IMPORTANCE OF IMPORTANCE OF IMPORTANCE OF IMPORTANCE OF FINANCIAL FINANCIAL FINANCIAL FINANCIAL MANAGEMENT FOR MANAGEMENT FOR MANAGEMENT FOR MANAGEMENT FOR SMESMESMESMESSSS’ IN ’ IN ’ IN ’ IN RETAIL BUSINESS IN INDIARETAIL BUSINESS IN INDIARETAIL BUSINESS IN INDIARETAIL BUSINESS IN INDIA
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CHAPTER III
IMPORTANCE OF FINANCIAL MANAGEMENT
FOR SMES’ IN RETAIL BUSINESS IN INDIA
This chapter aims to provide information on the uses of financial
management by the small business owner managers to monitor their business
performance. Attempts have been made to portray the role of SMEs’ in retail
business with a focus on knowledge and financial management practices.
The chapter is divided into two sections. Section I deals with the role of
SME’s in Retail Business. Section II discusses the SME’s function of
knowledge and financial management practices.
SECTION I
ROLE OF SMES’ IN RETAIL BUSINESS
In this section the researcher depicts the meaning of small business and
their characteristics. It also portrays the role of MSMEs’ in retail business.
With the advent of planned economy from 1951 and the subsequent
industrial policy followed by the Government of India, both planners and
Government earmarked a special role or small-scale industries and medium
scale industries in the Indian economy. Due protection was accorded to both
sectors, and particularly for small-scale industries from 1951 to 1991, till the
nation adopted a policy of liberalization and globalization. Certain products
were reserved for small-scale units for a long time, though this list of products
is decreasing due to change in industrial policies and climate.
It has been observed that by and large SMEs in India met the
expectations in this respect. SMEs developed in a manner which it possible for
them to achieve the following objectives:
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• High contribution to domestic production
• Significant export earnings
• Low investment requirements
• Operational flexibility
• Location wise mobility
• Low intensive imports
• Capacities to develop appropriate indigenous technology
• Import substitution
• Contribution towards defense production
• Technology-oriented industries
• Competitiveness in domestic and export markets
At the same time one has to understand the limitations of SMEs, which are
• Low capital base
• Concentration of functions in or two persons
• Inadequate exposure to international environment
• Inability to face impact WTO regime
• Inadequate contribution towards R & D
• Lack of professionalism
In spite of these limitations, the SMEs have made significant
contribution towards technological development and exports. SMEs have been
established in almost all major sectors in the Indian industry such as
• Food processing
• Agricultural inputs
• Chemicals and Pharmaceuticals
• Engineering , Electricals, Electronics
• Electro-medical equipment
• Textiles and Garments
• Leather and leather goods
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• Meat products
• Bio-engineering
• Sports goods
• Plastic products
• Computer software, etc.
3.1 Small Business in India 1
In layman’s language, a small scale business can be termed as ‘project’
or ‘venture’ which involves a small budget, or is run by a small group of
people. According to the definition provided by the government website for
business, business.gov.in, a small scale industry (SSI) is a business setup in
which the financial commitment towards infrastructure such as building and
equipment, on an owner or rental or purchase basis, should not exceed
`. 1crore. However, this ceiling on investment is subject to change by the
Government of India.
3.1.1 Government Rules and Regulations for Small Scale Industries
As per the rules of the government, it is not necessary to procure a
license either from the state or central government to set up a small business
venture anywhere in India. Nor is there a need to register for small business.
However, registering small scale business with the State Directorate or
Commissioner of Industries or DIC's will make it easier for MSME (Micro,
Small and Medium Scale Entrepreneurs’) to apply for financial assistance from
the government bodies such as the Department of Industries. Nowadays, State
Financial Corporations and other commercial banks disburse medium to long
term MSME loans. The National Small Industries Corporation is also a
government body which assists small business owners in availing financial
assistance to procure machinery on hire-purchase basis. The government has
also eased the rules and regulations to avail the benefits of schemes such as
capital subsidy, reduced custom duty on selected items, credit guarantee
scheme, various state government benefits and ISO-9000 certification
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reimbursement, and furthermore, it need not register as a small unit in order to
avail all these.
3.1.2 Sector-wise Growth of Small Businesses in India
The study provides an overview of how small scale industries are
growing sector-wise through figures of employment generated by those sectors.
Food products industry comes on top in terms of employment generation,
providing jobs to nearly 5 lakhs people. The second rank goes to non-metallic
mineral products which created 4.5 lakhs jobs and metal products industry is
ranked three with an employment of 3.75 lakhs people.
It is followed by small businesses like wood products, basic metal
industries, chemicals and chemical products, machinery parts, hosiery and
garment units, repair services, paper products & printing industry, and rubber
and plastic products contribution to employment generation somewhere
between 10percent and 5percent. Therefore the total contribution in
employment generation by the above mentioned sectors is around 50per cent.
The rest of the small scale businesses have less than 5per cent part in the total
employment creation.
3.1.3 Government Policies to Promote MSME Sectors
The government is striving hard to promote smaller scale industries by
announcing different promotional schemes. The first and foremost step of the
government in the direction of providing financial benefits was to announce tax
concessions and certain exemptions on indirect taxes. As a matter of fact, there
were many sick units, where more funds were to be allotted as they needed
rehabilitation.
