The market is ruled by working capital and companies require them to keep up with the growing competition. Not being able to identify the working capital needs of the company can lead to distress and even bankruptcy.
Now that the need for working capital is established, it is critical to understand the ways of acquiring it. It is time to move past the traditional method, which eventually might become obsolete, and look for something that aligns the urgency to access the capital. Taking note of this issue, we decided to get it addressed by someone who is a maestro in this field. Mr. Prasanna Madhyasata, Head of Enterprise Business at KredX has come up with a series of blogs which will guide our readers to understand the term ‘working capital’ and the means to acquire it. The first blog of the series, ‘Finding A Sustainable Working Capital Solution’ educates the readers about the importance of working capital and how to identify the need for it.
In an ideal world when one runs a business, the realisation of funds immediately against the sale of any goods/services and all related expenditures are paid only after the accomplishment of the sale of goods/services. The services include payment to purchase raw materials, plant and machinery, spare parts and others like technology, manpower, logistics to name a few.
Today’s business ideologies demand a far more effective financial assistance to reap the benefits. Businesses flourish as per the need, and market drivers and hence, the need for working capital arises. Finding a sustainable working capital solution has become a significant activity for a growth-oriented company and therefore, an organised working capital solution is the ideal path for taking the company’s growth to newer heights. It’s unfortunate that many good ideas and businesses have succumbed as they were unable to find a working capital solution. CRISIL’s analysis of nearly 1,700 MSMEs (annual turnover up to Rs 2.5 billion) shows that their working capital gap — or the difference between current assets and current liabilities (excluding short-term bank borrowings) — has widened consistently since the financial year 2015. The working capital gap is estimated to be expanding for the services sector at 16 per cent annually, compared with 13 per cent for the manufacturing industry. The reason is due to payment delays, especially in the services sector.
Liquidity is required for running the day to day operations in a good business model by bridging the gap between receivables and payables, keeping in mind the company’s growth is working capital.
Working Capital – A Catch 22 Situation
Traditionally, Indian businesses have always managed working capital gaps either by own funds, funds from friends and relatives, private financiers and through financial institutions.
An unideal situation is when a business relies upon investing funds to meet the working capital needs as the amount raised, in most cases, is insufficient.
Borrowing working capital from friends and relatives don’t make a sustainable model. The cost of private financers is usually higher than the margins available in the business market and considered solely in a worst-case scenario.
Mundane and Outdated Strategies
Financial Institutions – India has a history of more than 100 years of financial systems, but in the recent past, we have been observing drastic changes in the Indian economy and hence the businesses. These factors must be taken note as far as solving the problem of working capital is concerned.
The current framework in the contribution of the financial sector towards solving the need for working capital to businesses in our country:
- A report driven by the financial statement restricts the access of liquidity to companies with a history of more than three years.
- A more technical approach to evaluation – concentrates on profitability.
- Only stable companies with a standard percentage of growth are targeted for solving the liquidity problem.
- Companies that are growing and are willing to provide additional security in the form of land and buildings, plant and machinery or any other kind of collateral will get access to liquidity.
- Most of the promising and growth-oriented sectors that are indicators of healthy growth of economy are left out or ignored, in providing access to cash especially industries like logistics, warehousing and packaging, workforce and staffing, others include companies in service sectors, emerging corporates across various sectors, etc.
- The period between identifying the need for working capital and getting the same from financial institutions is long. Moreover, not a single financial institution meets the entire need leading to multiple exposures. The whole work process and the cost involved in getting the same approved and managing becomes tedious.
- Off-late, the Indian financial system is busy in tackling the current problems of their own like increased percentage in a stressed portfolio and liquidity issues.
According to the latest proposal by the central bank through a draft, the guideline is to make all borrowers enjoying working capital limit in excess of Rs. 150 crore to compulsorily borrow through the demand loan route for at least 40% of the limit before touching other modes like cash credit, overdraft, bill discounting, etc.
Next Generation Radical Move
The economy has been shifting to a more organised and transparent way of running businesses. On the contrary, with re-structuring of direct and indirect taxes adding more taxpayers to the list, need of working capital from a legitimate source with a new and or alternate approach to access to liquidity has become the need of the hour.
With the economy making great strides and growing at an exponential rate, newer concepts/ideas leading to favourable emerging businesses and the country’s consumption on both B2B and B2C increasing, solving the liquidity problem is something that businesses today expect.
Read more about the current trends of tackling working capital gap and what alternate solutions are available in the market to meet the liquidity requirement of your growing business in our next blog ‘Winning tactics to overcome working capital issues’.