close
Sunday December 05, 2021

Cash-strapped SMEs close to crashing

October 19, 2021

LAHORE: It has been observed that small and medium industries lag behind in growth compared with the large-scale industries during high growth cycles. The reason is financial crunch and not production capacity.

The SMEs that suffer operate as vendors of large-scale manufacturers. The auto-parts vendors for instance are the most organised SMEs and are comparatively better financially as well. Their plight in times of high growth in the auto industry would give a glimpse of the way the SMEs operate.

They operate comfortably when the vehicle production levels are normal. But they suffer whenever the production goes steeply down or moves upward. There are valid reasons for this. Auto-part vendors naturally depend on vehicle producers to manufacture auto-components.

Orders are placed in advance at an agreed price. The vendors know the supplies they have to make in three months. Inventories are kept for this period, keeping in view the supply constraints that Pakistani entrepreneurs normally face. They cannot default on supplies as it would disrupt the car, tractor or bike manufacturing cycle.

In case of default, the vendor is blacklisted. They produce components much earlier than the supply period, but the buyer accepts the goods on the date mentioned by them on the order sheet as the payment schedule starts after the vehicle manufacturer lets the components enter its premises. Payments are usually made after 30-45 days of supply.

This works well in normal times because the vendor has made arrangements both for finances and the raw materials of the components. However, when the demand for components increases beyond a limit, the financial side comes under stress.

Arrangement of raw material needs money. The buyers continue with their normal routine payments and do not default. But in times of shaky global commodity markets, normal supplies become a problem for the vendors.

Currently, the vendors face multiple pressures and constraints. Prices of commodities and raw materials have doubled in one year. To add salt to the injury, the ever-declining rupee value has a multiplier impact on the raw materials that are imported.

The vendors somehow managed the additional finances needed for normal supplies of equipment to the original equipment manufacturers. The financial institutions mostly facilitated them to some extent and they arranged some money privately (the finances for components more than doubled in commodity rates and rupee depreciation).

They do not have resources to make additional components due to remarkable growth in the auto-industry. Still, they are managing supplies by curtailing their inventory from 90 days to 45 days. But for how long would they be able to do so.

Inventories of some vendors are drying out and they may be forced to close down because of their inability to meet higher demand of parts. Many wonder how the OEMs manage the sudden rise in their production. There are many reasons.

The banks facilitate them wholeheartedly because of their huge reserves. Moreover, the bigger players get 30-100 percent advance at the time of booking of their vehicles. They get the component on 30-45 days credit from the vendors. They have no financial need by the time the car or tractor rolls out in the market.

They get 50-90 percent of the components from the vendors on credit, while enjoying the advance provided by the consumers. In case of tractors, the manufacturers get 100 percent advance for the unit that they supply after three months, but the manufacturers withhold the payments of the vendors insisting for supplies on credit.

This system is unfair as it deprives the vendors of prompt cash when the manufacturers have 100 percent advances. SMEs remain on the receiving end of this system.

The SMEs in other sectors suffer the same fate. As vendors they are not on the priority list of the LSMs as far as payments are concerned. Since these SMEs remain starved of cash all the time, many succumb to the pressure.

An interesting development gives a glimpse into how the bureaucracy invents ways to create obstacles for businesses. One instance in this regard is that the tractor manufacturers get a refund of the sales tax from the Federal Board of Revenue (FBR).

The portion of tax paid is refunded by the manufacturers to the vendors who paid that tax. The FBR has come up with an innovative idea to deny sales tax. Their assertion is that only the farm tractors are entitled to sales tax refund and not the ones that are used for commercial activities. It has asked the manufacturers to identify which tractors were sold for farm use and which were sold for commercial use.

The manufacturers are at a loss as to how to separate the two usages as every farm tractor is also used by the farmer for commercial use for taking their produce to the market on a tractor trolley. Billions of refunds of the tractor manufacturers are struck; most of which are to be refunded to the vendors. As the stalemate prolongs many tractor vendors are forced to close down due to the financial crunch.