A couple of weeks ago, an entrepreneur with a track record of two decades in commodities trading business walked into my office for financial planning. He is a successful entrepreneur with a business which has the ability to generate four to five lakhs income without much effort. Considering that he runs an office with staff strength of five to six people with average salary cost, you would be tempted to call him successful. But the guy has a loan which is more than two times his annual income flow. Needless to say, he is in a complete financial mess.
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| Srikala Bhashyam |
Managing cash flow and liability is a bigger challenge for an entrepreneur and has to be at the top of the list of priorities. Since an entrepreneur does not have the luxury of regular and assured cash flow (at least for a while), financial prudence is a necessity than luxury. The trouble of liquidity management becomes less challenging when liabilities are under control.
Then how does one manage liability when they are needed to grow business? While a traditional accountant would tell you that debt-equity ratio of less than one is always welcome and mangeable, it probably holds good for larger enterprises. In the case of small and medium-sized enterprises, debts are built up in the hope that they would help the business to generate higher revenues over a period of time. The trouble comes when the business faces the pressures of cyclical downtrends immediately after the loan book expansion.
In the case of smaller enterprises where there is no distinction between enterprise and entrepreneur, the loan book includes both personal as well as corporate organization account. As a result, business has the potential to suffer even if an entrepreneur has borrowed for his personal needs. The client who walked into my office was in the above situation as some of his loans were a result of home loans borrowed against multiple properties purchased for personal use. His intention of investing in properties began with the idea of creating assets which were expected to help during the downtrend!
Often, entrepreneurs get into the over liability zone due to a number of factors. Here are some of those:
1. Focus on liquidity: Ask an entrepreneur and he would tell you that his biggest challenge is liquidity or lack of it. Every small scale industrialist would tell you that his business has the potential to grow by another 15-20 percent but the stumbling block is the banker. Since a banker focuses on assets and receivables for fixing working capital limit, no industrialist is happy to deal with his banker. As a result, he ends up with multiple borrowings to meet liquidity needs. While a loan can give instant relief, check out if the business has the ability to service and repay the liability.
2. Fix the term: While borrowing in itself is not a crime, it can be if the business does not have the target to get rid of liability. While borrowing is a continuous process, particularly in the manufacturing sector, every loan should have a mortality rate. So business should focus on closure of loan as part of its business plan.
3. Explore options: It may be easier said than done but often tendency of an entrepreneur is to go for a borrowing which is less tedious despite being expensive. The enterprise should set itself the target of being a preferred bank borrower to enjoy lower rate of interest rather than opting for easy loan products from the unorganized sector which are more expensive. Over a period of time, small and medium-sized enterprises should aim for the next level of funding options like private equity or capital market products which are less expensive.
Critics are bound to argue that loans are an integral component of a business and particularly in non-service sectors where receivables are the main culprits. With payment cycles getting longer in India Inc., companies are forced to take the borrowing route to keep the production running. Over a period of time, businesses too get used to the idea of running these loan books. While loan in itself is not a culprit, the trouble comes when it reaches a flash point. Hence it is important for the business to read these signs well in advance.
For instance, a business which does not have the ability to generate cash flow to meet its interest cost should not have the mandate for fresh borrowing. If an enterprise hasn’t been successful with its operations, chances are that it is unlikely to become even with fresh funds. So, when a business fails to clock profits within the stipulated duration, look for sore points and fix them rather than putting further strain through borrowings.
More importantly, business should get into the habit of creation of wealth after infancy as it would become a habit. A mere focus on volumes would be meaningless unless operations have the ability to leave something on the table. Besides actual expenses, businessmen should also get into the habit of taking care of notional expenses. A classic example is the salary of an entrepreneur. Treat your enterprise as an employer and hence make it pay up your salaries on a regular basis. Not only will it bring the desire efficiency into business but will also make the entire business process accountable.
And a final word for entrepreneurs. Do not get into the habit of creating assets in the hope that it would come in handy for funding your business at a later date through borrowed capital. It is a receipe for financial muddle at a later date.
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Srikala Bhashyam is an investment consultant and runs her own consulting firm in Bangalore. She has been a regular columnist for the print and internet media on personal finance.
To write to the author, please send an email to dare@cybermedia.co.in with the subject line 'Srikala Bhashyam'.
Disclaimer: The views expressed here are that of the author and do not represent the magazine's.
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