Leverage and SMEs- Is capital structure of any relevance?

Optimal mix of debt vs equity helps define the hurdle rate while taking capital expenditure decisions. Choice of capital structure; its optimal level compared to equity and how and when companies churn their capital structure has been researched widely in academic research.

 

While reviewing the relevance of capital structure for Indian companies due consideration to constraints to finance is important. Large and 'A' rated companies have a wide array to chose from while SMEs are highly constrained in terms of choices. Further, most of the SMEs in Indian are family-owned businesses who have a strong aversion to debt.

 

For SMEs, pecking order of financing (when internal accruals are not enough) are:

1) Unsecured loans from promoters/group companies;

2) Equity from promoter;

3) Secured borrowings from banks;

4) Equity/quasi-equity from non-promoters.

 

Working capital gap is funded by stretched trade credit and borrowings from non-market sources, as well. The quantum of borrowing usually depends on the nature of business and reputation the promoter enjoys in the business circle.

 

Traditionally, world over, family-owned businesses are known to re-deploy the retained profits to reduce debt and/or grow their business. Cost of capital is not a very important criteria for two reasons:

1) Promoters have reasonable return expectations and hence unlike an ROI of 20% and above for a PE, promoter is happy with a return of 10-12% spread for over a longer time horizon;

2) More than the cost of debt, control dilution is a far bigger reason for aversion to debt from banks.

 

 In recent years- with what is observed by me in case of Indian firms- over-leveraging has become quite evident in the balance sheets of Indian companies, especially more alarming in case of SMEs. Increased competition and shrinking profit-margins have forced firms to resort to debt, to ensure enough liquidity to tide over trough phase of business cycle.

 

Hence, any attempt to comment on the relevance of capital structure for SMEs, we should look at them in a financing-need induced framework. Byoun (2007) has suggested to review capital structure changes under 4 scenarios:

 

1) Financial SURPLUS with MORE than optimal level of debt

 

2) Financial SURPLUS with LESS than optimal level of debt

 

3) Financial DEFICIT with MORE than optimal level of debt

 

4) Financial DEFICIT with LESS than optimal level of debt

 

* Byoun, Soku, How and When Do Firms Adjust Their Capital Structures Toward Targets?. Journal of Finance, Forthcoming.  

 

CHANGE IN MY LIFESTYLE- Exercising my way to a new life

Going for a preventive health check-up was an impulsive decision last year in March-2012. I was sensing some discomfort in my overall fitness and well-being. Finally, the trend to go for a preventive health check-up caught on me.

I was never so unfit in my life. I have a past of a sportsman. I did some rigorous cycling during my college days. My fitness levels were- weighed 65 Kg (for a 5ft 10 inch height); heart beat in resting stage was 60 beats per minute (indicative of the stamina); cycled some 3000 km in a month.

 

 

Today, 15 years hence, I had enrolled myself (unknowingly, just like others) in the rate-race club. While getting my love was my decision, rest all events in my life unfolded, as if they were freebies with that one decision of mine. However, no excuses on my laziness and negligence. I WAS RESPONSIBLE and I AM RESPONSIBLE  for my health and fitness.

 

 

My test reports were out in a day's time and was shocked to note that atleast five readings across lipid profile, liver function and kidney function test were out of the normal range. Nothing alarming medically though, but shocking to me personally since my body was expected to work for some 40 years more to take care of seven dependents. Outliers in my medical tests may be acceptable to a statistician and a doctor but no way acceptable to me personally.

 

 

Finally, I had that one reason to stretch myself to come out of self-created web of reasons of not having enough time to exercise. Since that day, I am awake before alarm goes-off on my mobile phone- Good Morning- at 5:30 am.

 

 

I started initially with 2-3 km runs and then exercising at home. I exercised a min of 4 times in a week. First one month was an acclimatizing phase when my metabolism was increased to a level that demanded I ate more and rested post workouts. But resting was not possible. I had to be at work by 10:00 am six days of week.

