The Cash Flow Plague Among Indian SMEs

Business to Business (B2B) Companies in India are reeling under the stress of delayed payments, say Adam Walker & Aniket Saksen, Founders of Hummingbill. More than 60% of SMEs in India receive payments from clients only after 60 days or longer, and 35% receive their receivables due only after 90 days or longer say the duo. 

India’s GDP is on the rise, at an estimated growth rate of 7.4% delivering an expected $2.1 trillion in the current fiscal year, according to this article from Livemint. Within this atmosphere of expected future prosperity, the service sector currently accounts for roughly 57% of India’s GDP, and SMEs contribute 17% to the same.

Moreover, the recent Economic Survey by the Government of India expects the next year’s growth to fall between 8.1 to 8.5%, as the country enters a “sweet spot…in which it could be launched on a double digit medium-term growth trajectory.” And yet, with India falling further down to 142nd rank out of 189 economies on the Ease of Doing Business index, the SME sector is facing very real cash flow problems in expanding and capitalizing upon the expected opportunities in the near future.

Largest Obstacle To Profitable Expansion For SMEs

As identified in this report from the Greyhound Knowledge Group, 79% of Indian SMEs (among their respondent group) believe their most crucial challenge to be a “dearth of easy finance and credit instruments”. This reveals a deeper cash flow problem, which smaller businesses negate by turning to credit providers. However, rather than travelling further down this chain of thought and attempting to resolve the cash flow issue, let’s back up and examine the source of this complication.

Late Payments Start Cash Flow Deficits

Let me start with a simple statement: The reality of late payment cycles faced by smaller businesses is so intrinsic to the professional ethos in India that it’s automatically written off as a given.

In fact, as corroborated by this article by CapitalFloat, more than 60% of SMEs in India receive payments from clients only after 60 days or longer, and 35% receive their receivables due only after 90 days or longer.

The reality of late payment cycles faced by smaller businesses is so intrinsic to the professional ethos in India that it’s automatically written off as a given.

As well, to put this in perspective, an Atradius report in 2013 clearly stated that India had the largest average Days Sales Outstanding at 80 days within the Asia-Pacific region. While services provided on credit to clients, especially larger, long-term ones, is undeniably required as a business tool, gross delays even from the accepted dates of cycles of receivables due lead to extreme complications.

Cash Flow Outcomes Due To Late Payments

Increasingly, the metrics for success prediction in businesses are shifting from the traditional profit loss statement to measures of cash flow. This is primarily because, regardless of product or service, one of the top reasons for failure of smaller businesses is a dearth of capital funds.

Profits Versus Cash Flow

SMEs usually operate along a model which espouses tiny profit margins in order to remain competitively priced against bigger businesses with larger resources. And yet, at any given point of time, about 15-20% of their revenues are locked up due to delayed payments.

In order to resolve this cash flow problem, they often turn to available credit instruments. However, due to lack of meaningful support so far from the government and banking sectors, the major available recourses for SMEs either involve factoring – selling their loan at a loss to third party fund providers in exchange for immediate payments. Or approach informal credit providers for immediate funds received with high interest rates, which are estimated to account for more than 40% of all credit transactions availed by SMEs in India. This means that, even when operating on small profit margins, SMEs usually end up cutting further deeper into them in order to free up funds for immediate cash flow – thus throttling future profitability and expansion. And that is the best case scenario. In the worst case scenarios, this late payment problem can even lead to insolvency and bankruptcy.

Forced Downsizing versus Extra Personnel

In between those two lay myriads of examples where SMEs, faced with late payments – usually from their large corporate clients – had to downsize their already meagre staff to be able to meet wage needs, even though they had healthy order registers. Others yet had to hire and maintain personnel to sustain dedicated “Receivables Due” departments, whose sole job was to chase and recover late payments either personally or online.

Service Tax Liability

One of the most conclusive effects of late payments is their implication on the service tax due to the Indian Government by SMEs. Since the point of taxation is calculated at the time the invoice is created, these smaller enterprises are liable to payment of service tax even on invoices which have not yet been paid, thus further eating into cash flow without redressal through incoming receivables due. Moreover, this leads to subsequent legal and administrative complications from the clients, who often demand issual of fresh invoices if the delayed payment is carried over to the next financial year.

Why Do Late Payment Problems Occur? 

According to respondents, most late payments are usually associated with large corporate firms, owing to their complicated accounting procedures. As per one business owner, SMEs usually raise a service request which is sent to the client’s Purchase department for a final tender. This offer is then finalized and communicated back to the SME. After the service is performed, the invoice is raised and submitted to the client’s Purchase or Payment department, which then forwards it to their Finance section. Once the Finance department checks through the invoice, the amount is released to the Payment department, which then forwards the funds back to the SME.

In this particular case, the respondent also noted that such firms usually have these orders and associated memos flying between segments of the company, the loss of any of which usually results in paperwork being handed back to the originating department for re-processing or duplication. While these rigid procedures ensure that the large firm operates smoothly, the cash flow backlash of the incessant delays is almost always born by the SME service provider alone. As well, these cases don’t even touch upon examples where clients simply feigned non-receipt of invoices in order to delay payments for their own cash flow convenience.

Moreover, while SMEs can enforce laws in place and either initiate litigious procedures or report delayed payments to the RBI’s Blacklist, such measures would only result in lengthy and time-consuming processes which would further exacerbate the cash flow problem. Not to mention the fact that it would alienate the client as well.

In most cases, large firms are well aware of the power they hold. And this has led to further horrific tales where SMEs which had ironclad credit policies and late payment interest agreements in place with clients were faced with repeated requests for discounts on receivables due if they ever wished to see the funds.

Verdict & Solution

In the face of expected 22% contributions to GDP, SMEs need to improve some critical business metrics in order to provide that GDP contribution through expansion, and not just addition of newer enterprises in this cut-throat atmosphere. However, even with the provisions of “Mudra” bank in the budget, which would provide better financing opportunities for SMEs in India, these redressals fail to solve the basic problem. Furthermore, while the Rs.5,000 crore liquidity support package announced by the RBI in 2013 goes some way towards solving immediate cash flow crunches, it’s a half measure at best which is yet inaccessible by many.

The ethical issue of delayed payments is an insidious obstacle to healthy cash flow and subsequent growth of SMEs in the country. And before this problem is written off as a given, India needs to increase the litigious accountability of larger corporate firms and bring it on par with developed nations. However, realistically speaking, an infrastructural tune-up of such magnitude is some ways off.

So, what other options are left to ensure that clients pay on time? Well, that is the answer we provide through our product Hummingbill Collect, a user-friendly Chrome extension that guarantees to significantly increase on-time payment rates for SMBs through better organization of invoice data, automated payment reminders, and embedded payment links in invoices. Sign up here for free to get started! (Image Courtesy 3.bp.blogpsot.com)

Authored by Adam Walker, Founder & CEO at Hummingbill & Aniket Saksen, Founder, Hummingbill