The Reserve Bank of India formed a committee in 2000, headed by the
Chairman of Indian Banks Association to handle the issue of rehabilitation of
sick small scale units. This committee also undertook the task of providing
assistance in marketing through National Small Industries Corporation by
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providing an umbrella brand, encouraging top quality standards and ISO 9000
certification and setting up Technology Up-gradation Funds.
The government also emphasized on greater cooperation between the
Industry and the Government. Government also asked the small business
owners, to pool their resources with that of the government-resources in order
to create strong partnerships in R&D (Research and Development) to sustain
the global challenge.
A new initiative was taken by the government to help ease the central
and state industrial laws for small scale industries to boost entrepreneurship
and reduce red tapeism. A body under the cabinet secretary was formed to
execute this task. The Marketing Development Assistance (MDA) was
established to help SSI in 2001. The Purchase Preference Scheme was launched
to provide priority to small business units during departmental purchases of the
government. According to the latest news, Indian government agencies such as
the Small Industries Development Bank of India and International Finance
Corporation are planning to set up venture capital funds comprising of a
whopping US $1.4 billion fund for small scale sectors.
In a latest development, the government is working upon to increase the
loan amount to be provided to the SSI to `. 25 lakhs under the Credit Guarantee
Fund for Small Industries (CGFSI). The investment cap is also being extended
to `.5crore from the existing `.1crore for four businesses viz. auto components,
hosiery, hand tools, and granites. The government is also considering to raise
this investment cap to some hi-tech and export oriented industries up to `.5
crore in the wake of growing challenges faced by these industries.
3.1.4 Definition of SMEs in India as well as globally
In India the small and medium enterprises are not well defined. The
internal group set up by the Reserve Bank of India has recently recommended
that the units with investment in plant and machinery in excess of SSI limit and
up to `. 10 crores may be treated as medium enterprises. The definitions of
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small and medium sized enterprises differs from one country to another. SMEs
have been defined as having a number of workers employed as per the volume
of output or sales, value of assets employed, and the use of energy.
The organization for Economic Cooperation and Development (OECD)
defines establishments with up to 19 employees as very small; between 20 and
99 employees as small; from 100 to 499 employees as medium; and over 500
employees as large enterprises. However, many establishments in some
developing countries with 100 to 499 employees are regarded as relatively
large firms.
Small and medium scale enterprises have been defined in various ways
by various people and government agency just as it has been worked on in
various ways by different nations. Micro business has been recognized as
medium scale business.
India has a vibrant micro and small enterprise sector that plays an
important role in sustaining the economic growth by contributing around 39
percent to the manufacturing output and 34 percent to the exports in 2004-05. It
is the second largest employer of human resources, after agriculture, providing
employment to around 29.5 million people in the rural and urban areas of the
country. Their significance in terms of fostering new entrepreneurship is well
recognized. This is because most entrepreneurs start their business from a small
unit which provides them an opportunity to harness their skills and talents, to
experiment, to innovate and transform their ideas into goods and services and
finally nurture it into a larger unit.
3.1.5 New Arrangement and Classification of MSME:
Micro, small and medium enterprises (MSME) sector has been recognised
as an engine of growth all over the world. The sector is characterized by low
investment requirement, operational flexibility, location wise mobility, and
import substitution. In India, the micro, small and medium enterprises
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Development (MSMED) Act, 2006 is the first single comprehensive legislation
covering all the three segments. In accordance with the Act, these enterprises
are classified into two:
(i) Manufacturing enterprises engaged in the manufacture or production of
goods pertaining to any industry specified in the first schedule to the
industries ( Development and Regulation) Act, 1951. These are defined
in terms of investment in plant and machinery.
(ii) Service enterprises engaged in providing or rendering of services and
are defined in terms of investment in equipment.
Both categories of enterprises have been further classified into micro, small
and medium enterprises based on their investment in plant and machinery (for
manufacturing enterprises) or on equipment (in case of enterprises providing
or rendering services). The present ceiling on investment is to be classified as
micro, small (or) medium enterprise.
i. Manufacturing Enterprises
• A Micro enterprise, where the investment in plant and machinery does
not exceed twenty lakhs rupees.
• A small enterprise, where the investment in plant and machinery is more
than twenty five lakhs rupees but does not exceed five crore rupees.
• A medium enterprise, where the investment in plant and machinery is
more than five crore rupees but does not exceed ten crore rupees.
ii. Service Enterprises
• A Micro Enterprise, where the investment in equipment does not exceed
ten lakhs rupees.
• A small enterprise, where the investment in equipment is more than ten
lakhs rupees but does not exceed two crore rupees.
• A medium enterprise where the investment in equipment is more than
two crore rupees but does not exceed five crore rupees.
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3.1.6 Characterization of Small Business
The variety of definition used in these papers is unable to set an
agreeable format for small business definition. The objective of this study is to
suggest some guidelines that can help reduce the level of ambiguity. The
method to reach that objective is through the analysis of five significant
parameters that have been used by different scholars to define small business.
Each of these parameters is being characterized and analyzed in order to clarify
the existing status and for suggesting the less ambiguous alternative for using
that parameter.
I. The business must be independent: For that matter, a subsidiary
or a branch cannot be considered as independent business.
II. The business is not dominant in the industry it is operating in:
part of “Monopolistic competition” definition can be used to
characterize the parameter. There are many sellers who believe that their
actions will not materially affect their competitors.
