2020 has been a tough year for small and medium enterprises (SME) in India. With B2B customers delaying invoice payments well beyond the usual Net30 or Net60, i.e 30 to 60 days after the due date, maintaining liquidity became a huge challenge for suppliers. On the other end of the spectrum, many start-ups and small firms have been unable to buy critical supplies such as raw materials and spare parts because of lack of cash flow. The overall slump in demand has also made it impracticable for SMEs to continue operating as usual.
To top it all, there has been a sharp increase in the number of bankruptcies since the lockdown which has only increased the atmosphere of uncertainty in the market. Given that the average turnaround time for business credit for SMEs is still around 26 days in India, cash-strapped suppliers and buyers have been actively looking at other alternatives to meet working capital shortfalls.
While some have resorted to selling used equipment to raise much-needed funds for buying supplies, others are exploring long-term lease options, wherever possible. The efficacy of invoice financing- to include both discounting and factoring – has been diluted as large companies too have been demanding more time to make payments to lenders against bills endorsed to them by SME suppliers. This has made it harder for small companies working as Tier-II or Tier III vendors in large supply chains to honour their existing commitments to their own suppliers.
However, a growing number of Indian companies have been putting their faith in a relatively new method of credit financing that promises to optimise the flow of working capital while helping them focus on growth. Incidentally, this method is highly popular abroad with 55% of businesses surveyed by PWC using it to access working capital.
Supply Chain Finance or SCF, for short, thus has immense potential for compressing the wide gap between invoice generation and settlement. It can enable small businesses to address the uncertainty of cash flow and build stronger supplier relationships in the post-COVID market.
What is Supply Chain Finance and how does it work?
SCF is a method of trade finance where a buyer can approach a financial institution or lender for credit to pay the invoice value of goods purchased from the seller, either on or before the due date. The rate of interest is lower than traditional financing options like a working capital loan. There is no collateral involved either.
In turn, the lender charges a fee for providing the credit line. The buyer undertakes to repay the lender at a specified date. Unlike invoice discounting or factoring, the SCF process is initiated by the buyer and the line of credit extended by the lender helps finance the ‘purchase’ of the goods in question. The seller of the goods is thus only the beneficiary. That is why SCF is also called purchase finance or reverse factoring. However, SCF does have benefits for the buyer in that it makes accounts payable easier as multiple suppliers’ invoices can be paid through a single lender. Online SCF platforms are the latest evolution in the B2B lending space. These platforms allow buyers, sellers and lenders to interact with each other and decide in which order invoices are to be paid.
Benefits of Supply Chain Finance for SMEs:
Supply chain disruptions can result in time and cost overruns for companies and reduce their competitiveness in the global markets. To consolidate their supply chains, many enterprise firms have been leveraging SCF to boost liquidity for SMEs- usually second and third-tier suppliers- that provide a wide range of components and support services to them. This not only improves the cash flow position of smaller companies but also helps them overcome poor credit ratings.
Here are some of the other key advantages of SCF:
1) Improves liquidity:
Extended credit lines of up to 120 days have been necessitated by the severe cash crunch being experienced by businesses on account of COVID-19. If the buyer faces a working capital shortfall, SCF can relieve the pressure on their accounts payable, helping them to focus on top-line growth.
2) Enhancing credit financing options for stressed SMEs:
SMEs in India have been traditionally viewed unfavourably by lenders because of their poor or non-existent credit history. Banks are understandably averse to taking on more risk even as the Non-Performing Assets (NPA) volumes on their books remain high. SCF allows large companies to leverage their relatively higher credit ratings to provide credit access to SMEs. This enables smaller companies to get financing that they otherwise would not have eligible for.
3) No collateral required:
With SCF, SMEs are no longer constrained by a lack of collateral for securing credit financing. The pending bill serves as security for the release of funds from the bank. Until recently, small business owners would have had to offer their personal assets to meet the lender’s collateral requirements. This improves the ability of small businesses to overcome one of the biggest hurdles in running normal operations, especially in the post COVID scenario.
4) Lower cost of borrowing:
The average interest rate on working capital loans in India ranges from 12% to 16%. While such loans are significantly cheaper than financing from traditional moneylenders, high EMIs can stretch SMEs thin, especially when business is slow. In comparison, the interest rates for supply chain financing vary from 2-4% which makes it the obvious winner when it comes to getting quick access to working capital. It is a much more sustainable form of business finance when there is uncertainty in demand-supply cycles.
5) Provides strategic flexibility:
SME buyers can take advantage of SCF to source products from suppliers at low cost and improve their margins. Cash discounts offered by suppliers for timely payments can be substantial too. Buyers can nurture an ecosystem of preferred suppliers by offering financing support and increase their competitiveness in a volatile pandemic-hit market.
Cash flow disruption is perhaps the biggest challenge facing SMEs today which makes timely access to credit doubly important. SCF enables businesses to speed up the sales cycle and aggressively pursue growth opportunities. For lenders, it can play a key role in restoring confidence in the market which will, in turn, create greater credit volumes – and more growth- and across the market.
Finezza is an ideal partner for financial institutions looking to tap underserved segments to grow their market share. Its comprehensive analytics suite and integration support for business intelligence apps make it a strategic investment for customers. Contact us today for more information!