Profiling The Risks Of MSMEs

Enterprise risks

The entrepreneurs’ choice of a lending institution plays a key role in furthering the growth of the enterprise. Some entrepreneurs choose an institution close to their location. Most entrepreneurs take the trouble of drawing up a road map for the enterprise for the next five to ten years and see which bank best suits their requirements.

The choice of a bank based on close affiliation to a political party or a neighbouring friendly branch manager or on the basis of proximity to the units or size of the branch or bank poses varying risks for sustainable financial institutional relationship.

Entrepreneurial risks

Entrepreneurial risks arise from the perceived knowledge levels required for the enterprise, qualifications, family background, egocentric issues, family relationships, relationships developed during the course of setting up and running the enterprise. Entrepreneur risks could also be attributed to our educational system that is geared towards preparing people for employment and not towards developing entrepreneurship. As a result, those who do not secure jobs in the job markets move towards setting up enterprises, with the exception of family-based entrepreneurs.

Character and integrity, competence and attitude are the four attributes generally applied to judge entrepreneurial risks. The first two are subjective and mostly on-time assessment. An entrepreneur may be of excellent character and integrity and could also be coming from an excellent family known for such characteristics. But when the failure occurs either for want of money in time or when markets deceive him, there could be a prospect of his moving into the risk area of default. The usual probability analysis would not have captured such an eventuality.

There are entrepreneurs born; there are family-based entrepreneurs where they walk into the enterprise at some convenient stage in their career; there are failed graduates and technically qualified persons who fail to secure employment of their choice and start enterprises with a small amount of capital at their disposal and with confidence in their technology skills; they are also known as technopreneurs. Their location–rural, semi-urban, urban and metro– determine their reach to the markets as also the nature and complexion of their products.

Some technopreneurs, overconfident of their technological capabilities, choose to go in for second hand machines with a view to squeezing oil out of sand. They simply do not realize that the seller of the second-hand technology moved to a higher level of technology to push a more cost-effective product into the market ahead of them. As a result, these entrepreneurs do not penetrate into new markets or new products. They end up as enterprises killed by the slow poison of incompetence, inefficiency and loss of reputation. The lending institution that reposed faith in the qualification and experience in technology alone in such technopreneurs pays a heavy price (Raju and Pujari, 2009: p35-37).

There are many entrepreneurs who do not possess knowledge of finance and do not maintain the required books of accounts and stocks properly or in a manner that the lender wants them to maintain. Recognizing this need, some banks invest in educating the entrepreneurs through their own or collaborative training institutions and fill this gap. Some progressive banks have chosen to finance computerization as part of the project cost when on-line access to information on stocks, debtors, creditors and capacity utilization has insured the financing institution against the usual credit and marketing risks.

The pressure to produce results is great, given the volatility of the start-up environment and stakeholder impatience. Thus, start-up delivery units risk over-promising and underachieving. To minimize this possibility, initiatives should be based on estimated impact on start-up activity (usually measured by how much activity can be enhanced along the funnel from start-up creation to growth and maturity) and the feasibility of implementation (a more qualitative internal assessment).” (Kirchherr, Scherf and Suder, 2014)

Environmental risks

An estimated 70% of the total industrial pollution load is attributed to the Small and Medium enterprises (SMEs) many of which, particularly the small-scale units, continue to use obsolete technologies with primitive or no pollution control methods. This is an issue which has been of concern to the industry associations also. CII Natural Capital Conservation & Development (NCCD) Council in its key Issues / directions calls for developing ways in which SMEs could be assisted to implement sustainability practices. A study of the environmental performance of Indian SMEs would reveal that a progressive framework or roadmap of environmental performance does not exist. The existing assistance and financial schemes are to an extent piecemeal and uncoordinated and require integration into a well-thought-out framework. The accepted challenges to improving environmental compliance by SMEs can be stated as:

(i) The government’s regulatory stand, reflected by its Legislation, policies and procedures.

(ii) The challenge of Education and Awareness: The need for the businesses to understand and appreciate the degradation of the environment by their actions.

(iii)The third challenge is time. Time to start and the time for the actions to yield results. The lesser the time taken, the better.

(iv)The fourth challenge is cost. Funding compliance which in most cases is viewed as unproductive expenditure.

According to the Ministry of Environment and Forests (MOEF), SMEs account for 40% of industrial production, employ limited pollution control technologies and are responsible for an estimated 70% of the total industrial pollution load nationwide. Effective environmental enforcement requires informed consensus on environmental management objectives and policies that are based on a good understanding of the shared roles and responsibilities of all players, including the regulator, the regulated community (developers and polluters) and the affected community (general public).

Self-Monitoring and Reporting

Lack of reporting or false reporting may lead to criminal or administrative penalties. The existing legal framework, however, does not authorize enforcement actions through the courts based on self-disclosed reports. Rather, government agencies can only pursue legal action on the basis of “legal” samples taken by inspectors who are certified to conduct inspections in accordance with specified procedures. As a result, not using self-reported information is a significant constraint in promoting compliance and enforcement.

Marketing risks

Small entrepreneurs often suffer from both pricing and branding risks. This arises because of lack of comprehension of the risks in pricing the product hedging this risk. If marketing expenditure or advertisement expenditure or branding expenditure is treated as a part of working capital, the industry has potential to turn sick for it cannot realize these costs from the price of the product. It has to be spread over a number of years when the product acquires competitiveness in domestic and global markets. The entrepreneurs require professional expertise or hire professional expertise in framing a proposal to the banks seeking investment capital for these purposes.

RISK MITIGATION MEASURES

More recently the RBI has called upon banks to set up financial management advisory desks to help MSMEs with non-core functions such as accounting, taxation and financial management. Banks could charge a reasonable fee to provide these services to the enterprises. According to the Central Bank, the top management of banks should show their commitment to the MSME sector by clearly spelling out the targets for expanding the MSME portfolio at the branch level and closely monitoring them. Further, to ensure transparency, banks should disclose the interest rates they charge their borrowers segment-wise in the balance sheets. Despite the wide-ranging discussions on Business Development Services (BDS) following the Donor Committee Report (2004), there are several cultural factors in India that hold back the development of BDS markets in the country. These factors need to be overcome. All these would demand that banks should tighten their credit appraisal standards. They should not relax their standards just because credit guarantee institutions such as the CGTMSE and the ECGC will pick up the tab should loans turn bad. A pro-active policy would imply that entrepreneurs should be encouraged to experiment with business ideas. If the entrepreneurs fail in their ventures, they should have an easy exit policy.

(This represents final part of Chapter-III of MSME Business Environment and Challenges of “The Story Of Indian MSMEs by the author; The author is an economist and risk management specialist and former Dean of Studies, ASCI, Hyderabad)