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.