III. Firm size (number of employees): This parameter is obviously
the most popular among scholars for defining small business;
nonetheless its use varies dramatically. With regard to business in India,
an employer with approximately 50 employees will consider the same as
small business. Taking into account the global scenario, ninety percent
of the operating businesses are employing less than 20 employees; but
50 employees is a more suitable limit. Moreover, business with more
than 50 employees employs operational and managerial techniques,
which has become more similar to those of large businesses.
Characterizing the upper limit brings us half way, in order for us to go
all the way, but the lower limit should be characterized as well. A rule of
thumb is that business with less than five-to-ten employees do not even
have the minimum operational and managerial structure, which can be
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treated as small business. Any business with less than five employees is
inadequate for any analysis, and should be named micro-business.
IV. Firm age: The use of firm age by scholars characterizes the
minimal period of time needed for a business in order to form some
operational and managerial backbone. Otherwise, there would be a risk
that data collected for statistical analysis would not be suitable.
Biggadike (1979), supported by Miller and Camp (1985), concludes that
a new venture needs an average eight years to achieve profitability. The
barrier of eight years should be analyzed depending on several factors,
such as the industry that the firm operates in, or the initial capital raise
for starting a new venture. Moreover, Biggadike based his definition on
the basis of the period needed to generate profitability, which is only one
among the numerous measures of performance. Taking all into account,
a conservative estimation will be that business can be still considered as
new if the period of establishment is two-to-five years.
V. Annual revenue: What can be considered as acceptable annual
revenue for small business? In order to be able to characterize this
parameter, a preliminary step of defining the industry that the business
relates to, must be taken. There is a substantial difference regarding the
revenue in different industries. For example - Annual sales of five
million dollars generated by a car dealer must be treated as entirely
different from the same kind of revenue produced by any other type of
consulting firm. The source of revenue is of great importance. Revenue
from selling goods cannot be treated as revenue from selling knowledge
or labor. Subject to that remark, and for the vast majority of small
businesses that operates in either manufacturing or trading (retail/
wholesale) industries, annual revenue of ten million rupees can be used
as proximity to characterize the upper limit. This annual revenue
correlates with the upper limit of 50 employees, characteristic of firm
size.
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3.1.7 Profile of Small and Medium Scale Retailer Entrepreneurs in India
Most Indian shopping takes place in open markets or small, independent
grocery and retail shops. Shoppers typically stand outside the retail shop, ask
what they want, and cannot pick or examine a product from the shelf. Access to
the shelf or product storage area is limited. Once the shopper requests for the
product he is looking for, the shopkeeper goes to the container or shelf or to the
back of the store, brings it out and offers it for sale to the shopper. Often the
shopkeeper may substitute the product, claiming that it is similar or equivalent
to the product the consumer is asking for. The product typically has no price
label in these small retail shops although some products do have a
manufactured suggested retail price (MRP) pre-printed on the packaging. The
shopkeeper prices the food product and all household products arbitrarily, and
two consumers may pay different prices for the same product on the same day.
Price is sometimes negotiated between the shopper and shopkeeper. The
shoppers do not have time to examine the product label, and do not have a
choice to make an informed decision between competitive products.
India's retail shops are both organized and unorganized in combination,
and employ about 40 million employees (3.3percent of Indian population). The
typical Indian retail shops are very small. Over 14 million outlets operate in the
country and only 4percent of them are larger than 500 sq ft (46 m2) in size.
India has about 11 shop outlets for every 1000 people. A vast majority of the
unorganized retail shops in India employ family members and do not have the
scale to procure or transport products at high volume wholesale level. They
have no quality control or fake-versus-authentic product screening technology
and have no training on safe and hygienic storage, packaging or logistics. The
unorganized retail shops source their products from a chain of middlemen who
mark the product as it moves from farmer or producer to the consumer. The
unorganized retail shops typically offer no after-sales support or service.
Finally, most transactions at unorganized retail shops are done with cash, with
all sales being final.
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Until the 1990s, regulations prevented innovation and entrepreneurship
in Indian retailing. Some retails have to comply with over thirty regulations
such as "signboard licences" and "anti-hoarding measures" before they could
open doors. There are taxes for moving goods, from state to state and even
within states in some cases. Farmers and producers had to go through
middlemen monopolies. The logistics and infrastructure were very poor, with
losses exceeding 30 percent. In the 1990s, India introduced widespread free
market reforms, including liberalisation retail business for private investment.
Between 2000 and 2012 consumers in select Indian cities have gradually
begun to experience the quality, choice, convenience and benefits of organized
retail industry.
3.1.8 Characteristics of SMEs’ Retailers’
Small-store (Kirana) retailing has been one of the easiest ways to
generate self-employment, as it requires limited investment in land, capital and
labour. It is generally a family run business, lacking in standardization and the
retailers who run this store lack education, experience and exposure. This is
one of the reasons why productivity of this sector is approximately 4percent
that of the U.S. retail industry. Unorganized retail sector is still predominating
over organized sector in India, unorganized retail sector constituting 98percent
(twelve million) of total trade, while organized trade accounts only for 2percent
in 2009 and this percentage has changed to 96 percent of unorganized retailers
and 4 per cent organized retail outlets. The undeniable myth is that the
organized global retailers are slowly eating up local retail chains including
kirana shops / ‘mom and pop’ stores.
