What is the benefit of trade accounts receivable?

Many Indian MSMEs face significant cash flow challenges, especially in manufacturing and construction. This often happens because client payments are delayed for 60 to 90 days while businesses must continue purchasing materials and covering day-to-day expenses. As a result, MSMEs usually struggle with liquidity, slowing down their operations and even delaying project completion. This cash flow gap can hinder growth and create financial stress, especially when upfront payments for materials like steel or machinery are required.

Trade accounts receivable effectively solves this cash flow issue. trade accounts receivable allows MSMEs to sell materials or services on credit and collect payments after 30 to 90 days. This gives businesses more time to manage their finances, align customer payments with their operational costs, and avoid upfront expenses.

How trade accounts receivable solves the problem:

• Improved cash flow: MSMEs can maintain liquidity by delaying customer payments, allowing them to continue operations without waiting for cash up front.

• Increased sales: offering credit terms attracts customers who prefer flexible payments, leading to higher sales.

• Stronger customer relationships: giving customers the flexibility of credit builds loyalty and repeat business.

• Growth opportunities: trade accounts receivable frees up working capital, allowing MSMEs to take on more projects and grow their businesses.

Case Study: Shree Constructions Pvt Ltd

Company background

Shree Constructions is a mid-sized Indian construction firm specialising in large infrastructure and commercial building projects. Like many MSMEs, the company heavily relies on consistent access to raw materials like steel, cement, and concrete to keep its projects on track.

The problem

Shree Constructions faced severe cash flow problems. Their projects were large and required substantial upfront investment in materials. For instance, the company regularly purchased steel worth ₹10 lakhs per month to maintain project timelines. However, with client payments delayed by up to 90 days, Shree Constructions struggled to balance operational expenses, including paying for materials, labour, and overhead costs.

Key issues they faced:

Liquidity crunch: client's 90-day payment cycle left a significant gap between outflows (material and labour costs) and inflows (client payments).

Delayed project timelines: despite consistent cash flow, the company sometimes could not procure the necessary materials on time, leading to project delays.

Growth constraints: cash flow issues limited the company's ability to take on more projects, stifling its growth potential.

The solution: trade accounts receivable

To resolve these cash flow challenges, Shree Constructions negotiated a trade accounts receivable agreement with one of its key suppliers. The terms allowed Shree Constructions to purchase steel on a 60-day credit basis, meaning they could take delivery of the materials and delay payment for two months. This arrangement helped bridge the gap between their supplier's payment obligations and the time it took to receive client payments.

The specific terms of the trade accounts receivable agreement were:

60-day payment terms for steel purchases worth ₹10 lakhs per month. There are no upfront payments, allowing the company to allocate its limited cash resources to other operational needs like labour and equipment.

The impact

Shree Constructions began using trade accounts receivable in early 2023, and within a few months, they saw significant improvements in their financial health and project efficiency.

Improved cash flow

Over one quarter, the company purchased ₹30 lakhs worth of steel on credit. The 60-day payment terms meant that Shree Constructions no longer had to pay immediately for materials.

Risk management

While trade accounts receivable introduced the risk of defaulting on supplier payments, Shree Constructions carefully managed this by monitoring its accounts receivable from clients. It implemented stricter credit control measures and followed up more rigorously on client payments, ensuring it could always meet its supplier obligations within the 60-day window.

In the event of client delays, the company set aside a portion of its existing cash reserves as a buffer to cover unforeseen gaps in payments.

If you're dealing with customers who regularly pay late and require frequent reminders, you may be better off discontinuing their service. Evaluate the financial risk associated with their late or non-payments to decide if retaining them is beneficial. Alternatively, you could request that they pay in advance rather than extending credit to them.