The right credit management techniques can help SMEs boost business

Every business exists to make a profit. However, as every experienced businessperson knows, financial liquidity, i.e. cash flow, is much more important than profit. The tighter the cash flow, the greater the chance of a business failing. 

All over the world, in business-to-business transactions, most enterprises make sales on terms of credit. In particular, small and medium enterprises in the trade credit sector face cash-flow challenges due to major portion of sales tied up in credit to buyers. So, cash flow is even more of an issue for SMEs because, generally, they don’t have as many options for financing as large enterprises have. Quite often, there are delays in payments, resulting in consequences for every connected entity in the value chain. 

In this article, we look at a few effective credit management techniques and how they can boost business.

Setting the appropriate credit terms:

Often SMEs make decisions on credit extension based on the buyer's familiarity, size of the order, etc. This age-old practice has led to delayed payments and defaults. Making decisions based on the buyer's historical facts related to payment behaviours, credit usage in banks, business identification information, etc. can make a lot of difference while setting credit terms. Sellers should push the buyers to submit such information before offering credit. Or sellers can access some of the existing online platforms which offer such due-diligence services or data insights. Adopting such a practice not only helps reduce the risk of delayed payments and defaults, but also helps in business growth as expanding to new horizons would be less risky with information handy.

Some of the new age credit management platforms also provide features to monitor existing buyers' financial health to help alter credit terms on an ongoing basis.

Intelligent documentation:

Commercial relationships without proper documentation can leave both the parties nowhere in extreme cases of defaults on either side. There are several acts and procedures to help SMEs in such extreme cases of defaults.

Documentation should cover such clauses which help resolve issues at a faster pace through a structured process. The internet adoption has enabled hassle-free electronic documentation which was earlier a time-taking process. Electronic documentation is legally accepted in India. Some of the clause’s sellers should consider adding to buyers' agreement are listed below

Exclusively for SMEs, the Micro, Small and Medium Enterprises Development (MSMED) Act 2006 stipulates a 45-day maximum for credit period and three times the bank interest rate to be applied and paid monthly by the buyer until the date of fulfilling the delayed payment. Further, in case of dispute, SMEs and/or buyers can approach the Micro and Small Enterprises Facilitation Council constituted by their State Government.

E-arbitration clause: E-Arbitration helps resolve issues without jeopardizing business relationships while maintaining full confidentiality. The entire mediation and arbitration process is seamless, digital and paperless. Disputes from up to 3 years can be revisited and resolved through E-Arbitration as long as the prerequisites for the process are met.

Credit Management Software:

Accounting softwares have been in use for a while now among SMEs with majority of them using tally software. But SMEs need to adapt online platforms which are an extension of tally or other accounting software to help manage their buyers and credit extended through intelligent features and services. Large enterprises have a dedicated credit control or credit management departments, but SMEs don’t have such a luxury. In today's scenario, thanks to technology and fintech start-ups, such credit control and credit management can be easily achieved through online platforms specifically built for SMEs.

There are very few such end-to-end credit management software platforms which gets integrated with tally and other accounting softwares. These softwares help SMEs onboarding buyers through proper due-diligence, monitor existing buyers' financial health, invoice reconciliation, sending payment reminders, online dispute resolution, credit analytics, collections analytics, sending legal notice, raising e-arbitration, etc. Some of these softwares also help with loans for business growth. These softwares are very effective when used as part of business work-flow.

Insuring Credit Exposure:

In recent times, easy-to-use trade credit insurance products have been introduced in the market. These trade credit insurance products help SMEs insure the credit exposure up to 90% by paying 0.3% of the total credit value as a premium. There are also trade credit insurance products which are priced flat. To avail these insurance products, seller should be able to provide buyers' financial or transaction information for due-diligence and risk assessment to insurance companies.

Invoice Discounting:

An innovative system from the Government of India (under the aegis of RBI), the Trade Receivables Discount System (TReDS) allows MSMEs to convert their invoices (called “trade receivables”) into liquid funds. Broadly, the process is as follows:

• An MSME uploads their trade receivable(s) into a particular TReDS platform (there are three at present).
• Financiers will place bids (obviously lower than the total amount of the receivables).
• The MSME accepts the best bid.
• The financier of the selected bid will pay the MSME.
• The buyer pays the financier as per the agreed upon schedule.

Though an MSME gets an amount lower than the invoiced amount, the system ensures that they maintain cash flow.

A buyer can also use TReDS to ensure finance for payment by uploading invoices that they have to pay, creating a Reverse Factoring Unit, obtaining the acceptance of the MSME, and selecting a bid. 

There are over 78 lakh MSMEs registered on Udyam, and there are more than 60,000 large companies (revenues greater than ₹50 crore). Unfortunately, all the three TReDS platforms combined have only about 3,000 buyers (a tiny fraction of the total) and 30,000 sellers. 

On the bright side, the MSMEs registered on the platform are getting their funds as they are supposed to. This has led to a 300% increase in participation by buyers (including PSUs), MSMEs, and financiers. 

In India, according to the latest figures of this year, nearly ₹11 lakh crore is stuck in delayed payments to SMEs. The cascading effects of this situation: Delayed salaries to employees, delayed payments down the line to the suppliers to the SMEs, slowdown of growth, and disruption of supply chains. Combined with the effects of the recent pandemic and the current high inflation, the situation of many SMEs in India is precarious. If SMEs start adapting some of the intelligent and new age credit management platforms, solving this mammoth problem is possible in the near future.

The article has been written by Winny Patro, CEO and Co-Founder, Recordent