WHY DO SMALL INDUSTRIES REMAIN SMALL? — PART 4
Minish Umrani (Industrial Consultant)
Mobile: 9822390363
FINANCIAL MISMANAGEMENT
Once I received an enquiry from an LED light manufacturing company in Silvassa. I visited their factory.
The company building was very large, but it looked extremely disorganised. The receptionist directed me to the MD's cabin. He was working on his laptop and asked me to wait for ten minutes.
As usual, I began observing his table, cabin and face.
Among various things on the table, I noticed a large stack of cheques in a tray—at least 50 or 60. The top cheque had not been signed, and its date was twenty days old.
When he finished his work, he turned towards me and said, “Yes, sir! Shall we talk now?”
Normally, I first ask the company head about his problems and why he invited me, and write the answers in my notebook.
But while observing his face, I said, “Sir, may I ask you something? I hope you won't mind.”
He smiled and said, “Of course, please ask.”
I said, “I can probably tell you why you called me here. One possibility is that management in your factory is not functioning properly—employee absenteeism, people not coming to work on time, production below capacity, high rejection and so on.”
A slight frown appeared on his forehead. Raising his eyebrows, he said, “Yes. We have almost exactly those problems. But I haven't told you any of this.”
I replied, “I can also estimate some of your other problems. You can tell me whether I am right.”
“You told me on the phone that last year's turnover was ₹25 crore—roughly ₹2–2.25 crore per month.
My guess is that you may have a problem with bill recovery. You probably have four to five months of outstanding receivables—around ₹10 crore.
You should also have inventory of roughly ₹8–10 crore. Of that, perhaps ₹1.5–2 crore is non-moving inventory.”
I watched his face more carefully.
He tried to keep a blank expression, turned his chair towards his laptop, quickly opened Tally and checked some figures.
Then he turned back, stood up and asked in astonishment, “How did you estimate this so accurately?”
It was actually not very difficult.
The stack of unsigned cheques on his table was telling me almost everything about the business.
If he was making payments by cheque and was keeping cheques unsigned for twenty days, he was likely facing a cash-flow problem.
The obvious possible reason was outstanding receivables in the market.
If monthly sales were around ₹2 crore and the gross margin was 30%, around ₹60 lakh should remain before operating expenses.
But if 70–80% of the payments were delayed, and one major payment remained stuck for three or four months, the effect on cash flow would be obvious.
Then, naturally, salaries would also be delayed.
If a large expense—such as buying a car or a machine—was incurred in a particular month, the cash-credit facility could get blocked.
And if workers' salaries were not paid on time, absenteeism would naturally increase.
That was the whole calculation. I made an estimate and it happened to be almost exactly right. I had simply thrown the stone and hit the mango!
I am sharing this incident because higher turnover does not automatically mean that the company is doing well.
The company's financial affairs have to be managed with the same discipline as its operations.
Normally, the size of an industry is described by its sales turnover.
Suppose monthly sales are ₹50 lakh. Even with a 30% gross margin, only ₹15 lakh remains. After all expenses, let us assume that 5% remains as net profit.
That profit is actually your own money.
When you keep investing that profit into the business, the capital base of the business grows. A major part of the capital required for new machinery, space, buildings and other investments comes from these profits.
And it is on this strength that the bank also gives you loans.
But in a small business, the situation is often such that the ₹2.5 lakh appears only in the Profit & Loss account. You may not actually see the same amount sitting in the bank account every month.
For a business to grow, turnover has to increase. And to increase turnover you need raw material, machinery and space.
These cannot be funded entirely through bank loans. You also need your own seed capital.
A small entrepreneur must continuously build that capital.
Let us therefore understand a few commonly used financial terms.
Gross Margin = Revenue – Cost of Goods Sold (COGS)
In simple terms, your net sales for a financial year (the net invoice value before GST) minus the cost of raw material used in the goods sold gives the gross margin.
COGS = Beginning Inventory + Purchases – Ending Inventory
In other words, opening inventory plus purchases minus closing inventory, in rupee terms.
