UNIT I: STEPS IN SETTING-UP A MSME (30 Marks)

Introduction

MSME’s are the growth engine of new India, they’ve proved essential in this age of
economic development that we’re witnessing around us. MSME’s have slowly helped revive
the artisan class in the far reaches of the country by providing them with employment and
in turn access to loans and other services. They constantly support the up-gradation of
technology, infrastructure development within the country, and have triggered the
modernization of the country as a whole.

Concept

Micro, Small and Medium Enterprises are better known by the acronym MSME. MSME’s are
the backbone of the Indian economy. Silently operating in different areas across the
country, more than 6 crore MSME’s have a crucial role to play in building a stronger and
self-reliant India. These small economic engines have a huge impact on the country’s GDP.

MSME’s contribute a staggering 30% to the country’s GDP, and around 45% of the
manufacturing output, and approximately 48% of the country’s exports. Additionally, more
than 11 crore people are employed in the MSME sector. They’re rightly referred to as the
‘Backbone of the country.’

The MSME ministry in order to strengthen the backbone of the country targets to increase
its contribution towards GDP by up to 50% by 2025 as India moves ahead to become a $5
trillion economy.

Headquartered in New Delhi, the Ministry of MSME is a branch of the Indian Government,
which is the apex body for the formulation and administration of rules, and laws, pertaining
to micro, small, and medium-sized enterprises in the country. At present Narayan Rane is
the union minister of Ministry of MSME in India.
What are Micro, Small and Medium Enterprises? Previously the existing MSME
classification was based on the criteria of investment in plant and machinery or equipment.
So, to enjoy the benefits, the MSME’s have to limit their investment to a lower limit, as
mentioned below:

T
hese lower limits were killing the urge to grow as they were unable to scale their businesses
further. Also, there had been a long-pending demand for the revision of MSME classification
so that they can further expand their operations while continuing to avail the MSME
benefits.

Now, under the Aatmanirbhar Bharat Abhiyan (ABA), the government revised the MSME
classification by inserting composite criteria of both investment and annual turnover. Also,
the distinction between the manufacturing and the services sectors under the MSME
definition was removed. The following is the current revised MSME classification, where the
investment and annual turnover are to be considered for deciding an MSME.
Features of MSME’s

 Welfare of the workers and artisans:

MSME’s work for the welfare of the workers and artisans. They help them by giving
employment and by providing loans and other services.
 Promote the development of entrepreneurship:
They promote the development of entrepreneurship as well as up-gradation of skills
by launching specialized training centres for the same.
 Support technological development:
They support the up-grading of developmental technology, infrastructure
development, and the modernization of the sector as a whole.
 Exports:
MSME’s are known to provide reasonable assistance for improved access to the
domestic as well as export markets.
 Testing facilities:
They offer modern testing facilities and quality certification services.
 Support Product development:
Following the recent trends, MSME’s now support product development, design
innovation, intervention, and packaging.

Role of MSME’s in Indian Economy

 Since its formation, the MSME segment has proven to be a highly dynamic Indian
economy sector. MSME’s produce and manufacture a variety of products for both
domestic as well as international markets.
 They have helped promote the growth and development of khadi, village, and coir
industries.
 They have collaborated and worked with the concerned ministries, state
governments, and stakeholders towards the upbringing of rural areas.
 MSME’s have played an essential role in providing employment opportunities in
rural areas.
  MSME’s also contribute and play an essential role in the country’s development in
different areas like the requirement of low investment, flexibility in operations,
mobility through the locations, low rate of imports, and a high contribution to
domestic production.

