Non Performing Assets (NPA) is an oxymoron!! – If it is non performing , it is hardly an asset.
Typically NPA refers to sticky and potentially non serviced loans in its balance sheet. Billions of rupees are said to be NPA in the balance sheets of Banks. But the story does not end there. The real non performing asset sits in the borrower’s balance sheet. So assuming that the bank has taken on an average 50% margin for lending, the real problem if NPA in the economy is at least TWICE the size of bank NPAs.
How did we end up there in the first place?
Dr Anil Lamba, an evangelist for financial literacy says it simply.” For every asset, there is a corresponding liability and for every liability there is a cost”. This is a cardinal rule. every institution has to generate enough money using its assets to service this cost.
In fact the assets need to produce much more than the cost of funds. Most of the NPAs are due to the inability to service the repayment of principal obligation. So, entrepreneurs must remember that the mere profit making to take care of interest is NOT enough. The cash generation has to be enough to service the repayment of loan as well. This is mostly forgotten and financial models are prepared to address the magic words of MPBF and DSCR( Debt Service Cove Ratio – representing the amount of cash required to service interest and repayment obligations) and the real cashflows do not come anywhere close to the DSCR, which is the real issue.
So Entrepreneurs have to be NOT ONLY careful in choosing the mix of source of funds between own funds and third party funds as well as the timing obligation on the repayment of principal on third party funds BUT ALSO careful in the quality of assets in which the funds are deployed and the cash generation capacity of the assets.
Assets need to perform not just for the interest but the repayment of principal. Then there is return for the Shareholders finally. Wow! – typically the demand on earning rate from assets is upwards of 70% during the prime years – what is your story?