Operating margins of micro enterprises in engineering sector are competitive compared to those of small and medium enterprises (SMEs). Yet, their ability to generate superior return on capital employed compared to these peers remains constrained.
This analysis is based on a dissection of four financial indicators — capital efficiency, operating efficiency, sales leverage and debt coverage of over 2,000 CRISIL-rated MSMEs which are Tier-II/Tier-III suppliers of engine spares or valve components to original equipment manufacturers.
Other rated players include light engineering firms and fabricators.
A majority of these non-corporate micro enterprises experience challenges in getting bank loans for capacity expansion and meeting working capital requirements. Hence, the bulk of their capital employed comprises promoters’ funds, capital contribution and unsecured loans.
According to CRISIL’s analysis, 50 per cent of the capital employed by these entities is locked in low-yielding assets such as outdated equipment, land and building. This results in a lower asset-turnover ratio.
Such sub-optimal capital allocation adversely affects their ability to churn funds towards working capital.
A combination of lower operating scale and weaker capital efficiency in relation to SMEs results in a high debt-to-turnover ratio, an indicator of leverage.
This, in turn, cascades into a weaker debt coverage ability despite better operating profitability.
Given this, the upgrade of the manufacturing infrastructure of micro enterprises becomes imperative in order to enhance productivity and improve their return on capital.
Towards this end, policymakers could use credit-profiling tools for shortlisting credible micro enterprises that can be offered capital subsidies for capacity upgrade and financial assistance for meeting their skilling needs.
This would also support the government’s ambitious agenda to promote indigenous manufacturing and meet the skill deficit.