Importance of MSME’s for the Indian Economy

 MSME’s are accepted as a means of economic growth and for promoting equitable
development. They are known to generate the highest rate of growth in the
economy.
 MSME’s have driven India to new heights through requirements of low investment,
flexible operations, and the capacity to develop appropriate native technology.
 MSME’s employ around more than 11 crore people, becoming the second-largest
employment generating sector after agriculture.
 With approximately 45 lac units throughout the country, it contributes about 6.11%
of GDP from manufacturing and 24.63% of the GDP from service activities.
(Approximately 30% in total)
 MSME ministry targets to increase its contribution towards GDP by up to 50% by
2025 as India moves ahead to become a $5 trillion economy.
 Contributing around 45% of overall Indian exports.
 MSME’s promote all-inclusive growth by providing employment opportunities,
especially to people belonging to weaker sections of the society in rural areas.
 MSME’s promote innovation by providing an opportunity to budding entrepreneurs
to help them build creative products hey and thereby boost competition in business
and fuel the growth.
 The Indian MSME sector provides silent support to the national economy and acts as
a defence against global economic shock and adversities. Hence, we can say that
India is propelling towards a robust global economy through a silent revolution
powered by MSME’s.
Challenges faced by MSME’s in India

The MSME sector has grown tremendously in the last few years in India, and it has
enormous potential for growth in the future years while eliminating poverty and
unemployment, which are two of the biggest bottlenecks for growth. Despite the potential it
possesses, the Micro, Small, and Medium Enterprises are not free of challenges.

In spite of the high growth rate and good prospects, the MSME’s have faced certain
challenges that have obstructed its way of achieving its true potential. Following are some
of the challenges faced by them.

Technological Backwardness:

This is one of the biggest constraints faced by MSME’s till date. The MSME in India lacks up
to date information and are often unaware of the latest technological developments in the
global market. Sometimes they lack managerial skills, knowledge, and technology-intensive
education to run a competent MSME. This challenge is most prevalent in rural parts of India.
It is believed that technology can play a pivotal role for MSME’s because of the competition
it faces from neighboring countries. Therefore, MSME’s must look into this matter very
seriously.

High Cost of Credit:

Another challenge that haunts this sector is their inability to access adequate and timely
credit at a reasonable cost. Quite a few researchers have indicated that MSME in India are
hindered by poor credit availability. Now, if we look to understand the reason behind this,
we know that there is a high-risk perception among the banks regarding this sector, and the
transaction costs are also high for loan appraisal. The players of MSME are not in a great
position to provide collateral to get loans from banks.

Procurement of Raw Materials:

The availability of economic resources is critical for any business development. It has been
one of the growing concerns of this sector as procurement of raw materials is done within
local territory due to their financial limitations.

Inadequate Infrastructure Facilities:

Having good infrastructure facilities is essential to the growth of a business, and lack of
infrastructure facilities such as electricity infrastructures negatively affect the productivity
and the profitability of manufacturing SMEs. The availability of infrastructure and skilled
manpower will ensure the competitiveness of MSME’s. MSME’s are either located in
industrial estates or are operational in urban areas or have come up in an unorganized
manner in rural areas of the country. The infrastructure facilities in such areas are poor and
not reliable.

Lack of Skilled Manpower:

Although India is having a big pool of human resources, the industry still faces a deficit in
manpower with the skills set required for manufacturing, marketing, etc. A set of skilled
personnel will save time and effort as they use their expertise and talent, and knowledge in
their respective fields.

Inadequate Access to Market:

In India, MSME’s have struggled to have access to the market due to a number of reasons
like inadequate capital, inadequate use of marketing tools, etc. Thus, it makes it difficult for
MSME’s to sell products to government agencies.
Conclusion

Recently the government of India announced a stimulus package of 3 lakh crore rupees
collateral-free help to the MSME in India as part of the Atmanirbhar Abhiyan.
However, if adequate reforms are not implemented to solve the pressing challenges,
providing a stimulus package may not be effective.

Opportunities for MSME’s in India

1) Leveraging the E-Commerce Trend:

MSME’s now can make their presence in the online world by going digital. For many years,
the MSME sector was struggling with the intense competition, but going digital can give
them the required edge.

2) Adoption of Technology:

Since social media, mobile phones, and cloud technology is the talk of the town now,
MSME’s can take help of these platforms. Embedding the social and cloud platform will
open up vast opportunities for revenue growth and operational efficiency.

