SMEs want on-demand liquidity, who’s listening to them?

Ankur Bhageria

As a backbone of the national economy, SMEs contribute significantly to our country’s GDP and play a crucial role in expediting government progress and development. As of November 2021, India has 6.3 crores MSMEs and they contribute over 30% towards the GDP through its national and international trade. However, due to the pandemic since the beginning of 2020, a large proportion of SMEs are in financial stress and require critical support from the government, corporates and other key stakeholders to be able to run smoothly and recover from the pandemic. A survey by the All-India Manufacturers’ Organization stated as many as 35 per cent of MSMEs and 37 per cent of self-employed individuals had to close their business as a result of the pandemic. Another survey conducted by SIDBI stated as many as 67 per cent MSMEs had to temporarily close for up to a three-month period as result of the pandemic in FY21.

The SME credit gap in India is over $380 billion and this has only increased post-COVID. The direct consequence of this credit gap for SMEs is a vicious cycle of borrowing at high costs, leading to lower profitability, stunted growth and inability to withstand any mild economic shocks in the near future. According to a survey conducted by Consortium of Indian Associations (CIA), 73 per cent of Indian small and medium enterprises (SMEs) couldn’t make a profit during the last financial year (FY21) while only 13 per cent broke even amid Covid impact.

To revive the MSME industry, the Government has implemented a number of measures to provide liquidity to MSMEs over the last 18+ months.

• In May 2020, the Government of India announced 6 schemes under the Rs 20 lakh crore Aatmanirbhar Bharat stimulus package. The three main ones were the Rs 3 lakh crore Emergency Credit Line Guarantee Scheme (ECLGS) collateral-free loan scheme, the Rs 20,000 crore subordinate debt for MSMEs, and the Rs 50,000 crore equity infusion through the Funds of Funds (FoF).
• In July 2021, the Indian government announced inclusion of retail and wholesale trades as MSMEs to strengthen the sector and boost economic growth.
• In June 2021, the Union Minister of MSME and Road, Transport and Highway, Mr. Nitin Gadkari launched the Indian Bank’s ‘MSME Prerana’ in Maharashtra to empower MSME entrepreneurs.
• In June 2021, the Minister for Road Transport & Highways and Micro, Small and Medium Enterprises, Mr. Nitin Gadkari announced simplification of process for registration of micro, small and medium enterprises. He added that only PAN and Aadhaar cards will be required for registration of MSMEs.
• Under the ‘Startup India’ initiative, the government recognized 50,000 start-ups that created 5.5 lakh jobs, as of June 03, 2021.
• The government also announced Rs. 3 lakh crore (US$ 40.85 billion) collateral-free automatic loans for businesses.
• In Union Budget 2021, the government announced funds worth Rs. 10,000 crore (US$ 1.36 billion) for ‘Guarantee Emergency Credit Line’ (GECL) facility to eligible MSME borrowers, giving a major boost to the sector.
• Budget allocation for MSMEs in FY23 increased by 26.71% to Rs.21,422 crore, vis-à-vis Rs. 15,700 crore in FY22, and tripled from Rs. 7,572 crore in FY21.
• Additionally in 2022, ECLGS has been extended up to March 2023 with its guarantee cover expanded by Rs 50,000 crore to the total cover of Rs 5 lakh crore. Credit Guarantee Trust for Micro and Small Enterprises (CGTMSE) scheme will also be revamped to facilitate additional credit of Rs 2 lakh crore
• In order to boost these cash-starved MSMEs, the Government of India recently implemented The Factoring Regulation (Amendment) Act 2021, which has widened the scope of entities that can engage in factoring, and will significantly boost the funding availability to SMEs in the country.

Also Read: Financing solutions that can re-energize the MSME sector during COVID and beyond

All these efforts primarily provide liquidity in the form of external borrowings. In addition to typical means of accessing such liquidity such as OD and CC lines, MSMEs also use business loans, and with increasing popularity post-COVID, invoice discounting. However, both these channels – business loans and Invoice Discounting, only support a tiny fraction of MSMEs and their working capital requirements. A large part of this is due to the extent of the commitment. Business loans of course are for long term periods, but even invoice discounting, as implemented by buyer corporates and banks till date, often require high levels of commitment in time and receivables discounted.

Most vendor financing solutions, as implemented by banks for their customers, often require a business to do “whole turnover” discounting – which means, irrespective of whether the business needs capital seasonally or not, they have to necessarily discount 100% of their invoices. Imagine a vendor that only needs money in the few months leading up to festive season, but is forced to sign up for whole turnover discounting – hence bears interest cost for entire duration of the year, when in reality they needed money only for 3 months.

It goes beyond that, with buyers constraining vendor flexibility on three key axes – rate, volume and time. Vendors are required to accept the rate set by the buyer and banks, are required to discount 100% of their receivables, and are required to do so for the entire (now increased) credit period.

As a result, real costs to vendors increases by as much as 200%, with the interest rate and volume commitment doubling costs, and the extended credit periods increasing it further.

This system works great for banks, giving sizeable and predictable returns on capital deployed through such a channel. But the buyer sees sub-par participation from vendors, and vendors see their cost of capital go up.

Invoice discounting can and should deliver affordable on-demand working capital – when invoice discounting becomes “dynamic discounting”.

A dynamic discounting model allows for variable cost and timing. This “anytime access” allows suppliers to provide a discount in real-time when they need cash flow. Early payment could be by 6 days or 60, or any period in between depending on payment terms and their need. The early payment window of time is available throughout the entire payment term — on demand as suppliers need it

Dynamic discounting is a true win-win solution that benefits both trading partners. Not only does this solution strengthen each party’s financial health, it also improves relationships throughout the supply chain. Buying organizations can put their excess cash to work to gain early payment discounts that decrease COGS, improve margins, and earn a high yield return on liquidity. Suppliers benefit from the flexibility of discounting some or all of their receivables. For suppliers, dynamic discounting provides the flexibility to be paid earlier than the invoice maturity, often at more attractive terms than alternative methods such as asset-based lending or factoring.

Also Read: How Prioritizing Financial Education is a Must to Uplift the MSME Sector

On the CashFlo platform, we have seen vendors choose different rates for every transaction, discount invoices for as little as one day, and discount as little as 5% of their current receivables, all in an effort to match early payment to working capital needs. As a result, participating vendors, successful transactions and overall throughput all increase versus previous structures.

What SMEs need is on-demand access to liquidity wherein they can simply draw down on the amount they need by liquidating invoices as and when they want. Effectively an unsecured and collateral-free version of CC limits, but in the form of Invoice Discounting. Dynamic invoice discounting achieves this. This makes access to capital far more affordable and avoids any cost being passed back to the buyer.

On-demand discounting is the future of vendor financing – a truly sustainable and scalable model for the Indian economy, and it’s not a pipe-dream any more, it’s a reality now.

Article by 

Ankur Bhageria, Founder & CEO, CashFlo.

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