Profitability of small and medium industries is affected by factors like the strength of markets, growth of sales, price of inputs, tax rates and a host of other variables. These factors, though mostly external, in the sense that they are largely outside the control of the firm, impact a unit’s margins and profits. However, one factor that is crucial to SME profits and can be reasonably influenced by SMEs is cash inflows or payments made by customers. A Crisil study of 5,000 small and medium enterprises (SMEs) reveals that SMEs can enhance profits significantly if they receive payments on time from their large corporate customers.
Crisil estimates that timely payments from large customers will help SMEs reduce interest costs and improve profitability by around 15%, and have a positive impact on the long-term health and sustainability of the sector.
SMEs with large corporate customers have receivables of 90 to 120 days of sales on their balance sheets, as against 45 days stipulated by the Micro, Small, and Medium Enterprises Development (MSMED) Act.
The Crisil study reveals that high receivables are endemic across industry sectors and geographies. The smaller the SME, the weaker its receivables position tends to be. Small enterprises constitute a sizeable portion of India?s SME space and are the most susceptible to liquidity pressures; it is, therefore, critical that the small entities receive payments on time from customers.
Says Ramraj Pai, director, Crisil Ratings, ?SMEs need to understand the costs and impact of delayed receivables, and factor this into the selling price. Further, industry associations and trading bodies need to increase awareness among SMEs about the provisions of, and the redressal mechanisms under, the MSMED Act.?
SMEs, which have relatively weak capabilities to estimate the actual costs of delayed payments, usually ignore the aspect and seldom factor in it in pricing. The consequence is unexpected losses when payments lag and the firm is forced to mobilise more funds. One possibility is to divert funds from other sources to compensate for the late payments, which will impinge on other functions like advertising. Alternately the firm can raise additional credit to ensure liquidity. But this will burden it with additional interest that will directly impact profits.