3) Taking Advantage of Government Schemes:

MSME’s need to receive benefits of Government initiatives such as ‘Make in India’, ‘Startup
India’ and ‘Skill India’. These schemes introduced by the government are aimed to promote
an entrepreneurial culture to grow the current MSME status.

4) Abundance of Fintech Firms:

With the number of Fintech firms and lenders on the rise, MSME’s will have the opportunity
to get accessible and affordable financing options. MSME’s always had to worry about the
gap in their cashflows while taking the MSME loan from the traditional lender. But now,
they will be able to focus on their business entirely, as enhanced speed, transparency, and
quick MSME loan facilities are about to increase significantly.
Following are the business needs catered by the MSME loan:

 Launch of a new product range

 Business expansion

 Paying out salary to employees

 Warehousing needs

 Purchasing new equipment

 Credit for marketing and advertising activities

Getting easy access to loans is not the only decisive factor, many lenders now do not require
the borrowers to put their personal or business assets on the line to qualify for financing.
Funding now has become faster as there is no need to pledge collateral, less paperwork, and
minimal documentation.

Conclusion

Progressive changes will take place in the Indian MSME sector based on the trends
mentioned above. With a significant rise in technology and innovation, a business-friendly
atmosphere for the MSME’s will become a reality.

Steps in Setting up a MSME

I. Selection of a Product

II. Preparation of Project Report

III. Selection of Form of Ownership

IV. Selection of Site

V. Designing Capital Structure

VI. Quotation for Machinery or Equipment

VII. Provisional Registration

VIII. Obtaining NOC and Other Statutory Licenses from Pollution Board, Food and Drug
Department, Municipality, Health, Factories and Boilers

IX. Apply for Power/Water Connection 

X. Recruitment, Selection and Training of Staff

XI. Trial and Commencement of Commercial Production

XII. Permanent Registration

Step I: Selection of a Product

The first step is to decide what product or range of products that shall be taken up for
manufacture. Selection of product refers to making choice of the product to be
manufactured. One could generate a number of project ideas through environmental
scanning, short list a few items, closely examine each one of these and select the final
product to be manufactured.

Factors to be considered during product selection process

Nevertheless, the first step towards successful commercialization is the selection of

essential service or product.

Here are some key factors associated with product selection:

Financing:
The size of the amount needed is one of the biggest factors that influence product
selection. For proper development, production, promotion, sales as well as
distribution, an adequate financing and resource is an essential requirement in
product selection process.
The Disparity in the Supply Chain (Gap between Demand & Supply):
It is the size of the demand in an unfulfilled market that will determine the selection
of a particular product. Business opportunities arise as a result of the magnitude of
the demand for a particular product. Therefore, the product which has a high chance
of success will be selected. The existence of a noticeable demand for the selection of
a product is paramount.
Accessibility and Availability of Raw Materials:
Since different products require the use of various raw materials, the source,
quantity as well as quality of the materials are some of the major influencing factors
that affect the process of product selection. Are the raw materials easily obtainable
within a few hours or days? How much is the magnitude of the materials and is the
source of the raw materials impeccable? Can you readily access the location where
the raw materials are situated? Answers to these and many other questions must be
amply provided and be satisfactory.
Nature of the Product:
The nature of the product is also one of the important factors to be taken into
consideration. The physical characteristics of a commercialized product will
determine its means of distribution. The type of distribution channel for perishables
will not be the same for imperishable products. Perishable products have to utilize a
shorter channel to reach customers in the shortest time possible to maintain its
quality.
Marketability and Profitability:
The product that has the highest potential for profit is most often, the product that is
selected. On the other hand, if a product can be sold as an accompaniment to an
existing product and is marketable, then it is a wise option to consider.
Technical Issues:
Another factor that affects product selection is the technical process of production.
It is the selection of a particular product that determines whether the available types
of machinery will suffice or if there will be a need to procure new or refurbished
machinery to handle the manufacturing process. How satisfactory and acceptable
the product will be for the consumer and its technical acceptability will go a long way
in meeting the requirements in the product selection process.
Qualified Employees:
How many of your employees or workers are professionally qualified to handle the
production process as well as the promotion of the product when it is ready to hit
 the market? The availability of skilled human resources will go a long way in
determining the profitability of the product as the costs of creating the product will
be kept to a minimum. There will be a drastic reduction in some wastage since
professionals are the ones handling the production process.
Policies of the Government:
There is so much one can do regarding this factor, as it is one factor that is totally
uncontrollable. The focal point of public policy can inadvertently influence or affect
the selection of the product you want to produce.
Company Objectives:
One more factor that affects product selection processes is the realization of the
organization’s short as well as long-range goals and objectives. Is the creation of the
product going to contribute to the accomplishment of the company’s objectives? If
not, then the product may have to be revised.

