Contrast this with the US data — Small and medium-sized enterprises (SMEs), firms with fewer than 500 employees and considered the backbone of US economy make up 99% of all firms, employ over 50% of private sector employees, and generate 65% of net new private sector jobs. SMEs account for over half of US non-farm GDP, and represent 98% of all US exporters and 34% of US export revenue.
Clearly, the Indian SME sector needs to develop, grow and mature a lot more to start contributing to the core growth story in India. Barring a few sectors like Automotive and select engineering there are no other sectors that can take pride of being robust, dependable and quality focused SMEs which can make for a good supply chain contributor to the sector. India has lately begun to understand that SMEs are the prime movers of growth.
Demonetisation has impacted the SME sector in its present form. In the short-term it will have created a lot of uncertainties, but the long-term impact will be positive. In the medium to long-term a lot of SMEs will come into the ‘formal’ economy. Investments in the SME sector will look up and that will drive overall economic acceleration in the country.
Construct of a SME and complexities of managing an SME
In the Indian context SMEs are primarily companies that do not have more than Rs. 6-7 crore in capital investments. They are primarily family owned, flexible and acutely profit focused businesses. Not much is invested on proactive development and compliance. Decision making is centralized and business practices are predominantly informal. Commercial transactions involve an element of cash both at the input and output points of the business. Some sectors like entertainment, restaurants, tourism, unorganised retail, and agriculture are extremely informal and in current state are cash dependent.
Managing SMEs in India is unique. Majority of the SMEs do not have mature management structures, practices and compliance thereof. Financial management involves a mix of formal and informal methods of sourcing raw material and selling finished goods. Some amount of cash is needed in the system for a SME depending on the size of operation. Since management is primarily headed by owners of the business, there is a temptation to maximize profits.
Formal profits get reinvested in the business and informal or ‘leaked profits’ go into the creation of private assets. Businesses need more of formal profits for investments and job creation. Demonetisation has temporarily impacted SME operations since cash has temporarily dried up. Input and output have been squeezed because there is shortage of cash at both ends. In the short term there is uncertainty on how financial transactions need to be treated.
Business practices set to change with demonetisation
Demonetisation has set the cat amongst the pigeons. The entire SME sector is shaken. Businesses are evaluating alternate methods of conducting business. Sectors like entertainment, healthcare, hospitality, food, retail etc. which are primarily driven by the ‘pull factor’ have started to adapt formal systems of transactions at a pace of knots.
There are examples that indicate this. Movies released during the demonetisation period have reported normal collections, the India-England cricket match in Mumbai had nearly 20,000 people watching the game at the ground every single day, restaurants and food vendors are conducting business to near capacity. Digital India has been kickstarted through demonetisation.
The short-term consequences of demonetisation are clearly visible. SMEs do need cash at a transactional level. For examples, salaries of workers and contractors are primarily paid in cash. However, it is imperative on SMEs to change. SMEs that do not take aggressive and well calibrated steps towards change will lose revenues and possibly their credit rating. Companies with high working capital cycles and high operating leverage are especially vulnerable if they do not change.
Demonetisation could well be a blessing in disguise for SMEs. It will possibly trigger a new ‘reset’ that the SMEs so badly needed to grow. With policies like Make in India, Smart Cities, Digital India, etc. determining the new growth path, demonetisation will open a new window of opportunity for SME businesses:
It will force businesses to move from a relatively ‘informal’ economy to a ‘formal’ economy.
It will not allow SMEs to easily leak ‘cash’ through the system. That will result in higher declared profits and will translate to investments into capacity expansion/ augmentation, marketing etc. More jobs will get created. SMEs will have to clean up their operations and introduce more technology into manufacturing, financial transaction management and also customer development.
After demonetisation, banks will have more cash than ever and this will result in a lending rate reduction. SMEs can benefit from these.
US dollar is hardening against the Indian currency. Smaller export-led SME companies can benefit from this arbitrage for a short while as they examine and stabilize in the exports business.
SMEs will embrace e-commerce platforms a lot more for procurement and sales after demonetisation.
What should Indian SMEs do?
SMEs should evaluate all aspects of their business under three clear tenets – sustainability of business, efficiency improvement all round by adapting industry best practices and technology interventions, and creating more financial transparency across the value chain.
Sustainability of businesses
In their present form SME businesses need to de-risk. Work towards a business model that can take any monetary shock and short bust developments. De-risk from local markets by evaluating export opportunities. A stronger dollar will aid in better returns to start with. With cost of capital expected to reduce, SMEs can keep diversifying and investing in newer business areas to keep themselves relevant for longer periods of time.
Efficiency improvement
Demonetisation will influence SMEs to secure themselves from shocks of all kinds. The best proven method to do that is to imbibe industry best practices. Invest in technology and processes that connect supply chains, drive right through operations and reach customers. Collapse time between transactions by adapting the digital medium.
Create more financial transparency
Go digital. Cost of transactions and simplicity will improve in making the entire organization transparent, efficient and compliant. Going digital will become an imperative and not a choice at some point in time. Regulatory and compliance authorities will now expect transactions to be conducted online. This will mean the organization will not handle more cash than required.
There are more opportunities than challenges for SMEs from demonetisation. For once the short term pain and long term gain slogan reverberates positively.
(The writer K Shankar is CEO of Feedback Business Consulting)
Source: Economic Times