1. www.smeworld.org49AUGUST, 2014
orking Capital
is a lifeline for
Wany business
more so in the case of small
and medium sized
enterprises (SMEs). With
the ever increasing cost of
operations, in particular the
high cost of finance by
financial institutions in
India, management of
working capital (WC) has
become more important than
ever. And therefore prudent
working capital
management (WCM) is vital
to ensure success of SME
businesses.
most important shift in thinking has to
be that WCM is not the responsibility
of the finance department alone. The
way to make sure that cash-focused
management happens is to use key
performance indicators (KPIs) on
working capital all the way down the
business to operational level. Ensure
that the KPIs are aligned with
individual managers' responsibilities.
Cash management should be an active
process, linked to improvements in
working processes. Hence, working
capital improvement should be
integrated into the firm's strategic and
tactical thinking, rather than viewed
just as an act of hard negotiation with
your stakeholders.
Lack of proper finance
department
Accounting is generally not viewed as
a core part of many businesses; hence
SMEs tend not to employ qualified
accounting personnel. In most cases it's
a trusted family member or a trusted
aide that's overseeing the finance
portfolio if not the promoter himself.
The operative word being “trust” and
not “ability.” Finance departments
generally consist of a few low cost
employees to manage day to day
transactions and oversee administrative
activities. Most of these SMEs assume
they are saving money by employing
`cheap labor' to carry out accounting
functions. Also most SMEs go to
professional accountant or project
financing firms only when they have to
complete their books, file taxes or
present financial statements and cash
flow to their bankers to support their
loan applications. An “in the know”
www.smeworld.org48AUGUST, 2014
finance professional would be able to
conserve WC effectively and
identifymultiple instruments to help
raise capital as and when needed by the
business. There are host of special
situation financial instruments
available in the market these days for
SMEsto raise capital and expert
knowledge can assist you in unlocking
the full potential of your business.
Don't forget to collect your
cash
As obvious as it may sound, many
businesses fail to implement effective
ongoing collection procedure to
prevent buildup of overdue funds or
excess old debts. Customers should be
asked if invoices have been received
and are clear to pay and, if not, to
identify the problems preventing
timely payment. Customers
will give all sorts of excuses
to pay late. One of the most
common is an inaccurate
invoice, so make accurate
invoices a key performance
measure for receivables
billing. Do not hesitate to
follow up effectively as in
most cases it's just lethargy or
lack of proper processes that's
delaying a payment and not an
intentional desire to hold up a
payment. The power of follow up is
most evident during year ending when
old invoices are brushed up, frantic
calls are made and payment collections
are expedited. This habit of timely
collection should be part of the DNA
and not a once a year activity.
Bring down your cost of
Finance
It's an active practice in India to
“manage” profits using various
methods including innovative
accounting methods and cash dealings.
Low profits lead to lower taxes.
However one of the biggest challenges
in showing low profits is the impact it
has on your firm's external rating. All
financial institutes determine their
internal rating and hence the cost of
debt to be issued based on these
ratings. Is the tax saving more
Accounting is generally not
viewed as a core part of many
businesses; hence SMEs tend
not to employ qualified
accounting personnel. In most
cases it's a trusted family
member or a trusted aide that's
overseeing the finance portfolio
if not the promoter himself.
significant than the interest burden on
your WC? Moreover lower ratings
mean a higher rate of interest and
reduced access to affordable capital.
The capital constraint can hurt most in
cases when the business has an order
from a client but lacks the working
capital to service it. Hence never forget
the old English adage “Penny wise
Pound Foolish”. Actively monitor the
risk reward ratio of your cost of funds.
Make expenses more visible
Even expense claims with small excess
amounts can have a cumulative
negative impact on working capital.
The key is to set clear rules in all key
areas of expense, be it travel,
accommodation, petty cash expenses
etc. – and then to ensure that these are
followed. It is important to have the
tools to monitor expense claims
without huge manual effort. Currently
many small business owners in India
micromanage expense and go through
each claim or bill in detail thus
investing precious promoter
bandwidth. This is unsustainable if the
SME wishes to scale up significantly
and hence the habit of inculcating good
processes and tools must be developed
from an early stage.
To summarize, think innovatively
along different lines to manage
working capital better. Being aware of
the pitfalls and by taking small
proactive measures healthy capital
management habits can be developed
and WC issues can be significantly
addressed.
money would have earned even if it
would have been invested in secure
debt instruments. The challenge arises
when business profitability comes
under pressure or sales go down, as it's
then difficult to quickly change set
working capital habits within the
company and outside. Pushing regular
customers to pay faster than usual,
negotiating with regular vendors for
delayed payments etc. is very difficult.
Some of the key areas where
businesses need to change their
approach based on our experience of
dealing with SMEs over the years are
as below.
Change your perspective:
There is more to WCM than simply
pushing debtors to pay as early as
possible, delaying payment to
suppliers as long as possible and
keeping stock levels as lean as
possible. Any properly planned WCM
program would certainly focus on
optimizing each of the above
components, but that's not all. The
WC is an invisible form of cost as it
occurs mostly due to timing difference
between expense/purchase payment
and collection of customer's due
balances. It can creep up gradually and
even before the business realizes the
working capital investments in the
business would have shot up
significantly. Often SMEs are so
caught up in running the business that
they do not realize the 'creeping up'
working capital requirements
particularly if the business has good
profitability or a cash/overdraft limit
with a bank.
One barometer of efficiency of a
business is how tightly it can manage
WC. Some SMEs think that since the
working capital is cyclical, and the
money ultimately is recovered, it
should not be a major issue if working
capital goes up. They fail to factor in
the opportunity cost i.e. what return
this money would have earned had it
not got tied up in working capital. You
can take a bare minimum opportunity
cost of at least 9% interest that the
Some SMEs think that since the working capital is cyclical, and the money ultimately is recovered, it should not be a
major issue if working capital goes up. They fail to factor in the opportunity cost i.e. what return this money would
have earned had it not got tied up in working capital.
SMEs Need to Improve
Working Capital Management
Chirag Mehta
Chirag Mehta is a Director, Clip Financial