This calculation can also be made every month.
Example:
NET SALES = Rs. 10,00,000/-
COGS = Rs. 7,25,000/-
GROSS MARGIN = Rs. 2,75,000/-
This means that although your sales show ₹10 lakh, only ₹2.75 lakh is available to cover your electricity bill, rent, salaries and other expenses—and, yes, the money you need to take home for household expenses.
If you purchase more than necessary, COGS increases and gross margin automatically falls.
And if you conduct business on credit, you may not see the gross-margin amount actually available in your bank account.
WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES
Working capital is the measure of the assets available to run a business's day-to-day operations.
Current assets include cash, inventory in the warehouse, receivables and other short-term assets.
Current liabilities include short-term loans, payables and other short-term obligations.
Positive working capital means the business has sufficient liquidity to meet its short-term obligations. Negative working capital indicates financial stress.
BANK CC ACCOUNT
When I ask entrepreneurs how much their CC limit is, I often receive an astonishing answer:
“The CC limit is a comfortable ₹35 lakh, but it is blocked.”
“What happened?”
“Last year I bought a Fortuner. I was short of ₹20 lakh, so I withdrew it from the CC. A large payment was expected, but it did not arrive on time. Now whenever money is deposited into the bank, it disappears like a black hole. I cannot use it.”
Then the bank gives an overdraft. That too gets blocked. And the financial struggle continues.
This is not something entrepreneurs do not understand.
Often entrepreneurs are technically sound but weak in financial management.
Maintaining the financial soundness of the business is extremely important because the creditworthiness of the business depends on it.
If you cannot pay salaries on time or pay suppliers on time, your credibility declines. You then have to keep giving one excuse after another.
Doing this continuously makes it difficult to focus on the core business, and the entire internal system becomes stressful.
Micro and small businesses already have limited capital. Therefore, that capital must be used very carefully.
For this reason, a small entrepreneur needs to take several precautions.
.... PART 4 ENDS | 7 July 2024
Minish Umrani (Industrial Consultant)
Mobile: 9822390363
FINANCIAL MISMANAGEMENT
Once I received an enquiry from an LED light manufacturing company in Silvassa. I visited their factory.
The company building was very large, but it looked extremely disorganised. The receptionist directed me to the MD's cabin. He was working on his laptop and asked me to wait for ten minutes.
As usual, I began observing his table, cabin and face.
Among various things on the table, I noticed a large stack of cheques in a tray—at least 50 or 60. The top cheque had not been signed, and its date was twenty days old.
When he finished his work, he turned towards me and said, “Yes, sir! Shall we talk now?”
Normally, I first ask the company head about his problems and why he invited me, and write the answers in my notebook.
But while observing his face, I said, “Sir, may I ask you something? I hope you won't mind.”
He smiled and said, “Of course, please ask.”
I said, “I can probably tell you why you called me here. One possibility is that management in your factory is not functioning properly—employee absenteeism, people not coming to work on time, production below capacity, high rejection and so on.”
A slight frown appeared on his forehead. Raising his eyebrows, he said, “Yes. We have almost exactly those problems. But I haven't told you any of this.”
I replied, “I can also estimate some of your other problems. You can tell me whether I am right.”
“You told me on the phone that last year's turnover was ₹25 crore—roughly ₹2–2.25 crore per month.
My guess is that you may have a problem with bill recovery. You probably have four to five months of outstanding receivables—around ₹10 crore.
You should also have inventory of roughly ₹8–10 crore. Of that, perhaps ₹1.5–2 crore is non-moving inventory.”
I watched his face more carefully.
He tried to keep a blank expression, turned his chair towards his laptop, quickly opened Tally and checked some figures.
Then he turned back, stood up and asked in astonishment, “How did you estimate this so accurately?”
It was actually not very difficult.
The stack of unsigned cheques on his table was telling me almost everything about the business.
