SMEs (Small and Medium Enterprises) play a key role in market-based economies around the world and India is no exception. It is estimated that Indian SMEs employ 40% of the country’s workforce, contribute to 45% of manufacturing output and 40% of exports.
However, a lack of effective financial management prevents many businesses from achieving their potential. CFO Bridge, an on-demand CFO service firm founded in 2012, works extensively with SMEs and startups. Over the years, we have identified patterns of financial management behaviour that businesses should seek to avoid. Here are the top seven.
1. Equating accounting with financial management: If anything, accounting and financial management are mutually exclusive. As Anil Lamba succinctly states in his book “Romancing the Balance Sheet”, the accountant is probably the only non-finance person in the organization! The accountant plays a critical role in capturing the true state of the business. However, financial management decisions are best made by those who fully grasp the implication of those decisions financially and operationally. Credit period Vs. price discount, permanent staff Vs. contract staff, inventory order quantity and re-order level, tax incentive Vs. higher cost of operations, buy Vs. make Vs. lease, bank loan Vs. equity investment etc. are some of the critical financial decisions that a business makes. Even though decision making in an SME may be concentrated in a few executives, it is important to ensure that those making such decisions have the expertise to determine the true financial impact of their decisions.
2. Selective focus on working capital: Often, business owners focus exclusively on the days receivable and days payable. They ignore the time value of money when evaluating trade-offs between credit period and price discounts and the time spent by raw material in the manufacturing process at various stages. This is largely due to SMEs not having the expertise to measure these parameters and not realizing the importance to such measurements. “Businesses will be better served if they evaluate working capital as comprised of micro cycles- a procure-to-pay cycle, a raw material-to-finished goods cycle, a sales-to-collection cycle etc.” V. Srinivasan, Founder Partner – CFO Bridge.
3. Late to identify capital needs: “Firefighting” is a word we often hear as business leaders describe their typical day. Urgent (but not necessarily important) priorities push long-term business planning down the list of priorities. In the absence of long-term planning, a large customer order or the imminent obsolescence of an equipment may trigger a scramble to raise capital. Negotiating from a weak bargaining position, promoters often lose control over their business or agree to terms that endanger the long-term survival of the business. While the impact of mismanaging working capital can be fixed relatively easily, delay in identifying capital requirements can have devastating impact on the business.
4. Choosing the wrong type of capital: SMEs typically do not consider it necessary (or assume that the costs are not justified) to engage experts when raising capital. Instead, they follow advise from their circle of peers. In reality, the choice of the type of capital (equity, debt, hybrid) is a highly nuanced one which is dependent on the operating history, proposed use, available chargeable assets and anticipated volatility of cash flows, among others.
5. Ignoring compliance requirements till it is too late: Many business leaders, when faced with the choice of investing in capacity Vs. compliance, choose the former. In fact, the existence of such a choice is an illusion. The cost of non-compliance can be debilitating and long-lasting. At CFO Bridge, we advise our clients to consider investments in compliance as a long-term investment with assured, high returns, albeit in ways that are not directly measurable. A compliant business will be able to raise more capital quicker, pass prospective client’s vendor audit etc. – priceless advantages to a business operating in a competitive environment. “The cost of ensuring ongoing compliance is actually much lower than what many business owners estimate. When seen in conjunction with the adverse impact of non-compliance, there is a compelling case for SMEs to invest in efficient and cost-effective compliance management systems.” Partner at CFO Bridge LLP.
6. Not utilizing available incentives and benefits: Although not as common as other missteps, some businesses do leave money on the table when it comes to making full using of available government schemes. Most SMEs may be aware of flagship programs such as Credit Guarantee Trust Fund for Micro & Small Enterprises (CGT SME), Merchandise Exports from India Scheme (MEIS) and Service Exports from India Scheme (SEIS). However, many other schemes such as Financial Support to MSMEs in ZED Certification Scheme, A Scheme for promoting Innovation, Rural Industry & Entrepreneurship (ASPIRE), Credit Linked Capital Subsidy for Technology Upgradation (CLCSS), Lean Manufacturing Competitiveness for MSMEs etc. miss the attention of the SME.
7. Mistiming the transition to professional financial management: Having closely nurtured their business from infancy, SME owners are reluctant to let go of the control of the day to day operations of their business, including the finance function. Further, attracting and retaining high quality talent has always been a challenge for SMEs. As a result, they often delay the transition to a professionally run organization. This leads to mis-managed and out-of-control business operations and finances which further dissuade professional managers from joining. On the other hand, businesses that attempt to transition too early find it difficult to retain talent. At CFO Bridge, we believe that there is an optimal stage at which businesses should transition to a professionally run finance organization. While the exact timing of such transition is dependent on the nature, complexity of the business and ability to bear the higher cost, as a thumb rule, businesses that have annual revenue in excess of Rs.500 crores should consider having an in-house, professional finance organization. Smaller businesses may be better off adopting a shared CFO model.