Did you know that there are more than 90 million MSMEs in India? Despite this mind-boggling number, only 6-9 million MSMEs have access to formal credit. The Parliament’s Standing Committee on Finance reported earlier this year that the MSME sector faces a credit gap of Rs.20-25 lakh crore. The Committee’s Chairman also expressed concern about delayed payments hampering the progress of small firms. Why are other MSMEs left in the lurch without financial credit to fund their businesses?
A large majority of MSMEs in India do not conform to traditional financing institutions’ requirements, making it almost impossible to acquire formal credit. Experts blame the credit chasm on traditional funding options with stringent criteria to disburse cash credits, overdrafts, and term loans. In this critical environment, Invoice Financing could be the best funding solution for the MSMEs that banks do not favour.
Also Read: All You Need to Know About Blockchain & SME Financing
Invoice Funding: A Hopeful Financial Prospect for MSMEs
Invoice funding refers to short-term financial help given to customers against unpaid invoices like account receivables. This financial solution is favourable for MSMEs that thrive on invoicing. Rather than wait for days for customers to pay their invoices, lenders can advance businesses the exact value of money, thus ensuring a consistent cash flow to keep the business running.
Invoice funding works in two ways:
- Factoring, where small businesses sell their unpaid invoices to lenders. Small businesses and companies can receive up to 75% of the invoice from a lender. If the lender receives the total amount from customers, he will repay the company after deducting interest.
- Discounting, where MSMEs can acquire upto 90% of the invoice amount, and the customer repays the amount directly to the company without knowing that a lender is involved in the transaction.
Considering traditional banking institutions are hesitant to provide invoice funding to MSMEs, how can invoice funding help them? Firstly, banks have stringent requirements to lend loans to any business, and most MSMEs do not conform to these criteria. Experts attribute this reluctance to reasons like:
- Low-profit margins for many MSMEs
- Lack of proper collateral for loans
- Small ticket size for loans
- Lack of borrower’s credit history
Why Do MSMEs Need Invoice Funding?
Unlike established organisations, MSMEs need to evolve with changing business environments to survive in the long run. In such a volatile scenario, businesses require enough cash to buy raw materials, invest in automation and digital upgradation, and sell their products on credit. Invoice funding can make a difference because it does not need collaterals and is particularly suitable for industries that do not have assets such as tangible goods or heavy-duty machinery as sureties. It can also be a helpful tool to support MSMEs’ cash flow.
Banks disburse cash credits and term loans based on the value of collaterals, which may also limit the MSMEs’ eligibility to avail of credit. Furthermore, MSMEs don’t receive collateral-free advances from banks because they negatively impact their balance sheets. In fact, invoice funding is cash-flow-based financing, whereas acquiring loans from NBFCs and banks is asset-based financing.
Increasingly, MSMEs are turning to receivable financing as their primary funding method because of the many benefits that allow these small trades to grow.
Invoice Funding & its Benefits For MSMEs
1. MSME-friendly financing
In more ways than one, invoice financing aligns better with the needs of MSMEs than traditional banking. Invoice funding:
- Provides customisation.
- Is more flexible than conventional banking.
- Is more transparent.
- Has no down payment or lock-in periods.
- Has no monthly EMIs or high-interest rates.
- Allows businesses to increase or decrease credit when required.
2. Streamlined balance sheets
Invoice financing does not create debts but accelerates the payment of invoices. Cash is readily available to boost productivity and accelerate the production cycle without taking a toll on the balance sheet.
3. Competitive funding options
Businesses no longer have to choose a funding option based on geography. TReDS, for example, provides a broader variety of services than traditional platforms. On TReDS, small entrepreneurs can get competitive bids for their invoices from lenders based anywhere in India.
Invoice finance is becoming a game changer for MSMEs due to recent policy initiatives like The Factoring Regulation (Amendment) Bill, 2021 that made TReDS registration mandatory for all companies with a turnover of Rs. 500 crores and above.
Summing It Up
Invoice funding will give cash-strapped MSMEs a lease of new life. With better cash liquidity, small businesses can carry on without financial hiccups and make bigger contributions to the Indian economy.<
MSMEBlog advises MSMEs on how to obtain proper financing and provides information on available funding sources. Find out more about MSME financing at https://www.msmeblog.com/.
