Supply Chain Financing: Opening doors for MSMEs to access formal credit

World Bank data reveals that MSMEs are the largest employers in developing countries despite having the least financial and regulatory support. If MSME’s are facilitated with formal access to credit on time, it will have a ripple effect in boosting job creation, rising income levels, reducing vulnerability, and accelerating growth. 

In India, MSMEs account for a significant share of employment and GDP contribution. However, due to their informal nature, MSMEs lack access to formal credit. Lenders face challenges in credit risk assessment owing to the lack of availability of structured financial information, historical cash flow position, repayment trends data, etc.

Supply chain financing (SCF) is a form of lending where MSME sellers can receive early payment against their invoices to large buyers. As the lenders advance funds based on the buyer’s financial standing and net worth, suppliers receive SCF at a lower cost when compared to borrowing on their standalone balance sheets. By optimising both the buyers and sellers working capital position, SCF deepens supply chain relationships and enhances trust and goodwill among the partners. 

Mechanics of Supply Chain Finance

It is standard practice for the buyer to negotiate payment terms with the seller for any underlying trade transaction. 

For example, a buyer might trade on 60 days credit. The buyer gains 60 days from the delivery of the goods to settle the invoices. In the meanwhile, the seller requires immediate financing for working capital to maintain stocks and pay salaries. 

A third-party financial intermediary like Tata Capital partners with the corporate buyer to advance early payments to its suppliers. Upon confirmation of invoices from the buyer, payments are made to the seller after deducting a nominal rate of interest determined basis the total amount and days financed. The longer the funded days, the higher the fees. On the due date, the payments are collected from the buyer and dues are settled. 

With Tata Capital’s tailormade SCF programs, sellers and buyers can improve liquidity and obtain relief from the constant stress of inadequate cash flows.

Benefits of SCF

• Working Capital Optimisation: SCF helps optimise working capital for both buyers and sellers. With SCF, suppliers can receive payment for their invoices earlier, reducing their day sales outstanding and increasing the availability of cash to invest in their future. 
• Lower cost of financing: Since lenders consider the buyer’s creditworthiness, vintage of association, and supply chain relationship before sanctioning such funding, the cost of funding is more competitive than traditional sources of financing. This makes SCF an attractive way of obtaining finances for MSME sellers.
• Improved Supply Chain Relations: Several small businesses suffer in their growth stages due to a lack of timely access to capital. SCF provides such access to funds and stabilises operations of growing concerns, thereby strengthening buyer-seller trade relationships.

Role of SCF in opening doors for MSME

Despite the vital role MSMEs play in contributing to the growth and development of emerging economies like India, they remain largely underserved by formal banking channels. Over 80% of MSMEs in India fall outside the purview of traditional bank credit and access financing from private or informal sources at much higher costs. 

Several challenges limit lenders from extending financing to smaller businesses: 

1. Lack of standardised financial reporting 
2. Lack of visibility on business performance data
3. Difficulty in measuring risk accurately 
4. Higher risk of default
5. Limited bandwidth and resources with financiers to underwrite and onboard customers

SCF helps lenders overcome these barriers and extend financing to MSMEs for many reasons –

1. SCF extends financing basis the underlying trade relationship between MSME sellers and large corporate buyers. Lenders do not have to assume high risk as reputed, and well-known large corporate buyers make the settlements.

2. Given how SCF transactions are structured, lenders can onboard more partners as the documentation and underwriting process is simplified and less tedious.

3. With the advent of technology, onboarding to disbursement and settlement can be streamlined, making it easier to advance finances to small businesses without being resource-intensive or impacting the bottom line. 

Previously, SCF was limited to larger corporations due to high onboarding costs and transacting costs. But now, with the pandemic and technological advancement, SCF is increasingly being seen as a panacea for MSMEs and lenders alike in bringing down the cost of operations. Digitisation of SCF processes like invoice acceptance, billing, e-payments has drastically brought down the cost of SCF, making it viable even for small transaction values.

MSMEs account for over 90% of commercial enterprises in India, comprising 63 million MSMEs across diverse geographic locations. The financing of MSMEs has been identified as a chief priority amongst India’s economic goals.

SCF offers multiple benefits to the MSMEs and equips them with resilience to navigate working capital deficits and stabilise operations. With SCF, MSMEs can expand and grow. By partnering with a financial institution like Tata Capital for SCF, MSMEs can yield maximum returns. Reach out to Team Tata Capital to know more about how you can bridge your working capital gap using our diverse range of supply chain finance solutions.