One of the most crucial elements for any business to thrive or even just survive is working capital, which is probably even more crucial than the company's bottom line. Most typically, the differentiator that enables certain organisations to grow quickly is a well-considered working capital optimization strategy. This is especially true for Micro, Small, and Medium-Sized Companies (MSMEs), who frequently lack access to financing and must, as a result, pay much greater attention to their working capital requirements.
Therefore it is vital to look at the numerous working capital financing options available for Indian MSMEs as well as the value they offer in a country like India, where MSMEs account for more than half of exports and up to 29% of the country's GDP.
The aforementioned Chief Financial Officers (CFOs) are making efforts to assist their MSME suppliers and other stakeholders through dynamic discounting, factoring, or even by assisting them in obtaining loans from financial institutions; however, it has become apparent from our interactions with a number of CFOs of organisations who have registered themselves on our platform that their knowledge on the same is surprisingly insufficient: they are not familiar with the numerous.
In this blog post, we'll go over the various supplier finance options available to MSMEs in India today.
SOLUTIONS FOR FINANCING SUPPLIER EXPERTISE
1. NBFCS BANK FINANCING AND FINANCING
Banks are among the most often used sources of financing since they have traditionally played a significant role in supplier finance. For a very long time, banks have met the financial needs of every link in the supply chain. Due to the huge arbitrage created by this system, not to mention the time and effort needed to secure it, bank funding is currently relatively uneconomical for MSMEs.
The most common forms of bank financing include loans, overdrafts, and cash credit limits, which enable the aforementioned to withdraw or overdraw money as necessary at an agreed-upon interest rate. Yet, the interest paid seems unreasonably excessive in comparison to other types of supplier financing, and securing bank financing is a challenging process in and of itself.
So, it is safe to say that commercial banks have been relying on arbitrage to survive for too long without making a meaningful effort to address suppliers' liquidity issues.
As opposed to this, borrowing money from NBFCs is a lot quicker than doing it through a bank. Yet the price is greater (often 18–24% p.a. and higher with added processing fees). This is the first one to be abandoned when the economic climate changes negatively, which might make cash flow issues during payback even more problematic.
2. VENDOR FINANCING PROGRAMS:
A number of commercial banks, non-banking financial institutions (NBFCs), fintech firms, and other financial organisations have introduced what they refer to as "Vendor Financing Programs," whereby they extend Credit Facilities to the Suppliers of large corporations using instruments like invoice discounting, loans and advances, as well as other working capital facilities.
3. INVOICE FINANCING: The procedure by which a Supplier secures a loan from a lender in consideration for payment of an outstanding bill or invoice is known as invoice financing. The Modern Idea of Discounting is a result of recent advancements in this strategy. The traditional method limited the flexibility of invoice funding, making it a rigid decision. As a result, the industry experienced an identity crisis and switched to dynamic discounting (more on that later).
If this invoice is provided to the lender as "collateral" in exchange, the transaction is classified as invoice discounting, with the loan amount to be repaid as soon as the supplier's account is credited with the amount shown on the invoice.
However, if the invoice was "sold" to the lender (also known as the factor), who would then be in responsible of obtaining payment from the client, (invoice) factoring would apply.
Factoring is the practise of selling one's accounts receivable to a financier or lender at a discount, just before the relevant instrument matures, in order to meet one's immediate cash demands.
Factoring has the potential to greatly boost liquidity for both parties involved in the transaction since there may be a few weeks to several months between the date the invoice was sent and the due date.
Modern supply chain financing techniques
Due to fiercer competition, unpredictable sales cycles, unheard-of supply chain interruptions, and more overall uncertainty, it was evident that traditional methods to supply chain financing were poorly unprepared for the attack of what was to come. The lockdowns and shutdowns that followed the global outbreak brought on by COVID-19 demonstrated how vulnerable the financial system actually is.
The industry must reinvent itself to give all participants better access to working capital in order to boost supply chain efficiency, return on investment, and general ease of doing business.
At this point, it was emphasised how important modern solutions were to supply chain finance's age-old problems. The following is a list of some of the more noteworthy ones:
1. Dynamic Discounting
Although its applications have been severely limited, the concept of discounting bills and invoices is not new. It has long been a mainstay of the supply chain finance industry. Several issues with older supplier-led intermittent discounting systems were the cause of this. Under this system, a big problem that needed to be fixed was the margin leakage from the buyer-seller ecosystem, where the borrowers (suppliers) would borrow at 18 to 24 percent and the buyers would earn between 5 and 6 percent on their deposits. Many FinTech companies are involved in this area of arbitrage in order to provide their clients with Dynamic Discounting (also known as Invoice Discounting) services. These FinTech companies' clients can get cash discounts in the form of margin.
The aforementioned platforms calculate discounts on a sliding scale with the guiding premise that the more days, the higher the discount, providing a flexible solution for both customers and suppliers. As a result, suppliers can take early payment before the due date in exchange for a slight discount, and customers can pay their suppliers a cheaper price for all orders.
2. Reverse Factoring
Like factoring, reverse factoring can dramatically boost liquidity for both buyers and suppliers. With reverse factoring, the buyer initiates the transaction, and the interest rate the bank or financial institution charges is determined by the buyer's credit score, which dramatically reduces the overall cost of funding.
3. Algorithm-based discounting
Another cutting-edge method for supplier funding offered by a few FinTech companies in this sector is algorithm-based auction. It is a unique tool for price discovery in which the buyer(s) hold an auction based on weighted attributes with the assistance of their provider to establish the market price (s).
Algorithm-based discounting, also known as an algo-based auction, enables buyers to accomplish their strategic treasury objectives—something that other solutions do not. It does this by allowing suppliers to bid or rebid on the discount they are willing to offer, suppliers raising the bids, and an algorithm dispatched to select the bids.