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Over the last three decades that I have been working on small and medium enterprises (SME), one aspect that stood out across all of them irrespective of the size and industry was their constant problems in managing cash flow!

Cash flow management is not, always, about sourcing additional funds for the organization but more importantly optimally utilizing the available funds! The problems associated with cash flow management are going to get even more pronounced in the years to come.  This can be attributable to fiscal measures being adopted by the regulatory authorities to rein in inflation as much as banks themselves becoming increasingly becoming risk averse to lending.  The fiscal measures have a dual impact – firstly availability of money from the banking system is going to get a little more difficult and second terms under which banks lend are potentially going to be stiffer.

Given a situation like this, it is imperative for SME’s to start looking the following three aspects to effectively manage their cash flows.

1. Start Preparing a rolling 4 weekly cash flow forecast – The management of cash flow is akin to driving a car for two reasons again.  First, what is seen is the most   manageable part i.e. the objects right in front of the driver. The skill of the driver is managing the left extreme (that is if you are driving a right hand drive!).  It is there that you invariably get hit.  The second is that you cannot always drive looking at the rear view mirror!

Four cash flow forecast helps you to manage this better by virtue of understanding your potential receipts and payments.  To manage it even better try and categorize your payments at Critical (the show-stoppers), Major and Others. Many experts recommend preparation of a “Thirteen Week Cash Flow Forecast”.  In my view, most SME would initially find even managing a four week statement a challenge driven by the low visibility that have on the receipts.  So to get a good handle on the management I would strongly recommend a 4 week statement. 

The other aspect is the extent of accuracy required in the forecast.  I have hand innumerable debates on this.  In my view the variation should not exceed 3% in the next immediate week, 7% in the second, 15% in the third and 20% in the fourth.

2. Manage your Receivables – Have a close watch on the receivables.  More often than not, customers do not pay because they are not asked. Using the classical ABC analysis works wonders on this. “A” category represents all receivables that cumulatively account for about 65% of the total receivables, “B” account for 25% and “C” account for 10%.  All “A” category items should be monitored every week, the “B” fortnightly and “C” monthly.  This enables greater focus on the receivables and more effective. Offer cash discounts to customers who are willing to pay ahead of the credit cycle. There are enough customers who are having surplus cash and are looking at better utilization of the funds!

3. Manage your inventory – Inventory is a silent killer in most organizations.  Here again the use of the ABC method helps you to manage the inventory and keep it at the minimum. Organisations should revisit their purchase policy and work with the vendors to reduce the cycle time for the delivery. This will help them to reduce the lead time for the delivery thereby the need to hold additional stocks. Another aspect is to review all the obsolete or potentially obsolete ones. Invariably many organizations tend to retain stocks, which are not currently in use, in anticipation of use at the later date!  This procrastination is bound to hurt them badly. First, they are locking up funds and probably losing an opportunity in the bargain. Secondly there is every possibility that the stock item would lose its value and probably end up in the scrap yard.  The stock could be used in a lower grade application or in a worst case scenario to sell it.  The funds freed up on the process will improve the cash velocity.  In difficult times the number of times the inventory is turned around is very critical.

Following these simple but effective steps can alleviate the problems.  My experiences of working with many organizations in the segment have had very positive effect.  I also read a analysis by CRISIL that every 1% increase in interest rates reduces the profitability of SME’s by 14%. These steps not only give the breathing space but also invariably improve the profitability. So why not give it a try?!

 

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Yesterday, Ministry of Company affairs has opened doors for start ups to accept deposits from any person, by inserting following clause xvii to rule 2 of Companies (Acceptance of Deposits) Rules, 2014.

“An amount of twenty five lakh rupees or more received by a start-up company, by way of a convertible note (convertible into equity shares or repayable within a period not exceeding five years from the date of issue) in a single tranche, from a person”

For the purpose of this clause, a Company shall be considered as start up company, if it is a Private Limited Company registered under Companies Act, 2013 or Companies Act, 1956 up to five years from the date of its incorporation/ registration and if its turnover for any of the financial years has not exceeded Rs. 25 crore.

For the purpose of this clause, "convertible note' means an instrument evidencing receipt of money initially as a debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of the start-up company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.

Now a Start Up falling within this clause, can accept deposit of 25 lakhs or more from any person in the form of convertible note which should be repaid within five years from the date of its issue or should be converted in to equity shares of the company at the option of holder of such note.

Tagged in: Deposit start up
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As per Section 56 (viib) of the Income Tax Act, 1961, where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be treated as income in the hands of the Company.

This clause shall not apply where the consideration for issue of shares is received,

  1. by a venture capital undertaking from a venture capital company or a venture capital fund; or
  2. by a company from a class or classes of persons as may be notified by the Central Government in this behalf.

