Cashflows are the lifebloods of businesses. The biggest challenge an entrepreneur faces is raising funds. New businesses must stabilise their fund flows to sustain their operations and scale up, whether it is equity or working capital. Small businesses must manage their receivables and payables meticulously to maintain a comfortable liquidity position. Sometimes, they look for short-term borrowings from the market to infuse liquidity.
Invoice financing is an effective approach for raising short-term capital without accumulating unnecessary debts. Supply chain financing is transforming SME lending in an unprecedented way. Even the banks are enthusiastically participating in invoice funding through supply chain financing routes.
The Liquidity Management Paradox
Liquidity shortages choke the supply chain process affecting everyone in the system. The recent experiences of the economy shut down due to the Covid-19 pandemic have shown us how massive supply chain disruptions can be.
Small businesses, in particular, were in a disadvantageous position. They were in a situation where they had to extend the credit to big B2B clients while paying off the dues to their suppliers on time. Often, these large clients of small-scale suppliers overshot the credit period due to administrational delays. Delayed payments result in missed opportunities. The small firms bore much of the brunt of working capital shortages in the supply chain.
As much as we try to deny it, the reality is that banks hesitate to extend traditional financing to new and small businesses due to concerns of credit risk and the relatively higher cost of servicing small loans. These young firms lack the credentials and credit history necessary to obtain traditional funding. Investors will then consider liquidity ratios to assess the firm’s strength, turning the situation into a vicious circle. With weak liquidity ratios, small businesses have to look for funds elsewhere.
Invoice financing methods effectively address these issues to the advantage of suppliers, buyers, and lenders. They let the small firms borrow against their outstanding invoices.
Supply Chain Finance to Solve Funding Issues
Supply chain finance(SCF) is also called reverse factoring. It is a form of receivables financing in which the buyer, who wants to settle a bill with his supplier sooner than the due date, approaches a lender. The lender or financier pays the invoice value to the supplier. The buyer will then pay for the invoice to the lender, along with applicable interest, when the invoice becomes due for payment.
This process differs slightly from invoice financing or factoring, where the seller/supplier borrows against the invoices generated in the sales processes. The basic difference is that in SCF, the process is initiated by the buyer, while in factoring, it is initiated by the supplier.
Supply chain financing provides many benefits, some of which include,
- Quick and easy access to funds tied up long billing cycles
- Faster turn-around of working capital
- With funds available, increased productivity and efficiency
- No predefined payment schedule for the working capital, unlike a business loan
- Particularly suitable for entrepreneurs whose businesses are held back for want of appropriate credit products and lack of collateral
- Borrowing at a low cost
Role of Banks in Supply Chain Financing
It is estimated that the small-scale suppliers to large Indian firms have an annual unmet credit need worth more than Rs. 15 lakh crore. One can objectively view this as a demand from the SMB industry and an opportunity for banks to widen their lending portfolios.
The Banks participate in supply chain financing in three ways.
1. Direct lending through invoice funding – Banks like SBI, Bank of Baroda, PNB, IndusInd Bank, and ICICI have already forayed into the SCF space, offering invoice financing services. Many banks offer digital platforms to their corporate customers to connect with their suppliers and dealers. They offer invoice discounting facilities for these suppliers/ dealers on approved bills by their clients.
2. Bidding through TReDS E-discounting platforms – Trades Receivables Exchange Discounting System (TReDS) is a digital system launched by RBI in 2018. TReDS allow MSMSE sellers (for factoring) and buyers (for reverse factoring) generate factoring units of invoices for bidding on e-discounting platforms. Three e-discounting platforms are mandated to operate TReDs- RXIL, M1xChange and Invoicemart. Many banks participate as financiers on TReDS platforms, reaching out to entrepreneurs needing short-term funds.
TReDS platform Invoicemart has IDFC Bank, Axis Bank, Bank of Baroda, Standard Chartered, and State Bank of India among their financiers. As per the latest update, HDFC Bank entered into a tie-up with M1xchange last month for onboarding to TReDs.
3. As collaborators in providing TReDs e-discounting platforms– Banks also occupy the supply chain financing space as collaborators providing and operating the TReDS platform. For instance, the Receivables Exchange of India(RXIL) is a joint venture between the Small Industries Development Bank of India (SIDBI) and the National Stock Exchange (NSE). Similarly, Invoicemart is a joint venture between mjunction services and Axis Bank. The third and last one in this group is M1Xchange by Mynd Solutions.
How TReDs Operate
TReDS operate as follows:
- MSME buyers and sellers create ‘factoring units’, invoices or bills of exchanges that will be traded on the platform.
- Financiers bid for the factoring unit. The buyer or seller selects the best bid, as the case may be.
- The Financier pays the invoice value to the MSME seller at an agreed discount rate.
- The buyer pays the financier for the invoice later.
The Road Ahead
Prospects look promising for small businesses in India. Now is the time for Banks to gear up and lend an extra hand to the sector. Extending credit is one way. But they can do more by acting as a catalyst in the supply chain finance scene. Banks can mobilise other lenders, such as NBFCs, provide advisory facilities, support regulatory frameworks, and provide technical support by integrating fintech into the system to contribute to the overall growth of supply chain financing in India.
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