Step II: Preparation of Project Report

The next step is preparation of project report. A Project Report is a document which
provides details on the overall picture of the proposed business. The project report
includes comprehensive information on the necessary land and buildings, annual
manufacturing capacity, manufacturing process, machinery and equipment prices and
specifications, raw material requirements, power and water requirements, manpower
requirements, project marketing costs, efficiency, financial assessments, and economic
viability.

Step III: Selection of Form of Ownership

The third step is to choose a form of business organisation. The various forms of business
organisations are explained as follows:

1. Sole Proprietorship: A sole proprietorship is a business owned by only one person. It is

easy to set-up and is the least costly among all forms of ownership. The owner
faces unlimited liability; meaning, the creditors of the business may go after the personal
assets of the owner if the business cannot pay them. The sole proprietorship form is usually
adopted by small business entities.

2. Partnership: A partnership is an agreement among two or more persons to carry on

jointly a lawful business and to share the profits arising there from. Persons who enter into
such agreement are known individually as ‘partners’ and collectively as ‘firm’. A partnership
is owned by two or more persons who contribute capital to conduct business. The partners
divide the profits of the business among themselves based on agreed terms.

3. Company: A company is a business organization that has a separate legal personality

from its owners. Ownership in a stock corporation is represented by shares of stock.
The owners enjoy limited liability but have limited involvement in the company's
operations. The board of directors elected from the stockholders, controls the
activities and direction of the corporation.

4. Cooperative Society:
A cooperative is a business organization owned by a group of individuals and is
operated for their mutual benefit. The persons making up the group are
called members. Cooperatives may be incorporated or unincorporated. Some
examples of cooperatives are: utility cooperatives (water and electricity), cooperative
banking, credit unions, and housing cooperatives.

5. Hindu Undivided Family (HUF): Hindu Undivided Family business is a precise kind of
business structure found only in India. This is one of the classical methods of business
structure in the nation. It is administered by the Hindu Law. The source of membership in
the company is birth in a family and 3 consecutive generations can be members of the
company.

The business is managed by the head of the family (eldest member) and he is called Karta.
However, all the members hold equal ownership over the property of an ancestor and they
are called as co-parceners.

Factors Influencing a Suitable Form of Organization

When an entrepreneur proposes to undertake business, he has to choose a suitable form of
organization. While selecting an appropriate form of organization, he has to keep in mind
the merits and demerits of every form. For choosing a suitable form of organization an
entrepreneur has to take into consideration several factors. They are:

