How supply chain financing can resolve capital issues for MSMEs
Authored by Shankar Saini, COO, Saraf Furniture
Micro, small & medium enterprises (MSMEs) employ approximately 111 million people and accounts for about 30 per cent of India's GDP. These businesses are known as the backbone of the Indian economy. According to World Bank data, MSMEs are the largest employers in developing countries despite having the least financial & regulatory support. Their ability to survive and thrive is dependent on their ability to obtain sufficient funding.
However, banks limit their exposure to MSMEs due to the high cost of service and the risk of lending without adequate collateral. Credit risk assessment is complex for lenders due to a lack of structured financial information, historical cash flow position, repayment trends data, etc. For MSMEs, the direct result of this credit gap is a vicious cycle of high costs, low profitability, stunted growth, and an inability to withstand even minor economic shocks. An economic disruption caused by the COVID pandemic results in an almost immediate tightening of credit terms from lenders for the fortunate few, who have access to the banking system.
Considering the significance of MSMEs to economic growth, it is crucial to assist them by removing working capital-related barriers to growth. Supply chain finance (SCF) is critical to accelerating MSME growth. SCF refers to technology-based solutions to lower financing costs and increase business efficiency for buyers & sellers in a sales transaction. It helps them by bridging financial gaps and providing desperately needed liquidity.
Why SCF is synonymous with easy financing?
Working capital optimisation:
MSMEs benefit from supply chain finance because it allows them to make early payments and meet their urgent working capital needs. With SCF, suppliers can receive compensation for invoices sooner, reducing day sales outstanding and increasing the cash available to invest in the future.
Low cost of financing:
SCF is an appealing option for MSME vendors because it can obtain low-cost financing. Before approving such funding, lenders consider the buyer's creditworthiness, length of association, and supply chain relationship. It is a more cost-effective source of capital than traditional forms of financing that promotes close integration between the buyer as well as the supplier. Buyers with good credit may be able to negotiate better terms with the seller. MSMEs' cash flows are accelerated as a result, and sellers are better positioned to contribute to the buyer's business growth.
Improved supply chain relations:
Several small businesses suffer in their growth stages due to a lack of timely access to capital. SCF provides such access to funds and stabilises operations of growing concerns thereby, strengthening buyer-seller trade relationships.
How SCF is opening doors for MSMEs:
Despite the critical role that MSMEs play in the growth & development of emerging economies like India, they are mostly ignored by traditional banking channels. Over 80 per cent of MSMEs in India cannot obtain standard bank credit and rely on private or informal funding sources at substantially higher costs.
Due to significant onboarding and transaction costs, SCF was previously only available to large organisations. However, with the pandemic & technical advancements, SCF is increasingly being considered a panacea for MSMEs and lenders alike in lowering operating costs. The digitisation of SCF procedures such as invoice acceptance, billing, and e-payments has reduced the cost of SCF significantly, making it viable even for minor transaction quantities.
SCF provides numerous benefits to MSMEs, including the ability to navigate working capital deficits and stabilise operations. MSMEs can grow and expand with SCF.
SCF assists lenders in overcoming these barriers and extending financing to MSMEs for various reasons – SCF extends funding based on the underlying trade relationship between MSME sellers and large corporate buyers. Lenders are not exposed to high risk because reputable and well-known large corporate buyers make the settlements.
Since SCF transactions are structured, lenders can onboard more partners because the documentation & underwriting process are simplified and less time-consuming. With the advancement of technology, everything from onboarding to disbursement and settlement can be streamlined, making it easier to advance funds to small businesses without being resource-intensive or negatively impacting the bottom line. Trade Receivable Discounting System (TReDS) platforms enable MSMEs to instantly secure highly subsidised credit from a variety of banks and NBFCs. SCF is a solution that would provide numerous benefits to MSMEs. It is pertinent to educate MSMEs and their anchors about such options for improving cash flow.