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BW Businessworld

The Going Gets Tougher

Photo Credit :

have not fallen for the past five years
(Pic by Subhabrata Das)

When the fortunes of the commercial vehicle industry began to wane early last year, it had an impact on the production lines of RSB Transmission, a Rs 600-crore small and medium enterprise (SME) in Pune. Strapped for cash, the company had to approach its banker to restructure its term loans from 12 months to 18 months. The problem did not stop there; its working capital cycle extended to 120 days from 90 days because of delays in payments from original equipment manufacturers (OEMs).
“The only solution was to conserve cash by reducing inventory, taking ruthless expenditure cutting measures,” says R.K. Behera, chairman of RSB. He had to cut down executive travel and other administration costs, such as increments, to maintain operational efficiency. If funding dries up, many SMEs could shut shop.
This is a microcosm of the financial troubles for SMEs in general. Part of the problem, say financiers, is in the way they manage their finances even in normal times: using short-term working capital to finance capital expenditure, for example. “Many SMEs are historically known to use short-term money for the long-term,” says Yogesh Dixit, head of Crisil Ratings. This makes it difficult for banks to lend to them during the downturn because the banker might not know whether the SME would have the ability to repay in the future. Other than banks, SMEs’ sources of finance include non-bank finance companies and personal loans that company owners are able to raise: most do not have access to bond markets or commercial paper.
Suffocated By Inventory
“It is not going to be easy, compared to two years ago,” says Ashima Bhat, country head of emerging corporates and infrastructure finance group at HDFC. She says many SMEs could default on their loans this year. BW’s analysis of 1,000 SMEs shows that inventory levels have not fallen for the past five years; last year, it was 5.5 per cent of sales, compared to large companies where the figure stood at 8 per cent of sales.
The result of the inventory build-up is that SMEs in the automobile and textile industries did not receive any payment from OEMs under negotiated terms, which is normally 60 to 120 days. How are they managing, then? “We are now living on money generated from our subsidiaries abroad,” says Gopal Patwardhan, chairman of Autoline Industries, a Rs 300- crore auto component SME in Pune.
His subsidiary in Butler, Indiana State, US, was generating enough business to support the parent company. But Patwardhan also had to raise Rs 30 crore from private sources to keep the working capital cycle going. “Only SMEs that have access to deeper pockets will survive this downturn,” he says. SMEs have resorted to squeezing their own inventories and availing higher supplier credit from their vendors. “There are several markets where intermediaries (traders) also provide financing support to manufacturers, although the cost of such funds is quite high,” says Nilesh Ganjwala, CEO of Innergize Solutions, a consulting firm for SMEs in Mumbai.
Cash Management
A recent trend has been to insure all trade receivables with insurance companies. But this is just additional comfort, as the process is not time-bound to receive claims against bad debts. “If the working cycle is blocked beyond a certain period, even banks stop recognition of book debts for calculating drawing power (against credit limits),” says Ajith Kamath, managing director of Arch Pharma Labs in Mumbai. Although the pharma industry continues to grow, Kamath says he is being cautious about expansion, and has kept production limited to meeting existing demand. “We never tie receivables to payables, so securing payments early is key,” he says.
How bad can SME finances get? BW’s analysis of the balance sheets of 1,000 SMEs with revenues between Rs 100 crore and Rs 300 crore showed that their debt-service coverage ratio (DSCR) — the ratio of operating income to annual debt service payments — was 0.9 (see ‘Cash Strapped’). A Crisil report says SMEs are not as leveraged as large companies in India; 50 per cent of 32,000 SMEs rated by Crisil show a low debt-equity ratio of 0.34 times.
But their cash accruals are paltry: the ratio of their earnings before interest, depreciation, tax and amortisation (Ebidta) to total income is 21 per cent, whereas for a large firm it is close to 30 per cent. This could be why SMEs are the worst hit during a downturn, besides not having the expertise to manage operational expenses.
Even bank credit has been falling in 2008-09. “Bank credit to SMEs grew only by 35 per cent last year, compared to 70 per cent in 2007,” says Kaushal Sampat, chief operating officer at Dun & Bradstreet in Mumbai. Although the Reserve Bank of India (RBI) has been pushing for lending to SMEs, banks remain cautious.

Source: CMIE

Tough Road To Hoe
So how are SMEs managing to stay afloat? Many have slowed down their capacity expansion, though the pace of growth continues for certain industries that made sound financial decisions, such as Pune’s Praj Industries, an engineering firm. It has managed to keep its working capital flowing by securing advance payment for delivery of a project.
“For both, breweries and distilleries, we follow the practice of advances followed by payment against progressive schedules of implementation,” says Shashank Inamdar, managing director of Praj Industries. Even the company’s international contracts are being executed against letters of credit, so payments were secure in a downturn. “We have a prudent credit control policy which ensures that receivables do not mount beyond a manageable level. This ensures that cash is available all the time, even when bank financing is low,” adds Inamdar.
Similarly, Ghodawat Energy, an SME from Kolhapur that manufactures wind rotor blades and turbines, manages to secure part of the payment with large OEMs well before the delivery. “These advances have kept us alive during the slowdown, and we have internal accruals generated through leasing our land for commercial purposes,” says Shrenik Ghodawat, managing director of the company.
The RBI has frozen lending rates by public sector banks at 8 per cent for SMEs till August 2009. Analysts feel this a great step forward for SME finances. The apex bank has also called for loan restructuring: State Bank of India has restructured 40,000 SME accounts. “The restructuring could reduce the number of bad loans,” says Dixit of Crisil. He says that banks will only fund SMEs when large companies recover or when export demand begins to rise.
The problems for SMEs do not stop there, though; the agriculture sector has been affected too. Last year, many cotton mills had expanded their capacity and bought cotton at higher prices, which were hiked by the government. “But the global demand for textiles went down and many were struggling to operate under full capacity. Such SMEs will be defaulting this year,” says B.S. Siva Kumar, executive vice-president and head of the agri-business group at Kotak Mahindra Bank in Mumbai.
Despite the election results, and general improvement in sentiment, it will be a while before things get better for SMEs. Till then, SMEs will have to depend on the good health of their larger corporate brethren, their banks and Dame Fortune. Or they could manage their financial resources better.
vishal dot krishna at abp dot in
(Businessworld Issue Dated 2-8 June 2009)