Across the world, the backbone of any developed economy has been a robust Small & Medium Enterprises platform. These SMEs are the top employment generators and contribute significantly to the economy and society as a whole. Many towns in developed economy love to invite SMEs to set up shop rather than big Enterprise. The importance of SMEs in the growth of any economy can never be understated.
While the SMEs face multiple challenges in running an efficient operations, the biggest of them all, arguably, would be in the area of working capital. Being the fuel which drives growth for the SME, managing the various levers working capital becomes that much important. A well-capitalized firm is the mark of a robust & efficient organization. While it sounds very simple in theory, the operational details of Working Capital Management can get highly complex basis the business environment, especially for the SMEs as many a times they tend to get marginalized when competing against bigger firms.
First and foremost, the access to funds for any SME in India is not an easy option. Indian banking system has an inherent bias towards the large corporates and despite governments’ schemes time and again for the SMEs, the scenario on the ground remains the same. SMEs have to endure huge procedural, documentary and collateral requirements to get access to funds, which came at a steep interest rates. With the cost of funds not ever in favor of the SMEs, the constant challenge to balance the available resources to get the maximum fuel for growth is the challenge SME CFOs face every day.
Working Capital Optimization is all about optimizing trapped cash in all the three areas: Payables, Inventory and Receivables. While there has been significant developments in all the three areas, the most publicized & focused has been managing inventory, where we have seen several approaches by very well renowned corporations leading to development of great techniques. SMEs also have invested considerable efforts to streamline the inventory process.
Technology has helped bring significant changes in the way payables are managed. However, for SMEs perpetually trying to get the working capital pieces together, this is an area of opportunity, if managed well. So depending on the business cycle, the payables system can be utilized very effectively to manage cash flows. On the other hand, SME can get squeezed from both ends on this front, if not nimble. Buyers can put sudden pressure on requirements due to faulty planning and the SME, in its endeavor to maintain the market share would have to oblige. This sudden upsurge in working capital requirement can bring the SME to its knees. On the other end, if the suppliers to the SME are big firms, then the pressure to pay up for the increase volumes would create a high pressure situations. Majority of the times the SME is stuck between tough terms and large orders.
Receivables is one of the most significant and yet one of the most underrated part of Working Capital Optimization. For SMEs, most of the time this becomes a part of the business operations as the large supplier would dictate the payments terms and to get access to bigger markets, SMEs have no choice but to adhere to these terms. As the payment tenures get elongated, the cost to SMEs go up exponentially due to increased cost of borrowing. SMEs then look for alternatives which, while can help with short term funding, increasing the costs further. Bill discounting, factoring, securitization etc. are some of the options available to the SMEs. These are good options but as mentioned, come with a cost. The other alternative is to ensure collections on time. Having a disciplined approach to collections can yield dividends in the long run. However, the activity of collections also is a time consuming process and takes efforts. SMEs while running a tight ship on manpower, finds it difficult to balance the bandwidth requirements from its sales/marketing staff.
Being disciplined in its approach to both payables and receivables can help create a goodwill among the suppliers and buyers giving the SME an edge when required. One of the ways to approach this would be to partner with someone who can bring this expertise to the SME thus lowering its cost and ensuring the focus of its employees for higher productivity. SMEs should look at leveraging the expertise of established firms and outsource most the support functions. Driven very clearly by well-articulated and measured SLAs, this can be a very effective tool in the hand of SME.