Some of the factors that could vouchsafe for the long existences of
unorganized retailers’ are:
i. In smaller towns and urban areas, there are many families who are
traditionally using these kirana shops (groceries) / 'mom and pop' stores
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offering a wide range of merchandise mix. Generally these kirana shops
are the family business of these small retailers which have been running
for more than one generation.
ii. These kirana shops have their own efficient management system and
with which they efficiently fulfill the needs of the customer. This is one
of the good reasons why the customer does not want to change the
transactions with the old fashioned kirana shop.
iii. In India a large number of working class people is employed on a
working as daily wage basis. At the end of the day when they get their
amount, they come to this small retail shop to purchase wheat flour, rice
etc., for their supper. For them this is the only place to procure those
food items because purchase quantity is so small that no big retail store
would entertain this.
iv. Similarly there is another consumer class the seasonal worker. During
periods of unemployment such people used to purchase from this kirana
store on credit and on receiving their salary, they would clear their dues.
Now this type of credit facility is not available in corporate retail stores.
So these kirana stores are the only place for them to cater to their needs.
v. Another reason might be the proximity of the store. It may be
conveniently situated for the customer. In every corner of the street an
unorganized retail shop can be found, hardly walking distance from the
customer's house. Many times customers prefer to shop from the nearby
kirana shop rather than drive to a long distanced retail stores.
vi. These unorganized stores are having a number of options to cut their
costs. They incur little to no real-estate costs because they generally
operate from their residences. Their labour cost is also low because the
family members work in the store. Moreover they use cheap child
labour. As they are operating from their homes, they can pay for their
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electricity/ transportation utilities at residential rates. They do not even
pay their taxes properly.
Currently the value of the retail market is estimated at around US $ 270
billion with a growth rate of 5.7 percent per annum according to the Indian
retail report which creates a big threat for the small unorganized retailers. The
well-established organized retail sector in India are Pantaloon Retail, Shoppers'
Stop, Spencers, HyperCITY, Lifestyle, Subhiksha & Reliance, besides many
newly emerging ones. Over 20,000 new retail outlets are expected to open
within this segment. Major corporate retail like Wal-Mart have started to take
over the Indian retail sector.
But, in India, the unorganized retail is source foods and other necessities
of millions of Indians, which is the major link between rural and urban
societies. It also acts as a convenient store for the customer offering right
products at the right time in the right place. In a country with a wide population
and high level of poverty, this model of retail democracy is the most
appropriate. So these unorganized retail sectors need to be promoted so that
they can organize and supply food to the Indian consumer.
SECTION II
RETAILERS’ SMES’ FUNCTION OF
KNOWLEDGE AND FINANCIAL MANAGEMENT PRACTICES
After discussing the SMEs definition, the study will analyze the
components of financial management with apt illustrations and the techniques
used in the SMEs. A discussion is presented in the following identified six
components of financial management: financial planning and control, financial
accounting, financial analysis, management accounting, capital budgeting and
working capital management.
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3.2 Importance of Financial Statements for SMEs’ in Retail Business
Accounting plays a critical role in decision-making. Accounting
provides the financial framework for analyzing the results of an executed set of
decisions and makes possible the continuous success of a business or
improvement in operations. Secondly, accounting provides much of the
necessary information needed in making good decisions. Thirdly, the
management accountant provides knowledge of basic decision-making tools
that help to find the best alternative in decision-making. It is the accountant’s
knowledge about preparing financial statements and his other abilities to
analyze and interpret financial statements that make the controllership function
in a business valuable to management. However, it is also important for the
management to have a fundamental knowledge of financial statements,
particularly regarding the analysis and evaluation of financial statements to
make decisions.
A primary objective of a business is to increase the assets from
operations. By operations is meant all the revenue and expense transactions of
a business for a defined period of time. Since the excess of revenue over
expenses (net income) increases the equity of a business, it is often said that the
primary objective is to increase stockholders’ wealth, assuming that the
business is a corporation. The success of a business in financial terms, depends
on how well a management manages revenues and expenses. In other terms, the
decisions that management makes concerning the operations of the business are
of paramount importance. Management has the responsibility to make the kinds
of decisions that generate net income.
Well-maintained and balanced accounting records are one of the vital
parts of a business whether it be large or small, a start-up, or a long-standing
business. When things are financially unstable, good accounting records can
provide the business with answers as to what changes to make or what to do
away with, in order to keep their business growing and prospering. There are
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many answers to good business management in the form of accounting records.
In order to keep good business accounting records, entrepreneurs need to have
a good accounting program and the knowledge to keep it well-organized and
up-to-date. Everyday accounting and financial information will need to be
processed and reviewed in order to achieve the goals and to be able to predict
future finances. Knowing where the money is spent and how they can reduce
costs are some of the most vital issues in starting and developing business.
A SMEs’ accounts record held on an accounts ledger gives a detailed
description about profits and losses in a cash spreadsheet format. Auditors and
stakeholders can study these financial statements and determine the accuracy
and integrity of their business. An accounting statement also distinguishes the
success ratio of the present business from past progress using accounts formats
that are recognized by other companies and bodies.
