Alternate Finance: What are your options as an MSME?

MSMEs are considered to be the building blocks of India’s economy as they comprise a significant chunk of the organized business sector in India, providing employment to a large section of the population. As per the ministry of micro, small and medium enterprises, more than 7.9 million MSMEs are functioning across various sectors in India. Together these MSMEs contribute around 30% to the GDP.

MSMEs, hence, undoubtedly are indispensable to the Indian economy. However, despite being so important to the economy, MSMEs face a lot of challenges in managing their finances and working capital management. The two major challenges for MSMEs are lack of adequate financing and cash crunch.

Liquidity crunch: Around 45% of MSMEs faced extreme cash shortages to make regular payments during the pandemic while the segment had a 20-50% drop in revenues. Last November, there were close to 45000 applications filed for debt resolution. The manufacturing sector suffered the most. There were 6.3 million job losses in the first phase of lockdown and 13.3 million in the second. The unemployment rate shot up to 7.1 in the segment in November last year. These numbers are worrisome and the situation hasn’t become any better so far.

In spite of the government of India focusing on liquidity and credit policies for MSMEs, the credit flow to the MSME hasn’t been ample. As per the trade estimates, less than 5% of MSMEs in India have access to formal credit. One of the major challenges has been the reticence of banks and NBFCs to extend credit to MSMEs due to high perceived risks. Despite provisions of collateral-free loans, banks don’t extend credits to the MSMEs.

Although there are numerous policies in place to financially support the MSMEs, the small businesses often face a lot of problems when it comes to actually accessing timely and sufficient credit at an economical rate. The credit flow to them is not proportionate to the economic activities ventured by them. As per RBI statistics, the MSMEs depend on various financing sources like personal funds, funds from friends, and external sources like banks, NBFCs, trade credit, etc. Even MSMEs with good credit scores find it difficult to avail of loans from banks because of smaller transaction sizes and the higher perceived risks. All of these factors hence indicate the need to alternate finance options like: -

Factoring: - It is a form of receivables finance wherein a business assigns its invoices to a finance company ( a factor) at a discount in lieu of immediate money to finance the business. The prolonged payment cycle by the large-scale MSME customer has a detrimental effect on their operations. As per a CRISIL study, MSMEs can increase their bottom line by at least 15% if they receive timely payments from their large corporate customers. On-time payments help these small and medium-sized businesses reduce their interest cost and improve profitability. Factoring allows the MSMEs to have liquidity against their receivables and acts as an alternate source of working capital. The absence of geographical restraints and collateral security makes factoring a lucrative option for MSMEs than bank finance.

Supply Chain Finance – Supply chain finance is another way to ease MSMEs access to sufficient finance. Supply chain finance enables MSMEs to receive short-term credit against the volumes during the payments receivables periods. Finance is available at various points in the supply chain. This can be made available at the point of sale, purchase, or production and even at the point of delivery. The most important thing is that you have a good relationship with your suppliers and buyers. These relationships should be based on trust, and both parties should be able to rely on each other. If there is a problem, it should be solved as quickly as possible so that the business can continue without any problems.

Angel funds – As per the industry experts, one of the major reasons why MSMEs in India constantly starve for finances is the failure to attract private capital. Angel funds or venture capital funds provide funding during the incubation phase. MSMEs in India are key employment providers and play an important role in the overall economic cycle. However, MSMEs also should consider getting access to quality capital to not just stay afloat, but also grow and transform. While lenders like banks and NBFCs provide temporary debt, private investors provide real capital for long-term growth. Private capital will not only give the MSMEs the financial aid that they would need to address their liquidity crunch but also help them infuse diligence in processes and quality.

MSME’s who are looking at expanding and growing their business can make the best of these alternative financing options, which are flexible and can be customized as per the needs and business requirements of MSMEs.