Types of Business: This is an important factor having a direct bearing on the choice
of a form of organization. In small trading, businesses, professions and personal
service traders, sole proprietorship is predominant. The partnership is suitable, in all
these cases where sole proprietorship is suitable provided the business is to be
carried on a slightly bigger scale. Business activities requiring pooling of skills and
funds, e.g., wholesale trade, stock brokers, etc. are better organized as partnership.
Manufacturing organizations are large size and more commonly set up as private and
public companies.
Scope of Operations: In case of large scale of operations, the company form is
suitable because large enterprises require large financial and managerial resources
which are beyond the capacity of a single persons. If the scale of operations of
business activities is small, sole proprietorship is suitable. If the scale of operations is
modest -neither too small nor too large partnership is preferable.
Degree of Direct Control and Management: If the entrepreneur desires direct
control over its operations, he will prefer sole-proprietorship. But if he is not
interested in or bothered about the direct control and management, he may choose
partnership or company form of organization.
Amount of Capital Funds Required: If the business requires huge amount of capital
company is best form of organization. If the capital is to be required is small, a sole
proprietorship or partnership form of organization would be suitable.
Size of the Risk: The volume of risk and the willingness of owners to bear is an
important consideration. If an individual is ready to bear all risks and liabilities of the
business, he may opt for sole proprietorship. A business with wider risks and more
labilities is generally started in the form company due to limited liability and a large
number of shareholders.
Continuity of the Concern: Sole proprietorship has a limited life because they are
not fundamentally perpetual. An illness of owner or his death can end the business
 partnerships are also unstable. A company is the most stable and permanent form of
organization. The life of the company is not dependent upon the life of the owners.
Comparative Tax Advantage: Corporate profits are subjected to uniform rate of
taxation and if the expected profits from business are going to be huge, it is better to
start such a business on company basis. Profits earned by sole proprietor or a
partner are subjected to progressive rate of taxation, i.e., the rate of tax goes on
increasing with increase in volume of profits. Thus, proprietorships and partnerships
face a lower tax burden at moderate levels of income.
Cost, Procedure and Government Regulation: Proprietorships and partnerships are
subjected to little regulation and control by the government while companies and
cooperatives are subject to severe restrictions and formalities. Sole proprietorship
and partnerships are easiest, cheapest and most convenient forms of organization.

It must be noted that these factors are interrelated and interdependent. Therefore, an
entrepreneur should not consider these factors in isolation. The interrelationship between
these factors should be duly considered.

Step IV: Selection of Site

It refers to choosing suitable plot for factory. In other words, location of the factory. Types
of locations available are:

 Industrial area developed by State Development Corporation or Directorate of

Industries.

 Factory Sheds in industrial estate constructed by State Industrial Development

Agency.

 Sheds developed by private developers.

 Buy private land and develop the same for industrial use.

Factors affecting location (Site) of MSME are:

Decision with regard to location of an industrial unit involves a careful study of many
factors. Proper and right choice of location is instrumental in future success of the business.
The various factors are explained as follows:

Availability of Raw Materials:

Raw material forms major proportion of the finished product. Unrestricted and
regular supply of raw material is very necessary for carrying out unrestricted
production. Nearness to the source of raw material is very economical for an
industrial unit. On account of this consideration many industries have been set up
near the source of supply of raw material.
Sugar factories in Uttar Pradesh, Textile units in Maharashtra and Gujarat, Cement
factories in Madhya Pradesh and Jute industry in West-Bengal. Nearness to raw
material is important in case of heavy and bulky materials having lesser value such as
coal and other weight losing materials.
Availability of labour:
The supply of un-skilled labour does not create any serious problem because such
labour is available everywhere. Skilled labour is available only at specific centers.
Industries requiring highly skilled labour have to select such sites which ensure
adequate and regular supply of required labour. Availability of skilled and efficient
labour is mainly responsible for the development of various industries in a particular
region e.g., cotton textile industry of Great Britain developed at Lancashire mainly on
account of availability efficient labour.
Availability of Power and Fuel:
Availability of cheap power and fuel supply sources is another decisive factor in
selecting proper location of an industrial unit. In the past, coal was the main sources
of power supply for various types of heavy and large-scale industries like iron and
steel, cement and aluminum etc., the industrial units which used to be located near
coal supplying centers.
Availability of Transport Facilities:
Adequate and quick facilities of transport must be kept in mind for quick delivery of
raw materials to the factory and finished products to the market.
In certain type of industries transportation is the sole factor which is taken into
consideration in deciding location of an industrial unit. For example, a cement
factory is always situated near the source of lime stone which is carried usually with
the help of trolleys to the factory.
Faridabad in Haryana developed as an industrial town on account of availability of
both rail and road transportation. Phagwara serves another very good example of
this type. Certain port towns like Calcutta, Bombay and Madras have attained
significant importance on account of availability of excellent water and rail
transportation facilities.
Nearness to Market:
Market greatly affects the establishment of an industrial unit and is in fact, dominant
factor in locating an industrial unit in modern times. The production of goods is
undertaken with the aim of selling them quickly which is possible only on account of
nearness to market.
Nearness to market is important in case of industries producing consumer goods
rather producers’ goods, this is because production of consumer goods require
constant adjustment of manufacturing programme on account of quick changes in
the tastes, preferences and buying habits of the consumers.
Markets may be national or regional. In case where the demand of the product is on
regional basis, the factory is usually situated near the major market for the product.
For example, a publishing house publishing Punjabi books cannot be located in
Calcutta or Bombay. It’s ideal location would be Jalandhar, which is a leading
publishing center in Punjab.
Nearness to Adequate Banking and Credit Facilities:
For the efficient and smooth running of the business and for meeting working capital
requirements, banking facilities play an important role. Nearness to banks and other
financial institutions is an important consideration now-a- days in deciding location
of an industrial unit.
This is because banking has become indispensable part of modern business. In case
of rural and small scale industries, banks and financial institutions play an important
role and provide invaluable service in order to cater their financial needs.
Soil and Climate of a Place:
Soil and climatic conditions are very important for the establishment of various type
of industries like tea, coffee, rubber and tobacco. On account of this factor, jute
industry developed in West- Bengal and tea industry in Assam.
Areas which are frequently subjected to earthquakes and other natural calamities
may not attract many industries. Climate of a place also considerably affects the
efficiency of workers. Efficient workers are found in cool climatic regions.
Government Policies and Regulations:
Industrial Development and Regulation Act of 1951 laid down clearly certain rules,
regulations and formalities to be complied before setting up an industrial unit. Prior
permission and licenses are necessary under the Act before the setting up of a new
industrial unit. Certain cash incentives and concessions are also given by Govt, in
order to promote a particular industry in a particular region. A careful thought to all
these rules, regulations and provisions of Act must be given before the
establishment of an industrial unit.
Tastes and Preferences of People:
Before establishing an industrial unit in a particular region, buying habits, tastes,
likes and dislikes of people in that area must be taken into consideration. Purchasing
power of the people and composition of population in that region should be
carefully studied. These studies and surveys render valuable information which is
greatly helpful in establishing and industrial unit in particular region.
Political and Economic Situation:
Political harmony and peace in a particular region encourage the establishment of
industrial units. On the other hand, disturbed political and economic set up
discourages the growth of industries in the region.
Possibilities of Future Expansion:
The area for location should be such as to provide all possible opportunities for
future development and expansion of the industrial unit without involving extra cost.
Every industrial undertaking is established with the aim to expand in future.
Existence of Competitive Industries:
Limited and healthy competition encourages the growth of industrial units in a
particular region. On the other hand, unhealthy competition retards the industrial
growth in a region.
 Availability of Research Facilities:
The main aim of any industrial undertaking is to have maximum production with
minimum cost. Large concerns can afford to have a separate research department to
meet this end, but in case of small and medium industrial units such facilities may be
provided by specialized scientific and research institutions. Existence of such
specialized institutions must be kept in mind before starting an industrial unit.

Step V: Designing Capital Structure

The most crucial component of starting a business is capital. It acts as the foundation of the
company. Debt and Equity are the two primary types of capital sources for a business.

Capital structure is defined as the combination of equity and debt that is put into use by a
company in order to finance the overall operations of the company and for its growth.

It is combination of various long-term sources which are being used by the company to
raise the capital.

It is proportion of various long-term securities which a company uses to collect the capital.

The different types of funds that are raised by a firm include preference shares, equity
shares, retained earnings, long-term loans etc. These funds are raised for running the
business.