3.2.1 Accounting and Financial Management Practices in India
In India, there exists a wide gap between theory and practice of
management accounting in case of small business. On the other hand, financial
accounting system is based on the traditional “Mahajani” or “Baniya” in North
India and “Chettiars” system in the south but is incomplete by nature. The
result of the earlier studies highlights the wide gap between theory and practice
of financial management. That is, in India, small business owner-managers
may hardly find the existing financial management techniques of use. At the
same time, little effort has been made in the field of research on developing
tools and techniques for small business. With their peculiar problems and
limited resources, this small business sector generally “relies more on
traditional accounting namely financial and taxation matters, rather than
financial management”. The theories of financial management so far developed
have little relevance in catering to the specific needs of the small business.
Thus, the theory and practice of financial management being interdependent
may form a vicious circle hindering the growth of this vital sector. In this age
of heavy competition, sophisticated financial management tools cannot be a
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luxury for small business units to flourish. However the onus of designing a
suitable kit for financial management for small business lies on the academics,
which in turn calls for the need of a “real life research”.
3.2.2The Traditional Financial Life Cycle of the Firm At various stages of growth, there are different levels and formats of
finance that can be exploited by the SME’s owner. The traditional financial
life cycle of the firm includes the following:
EXHIBIT: 3.1
TRADITIONAL FINANCIAL LIFE CYCLE OF THE FIRM
Stage Source of Finance Potential Problems
Inception Growth I
Owners resource as above plus:
retained profit, trade credit,
bank loans and overdrafts, hire
purchase, leasing
Under capitalization
“over-trading”
liquidity crises
Growth II
As above plus; long term
finance from financial
institutions
Finance gap
Growth III As above plus; new issue
market
Loss of control
Maturity All sources available Maintaining ROI
Decline
Withdrawal of finance firm
take-over, share repurchased(es)
liquidation
Failing ROI
Source: Developed for this study
This traditional view of the financial life cycle of the firm is found, for
example, in the finance text by Westonard Brigham.
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3.2.3 Financial Management in Business
The financial manager obviously is of high importance for the survival
of the firm both in the short and long run of the life of the business. In all forms
of business units, financial management systems are of crucial importance. In
fact, they are of significance to business success. Indeed, prior research has
asserted that the quality of accounting information utilized within the SME
sector has a positive relationship with an entity’s performance. Similarly, it has
been emphasized that there is a need for financial information for small and
micro business units due to the volatility normally associated with their
situation such as unstable cash and profit positions, and reliance on short-term
debt.
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EXHIBIT: 3.2
SIX FINANCIALMANAGEMENT
COMPONENTS AND TECHNIQUES
Source: Mohd Amy Azhar.B. et.al(1990)
Financial
Analysis
Current Ratio
Quick Ratio
Operating Profit Margin
Return on Assets
Return on Equity
Debt Ratio
Management
Accounting
Standard Costing
Just in Time
Activity Based Cost
Balance Scorecard
Capital
Budgeting Payback Period
Net Present Value
Profitability Index
Internal Rate of Return
Average Rate of Return
Financial
Accounting
Balance Sheet
Income Statement
Cash flow Statement
Working Capital
Management
Cash Management
AccountingReceivable
AccountingPayables
Inventory Management
Financial Planning
and Control
Financial Budgets
Operating Budgets
Components of
Financial
Management
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The financial manager provides some basic functions. i. Financial Decision: The financial manager is responsible for financial
decisions to finance a firm. The financial manager must ensure maximum
mixture of debt and equity in financing the firm, so as to ensure maximum
returns to the business owners.
ii. Investment Decision: The financial manager is assumed to be able to select
the most profitable investment portfolio that will reduce the risk of finance and
ensure maximum returns to the business owner(s).
iii. Dividend Policy: The financial manager is saddled with the responsibility
of deciding the dividend policy of the firm. In a small scale business the
responsibility of the financial manager would include that of identifying how to
distribute the profit from the venture to the various owner(s).
iv. Working Capital Management: It is the totality of management of cash,
debtor, prepayments, stocks, creditors, short term loans, accruals, etc., to ensure
profitability of the firm. It is the management of the current asset and liability
of the firm. Often the financial manager, in small scale business has to ensure
effective working capital and prevent insolvency and liquidity problem in the
firm. This effective working capital management remains the most vital area of
the research work as it applies to small and medium scale business.
v. Financial Control and Reporting: It is the duty of the financial manager to
ensure effective financial control and reporting in the business. There should be
physical control of assets to ensure the solvency of the firm.
The scope and role of financial manager in the firm has been narrowed
down to basic approaches as follows: traditional approach, managerial
approach and new approach.
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� The Traditional Approach: According to this approach, the scope of
the financial manager is confined to the rising of funds (Kehinde and
Abiola, 2005), during major events such as promotion, recognition or
expansion in the life of the firm. The financial manager has the basic
obligation of ensuring that the firm has enough cash to meet its
obligations. A notable feature of the traditional approach to financial
manager’s duty is the assumption that the financial manager has no
concern in the decision of allocating the firm’s funds. The problem of
the approach is that much emphasis is placed on long term financing, to
the detriment of working capital management.
