Working Capital – Crucial connect to success for SMEs
Running a potential business without sufficient working capital is heartbreaking for any entrepreneur. But a winning strategy has it at its core.
Recently I met an entrepreneur who has developed a very successful business model in a run-of-the-mill ordinary business. The industry-wide margin is just a single digit and entry barrier is quite low. However, he has developed a model wherein the operating margin is teens. The volume of orders on hand is quite substantial and visibility is quite high. He has successfully scaled up and operated at the higher end of value chain.
Due to perseverance, he could develop his business a significant entity in the industry at the national level. However continuous cash flow and stable business growth have probably prompted him to divert his attention to investing in properties. He kept raising debt from various sources by leveraging the cash flow of the business to meet the investment needs. This started slowly eating into liquidity of the business.
With the passage of time, the depleting liquidity started affecting the cash flow into business growth. The company started delaying the payment to suppliers and in turn, the cost of supply has started steadily going up. On the other, the delay started appearing servicing the debt. Also the regular payments like salaries, statutory dies, rentals etc are affected.
The entrepreneur landed himself in an extremely heartbreaking situation. On the one hand, there is an immense opportunity opening for his line of products. Many clients are willing to place more orders. But the intense liquidity crunch thrust on the company, due to the diversion of working capital, depriving it to execute the orders.
It is needless to emphasise that it takes years for any entrepreneurs to create a niche in any business in this competitive landscape. Having established himself in the niche area, he is unable to capitalise the opportunity as at the moment he does not have enough working capital to execute the orders.
Role of working capital:
Every business has a central goal of making money. Many SMEs in India fail to achieve their most important goal. Most often, it is not due to the absence of opportunities, but a lack of strong orientation to efficiently managing working capital.
Working capital is defined as the amount of capital needed to carry on a business or simply “current assets minus current liabilities”.
It reflects whether the company has enough cash to meet the short-term expenses. If you look at many stressed SMEs, you can find that they have strong product portfolio, process maturity or having a relationship with reputed OEMs. However, short of working capital makes them deprive of exploiting these strengths.
Secondly, most businesses do not plan the cash flow forecast and make prior planning to tie up the funds. They wait until they require funding and at that point, they are in a financially weak position. Once they are in that position, it is very rare to get a loan from the bank or other lending houses. Even if they get, the interest rate will be so high that it will pinch them hard.
Importance of working capital:
A sound management of working capital is central to financial stability and operational success
Financial stability: We are all aware that the relationship between sale and debt is very dynamic. If sales go up, the debt will come down automatically. If sales come down, the high debt level will consume the liquidity to service the interest and squeeze the ability to deploy funds to purchase inputs, thereby aggravating the situation. The continued prevalence of such a scenario may push the company into bankruptcy.
Operational success requires that all inputs including labour, ram materials, and other items are readily available to execute the orders. Inability to mobilise the inputs will put the company in a difficult situation. It may even harm the company in terms of penalties & liquidated damages and put at risk the reputation. This may eventually lead to sudden loss of position in the business.
How one can pull back from such a situation?
The entrepreneurs indulging in the situation like the above is not uncommon, especially among the first generation entrepreneurs. However, it is very important to take a pause & analyse the situation and explore the pragmatic solution. One should keep in mind that there is neither a quick fix nor any miracle can happen to save one’s business. They have to take some hard decisions, though painful, in the long-term interest of the firm.
We suggest following few ways to tide over the difficulties.
- Sales turnover is crucial to prevent the debt becoming overwhelming. Work out a strategy to maintain /increase sales by taking suppliers and bankers into confidence.
- Explore equity placement with friends and relatives or explore even high-cost loan. Ensure that such money is not used to retire existing debt, however, pressurising it is. Such money should be used only to revive the sales and in turn, the profit from sales may be used to retire debt.
- Focus on products and customers wherein you can get quick cash even it means lesser profit.
- Reduce overheads and remain nimble-footed to reduce fixed expenditure.
- Explore liquidation of fixed assets. Remember, the value loss from failed business is more than the loss in sale of the asset. Once the business is revived, you can take the liberty to rebuild the asset portfolio.
- Desist from waiting in eternity to secure funding from odd sources or waiting for divine intervention. Business in troubled situation demands more cautious & scientific approach and of course a bit of spirituality.
Efficient working capital management leads to a healthy balance among growth, profitability and liquidity. This helps to capitalise the boom time in the industry on the one hand and equally strengthens the company to ride out the gloomy situation on the other.