Mr. X, who was once a very dynamic entrepreneur engaged in the pharmaceutical business, is now under depression for many years. Family expenses and cost of two daughters’ education was borne by other close family members. His wife was doing some domestic work until both daughters completed their studies. Marriage of both the daughters was solemnized with the help of close family members. This is a real-life story.
The reasons for depression for Mr. X?
Not knowing the seriousness of debt and mismanagement of money in good times. The account becomes NPA and bank initiated recovery proceedings resulting in the sale of all the assets. Being classified as an NPA account holder no more lending by other bankers. He could not recover from the shock.
Yes, debt is dangerous. It is not only killing poor farmers, but even the state of families of small and medium entrepreneurs whose accounts have become NPA is dire.
Apart from the financial and economic impact of NPAs, which we all keep discussing there is the huge social impact of NPAs. The vulnerability of families of entrepreneurs who become NPA. Yes, this is a huge social impact. Imagine the plight of Mr. X and his family members.
The NPA is cancer for the Indian economy. At 4.45 % at Gross level and 10.90% at Gross NPA Plus restructured standard asset situation at banks is alarming. These figures indicate almost 11% of banks’ advances are at risk.
Imagine 11% bad and doubtful debts for any company. The banks’ margin spread is around 2 to 4
%, where PSUs are at the bottom and foreign banks are at the top end of the range.
Money is dangerous. The excess money is more dangerous than adequate money. There are many examples of companies ruined just because of mismanagement of money. In India, there is a saying that companies are sick, but promoters are not.
But this is not the case in every situation. We are seeing the debt impact on the poor farmers. The scene is hardly better for small and medium-sized businesses. Though the total % of banks’ NPA is 4.45%, SME loan to NPA is 4.58% which means the ratio is higher and families impacted are many.
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As per the paper on ‘Non-Performing Assets and Public Sector Banks in India’ presented to the Parliament, factors responsible for NPAs are as under:
- Diversion of funds for expansion/modernization/setting up new projects/helping promoting sister
- Time/cost overrun while implementing
- External factors like a raw-material shortage, raw-material/Input price escalation, power shortage, industrial recession, excess capacity, natural calamities like floods, accident, etc.
- A business failure like product failing to capture the market, inefficient management, strike/strained labor relations, wrong technology, technical problem, product obsolescence,
- Failure, non-payment/over dues in other countries, recession in other countries, externalization problems, adverse exchange rate,
- Government policies like excise, import duty changes, deregulation, pollution control orders, etc.
- Willful default, siphoning of funds, fraud, misappropriation, promoters/management disputes, etc.
The above study and findings will help bankers to monitor and deal with their advances.
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In addition, RBI has earlier this year come out with 45 early warning signs for the banks to know the potential of the account become an NPA. Banks are vigilant about their money, shouldn’t entrepreneurs be equally or rather more vigilant about their survival?
Many a time, entrepreneurs do not understand the purpose of the fund and mismanage the usages.
Short-term funds for working capital is used for long term project purposes which deprives the company of much-desired working capital and business suffers. This suffering is so much so that if the entrepreneurs do not raise adequate working capital in time the account becomes NPA.
Long- term short-term mismatch and fund diversion are rampant across the companies.
Most of the time managing finance for SME entrepreneurs is a challenge. It could be because of not understanding the financial implications of decisions and secondly overconfidence of an entrepreneur about his own capability and understanding.
Both the shortcoming has to be supported and plugged by objective professional advice as the stakes are high and the implication could be socially fatal.
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Every entrepreneur must know about the following important eight financial ratios:
- Total Debt / Tangible Net Worth (Should be below 2)
- Total Outside Liabilities / Tangible Net Worth (Should be below 3)
- PBDIT/ Interest (Should be above than 2)
- Debt Service Coverage (Should be above 2)
- PAT / Net Operating Income (Higher the better, ideally around 6%)
- ROCE (Should be higher than the risk-free rate of market return, ideally around 15%)
- Net cash accrual to total Debt (Should be more than 15%)
- Current Ratio (Should be higher than 30)
(Remember: Use actual stock i.e. removing the dead stock and actual receivables i.e. removing the bad debts, while calculating these ratios. You can’t afford to fool yourself.)
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A weakening of these ratios is an indication of financial stress on the company. Forget bank debt even without debt these ratios are indicators of the health of a business.
SME business should first learn to make a true and fair financial statement, then only they will be able to analyse their business for their own benefit.
Banks are tightening their norms and systems. It would be difficult to escape their clutches if an account becomes NPA. Be it Vijay Mallya or Modi/Choksi escape is difficult. When the escape is difficult entrepreneurs must be ready for the social impact of their negligence or overconfidence while dealing with the borrowed money.
Even dealing with their own money would require some prudence and caution.
Mukesh Ambani in the last AGM decided to become debt positive by pruning the debt.
NPA could be financial cancer. It can spread fast and affect the good business too. Be cautious.
Either become financially literate or consult those who are. Flourishing business can die just due to financial imprudence and negligence. Neither for the banks nor for the business, but for the survival of the self and the family, financial literacy is critical.
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