� The Managerial Approach: The change in business situation in the
mid-1950s, made the traditional approach outlive its usefulness. The
increase in market, the population growth, the management efficiency
and future, during and after the mid-1950s necessitated efficient and
effective utilization of the firm’s resources. Consequently, financial
management approach and scope markedly changed. The emphasis
shifted from episodic financing to the managerial financing functions,
from rising of funds to include efficient and effective use of funds. This
approach includes profit planning function. The term profit planning
refers to operating decisions in the area of pricing, volume of output and
the firm’s selection of productive assets.
� New Approach: This approach derives its impetus from Lord Keynes’s
general theory. The core of the new theory, as applied to the business
finance, is found in the macroeconomic concept that the level of
aggregate economic investment depends on two factors viz: the
additional expected rate of return on investment (marginal efficiency of
investment) (Anao, 1990; Charles, 1992).
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Keynes defined marginal efficiency of capital as ratio between
the prospective yield of additional capital goods and their supply price
i.e.
E = Y
P
Where = Marginal efficiency of capital
Y = The estimated yield of the capital asset
P = The supply price of the assets respectively or the original cost
of investment.
The marginal efficiency of capital (e) is considered an important
determinant of whether an entrepreneur should or should not take interest (r).
Anderson D. (1982) opined that the entrepreneur will optimize his profit if he
continues to take up additional investment until e = r. Basically, according to
Geoffrey (1969) the function of the financial manager is to review and control
decisions to commit or recommit funds to new or on-going uses. Thus, in
addition to funds, financial manager is directly concerned with production,
marketing and other enterprises activities whenever decisions are made about
the acquisition or distribution of assets.
3.2.3 Importance of Accounting Information for Small Business
Accounting has an important role to play in any business – micro, small,
medium or large. Accounting information consists of book keeping, cash flow
management, payroll, budgeting, forecasting, credit and collections and
financial management. For an accounting information system to be functional,
it should be easy to understand, provide clear information to its users, and be
consistent. A lot of accounting information is aimed at different fields of small
business accounting, including financial, management, cost, advanced
accounting and others. Such information is used for learning purposes and does
not have any relation with the small business accounting information about the
business uses for financial reporting purposes.
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Sub Categories of Accounting Information
• Bookkeeping and Cash Flow Management: Cash flow control is a
simple method of projecting future needs for cash. It is an income
statement covering future periods of time that has been changed to show
only cash: cash coming in and cash going out and what the balance of
cash is at the end of designated periods of time. This is a great tool
because one can predict the future needs for cash before the needs arise.
• Payrolls: As business grows, the demands on business operations
ensure the importance of hiring human resources and paying them
salaries based on their responsibilities and deliverables. Salaries may be
fixed or based on performance or a combination of both. Additionally
business needs to conform to various labour laws that ensure employee
benefits.
• Budgeting and Forecasting: A budget serves as a control tool to
provide standards for evaluating performance. It may cover any of the
following:
1. Profit planning – forecast of revenues and expenses
2. Cash budgeting – forecast of cash needs and sources
3. Balance sheet forecasting – anticipating future assets, liability
and net worth position of the business
• Credit and Collection: Maximizing the value of credit reports requires
a good understanding of the information they contain. Whether a
business manager is checking the credit of others or ensuring that their
business report accurately reflects business, this guide helps to boost
their knowledge.
• Financial Manager and Reporting: There are a number of instances
when entrepreneurs’ may need to determine the market value of a
business. Certainly, buying and selling a business is the most common
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reason. Estate planning, reorganization, or verification of their worth for
lenders or investors are other reasons.
• Financing for Business: Money makes businessmen go to banks.
Normally loans are given only to businesses with operating histories.
i. Importance of Bookkeeping
Bookkeeping and record keeping play very significant roles in the
performance of small scale industries while accounting plays a major part in
large corporation and industries. This system has been widely used for all
business types so that they can safeguard the most critical business transaction
of their organization. This makes it a very strong reference in their decision-
making process where they can easily view their standing in records alone.
Sometimes, a small business like a home business, small store and other small
business may overlook such practices. They tend to neglect the task of
recording their transactions since they can easily recall a few of them but this
never usually happens considering that there are other things that they need to
organize, including themselves and their family. Bookkeeping is a good and
healthy practice in business since it can retrieve the transaction of the past
years.
The effect of bookkeeping in small business reveals practicality and
efficiency of business. The owners of small and medium enterprises find it
convenient to organize their most critical and confidential records of
transaction. They can easily view their records from time to time which would
reflect their present condition if they are making a good performance. Another
advantageous use of bookkeeping is that small businesses can use it as a
scientific projection for future operation of the records which are highly
important to determine the most valuable resources and customers’
information. The records can be easily corrected and customer’s history of
transaction can also be recovered if there is a query, comment or demand from
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the goods and services they have bought. Through this process , business can
be systematically guided and adjusted where need be.
Scientifically, a small and medium enterprise can make full use of
technology by which records can now be maintained using the industry
standard software and Microsoft Office programmes such as Word and Excel
programs. These programs help the small businesses to maintain and oversee
their performance systematically. The input of records makes budgeting,
customers follow up, miscellaneous expense and other transactions easy and
simple.
One of the most effective functions of bookkeeping in a small business is
the presentation of financial statement of the current assets, liabilities and on
hand capital which can be easily determined and analyzed. This can be a good
use to measure opportunities and threats involved in the organization that can
largely increase company revenue and profitability. The usefulness of these
records can make a sound and reliable attention grabbing action in making the
best references of the business. Somehow the decision to delay or enhance the
performance of a business through expansion or cost cutting is demanded by
the bookkeeping records.
