Bookkeeping & Accounts – Building Blocks of Small Business Financing

The Credit Guarantee Trust Fund for Medium and Small Enterprises (CGTMSE) scheme and its recent changes are about to make small business financing a lot easier in India. Let’s look at the other end of the challenge. Is there anything that entrepreneurs can do to better prepare themselves for funding approvals?

‘Adopting standard book-keeping and accounting practices would probably be the leading response of the Indian lending community. The ad-hoc and inconsistent book-keeping and accounting practices followed by Indian SMEs make it difficult for lenders to gauge the true potential of the business. Standardized book-keeping and accounting are thus tools that allow entrepreneurs to speak the lenders’ language.

Do you speak numbers?

Most entrepreneurs have a fair idea of the paperwork they need to submit with their small business loan request: credentials, financial reports, business plan, revenue projections, as well as collateral information (unless the credit is going to be collateral-free, as in the case of CGTMSE). While putting these together is often a challenge in itself for small entrepreneurs, even when being assessed by the lenders, SMEs find themselves caught short, unable to fully comprehend the processes and principles of the lender’s evaluation.

When assessing a small business loan request, lenders review the three Cs of the borrower: character, capacity and collateral. While character deals with the expertise, financial position and credit history of the entrepreneur, capacity is a largely quantitative assessment of the business’ capacity to repay the loan, and focuses on the income and expenditure of the business – both past and projected.

This is usually the stumbling block for small Indian businesses. Profit and loss statements and balance sheets reveal a lot about how the business has been run from a financial point of view, and unless the SME has been following regular book-keeping practices from the beginning, they do not convey a clear picture of the business’ health. Also, inaccuracies and large adjustments in statements can make the lender worry about issues with internal controls on misreporting and fraud. Cash flow statements are the lifeline of a small business, and can give lenders important insights into the way the business manages its debtors, inventories and creditors. Finally, the financial statements give lenders a benchmark with which to assess the borrower’s business plans: are the costs realistic, is the inventory turnover healthy enough to support projected growth, is the business over leveraged already, and so on.

Investing in Financial Management

With lenders being an important part of their growth, making small business financing easy should be a powerful, if not the most important, motive for SMEs to invest in the right book-keeping and accounting practices. Once implemented, accurate books of records and accounting statements are great tools for business growth too. They reduce the complexities of the business into finite, tangible numbers, making decision making and planning infinitely simpler for entrepreneurs, and giving them insights into their hidden strengths and opportunities.