Start up First few years
In general, the entrepreneur is very enthusiastic while starting the business. Before starting the project, He spends lot of his time in studying the market,
Process, Customer’s Preferences, sources of raw material etc.
He respects the opinions of experts in his field. His mentor is generally from the technical field.
What he does not concentrate or actually studies in depth is “Financial Requirements”
The topic of Finance has two aspects. Firstly the Amount and secondly the Timings’
Just like any requirement of Fuel for a car is needed at
a. Starting the journey
b. During the journey
c. Emergency , if there is no petrol pump immediately available
Requirement of finance is also to be studied for these three phases.
Therefore having adequate funds “Right at the beginning” of the business is very very important.
During the initial 2-3 years Businessman has to learn many things about managing his funds.
Many companies cannot identify their exact financial needs. The financial irregularities are due
to two basic mistakes, namely Short of funds or Excessive borrowings. These situations are called as Short of Working Capital and Over trading.
Let us concentrate on two topics
1. Working Capital Management
2. Over trading or Under Capitalisation
Working Capital Management.
This is a very vast subject and problems related to Working capital vary from business
to business as well as in the same business, from time to time.
For understanding what the Working Capital needs are, one must understand his own Working capital cycle or Cash cycle.
Working capital cycle is a period beginning from Purchasing of Raw material and ends on the date on which you receive
money from your customer on sale of the finished goods. Components of Working capital cycle are
Period for which stock of Raw Material is held
Processing time from purchasing the raw material to making final prouct
Credit period you enjoy from the suppliers of raw material and payment of other cost of production
Period for which you are required to hold semi finished goods in stock
Period for which you need to keep your finished goods in stock
Credit period which you allow your customers to pay the bill
Thumb rule is longer the manufacturing process, longer will be your working capital cycle
Your need for funds is for
Keeping adequate stock of raw material
Paying for utilities during the production cycle
Keeping adequate stock of finished goods to meet the sale orders
Providing funds for operations of business till you receive money from your customers
In this process, you must take into consideration the time period you get to pay your suppliers. Credit from the suppliers/ contractors is one of the method to fund your working capital needs. But the skill is to get optimum period of credit, not less not more. Because enjoying higher credit is also risky.
Working Capital finance
Need for working capital finance is calculated as under
Particulars Holding Period Amount
Stock of Raw Material 45 days 1,50,000.00
Stock of WIP 8 days 40,000.00
Stock of Finished goods 30 days 1,80,000.00
Receivables 90 days 7,50,000.00
Credit available for raw material 30 days 1,00,000.00
Credit available for expenses 30 days 60,000.00
Net working capital needs
OVER TRADING OR UNDER CAPITALISATION
Over trading means a person doing business much more than his capital resources permit him to do.
In other words he tries to cross the optimum level of activities which he can achieve with the available amount of capital.
Naturally when he tries to achieve more than his abilities, his additional activities are funded by the “borrowed” funds not by his
Many start up get carried away by the saying “ business is to be done with others’ funds”
This is a myth. Every successful business is based on a strong footing of Proprietor’s capital.
There has to be good balance between “Owned” funds and “borrowed” funds.
Financial experts calculate the Capital turnover ratio, that is how many times in a year, a businessman rolls his
funds in terms of Sales. Higher ratio indicates good efficiency of own funds, but it may tend to Over trading,
if borrowed funds are disproportionately less than the Outside funds.
Outside funds include
b. Secured loans
c. Creditors for material
d. Unpaid liabilities of tax, wages, utility bills, sub contractors etc
e. Temporary loans taken from friends etc
When a businessman tries to achieve higher turnover, without back up of owned funds, burden of unsecured creditors and short term loans gradually increases which he does not realise in regular course of his business
But these temporary loans, may be Credit cards, hand loans etc which he raises are to be paid through EMI methods, Unknowingly he fails in the EMI trap and funds generated from Sales are diverted for repayment of these loans in stead of for purchasing new raw material
UNDER TRADING OR OVER CAPITALISATION
This is exactly the opposite site of Over trading. Funds infused in the business must be utilised immediately to earn profit. If the business does not provide proper opportunities, then the funds remain idle in the form of bank balance, yielding zero returns. This situation is known as Under trading or Over capitalisation. In such a situation, there is a fear of funds being invested outside the business, because there are no good income generating activities in business. Or funds may get blocked in Non moving stocks, extra investments in fixed assets,
In current situation of fast changing technology, funds may get blocked in machinery or process which is discarded by the technology.