More than 50 million small and medium enterprises (MSMEs) contribute to nearly 40% of India’s GDP. The MSME sector also ranks among the largest employers in the country. These statistics are impressive but by no means the end of the road. A large number of enterprises still do not use banks. Small businesses struggle for finance and cash flow requirements.

The Problem

The SME sector is for the most part populated by the marginalised section of the society. Illiteracy, lack of exposure and awareness, social bias and other issues afflict this sizeable and hitherto ignored sector. Most businesses within this sector transact in cash. In this scenario, the recent introduction of GST and demonetisation took a heavy toll on this vibrant segment of the Indian economy.

The Challenge

Given the unique nature of this sector, recovering from the financial setback caused by GST and demonetisation was no easy task.

Some of the most significant financial challenges faced by small businesses include:

• Cash flow for small enterprises has always remained a challenge since most small businesses either originate from the marginalised social strata or are run by families with limited resources at their disposal.
• Banks are reluctant to finance small businesses due to perceived – or real – credit risk.
• SMEs, therefore, depend on customers for their cash flow needs.
• Where a substantial cash flow is required, they seek alternative sources of finance.
• A considerable number of small enterprises do not use banking facilities – ergo, no income from interest.
• SMEs also have a longer DSO (Days Sales Outstanding) clearance – often waiting six months for payment – as compared to larger organisations.
• A large number of workers are either illiterate, unskilled or under-qualified.
• There exists a general lack of awareness and knowledge in this sector.

These issues put SMEs at a disadvantage from the outset, and it becomes difficult for them to compete with larger businesses. Their latent talent remains unexplored.

The Risk

Given the cash flow challenges faced by small enterprises, some of the more stalwart businesses turn to alternative sources for finance. These include NBFCs and private lenders. These sources are comparatively more expensive than banks.

A substantial amount of revenue is lost because of non-payment and delayed payment by customers. With little or no resources to chase debtors, many businesses elect to write off these invoices as bad debts.

These losses further deplete the already low cash flow.

In this scenario, paying off loans takes a backseat, and EMI instalments are often delayed or defaulted.

Delay or default in EMI attracts a penalty, which adds to the burden and decreases their creditworthiness.

Low creditworthiness means inability to procure finance in the future, driving banks further away.

Breaking the Vicious Circle

What begins with lack of funds ends with a higher deficit, making the whole scenario a vicious circle. The problem has been partly resolved by launching TReDS (Trade Receivables Discounting System) and TREADS (Trade Related Entrepreneurship Assistance and Development) initiatives. However, there is still room for improvement.

Adoption of financial technology is one solution to this problem. Some ways in which fintechs can help MSMEs include:

1. Assessing the creditworthiness of the business
2. Evaluating the collateral available for granting a loan
3. Making the loan process faster and smoother
4. Customising products to consumer needs through data analytics
5. Making and receiving payments
6. Tracking invoices and payments

Fintech companies that offer a host of services to businesses are soon becoming a single window service for all the digital and financial needs of SMEs. Some of the services provided by fintechs include instant short-term loans, wealth management and invoice tracking.

The Way Forward

The Pradhan Mantri Jan Dhan Yojana (PMJDY) sought to include the unserved/underserved population by offering basic financial aids such as zero balance savings accounts and mobile banking facilities. The project took off to a good start and Tier I and Tier II cities in India witnessed a paradigm change with a large turnout for opening a savings account and many of them opting for mobile payment gateways.

The need of the hour then is to leverage this technology to the masses in the rest of the country. This would mean generating awareness and educating them in the use of this technology. While delayed payments are akin to an occupational hazard, the solution lies in establishing and sustaining relationships with small businesses and making them more resilient.

Looking at the recent developments such as escalating GDP and India’s rise to rank 77 on the ease of doing business, foreign investors are venturing into the fray. This fact, combined with initiatives such as Make in India and Digital India, spell success for MSMEs.