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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:


• 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


• 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


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


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


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


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.


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


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.


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.


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


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


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.


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


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


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.


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.


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


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.


� 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).


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.


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


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


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.


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.


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.


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


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.


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.


EXHIBIT: 3.3

COMPONENTS OF FINANCIAL MANAGEMENT

PRACTICE USED BY SMES


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


EXHIBIT: 3.4

FINANCIAL MANAGEMENT TECHNIQUES USED BY SMES


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)


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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