Rushing to the aid of small textile units in Tamil Nadu is all very well, but the manner in which their affairs are mismanaged also needs to be understood.

It is reported that 79 micro-, small and medium enterprises (MSMEs) fall sick in a day, probably three units an hour. Out of 1.33 crore sick units in the country, more than two lakh are currently sick and 29,000 units are being added to the list every year. In financial terms, these units account for more than Rs 7,000 crore of outstanding loans.

A unit is deemed to be sick in the following circumstance: when, after borrowing from financial institutions, it has not paid its instalments on due dates; the situation continues for more than six months in this way; and there is an erosion in net worth due to reported losses to the extent of half of its net worth in the previous accounting year.

In Tamil Nadu, for example, out of the 14 lakh SME units, 25,433 units are sick with 566 of them eligible for rehabilitation according to the guidelines of the Reserve Bank of India. Recently, there was a strong representation from textile units on the need to rehabilitate sick textile units, involving about Rs 50,000 crore.

After a lot of deliberations, the reference by the Ministry of Finance to the RBI did not elicit a positive response. It was thought that since only 22 per cent of the textile units had suffered, a mass-crisis approach to the problem was not warranted.

Thanks to some initiative by financial institutions, a relief package is likely to come of these discussions. But to ensure that efforts to help MSMEs in the sector do not lead to nought, the problems of these units should be understood. Or else, it might become a case of throwing good money after bad.

A study of each case will reveal some common factors, which can act as an insight for both financial institutions and new MSME players.

The textiles story involves unscrupulous speculative trading in cotton, pushing prices high and bringing it down in a short span, resulting in losses at lower prices of yarn. While this is the macro-reality, the nitty-gritty of management need to be accorded some attention.

How can a turnaround of textile MSMEs be brought about?

INFORMATION DEFICIT

Review and Documentation: Lured by the promise of some promoters of industrial/textile parks in Tamil Nadu, we find some first-generation entrepreneurs, who have traditionally been farmers, selling their land and starting micro-units in textile weaving, with little technical know-how. They find it difficult to break even, due to the unfulfilled promises of such industrial park promoters on issues such as power, export potential, water and roads.

As a result, the capital outlay and bank finance become non-performing assets, resulting in wastage of resources. Hence, any first-generation entrepreneur must take professional advice on documentation and technical details of the project, by earmarking a small portion of his capital outlays to this end.

Bankers, instead of rushing to give loans to such MSMEs, must also study the viability of industrial parks, as they have the wherewithal to evaluate such industrial parks.

Emu farming in the Tamil Nadu belt is one instance where promoters lured innocent farmers into a financial crisis. The Tamil Nadu Government, in its recent Budget, outlined the New Entrepreneur-cum-Enterprise Development Scheme for first-generation entrepreneurs. But it is yet to be effective.

Quantity versus Quality of Turnover: In their rush to record higher turnover, MSMEs tend to undercut prices, which affect their profitability. They resort to giving long-duration credit, impacting their break-even levels and triggering a liquidity crisis. MSMEs must strive for quality of turnover with lesser delays in realisation, enabling more turnaround of their working capital.

Export Risks: We find many MSMEs weak on the quality control side. Emboldened by the success they see in small exports, they resort to high volume exports without adequate safeguards, such as quality approval by their overseas customers. Not being exposed to export formalities, many MSMEs face rejection of their goods.

Products, involving a two to three months’ production cycle, are stuck up at destination points on account of quality problems raised by overseas buyers. This causes a liquidity crisis. Trade associations can play an effective role and arrange for effective advisory services.

DEBT TRAP

Lack of Qualified Accounting Personnel: We find that even Rs 300-crore units in Tirupur do not have qualified professionals to handle their finance, leaving the function to lesser qualified yes-men. As a result we find the absence of good MIS reporting standards and periodical review of operations on a broader scale.

The first golden rule of effective monitoring of operations monthly is sacrificed for preference for semi-qualified non-professionals. In the case of small units which cannot afford qualified professionals, the relevant trade associations can pave the way for advisory services.

Working-Capital Management: MSMEs must realise that working-capital funding is need-based and is not a permanent item to appear in their books. MSMEs must strive to reduce their exposure on this account when they show growth in sales and profitability, instead of constantly upgrading their exposure in times of plenty and struggling to service the debt in times of crisis.

In the absence of good financial reporting and planning, many MSMEs tend to ignore the need to trim or optimise their working capital.

They fall into a debt trap, thanks to the overenthusiastic financial consultants that they employ to secure renewals. To ensure more transparency in the financials, banks must reinforce independent audit of current assets of MSMEs to ensure that all is well with their portfolios.

A close look at the ailing units reveals that statutory payments such as PF, income tax and TDS slowly fall into arrears, indicating cash-flow problems. Any attempts to gloss them over and look for avenues of enhanced credit will lead to a debt trap. Perhaps this is vital factor leading to the liquidity crisis. Credit rating agencies must include this as one of the parameters while assessing the effectiveness of financial management.

Constant monitoring and guidance can prevent resource wastage of the partners of the enterprise, that is, the bankers, the lender, the supplier, the client, the staff and the Government.

(The author is a Chennai-based chartered accountant.)

(This article was published on September 20, 2012)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.