 

 

I was entering a phase where I needed some motivation to continue my new routine. I tried hard to restrict my diet to multiple but short bites during office hours. I kept narrating my workouts with my colleagues to ensure their encouragement kept me to go-on.

 

 

Then my dream of being back to cycling once again turned out to be a reality. One Sunday evening despite having fever my wife accompanied me to buy a racing bike.

 

 

That night, I could not sleep. I lived through my past life 15 years back, when I cycled. I could not wait for the morning alarm to go-off. First day, I cycled on my new Canondale cadd 8 series was Jun 29 2012. I covered some 32 km at 20.5 km/hr i.e. I took some 1:33:51 hrs to cover the distance. Compared to that, today, I average around 27 km/hr for same distance and same route of cycling.

 

 

Since my first day of cycling, after a chasm of 15 years, I have covered some 3,776 km at an average speed of 26.1 km/hr. I have burnt some 128,132 kcal in total. So after such an effort and with a balanced lifestyle, I do not have the urge to redo my medical tests. I have lost some 12 kg of fat and reduced waist size from 38 inches to 33 inches.

 

 

June 29 2013 was the first day of my workout recorded on the sports-tracker app. Today, I covered 48 km on same Gurgaon-Faridabad road and despite being a humid and hot day was averaging 26 km/hr.

 

 

I aim for competitive cycling now in my age group. I am assured that I have managed to change my lifestyle permanently but will not take it for granted. Today, I can cycle for some 40 km in morning and still me active through out the day. I have the luxuries to break rules of a controlled dieting over weekends. I sleep deep and sound. I am happy and less stressed. I have been impressing people around me with my new hobby and fitness levels. My wife is the first one to adopt the new regime in her life as well, easy for her since she has been a great swimmer through out her life. Since then, I have impressed upon my father and my chacha ji to buy a bicycle.

 

 

 

I intend to impress upon others as well- known or strangers- take-up fitness route to life.

 

Also do read - http://www.linkedin.com/today/post/article/20130625095621-250042058-the-5-30-a-m-workout-that-will-change-how-you-live

 

Why you should not look for a new job?

People end-up searching for a new job for varied reasons. While they have a convincing rationale to explain others, they fail to realize the exact reasons within and evaluate them thoroughly. Money is one of the key factors they often get carried away. Forget evaluating reasons for change, most of them fail to decode the new company's CTC structure which may be hiring them under pretext of higher increase ultimately paying far less. 

Before identifying the reasons for NOT changing a job, what situation(s) or reasoning prompts to upload their resume on Naukri should be listed:

Boss Related:

1. Hate his personality and behavior. 
2. Takes credit for my work.
3. Preaches transparency but practices conflicting task allocation amongst colleagues.
4. He knows nothing. I am better not report to a person who knows less than me. I wonder how is he my boss.
5. He is using me to meet his task and will render me useless in company the day he has a back-up for me.

Job Related:

1. I have a monotonous job. Sick of coming to work at same place with same frowning faces around.
2. I have an ugly workstation and no one cares or respects me. Only select seniors in the company are respected. 
3. I have a new role before I have settled well into the existing one. 
4. I actually do not like my current job. I landed up doing it accidentally. 
5. My father earns enough so why should I slog for someone else.
6. My current profile is name sake. Actually I have no job that could land me a new job easily. So lets move before its too late.
7. I have mastered my current job and equivalent to a Doctorate. Lets explore out I am sure I will be able to perform.
8. I will not be paid enough in my current company for this role.
9. The role may not last in my current company and I will have to change job since I am not ready to accept anything other than the current one.
10. My colleague wins "Best Employee" reward while I fail to get one.

Money Reasons:

1. My friends are earning more
2. I am yet to buy a house.
3. I need to own a car or a bike. 
4. Salaries are delayed as if my employer does not feel like paying me. 
5. I performed very well but then annual appraisal will average 10%
6. I already have an offer paying me 40% more.

