Thursday, March 12, 2020

MSMEs Need Cash Flow Based Finance


Cash Flow Based Finance to MSMEs:
The Need and the Deed

Access to finance is the Achilles Heel of the MSMEs not just in our country but entire world. U.K. Sinha Committee has recommended cash flow based finance (CFB) as the best possible way of resolving the working capital issues of the sector. The term simply means that the finance starts with cash-in to cash-out, normally referred to as the working capital cycle by the lenders.

This is a form of financing in which a loan is backed by a firm's existing and expected cash flow. This loan is very different from asset-backed loans where the collateral of the loan is based on business assets. The repayments are going to be based on business-projected cash flows. The debt covenants of these kinds of loans are focused on manageable levels of interest rates.

Charting the cash flow helps in entering the fixed costs, operating costs, accounts receivables and existing accounts payable into the future weeks/months realistically.

It is important to understand that financing cash flow is somewhat unique for each business depending on the industry, business size, stage of business, model size, owner's resources, among other factors. It is therefore important for each enterprise to assess its resources of financing cash flow: owner investment or equity; government incentives and remittances; inventory financing, trade financing, deposits on sale, receivable discounts, factoring, or purchase order finance etc.

Several MSMEs do not have uniform flow of cash for doing their business throughout the year. It is set with lows and highs in the stream. If they want to buy the raw material when it is available at low price, it needs storage space and lender’s tolerance for high stock. Unmoving stock is always viewed with suspicion. Whenever the turnover is low, the firm faces stress because it cannot afford the luxury of unloading the excess raw material.

Whenever the finished goods are not rolled out, it can be for a variety of reasons: either the buyer is not satisfied with the quality specified at the time of order; or the buyer is starved of resource to buy at the time of receipt of goods or he has himself shifted his line of activity and therefore, trying to find fault with the product somehow to escape his obligation. Payments get delayed. There are also number of cases where the payments are delayed even after acceptance of goods. If the goods are not returned within the specified period of contract, it will be deemed acceptance after that period is over.
If the contractual relationship between the buyer and seller that is invariably conditioned by the provisions of the Indian Contract Act, comes into dispute, the amount gets stuck under litigation. MSMED Act has provisions to tackle delayed payments under MSME Facilitation Council but has been ineffective. Therefore, at the tail end of production, where the sale occurs, the cash gets stuck.
E-marketing that is fast making inroads through institutions like Amazon, Flipkart, etc., and e-invoicing that is getting popularized through GEMS and TReDS are yet to significantly change the fate of manufacturing MSMEs.

Several MSMEs, pre-GST were indulging in buying raw material in cash and selling finished product in cash. This simply means that they have been bypassing the lenders’ books. This unorganized way of business is gradually transforming with GST introduction, notwithstanding several issues locked up in GST dispensation itself. It is expedient for an enterprise to have a revenue-based financing program to ensure that cash flows are not hurt for want of a loan from the bank/FI.

It is very easy to lend on cash flows for business enterprises right from the flower vendor or vegetable vendor to a trader dealing in gas cylinders or furniture. Same can’t be that easy if one would like to fund the cash flows of a manufacturing enterprise. This segment can also afford higher interest for their loans as they invariably pass on the interest to the buyer through sale price. If they want to offer competitive price, they indulge in discounts.

In other words, the cash conversion cycle (CCC) of MSMEs has many aspects for the lender to understand. This requires (1) change in mindset of the bank field staff, managers and (2) continuous follow up of the cash flows systemically with a consent-based ERP architecture. MoMSME that offers ZOHO ERP book free of cost to enterprises with turnover of Rs.1.5cr could increase the threshold to Rs.5cr. The initial cost of such shift could result in transforming 55-60 percent of the micro and small enterprises getting into organized finances when CFB lending becomes reliable data based and data monitored lending. Data itself will be the security. Its credit rating and collateral is either not required or based on movable short-term assets such as inventory, floating debentures (for limited companies), debtors etc.

Cash is the king. It is cash that repays the loan and not collateral as the latter takes enormous time, cost and effort to repay a facility. Documentation is also simple: in the form of invoices issued by the enterprise; sales records; supplier and customer references in addition to a thorough interview of the enterprise owner. It may be necessary to crosscheck with the suppliers the invoices provided. All this simply means that in CFB, banks should spend more time with the entrepreneur and they don’t have the wherewithal to do this now.

While the RBI has been working on Public Credit Registry the way it captures the data, the veracity and verifiability of the data it captures and ease with which it becomes accessible would make firm data itself as collateral for the banks and FIs.

The writer is author of ‘The Story of Indian MSMEs’. The views expressed are personal.
Published in the Hindu Business Line, 12.03.2020: www.thehindubusinessline.com



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