In this behalf, government vide notification number 45/2016, dated 14th June 2016, notified,  “person being resident, who make any consideration exceeding the face value for issues of shares of a start up company” as class of persons for whom above clause shall not apply. This is wonderful news to the start-ups, as the government opens the doors to issue the shares at a value more than its market value by lifting the hindrance made through above provisions.

For the purpose of this clause, a Company shall be considered as start up company up to five years from the date of its incorporation/ registration and if its turnover for any of the financial years has not exceeded Rs. 25 crore.

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What should be the ideal size of the capital expenditure budget for a company? This question has also been at the top of the mind for many who have found that many corporate like Reliance, Infosys, Coal India, ONGC,  to name a few, have been sitting on tens of thousands of Crores!

The challenge associated with growth driven by capital expenditure is bound to be high, be it organic growth or inorganic growth, through acquisitions. Challenges associated with organic growth can vary depending on the nature of the expansion viz., Greenfield or Brownfield i.e. expansion of capacity in the same place. Greenfield expansion which means building a new facility will be greater challenge as it could entail significant increase in manpower including managerial. Management bandwidth will always be tested and in the case of inorganic growth the pains associated with integration, predominantly soft issues, tends to be an additional one.

Financial

The discussion is not on the manner of funding projects but on the implications! Most financial analysts reviewing the financial performance of companies look at a couple of key ratios, amongst a host of others. These are Return on Capital Employed (ROCE), Capital Turnover ratio and Free Cash Flow.

ROCE is an efficient indicator of the returns that the company is in position to secure by sweating its assets. Since it is computed as a percentage of total assets i.e., fixed and net working capital any sudden increase in the base without a commensurate increase in profitability will prove to be drag.

The Capital Turnover ratio would indicate the number of times a company is in a position to turn its capital employed in terms of sales. If the gestation period of investments is long or in case of capital intensive projects any significant change would cause a drop in this ratio.

Free cash flow has of late shot into prominence. "Profit is an opinion; cash is a reality” so the famous quote goes. Given the fact that organizations are required to account for incomes on accrual which can get vitiated by aggressive sales practices, this measure is a good indicator of realized profits! This will help in the determination of not only the capital expenditure that a company can incur out of own funds but also the extent to which it could probably borrow. The ratio of Free Cash Flow to capital expenditure would definitely help the process.  The greater the number the better it would be.

Thus from a financial perspective there is no single yardstick but it would be appropriate to conclude that all the three ratios need to reflect a higher number with a positive upward trend.

Management Bandwidth

One of the biggest challenges, India in particular, has been the quality of project management. It is sometimes rare to see projects being completed without time or cost overruns, both of which can have serious financial implications. It is has also been observed that key operating personnel being transferred to new projects exposing current operations under the risk of time overrun. Delays in execution of projects coupled with problems in existing projects could be a double whammy.  In the case of inorganic growth challenges associated with cultural integration will be another crucial aspect.

Our project management capabilities can be evaluated by a comparative study of China’s landmark rail link between Beijing and Shanghai that was launched a year ahead of schedule! The Beijing–Shanghai High-Speed Railway is a 1,318 Km long high-speed railway that connects Beijing and Shanghai. The construction began on April 18, 2008 and commercial service was put into commercial service on June 20, 2011. More than the fact that it was completed in 3 years, what is even more important is that it was completed one year ahead of schedule. The train services are expected to carry about 2.20 lakh passengers every day!  The estimated revenue generation by advancing the project alone is about Rs.48000 crores for a year assuming the charge 700 Yaun per trip! Compare this with the Bandra Worli sea link project of 5.6 km that was to have been completed in 5 years at a cost of Rs.300 Crores. The project actually took 10 years and was completed at a estimated cost of Rs.1400 Crores. This is only a small example of the fate of similar other projects both minor and major! It would be inappropriate to assume that these delays happen only in public projects.  They are very much part of the system, in the private ones too probably the magnitude of the problem is lesser. It is not uncommon to hear of cases where the viability of the project has jeopardized due to delays.

Maximum Capital Expenditure

In the ultimate analysis there can be no single yard stick to determine the maximum capital expenditure that can be undertaken by a company. It has to function of both existing financials, especially the ratios referred and the management bandwidth to manage the successful project roll out.  Current situation of the economy need not necessarily be the only determinant as capital expenditure is always incurred with a long term perspective and in that context this may about the best time to incur the same as there is potential save substantially!

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Every business entity irrespective of its size has to set some goals and targets for the year. That would be starting point of an exercise. This is extremely critical else old management adage would come into play – “You manage what you measure and have no intention to manage what you do not measure”!

One of the best methods to start the process is through the medium of well structured budget.  To start with a budgeting process it would be good idea to determine as what the “limiting factor” would be. The limiting factor would basically be constraints that the organization would have to address in the business process. It would also imply that it would take more than year to address.  The limiting factor could be size of the market, production capacity, regulatory approvals or the like.

