How money sitting outside the books poses a threat to growth
Sometime in the first quarter of 2010, the Mint staff writer Deepti Chaudhary wrote a telling piece describing how small town businesses are finding it difficult to attract VC money. It felt odd and somehow, ‘unfair’, that VCs would ignore a geography that I felt was going to be a key driver of the next chapter of India’s growth story. [That article formed part of the basis for my friends and me to launch our advisory for businesses in Middle India, but that is not the point of this post].
Over the last few months, having met several VCs in big cities and businesses in Middle India, I am beginning to understand one of the reasons VCs are shy of putting money in those businesses.
It’s what you may call the ‘parallel balance sheet’, the business equivalent of the parallel economy. Now, not reporting part of your business income may not be a sole privilege of businesses in Middle India. Perhaps it’s equally prevalent in big cities and in all kinds of businesses in India. But I am pained by the inefficiency this money creates for a company looking for rapid growth.
MORALITY ISN’T JUST PHILOSOPHY One dimension of this issue is the morality of informal business dealings creating and often using unreported income and how much strain it may be putting on our country’s financial planner’s calculations. And indeed morality and ethics is an issue in business, it’s not something we can avoid any longer, not while our collective consciousness is being attempted to be woken up from slumber against graft in public life. It is true that for many businessmen, it has been a fact of life to run a parallel account consisting of cash. “It’s the way of business, sir, we can’t change it,” admitted a young first generation businessman to me in a recent trip. In fact, another gentleman told me of an accounting software available in the market that can help you manage balance sheet A versus balance sheet B. Apparently, in some of these you can programme a key on the keyboard to delete all the Type B data on a single keystroke, when the taxman comes calling.
The poignant part is many businesses may not even be aware that they are doing something wrong by maintaining two sets of books. “How else do I manage [read, grease palms] those in power to control my approvals?”, asked another entrepreneur, “they aren’t going to accept a cheque!”. On a dias in front of nearly 300 people in an event I attended recently, a successful businessman spoke of the existence of a ‘rate card’ of bribe in the local civic body and how he was asked to pay five lakh rupees [USD 10,000] if he needed some land surveyors to do their work fast. [‘working fast’, we all know, actually means ‘doing your work and not delaying it without reason’]. A realty company owner told me, “Often customers want to give me part cheque and part cash and ask for the agreement value to be lower, so that they can save stamp duty. What am I supposed to do? I can decline the proposal, but who knows whether I will have a business tomorrow if I keep doing it?” The more I talk to people, the more interesting are the justifications I hear, making it sound as if having cash sitting outside books for miscellaneous purposes like these is one of the most practical things to do, and is often a compulsion.
CASH MAY KILL GROWTH The second dimension of the issue is that of efficiency of money. When 40%-50% of your income is sitting outside your books, it also reduces your ability to borrow formal money by that extent. And for growth oriented businesses with turnover of no more than Rs 20 -30 Cr, it would appear that a large part of the income is indeed sitting outside books, carefully managed by the ‘well-meaning’ chartered accountant, a man usually the business owner depends completely upon.
This approach may appear smart and practical, but in my belief, it also keeps companies crawl in their growth trajectory. Think about it, one reason software services companies may appear to have grown really rapidly, is because often their clients are sitting in the USA or Europe and they certainly aren’t paying cash.
It’s possible that different professionals may have different views, but I have managed companies long enough to have developed a conviction that the cleaner a book you keep, in general, the stronger a reputation and company you will end up building. Too clever book keeping can sometimes land companies in trouble.
We live in a world where ‘financial prudence’, ‘corporate governance’ and ‘disclosure’ are more than mere management jargons. Companies are built and destroyed based as much on how much money they make, as how they make it. Enron, WorldCom, Satyam and many other enterprises are bright examples of corporate greed, misconduct and abuse of accounting rules. Many growing enterprises may feel that they are too small to be caught and they can get away. But it’s not about whether you can get away; it’s about whether you want to do something that forces you to try to get away.
More importantly, to fuel growth, you are going to need someone else’s money sooner or later – banks, private equity firms, and even public. Why would someone want to give you money if they believe that you are managing parallel and ‘creative’ balance sheets?
They say being cash rich is a good thing for your business. I agree. But if that cash is sitting outside books, you are actually starving your business of essential growth nutrients.
It’s worth a thought.