Some ratios for country's industrial recovery with immediate effect

Satyajit Kumar Sharmah Thakur

(sksharmahthakur@gmail.com)

If we make a thorough examination of the most vexatious problems that the government is facing in its efforts for expeditious growth of the economy, it is undoubtedly the very poor progress of the MSME sector. For the reason that in bringing about meaningfully positive changes in the economy, the MSME sector of the country has the most pivotal role, obviously, that sector has been demanding the maximum attention of the government since the trend of going haywire of that sector began in the country. While agriculture, for the reason that land is a fixed factor of production, cannot take the most leading role in the country's economic progress, the MSME sector is easily identified for assuming the most arduous role of the country's economic progress through vouching for meaningful generation of employment opportunities as well. The results of the government's financial benefits extended in different modes to the needy MSMEs are also not satisfactory. Of course, it will be an utterly biased view if at the same time failure on the part of almost all the limping and already wound up industrial units having failed to utilize the government assistances/helps thus creating perils for other stakeholders like the loan extending financial institutions, the preference shareholders and the equity shareholders etc., are spared without any scathing criticisms.

Unforeseen problems will definitely be there. Since they cannot be predicted well, except for being in a state of readiness to face such eventualities, the economy does not have any alternative. Similarly, our MSMEs must also gear up to face similar eventualities. The same being more dependent on internal managements, those MSMEs are having enormous challenges before their managements. I am really astonished to see how the poorly performing industrial units pay deaf ears and blind eyes to all those challenges. Hence, acquaintance with the concepts of management must be ensured by our MSMEs. For instance, a manufacturing unit of an FMCG product must keep a meticulous vigil on inventories remaining unsold in the market. Over and above that there is credit accumulation in the market. Such a situation dries up liquidity.

For such an industrial concern, there is a need for the creation of as much liquidity as possible to ensure a satisfactory liquidity position invariably keeping an eye on the cost of sales of course. That piling up of inventories if not dispatched to bring home liquidity, will inevitably invite the problem of stock-in-trade beyond the due dates of consumption also. In such a situation, budgeted profit has to be compromised on i.e. getting ready to accept less profit than what was determined at the time of preparation of the budget if somehow sustaining losses can be averted. Expenditures, which can be pruned, should be identified and actions should be taken expeditiously. If the sale price is 25 per cent more than the cost of sales, a 10 per cent discount on the sale price directly to the end consumers can ensure substantial betterment of liquidity. There are some areas, which must claim serious considerations by the MSMEs. Though almost all the ratios are of great significance for each and every business concern, some of which is very imperative for almost all the business concerns for keeping in mind always, are explained hereinbelow. Even though in business parlance, all the ratios are important, for those who are fighting for their survival, some ratios as dwelt on hereunder, to me, are a panacea for them.

The reason for people's option for setting up a company is very easily understood. A company is a separate entity apart from its owners i.e. the equity shareholders of the company. Generally, the equity shareholders can be squeezed in the event of winding up of the company, only up to the extent of their respective contributions made through subscription of shares. The company is a legal entity that can enter into contracts and thereby it can bind and can be bound as well. Obviously, a company can have paid-up capital which may be much more compared to the other forms of business like partnership firm and sole trading concern etc. By the strength of accumulation of sumptuous capital, a company can afford to do business on a very large scale thereby gaining several economies in production such as sophisticated machinery, more competent manpower, and more production with high productivity to capture a wide market with more convenience of further expansion etc.

The current assets to current liability ratio are one of the most important financial considerations for most of the manufacturing concerns. Obviously, to be well acquainted with that, there must be thorough concepts of current assets and current liabilities. Looking at the functioning of almost all of the ailing MSMEs, I am convinced that this ratio does not get due respect in their consideration. Current assets include cash and those assets which can be expeditiously liquidated into cash. In addition to cash in hand and cash at bank and equivalents, current assets may include inventories, accounts receivables, prepaid expenses and investments. Those which are not in cash form, to be current assets, must be convertible into cash within 12 months. Current liabilities, on the other hand, include accounts payable, accrued expenses, bank overdrafts, bank loans and interests or notes payable, current maturities of long term debts, dividends payable, income taxes payable, and interests payable etc., to name a few only for instance.

Since the requirement of liquidity is of paramount importance, it must be ensured that the total of current assets is more than the total of the current liabilities. This ratio which is called the liquidity ratio is in connection with a business concern's ability to settle its debt obligations. Even though a very ideal position is when the total of current assets is twice the total of current liabilities, however, that is not so hard and fast. And, an ideal position is dependent on so many factors like nature of the product and service, conditions of market and business strategies of the business concern for future etc. But that the total of the current assets must be more than the total of the current liabilities to signify propitious financial health is quite hard and fast.