The bookkeeping and recording process in a small business can also
predict and eliminate certain types of risk. If, for example, a business firm
decides to invest additional machineries in business, records might show that
the acquisition of such machineries can also affect payment of overdue taxes.
They can delay the demand and pay the necessary taxes that are far more
important. The regulations imposed by the government should also be given
priority because they have all the right to demand and control the business and
the proper bookkeeping dictates; when and how to budget their finances
according to priority such as government taxes, income taxes and workers’
compensation.
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The many benefits of bookkeeping and record keeping are the best ways
to manage business and its performance in the most accurate manner. Because
of its usefulness a standard business uses and hires professional services of a
bookkeeper or an accountant to further develop a good recording system of the
company. It will be the one to take the necessary measures to control the
records of the company. For its advantage it can further develop a new system
in recording using the basic and advance accounting that has been introduced
because of the demand to further strengthen the financial standing of its
business.
ii. Working Capital Management
Working capital is a proportion of a SMEs’ total capital which is
employed in the short term operations. Geoffrey and Elliot, (1969) stated that
working capital is customarily divided into two categories: Gross and Net.
Gross Working Capital is the sum total of all current assets, while Net Working
Capital is the difference between current assets and current liabilities.
iii. The Gross Concept
It is the totality of the current assets of the business which includes
account receivable, cash, short-dated securities, bill receivable and stock. The
gross concept advocates that a firm should possess working capital that is
adequate and sufficient to meet the firm’s operating cycle. It ensures that
excess investment in cash is avoided, since excess investment results in excess
liquidity resulting in loss of income or profit. This is called optimal level of
investment in current assets. Excess investment in current asset should be
avoided. The gross concept also emphasizes the availability of basic sources or
funds.
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iv. The Net Concept
An emphasis on the continuous liquidity of a firm advocates a finance of
the working capital by permanent sources of funds e.g. capital, long term debt,
retained earnings, etc., The net concept advocates the efficient mix of long term
and short term sources of financing working capital.
v. Current Asset Management
The current asset of a firm is the totality of asset whose expectation or
turnover period is within a year. It is a constituent of the working capital of a
firm. It needs to be stated that the working capital of a firm is the totality of the
current asset and current liability of the firm. The current assets constitute the
application of fund while the current liabilities constitute the source of funds to
the firm. The current assets are the assets used for day-to-day manufacturing
and retail trading activities of a business. It represents funds that are invested in
the short-term operations of the firm. Out of all possible investments SMEs’
could make current assets and those which can be expected to be turned over
into cash within a twelve-month period. These assets include: Stock: Finished
goods, work-in-progress (W.I.P) raw materials, Account receivable
(Debtors),Tax reserve certificate, Payments in advance, short-term investments
and cash (at bank, and in hand).
vi. Importance of Financial Management for Small Business
Financial management is crucial for the continuity of small and medium
enterprises (SMEs). The growing importance of this issue raises interesting
questions whether companies are improving their abilities to have effective
financial management and implementing changes that will enable them to
analyze results, to interpret, to forecast future performance and improve their
business decisions. The competition in SMEs seems to call for an investigation
towards the effectiveness of financial management. Furthermore, business
planning and strategies are depending on effective financial management.
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In theory, the same general principles of financial management apply to
small firms as they do to large firms. From the review of literature it could be
concluded that the owner/managers of the sample firms had not prepared any
management accounts. For a profit making entity, the main strategic objective
is to maximize share-holder wealth. This means achieving the maximum profit
possible consistent with balancing the needs of the owners. The profits made
by an entity can only be measured by preparing financial statements. Thus, it
will be very difficult for the owner/managers of the small firms studied, to be
able to compute their profits when they do not prepare financial statements.
Sound financial management is essential for the success of a business.
Successfully managing financial resources are important in new as well as
expanding businesses and so time should be taken to develop and implement
financial plans that will ensure the success of small firms. The action and
inaction of owners of small firms could also act as significant barriers to the
development of sound financial management systems. A lack of understanding
of accounting information is difficult could act as a barrier in implementing
sound financial systems.
3.3.4 SMEs’ Understanding of Key Components of Accounts
As per UNTAD report (2002) a business unit may belong to a formal or
an informal economy. For instance, entities which keep no accounts and pay no
taxes, are part of the informal economy and the reverse is the formal type. For a
business unit to account under a formal economy in order to generate the
necessary benefits, requires standard or fundamental practices. It should be
noted that the accounting needs of a simple business are simple, but as the
business gets bigger, so does its needs for more sophisticated internal
information and disclosures to the outside world.
Standard accounting practices require certain specific information
disclosures, though their contents may differ from one business unit to another.
It should be noted that standard accounting in business of a formal economy
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ends with information to the outside world in the form of financial statements.
However, for uniformity in practice and reporting financial information, the
International Accounting Standard One (IAS1) sets out clearly the content of
financial statements in this order. A complete set of financial statements
comprises of:
a. A statement financial position;
b. An income statement;
c. A statement of changes in equity showing either:
(i) All changes in equity, or
(ii) Changes in equity other than those arising from transactions
with equity holders acting in their capacity as equity holders;
d. A cash flow statement; and
e. Notes comprising of a summary of significant accounting policies
and other explanatory notes.