If he was making payments by cheque and was keeping cheques unsigned for twenty days, he was likely facing a cash-flow problem.
The obvious possible reason was outstanding receivables in the market.
If monthly sales were around ₹2 crore and the gross margin was 30%, around ₹60 lakh should remain before operating expenses.
But if 70–80% of the payments were delayed, and one major payment remained stuck for three or four months, the effect on cash flow would be obvious.
Then, naturally, salaries would also be delayed.
If a large expense—such as buying a car or a machine—was incurred in a particular month, the cash-credit facility could get blocked.
And if workers' salaries were not paid on time, absenteeism would naturally increase.
That was the whole calculation. I made an estimate and it happened to be almost exactly right. I had simply thrown the stone and hit the mango!
I am sharing this incident because higher turnover does not automatically mean that the company is doing well.
The company's financial affairs have to be managed with the same discipline as its operations.
Normally, the size of an industry is described by its sales turnover.
Suppose monthly sales are ₹50 lakh. Even with a 30% gross margin, only ₹15 lakh remains. After all expenses, let us assume that 5% remains as net profit.
That profit is actually your own money.
When you keep investing that profit into the business, the capital base of the business grows. A major part of the capital required for new machinery, space, buildings and other investments comes from these profits.
And it is on this strength that the bank also gives you loans.
But in a small business, the situation is often such that the ₹2.5 lakh appears only in the Profit & Loss account. You may not actually see the same amount sitting in the bank account every month.
For a business to grow, turnover has to increase. And to increase turnover you need raw material, machinery and space.
These cannot be funded entirely through bank loans. You also need your own seed capital.
A small entrepreneur must continuously build that capital.
Let us therefore understand a few commonly used financial terms.
Gross Margin = Revenue – Cost of Goods Sold (COGS)
In simple terms, your net sales for a financial year (the net invoice value before GST) minus the cost of raw material used in the goods sold gives the gross margin.
COGS = Beginning Inventory + Purchases – Ending Inventory
In other words, opening inventory plus purchases minus closing inventory, in rupee terms.
This calculation can also be made every month.
Example:
NET SALES = Rs. 10,00,000/-
COGS = Rs. 7,25,000/-
GROSS MARGIN = Rs. 2,75,000/-
This means that although your sales show ₹10 lakh, only ₹2.75 lakh is available to cover your electricity bill, rent, salaries and other expenses—and, yes, the money you need to take home for household expenses.
If you purchase more than necessary, COGS increases and gross margin automatically falls.
And if you conduct business on credit, you may not see the gross-margin amount actually available in your bank account.
WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES
Working capital is the measure of the assets available to run a business's day-to-day operations.
Current assets include cash, inventory in the warehouse, receivables and other short-term assets.
Current liabilities include short-term loans, payables and other short-term obligations.
Positive working capital means the business has sufficient liquidity to meet its short-term obligations. Negative working capital indicates financial stress.
BANK CC ACCOUNT
When I ask entrepreneurs how much their CC limit is, I often receive an astonishing answer:
“The CC limit is a comfortable ₹35 lakh, but it is blocked.”
“What happened?”
“Last year I bought a Fortuner. I was short of ₹20 lakh, so I withdrew it from the CC. A large payment was expected, but it did not arrive on time. Now whenever money is deposited into the bank, it disappears like a black hole. I cannot use it.”
Then the bank gives an overdraft. That too gets blocked. And the financial struggle continues.
This is not something entrepreneurs do not understand.
Often entrepreneurs are technically sound but weak in financial management.
Maintaining the financial soundness of the business is extremely important because the creditworthiness of the business depends on it.
If you cannot pay salaries on time or pay suppliers on time, your credibility declines. You then have to keep giving one excuse after another.
Doing this continuously makes it difficult to focus on the core business, and the entire internal system becomes stressful.
Micro and small businesses already have limited capital. Therefore, that capital must be used very carefully.
For this reason, a small entrepreneur needs to take several precautions.
.... PART 4 ENDS | 7 July 2024
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