Altering the scale of the project in the middle of execution- A risk for SMEs in India
Many entrepreneurs while executing the new project, fall to the temptation of revision in the scale of the project without proper funding arrangement and cause misery for themselves.
Recently I came across a case of an entrepreneur who set up a new modern rice processing plant. The capacity envisaged initially at 10 tonnes per hour. They had bank loan sanctioned for this and in addition, the bank had also sanctioned the matching working capital facility to be made available upon commissioning of the new plant.
As the project execution is being progressed, he was getting advice from many sources to expand the capacity to achieve the economies of scale. Encouraged by the advice of friends and suppliers, he decided to revise the scale of the project by three folds. He revised the cost of the project and placed the orders to buy the pieces of machinery and other related equipment to increase the capacity.
However, the decision to increase the capacity was taken without analysing implications of the cost factor and how it is to be funded. The existing business itself was struggling to meet its own requirement and there was no headroom to support the expansion. Neither the promoters have any wherewithal to support the expansion. Secondly, promoters did not approach the bank with a revised proposal. The entire execution was handled without any professional assistance.
As the execution was nearing completion, there is intense stress on meeting the creditors’ demand. Entrepreneur started using the working capital facility for completing the project. Still, not enough, they had to raise expensive private finance to meet the shortfall. By the time the project is ready for operation, there was no money to buy the raw materials. The capacity created is quite huge were as the capacity utilisation was not even 20% due to the paucity of working capital.
The balance sheet is badly bruised and there is no chance of raising any more money from the bank or other sources. The family which is very conservative and prudent in managing the finances, for the first time experience the impact of financial distress.
With the passage of time struggle to manage the financial issues got more complicated and reached a point of distress.
The diagnosis of the case:
In the instant case, there was a blunder of increasing the scale of the project in the middle of execution. The entrepreneur had done new project planning privately not taking professional help and keep all the aspects to him only. However during the implementation, many had come to advise him to increase the scale of the project to improve the market share and experience higher profitability. We observed that in the middle of execution, the entrepreneur like him attract so many advisors who try to sway their attention to change the scope and scale of the project.
Attracted by the better suggestion of higher level of business and associated enhanced social status many entrepreneurs seek to alter the project in the mid-course. However, these kinds of decisions more impulsive than backed by reasoning. This type of intuitive decision-maker relies on feelings, on summary superficial information and his decision is very rapid. Decisions are taken so hostility without thorough review and proper funding plan.
We have been emphasising the importance of robust and impassionate financial analysis of the new project conceived and planned to execute before the launch. We have seen seeing the similar agonising struggles many entrepreneurs are undergoing while setting up new projects.
The assumption that entrepreneurs are fully rational:
One reason for poor financial management is borrowing excessively. This propensity to borrow higher is by and large instigated by Accountants, bankers, machinery suppliers etc. Knowingly or unknowingly they commit a mistake by assuming that entrepreneur is fully aware of what he is doing. They believe that he will repeat the success since is running a business successfully. It is found to be wrong in many cases. There are many instances wherein entrepreneurs have been fallen prey to excessive borrowing which cannot be sustained by the cash flow in the business.
The solution- Be in control:
For SME owners’ Financial Management is a crucial aspect of their business. It is established that anyone who owns or manages a small business needs to be armed with the financial know-how to keep his business running effectively. A key concern for SME owners is cash flow management, more specifically the cash conversion cycle.
A good Financial Management system can protect the liquidity problem of SMEs and is vital to sustain themselves against any adverse external and internal challenges. It is extremely important in India wherein opportunity for course correction is extremely low for stressed entities. Even the well-crafted Insolvency and Bankruptcy code is diluted recently thus effectively forcing the entrepreneurs to abdicate their venture in the event of insolvency proceedings is launched by financial or operational creditors.
Midcourse modification in the project content needs to be handled with care and any change should be effected by analysing the financial implications. Further financial commitment if any should be attended to before embarking on the change of content. One should not forget that frugal management of money is one of the most important factors in sustaining financial capability throughout the execution phase.
Take assistance of independent financial advisors who do not have moorings with lenders or machinery suppliers. If possible retain them throughout the execution phase to support yourself taking appropriate decision.
Change of project content in the middle of execution is fraught with risk of losing out. An entrepreneur is should desist from doing so or if there is a compelling reason to do, approach carefully with due attention to financial implications.