The preparation of the budget would also require a bit of analysis of what the cost patterns of the organizations in terms of variable and fixed costs. We recommend budgets are prepared on “Zero Costs” basis.  This assumes that every line of expenditure would have to be fully justified as that would give a great opportunity to analyze all costs. Every function of the organization is to be analyzed for its needs and costs. Before estimating/ making assumption for an expense, a question has to be answered “what is the value that it adds to the business”. Some organizations have the tendency to make a provision of 10% additional based on previous year figures!  It is akin to conceding that if there was 25% inefficiency in the system the previous year to will add another 10% to it this year!!

We would strongly recommend that the budgets are to be prepared for a minimum duration of month and definitely not beyond a quarter.  A typical SME would require the following budgets to start with:

  1. Sales budget
  2. Production budget
  3. Manpower budget – both in terms of number and their costs
  4. Variable costs budget – Function of sales and production budget
  5. Selling & Distribution budget – This would mix of fixed and variable expenses
  6. Expenditure budget – mostly fixed expenditure
  7. Capital expenditure budget
  8. Cash flow budget
  9. Profitability budget

The cash flow budgets will help the organizations to determine their funding gaps and can take timely actions to source funds.  Even approaching the banks would mean that it could take up to 90 days to finalize the credit limits.  Another benefit out of the preparation of the detailed budgets will enlighten the organizations to define well defined policies in respect of all key functions starting from marketing, human resources, purchases, finance, capital expenditure etc.

These will go a long way to measure the actual performance at the end of periodical intervals, again not beyond a quarter.

Tagged in: Budget SME StartUp vCFO
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Posted by on in Uncategorized

The Finance Bill, 2016 had proposed a new Cess to be called as Krishi Kalyan Cess (KKC) @ 0.5% on all taxable services. With the President assenting the Finance Bill, 2016 on 14.5.2016, the new levy will be into effect from 1.6.2016 as proposed in the Budget.

Features & Provisions of KKC:

  1. Proceeds of KKC will be used exclusively financing initiatives relating to improvement of agriculture and welfare of farmers
  2. The Cess will come into force with effect from 1st June, 2016 and would be levied and collected ‘as service taxon the value of all taxable services
  3. W.e.f. 01.06.2016, the total Service tax to be charged will be 15%. i.e., Service tax @14%, Swach Bhatath Cess @ 0.5% and Krishi Kalyan Cess @ 0.5%. 
  4. KKC will be levied on the taxable value of service and not on the service tax component.
  5. KKC needs to be charged separately on the invoice, accounted for separately in the books of accounts and paid separately under separate accounting code which is 00441509
  6. Taxable Services, on which service tax is leviable on a certain percentage of value of taxable service (i.e., for which abatement is applicable), will attract KKC on the same percentage of value as provided in the Notification No.26/2012-Service Tax dated 20th June, 2012. So, this notification would apply for KKC also in the same manner as it applies for Service Tax. Thus, KKC will be applicable on the abated value wherever ST is paid on abatement.
  7. KKC is also payable along with service tax by the service recipient under Reverse Charge Mechanism.
  8. CENVAT credit of KKC shall be available and shall be utilized only for the payment of KKC. Thus, separate accounts needs to be maintained.
  9. Refund of this cess shall be allowed to Exporter of Service as well as Exporter of Goods as there is no restriction of its availment.
  10. Point of Taxation:

To determine the Point of Taxation for KKC, the amended Rule 5 of Point of taxation Rules 2011 will be applicable.  As per this rule, in case of new levy on services such as KKC, the new rate of tax will not be applicable if invoice is raised and money is received prior to 31.5.16. In cases where invoices is raised prior to 31.5.16 but payment is received after 1.6.16 then KKC will be applicable.

In case of advance received prior to 31.5.16, if invoice is raised within 14 days KKC will not be applicable or else KKC will be applicable.

The Summary of the applicability of KKC for the services raised before 1st June 2016 is as follows:

 

Particulars

Service is provided before 1st June

Invoice Raised before 1st June

Payment is made before 1st June

Applicability of KKC

Case 1

Yes

Yes

Yes

No

Case 2

Yes

No

Yes

No

Case 3

Yes

Yes

No

Yes

Case 4

Yes

No

No

Yes

 

The increased rate of tax from 14.5% to 15% will not just create financial burden on the consumers but also create hardship for the business entities during the transition period as KKC will be applicable on invoices raised prior to 31.5.16 for which payment was not received as on 31.05.16. One conservative option that an assessee can opt is be to pay KKC on debtors outstanding as on 31.05.16 and collect it subsequently from the customers via a debit note as they may be entitled for CENVAT Credit of KKC Cess paid.

 

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