The
current overall economic slowdown and the tight money policy and sustained
levels of high interest rates have heard one important segment of the economy
viz: the small enterprises (SEs).
Over
the past forty years, the moral for funding SEs has been that the promoter
brings in about 20-25% of the required level of working funds and banks lend
the balance. This model is no longer sustainable. An average SE pays not less
than 14% on its borrowed funds. Assuming that only 70% of its total funds are
borrowed, the SE is paying nearly 10% from out if it’s EBIDTA by way of
interest expense. Most SEs work with an EBIDTA of less than 15%. After such
level of interest payment, hardly any surplus is left for them to repay
principal dues, leave alone, ploughing back profits to strengthen its capital
base.
On
top of this squeeze, the SEs that have been suppliers to larger enterprises or
dealing largely with governmental and local bodies have seen the receivable
cycle double by more than two times. They have, however, continued to work with
limits from banks based on the old receivable cycle assumptions. As a result,
accounts become first as under ‘stress’ and then as ‘non-performing (NPL)’.
Banks,
when faced with such a situation, pressurized the borrowers to borrow money and
service the bank interest and principal repayments, an approach that only
accentuates the problems for SEs.
The
problem has to be resolved on two planes- the first relates to the approach of
the banks. Banks classification of loans as NPLs is strictly based on cash
flows. Whether debt and interest payments are overdue for three months or not
is the sole bench mark.
However,
the appraisal, the approval of the credit limits and the monitoring of accounts
are all based on inventory and working capital asset levels and not on cash
flows. The current severe NPL problems of banks have its origin in these two
operations being on different bases.
Banks
must move to sanctioning of working capital limits based on cash flows and as
annual loans with two sub-segments. The smaller segments, say 20% as cash
credit limit, and the larger core portion as an annual loan. The SE must
service interest monthly and apart of the principal (say 12.50%) has to be
repaid during the one-year period. This approach will bring up immediately, any
delays in cash flows for corrective steps.
One
the part of the SEs, they must realize that the old model of 75% or 80% funding
by banks is no longer viable. (Unless they have EBIDTA of 20%). SEs must, in
the current context, bring at least 35-40% of the total funds as their
contribution. In fact, many new banks have silently moved to this manner of
appraisal.
The
other problem faced by the SEs is on their receivable cycle. Legally, the
larger entities (LEs) have to pay SEs within 90 days of supply. Most LEs do not
pay SEs within this period. Some LEs pay the SE through a cheque, but the SE
told not to present the cheque for a defined period. The LEs must be pushed to
use RTGS/NEFT to avoid this practice. The other practice is that at the end of
the 90-day period, in NBFC belonging to the LE group is told to discount the
dues to the SE for another 90-day period, an NBFC belonging to the LE group is
told to discount the dues to the SE for another 90-day period. The SE
effectively bears the interest costs for the first 90-days and then it is
required to bear the discount costs of additional 90-days, in effect providing
180 days credit to the LE. Regulators inspecting books of NBFCs that discount
bills for the suppliers of the larger unit, must look at the original date of
supply to curb this devious practice.
Most
of the operating private equity funds in India look at a minimum of Rs 100
crores at ticket size for an investment. There is a gap therefore, in providing
private equity to SEs who need only Rs 15 crores to Rs 25 crores. While the
SIDBI arm has a presence in this space, the need is extremely large. Larger
banks must get together to promote private equity entities for supporting the
small enterprise, particularly for their long term fund requirements, including
growth capital.
(Author: PH Ravikumar, MD, Money Matters Financial Services)
(Views are personal)
Source: Economic Times, Guest Column, Date 11th May, Mumbai
(Views are personal)
Source: Economic Times, Guest Column, Date 11th May, Mumbai