Despite the easy way out, taking up a new job has its own challenges and at times and with some adjustments and thinking style you are better to continue in current job:

1. Start thinking like a businessman- just like your employer. Keep asking yourself- Why should I continue to be paid? Answer to this is easier to find with existing employer.
2. In case of Boss related issues, you are better off dealing a 'Known Devil' than an 'Unknown One'
3. You already know your boss's strengths and weaknesses; leverage them to your and your employer's advantage.
4. Be proactive at work this is possible only if you know what to do and enjoy the support of colleagues. In new company you will not be able to get this comfort with ease. 
5. Proving and establishing your credentials takes time. Better stick to current job them re-start it somewhere else. Remember- time not only heals old wounds but also create favorable biases.
   
6. Stability of a job is letting you plan for other things in life better- more time with kids; comfort of taking leaves; personal favors from colleagues; family connection etc.
7. Accepting change in a well-known set-up is far easier than in a new environment.
8. Better-off spending energy getting more efficient in current job than finding a new one.

Trending on New year eve

On new year eve, listed below are some trends that I sensed or hypothesized to turn into reality in coming years...

1) Market for small cars is shrinking. SUVs are a fascination. Good to see that manufacturers had to customize the SUVs to fit Indian customers' budget. Last year it was XUV 500 and this year DUSTER.

2) Indian Women may have to be more patient before she gets her rights- the wait seems to be longer. Jai Mata Di... 

4) Health consciousness is on the rise. Till few years back Baba Ram Dev marketed yoga that prompted people of adopt healthy living style. Going forward we may get to see marathon runs and sporting events like skating, cycling and golf taking lead over yoga.

5) Preference for football over cricket represents a divide between HNI and middle class of Indian society. Football is preferred over cricket by kids of HNI (High Networth Individuals). Cricket is left to middle class kids- My friend highlighted this to me and I believed it instantly.

6) Privatization of hospitals will reduce dependence on government hospitals. Within next 5 years we may see hospital chains in smaller towns of India. Where will they find good doctors? God Knows!

7) India moving towards presidential democracy..with decisions delayed and falling credibility of politicians what else is the option. But this may take another 50 years..

8) Online shopping may not be cheap for long. Dear Entrepreneurs of E/M-commerce industry please plan to make money from day ONE. Loyalties of customers are low and will not stay long to let you en-cash them. 

9) Gaming on couch is gone. More innovations on virtual gaming are on the way post launch of Kinect by XBox.

10) Networking sites like FB and Twitter may not last another 5 years.

Apps to be disciplined and stay healthy

On Health and fitness front:

Taking up cycling after almost 16 years was a totally different experience. Back then in 1993 we were restricted to using speedometers installed on our bicycles that tracked the speed and distance to be precise. And most of us never afforded the gadgets. I had not even heard about mobile phones then. Also, in those days rarely anyone would have spent INR 7.5 K to 20 K on a road bike and neither would have they been  available easily.

Today, we are overwhelmed with smart gadgets, most of them free to use, not only keeps one entertained during the workout but also tracks your performance. One of the main advantages, they help you step beyond just fitness, to performance.

Business line carried an article listed out some of these applications titled "Track your walk". Two additional apps that I would like to suggest here are http://www.sports-tracker.com/ .  This app is a free to use on symbian phones ( I am not aware about other OS). The app allows you to export the workout details in excel format, upload live to the its website and of course on facebooks and orkut. The website www.sports-tracker.com shows world map with blinkers of users already registered on site and sharing their workouts in public forum. This is one of the prime attractions to visiting their site.The apps tracks altitude as well and shows the speed and altitude as a graph.