The above prescription is for both general purpose reporting and
business in the formal economy.
Financial management entails planning for the future of a person or a
business enterprise to ensure a positive cash flow. It includes the administration
and maintenance of financial assets. Besides, financial management covers the
process of identifying and managing risks. The primary concern of financial
management is the assessment rather than the techniques of financial
quantification. A financial manager looks at the available data to judge the
performance of enterprises. Managerial finance is an interdisciplinary approach
that borrows from both managerial accounting and corporate finance.
Some experts refer to financial management as the science of money
management. The primary usage of this term is in the world of financing
business activities. However, financial management is important at all levels
of human existence because every entity needs to look after its finances.
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Broadly speaking, the process of financial management takes place at
two levels. At the individual level, financial management involves tailoring
expenses according to the financial resources of an individual. Individuals with
surplus cash or access to funding, invest their money to make up for the impact
of taxation and inflation. Or else they spend it on discretionary items. They
need to be able to take the financial decisions that are intended to benefit them
in the long run and help them achieve their financial goals.
From an organizational point of view, the process of financial
management is associated with financial planning and financial control.
Financial planning seeks to quantify various financial resources available and
plan the size and timing of expenditures. Financial control refers to monitoring
cash flow. Inflow is the amount of money coming into a particular company,
while outflow is a record of the expenditure being made by the company.
Managing this movement of funds in relation to the budget is essential for a
business. At the corporate level, the main aim of the process of managing
finances is to achieve the various goals a company sets, at a given point of
time. Businesses also seek to generate substantial amounts of profits, following
a particular set of financial processes.
This study was designed to address the research question: What are the
financial management techniques practiced by the SMEs in India? Based on
the review of literature analysis of previous study, two new models could be
designed to confirm the literature and be a contribution to the body of
knowledge. Firstly, the six components of financial management as discussed
in the literature review could be categorized into two: core components and
supplementary components. Three components could be categorized as core
components and the other three could be categorized as supplementary
components, as shown in Exhibit 3.2.
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EXHIBIT: 3.3
COMPONENTS OF FINANCIAL MANAGEMENT
PRACTICE USED BY SMES
Source: Mohd Amy Azhar.B. et.al(1990)
It has been observed that 19 techniques of financial management used
by SMEs have been confirmed from the data analysis to be included in this
study (Refer to Exhibit: 3.1). These techniques are categorized into two: core
techniques and supplementary techniques. From the 19 techniques listed, nine
are included in core techniques and 10 are included in supplementary
techniques, as shown in Exhibit 3.3.
Components of Financial
Management
Core Components
• Financial planning and control
• Financial accounting
• Working capital management
Supplement Components
• Financial analysis
• Management accounting
• Capital budgeting
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EXHIBIT: 3.4
FINANCIAL MANAGEMENT TECHNIQUES USED BY SMES
Source: Mohd Amy Azhar.B. et.al(1990)
The findings from various studies indicate that the range of financial
management tools used by the SMEs in the survey is still low. Many still use
only predictable and often used components such as financial accounting and
working capital management. Out of the six components of financial
management, only three are being practiced by a high percentage of the SMEs
in these study surveys. These are financial planning and control, financial
accounting, and working capital management. Three other components, namely
management accounting, capital budgeting, and financial analysis are being
practiced by only a small percentage of the MSMEs. However, because of the
important impact of all six components of financial management on the
wellbeing and survival of their business, managers of MSMEs should seriously
Financial Management
Techniques
Core TECHNIQUES
Financial planning and control
• Financial budgets
• Operating budgets
Financial accounting
• Balance sheet
• Income statement Cash flow statement
Working capital management
• Cash management
• Account receivable management Inventory management
• Account payable management
Supplement TECHNIQUES
Financial analysis
• Current ratio
• Quick ratio
• Operating profit margin
• Return on asset (ROA)
• Return on equity (ROE)
• Debt ratio
Management accounting
• Standard costing
• Just in time (JIT)
• Activity based costing
Capital budgeting
• Net present value (NPV)
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consider making financial management an important priority in their overall
management. The model designed for this research could be adopted by the
SMEs for their financial management. All six of the financial management
components should be given priority by the MSMEs.
3.3 Conclusion
Small entrepreneurial organisations are highly influenced by the
entrepreneurs’ personality and style, less formal planning and control and loose
organizational structure and administrative system. These organisations are the
outcome of initiatives of entrepreneurial talents. Small businesses have some
fundamental advantages. They need low investment compared to their larger
counterparts. However due to this reason they also face resource limitations–
both human and financial resources.
Financial management is a must for any type of enterprise. Lack of
proper financial management may create problems of various types in business.
One major weakness with regard to financial management in SMEs is no
proper planning of future finance. They achieve targets without any monthly or
annual estimation of expenditure, income and the expected profits. The future
plans of finance are almost invisible in MSMEs. There are a number of factors
for non-availability of financial management in MSMEs, such as lack of
knowledge of systematic book keeping, not having trained employees for book
keeping, not knowing the benefits of maintaining accounts, not having the
ability to keep mental records of customers, and not having a time schedule for
business. The small business must ensure strategic cash flows against its
needed cash outflow; this is a function of effective working capital
management. In managing the working capital of a firm, especially the small
business, the acute shortage of fund needed for growth remain a subject of
strategic financial management function.
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