support measures need to reflect sector-specific cash flow patterns and risk profiles. Capital-intensive sectors, in particular, require longer-term financing options and improved payment frameworks to reduce liquidity stress.

By identifying these disparities, the research provides a basis for more targeted interventions. It suggests that strengthening SME resilience requires aligning financial support mechanisms with the structural realities of different industries rather than applying uniform solutions.

Financial stability as the gateway to innovation and sustainability

Financially resilient SMEs are better positioned to invest in digital technologies, improve energy efficiency, and adopt sustainable business practices aligned with international development goals. These investments often involve upfront costs and delayed returns, making them inaccessible to firms operating with fragile balance sheets.

The research shows that liquidity and profitability create the conditions necessary for long-term planning. SMEs with stable finances can allocate resources to innovation projects, workforce development, and process improvements without jeopardizing day-to-day operations. They are also more attractive to external investors and lenders, further expanding their access to capital.

On the other hand, SMEs facing persistent liquidity constraints are forced into defensive strategies. Sustainability initiatives and innovation projects are postponed or abandoned in favor of immediate cost control. This dynamic helps explain why sustainability adoption among SMEs remains uneven, particularly in transition economies where financial markets are less mature and support mechanisms are limited.

The study focuses on the role of financial literacy and management capabilities. Sound financial decision-making, prudent debt management, and effective cash flow monitoring are shown to be critical skills for SME leaders. Without these capabilities, access to finance alone is insufficient to build resilience.

Policy implications flow directly from these findings. Programs aimed at promoting sustainable development among SMEs must address financial foundations alongside technological and regulatory incentives. Improving access to affordable financing, strengthening financial management training, and enhancing payment discipline across supply chains are identified as key levers for change.

The research also reframes sustainability as a process rather than a fixed outcome. Financially healthy SMEs are more likely to engage in incremental improvements that accumulate into meaningful transformation over time. This approach aligns with broader sustainability frameworks that emphasize resilience, adaptability, and long-term value creation.