Next, app that is not mentioned in the article is micoach by Addidas. This app is again free to use but allows you to track your heartbeat. ensure to check whether the same is compatible with app else they sell their own set of gadgets to track the same. Please visit http://www.adidas.com/us/micoach/


On Discipline front:

We at office may object to restricting access to Facebook,Linkedin, Orkut and Twitter and may even win the case with management for allowing access to these websites. But the reality is, with advent of these sites which are now accessible on mobile phones as well, lead to increased levels of distraction. Distraction in simplest terms is reduced focus on task at hand. Reduced concentration has its own problems- extra time to complete the task, lack of control, incorrectness in interpretation or calculation of data. All this, further complicates when most of us as professionals tend to carry "status quo" approach to decision-making. All the talk to innovation and efficient management remains in books and talks of consultants. Anyone who succeeds may smartly attribute it to what is said such books and talks. So we may all will agree that we have a problem at hand i.e. Distraction.

I came across some very good apps that control your distraction. Please read about them here Apps for Online workers  .

Limited role of non-financial stakeholders?

Financial decisions (funding of firm's investments) interact with overall strategy of the firm. The role of stakeholders assumes significance since a firm continuously engages with its customers, suppliers, employees (including prospective ones), lenders and shareholders. Each of them having their own objective for being associated with the firm. 

Customers expect the firm to service its product purchased while employees look at career growth. Vendors look to continue to supply so that they continue to have the firm as its customer while shareholders and lenders desire return on investment. None of the stakeholders would like to engage with a firm that is loss making or is highly leveraged (measured as Debt-equity ratio). This seems quite illogical atleast in case of equity shareholders or lenders who have put their own money into the business. For instance, in case of shareholders such a situation arises only when the cost of liquidation outscores the cost of running the firm. 

Stakeholders can be categorized into two types- Financial and Non-financial. Financial stakeholders have access to financial information using which they take decisions to invest or withdraw from the firm (irrespective of the size of the firm). However, in case non-financial stakeholders access to financial information is limited. This is true, more in case of unlisted firms/SMEs. Hence, it can be reasoned logically that non-financial stakeholders have limited role in shaping the overall strategy of SMEs. In other words, managers of SMEs will be more focused on protecting interests of its financial stakeholders over its non-financials stakeholders. Is this true?

Alternatively, is it that managers of SMEs, unlike managers of large corporations, are far less constrained in their choice of financial decisions? But do they have enough options to chose from?

Motivation for my research topic

I have struggled hard to work on my research topic due to lack of focus, time and motivation. My attempt below is to document the three key motivators to continue to pursue my research topic on capital structure theories:

1. Study of capital structure is a complex due to involvement of multitude of factors that vary within firms over time, across industry and across countries. Majority studies have taken large sample of firms across industries to ascertain the determinants of capital structure and its adjustments. Hence, its imperative small subsets of sample firms are studied to better understand capital structure theories. This is of immense significance in context of Indian firms. 

2. Existing studies convincingly argue that careful measurement of key variables including the dependent variable (debt/equity ratio) is critical. Studies have tried to develop statistical models that attempt to explain the capital structure variation but each is a partial fix and still leaves much of capital structure variation unexplained. (see Graham, John R. and Leary , Mark T., A Review of Empirical Capital Structure Research and Directions for the Future (April 7, 2011). Annual Review of Financial Economics, Vol. 3, 2011.) Hence, using non-parametric methods on primary data (collected through) questionnaire is expected to help identify qualitative factors that influence the choice and variation in capital structures. The proxies for qualitative factors in parametric models may have failed to capture their effects completely.

3. Despite years of research, capital structure remains a "puzzle" (see Myers, Stewart C., Capital Structure Puzzle (July 1984)). NBER Working Paper No. w1393.) Is capital structure of a firm an outcome of its business decisions or is it a determinant of business decisions? We have trade-off and pecking order theories  and several decades of empirical research attempting to validate the capital structure theories but the "puzzle" provides enough scope to validate and study it further. 

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Regards

Jaspal Singh
09711001973
New Delhi