Rebalancing of Debt by MSMEs to Free Cashflow - an urgent need!!
The Micro, Small, Medium Enterprises (MSME) is one of the most important sectors in the Indian economy, contributing almost 29% to the country’s GDP, and an employer to more than 11 crore people in its 6.3 crore enterprises[1]. Despite this, the sector has always faced ease of doing business concerns on the lines of market facilitation, access to liquidity, etc.
The pandemic only heightened these problems and created new ones, with most of the MSMEs struggling to keep their businesses open, challenged by severe working capital crunch and falling demand. In fact, as per a recent survey by EY, about 70% of the respondents were found adversely impacted due to the global health crisis that had triggered falling sales of their products and services, disrupted supply chains, availability of raw materials, and caused liquidity problems.[2]
The Government’s ‘Atmanirbhar Bharat Abhiyaan’ acts as a major fiscal policy and relief measure package to reduce India’s economic difficulty due to the pandemic with specific emphasis on MSME revival, offering the much-needed support in terms of liquidity and cost-saving measures. At a micro level, an MSME really needs to evaluate more closely its assets and liabilities distribution, debt structure, and how to strike rebalance it in order to achieve enhanced short-term and long-term operational efficacies. A good way to do so is to consider some of the important financial ratios.
Key Financial Ratios That Reflect MSMEs Business Health
Financial ratios can help in doing a performance comparative of one’s business with others within the industry, one’s debt volume and structure, to identify certain trends, such as decreasing cash and increasing accounts receivable balances as well as other predictions that can help the business growth in the long run.
SMEs may take out loans to fund ramping up of production to meet sudden surge in demand, with the expectation that the future sales will cover the borrowing costs. However, the business owner needs to be careful not to overuse debt or leveraging. Here, Leverage ratios can enable the owner to compare the debt-to-equity levels of his business to better finance operations and can help give an idea of how these changes in production will affect the income as a result, something that can give better idea before one borrows. For instance, a lower ratio is considered to be a good indicator that you can repay your debts and can take on additional debt to support other endeavours.
With most MSMEs constantly juggling between meeting their working capital expenses, their ability to pay the bills when they become due and have enough liquidity to meet any sudden contingencies. Therefore, it is vital that the business owners are well-versed with the Liquidity ratio that helps in assess the ease with which one can turn assets into cash.
In continuation to this, another vital ratio is the Solvency ratio – one that reflects the business’ level of liquid cash to meet current debt obligations and is critical in assessing a business’ health in the industry it is operating in. Understanding it and using this ratio effectively can safeguard the business from facing bankruptcy or liquidation.
Efficiency ratio is also used to scrutinize how effectively the company is using its assets and liabilities internally. It helps in calculating the receivables turnover, the liabilities repayment, the volume and use of equity and machinery.
There are many other important financial indicators including profitability ratio; quick and current ratios (that reflect the business’ ability to pay short-term obligations and long-term debt respectively); debt-to-worth; return-on-investment ratios, the list is quite exhaustive. What is important for an SME owner to deal with the challenges of operating in the post pandemic business ecosystem is to have a deep understanding of these financial health indicators in order to be better equipped in keeping their business vitals strong and healthy.
In conclusion…
At a macro level, there are a number of sources of incremental lending and credit lifeline to financially stressed MSMEs, be it government’s relief packages under Atmanirbhar Bharat or Non-Banking Financial Companies (NBFCs). The pre-pandemic challenges still exist that create hurdles for MSMEs’ growth opportunities such as absence of working capital, complex regulatory and licensing mechanism, strict loan disbursal rules, slow digital adoption, and a highly complicated taxation system [3]. However, to emerge stronger in the new normal, MSMEs must look at rebalancing their debt structure and delve deeper into what type of loan facilities, at what interest rates, duration, etc., work for them.