Total liabilities divided by total shareholders' equity is the Debt to Equity Ratio. Even though, the suitability of that ratio varies from company to company is subject to a number of factors like nature of the product, the volume of demand in the market, and strategy of the management for the immediate future etc., yet, an ideal Debt to Equity Ratio should be between 1.5 and 2.0. A higher ratio means more risk and in the context of the poorly performing companies, it is marked inefficiency with seeking out aggressive debt financing to obtain enough cash to fulfil debt obligations. However, if that ratio is less than 1, it may mean failure to utilize the paid-up share capital most suitably and on the other, that may be the result of efficient utilization of the equity for already ensured very satisfactory financial fortification of the business. But quite undoubtedly, a very high Debt to Equity Ratio is very dangerous and in the event of the winding-up of such a company, the equity shareholders are likely to suffer very much as I have already mentioned. Therefore, the management must be very sensitive to this ratio so that the paid-up equity share capital is utilized in the most productive way.

Availability of most liquid funds such as cash-in-hand and cash-at-bank is very important for the immediate requirement of cash. In business parlance, cash and accounts receivable divided by current liabilities gives us the Acid Test Ratio, which is very important for the short term operation of the business. If for meeting the cash requirement in the short run, there is no sufficient liquidity, a business is likely to suffer very much with the impact of that on the future prospect of business as well. Therefore, the business concerns must evaluate very scientifically the requirement of their liquid funds for meeting the necessities of current liabilities in the short run considering all the factors associated therewith. I strongly advocate for maintaining at least a 1:1 Acid Test Ratio and in the event of its becoming less than that, there is an urgent necessity of creating more quick assets.

All business concerns are with the main objective of earning profit. Gone are the days when the prime objective of the public utility concern was service to the people and profit earning was rather secondary. The concept of Net Profit Margin is, therefore, quite an indispensable consideration for all the business concerns nowadays. Net Profit Margin is how much net income or profit is generated as a percentage of revenue. Therefore, it is the ratio of net profit to revenue for a company or any other business concern which is typically expressed in percentage but that can be expressed in decimal form also. Since, for every rupee of revenue how much is the net profit that this ratio exhibits, that is why for every business concern, the net profit margin is an imperative consideration. Any reduction in the percentage is a matter of seriousness for the management to take action to set right the factors responsible for the erring trend of the business.

The most alarming situation arising out of the failure of most of the companies in the financial suffering of the equity shareholders of those companies. The equity shareholders are the owners of the companies but in the event of winding up of a company, before the claim of the equity shareholders, claims of most of the others like the sundry creditors, loan extending financial institutions, preference shareholders etc., come and only if anything remains after meeting those preferential claims, the equity holders' claim is entertained. Even in respect of the declaration of dividends, we notice how many companies declare dividends and how meagre the dividend amounts of a number of companies are. The position of the equity shareholders being so, we find the very indifferent and callous attitude of a number of companies showing main concern for hefty financial packages of those in the top management only.

Keeping long-term prosperity in mind, the management of each company should try to satisfy the equity shareholders of the company through a very favourable positive Return on Equity Ratio i.e. division of net income by shareholders' equity. While debt is a burden and in case of winding up of a company, the forms of debts like loans from the financial institutions, and the claims of the debenture holders, the bondholders etc. must be settled before arriving at any figure for distribution amongst the equity shareholders, in India, we have noticed with great dismay how the interest of the equity shareholders is put on back burners ignoring their interest, by growing numbers of companies. But the management should not forget that raising capital through issuing fresh equity shares is a very convenient step for most of the companies and for that to create a satisfactory turf for the equity shareholders, return on equity is of paramount importance.

Before us, there are the cases of Vatsa Corporation, Lanco Infratech, Reliance Communications Ltd., Reliance Naval & Engineering Ltd., Jaypee Infratech, Kaushalya Infratech, and Electrosteel Steels Ltd. etc. to name a few only and out of them, some were wound up long ago due to sheer mismanagement. Such managements are the main reason why the confidence of the prospective subscribers to share capital is on the decline and it is a very unhealthy sign for the country's capital market.

Considering the imperativeness of responding satisfactorily to the government endeavours to bring the ailing business units to the track of progress, while I do strong advocacy for the healthy maintenance of all the applicable ratios, generation of liquidity through an increase in production, productivity and resultant sales in the market, must occupy the driver's seat.