A Guide To Working Capital Management for MSMEs in India

‍Micro, small, and medium enterprises (MSMEs) form the economic bedrock of India's growing economy. Constituting over 90% of businesses in major commercial sectors, more than 60 million MSMEs contribute nearly 30% of India's GDP.‍

The MSME sector in India, employing over 100 million people, is becoming increasingly important for a self-reliant India. However, numerous MSMEs in India encounter challenges like limited access to significant bank credit and thin internal capital buffers, which can lead to constraints. External shocks or even minor cash flow issues risk destabilizing the entire ecosystem.

In essence, crucial elements essential for early-stage business thrive—access to markets, skills, and working capital—are significantly lacking for most enterprises.

Although Access to markets and skills is one thing, the most important one to discuss is Working Capital!‍

Effective working capital management is important for businesses to handle their day-to-day financial responsibilities, like paying suppliers and covering bills. When not handled well, it can lead to challenges such as delays in payments and strained relationships with suppliers, which can affect the overall operation and reputation of the company.

Relying excessively on external financing may result in increased costs and potential debt issues. Additionally, it may impact the ability to invest in growth opportunities, affecting areas like marketing and expansion. Insufficient working capital management can cause cash flow shortages, impacting daily operations and employee morale. Therefore, a considerate approach to working capital is important for businesses to navigate financial challenges and maintain stability.

What are the factors that contribute to inadequate working capital management? Let's explore them.

‍Poor working capital management in MSMEs can be attributed to several factors:

Limited Access to Bank Finance:

Even though the government has programs for small business loans, it's tough to qualify because there are strict rules and lots of paperwork required by public banks. Private banks, which usually focus more on big businesses, don't do a great job of helping when it comes to  MSME financing.  

Irregular Cash Flows:

A lot of Indian MSMEs, especially those in manufacturing, trading, and services, struggle with unpredictable sales patterns and changes in revenue during different seasons. Dealing with fixed operating costs adds more pressure on their limited cash reserves, making small-scale operations face ups and downs throughout the year.

Delayed B2B Payments:

MSMEs working with larger public and private sector corporations often have to deal with long delays in getting paid despite agreed contractual terms. Sometimes, these large buyers hold onto the money they owe to deal with their own financial issues, and it's the small suppliers who end up feeling the negative effects of this delay, disrupting their working capital management.

Seasonal Raw Material Price Fluctuations:

The notable ups and downs in the prices of important inputs, like fuel and commodities, connected to imbalances in demand and supply, make it hard to predict costs. This problem impacts MSMEs in the agriculture, manufacturing, and transport sectors.

Taking a smart approach to handling cash flows, dealing with late payments, and adapting to changes in raw material prices during different seasons is really important for the success and growth of small businesses.

MSMEs should focus on putting in place strong financial plans to make sure their operations can last, become more resilient, and take advantage of opportunities for growth in the ever-changing business environment. Good working capital management not only protects against financial uncertainties but also helps small businesses do well in the face of challenges, making the sector stronger overall.

Working Capital Management: A Vital Step for Small Business

Working capital management is a key practice for MSMEs, It helps them make the most of their assets and have enough cash on hand for smooth operations. It's not just about having enough working capital; it's about finding the right balance so businesses can handle both expected and unexpected costs while using their money wisely.

Efficient working capital management offers several benefits for small business owners.

Firstly, it plays a role in managing available cash, helping businesses analyze their expenses and plan how to use funds for short-term needs. Additionally, effective working capital management assists businesses in handling tight financial situations, ensuring stable operations even during challenging conditions.

Moreover, effective working capital management adds value to the business by encouraging timely payments and meeting commitments, building a positive reputation, and fostering good business relationships. Additionally, it supports decision-making related to working capital management by accurately assessing funding needs, offering a clear view of daily expenses, and the requirement for external funds or surplus allocation.

But the real question is how you can streamline the working capital management. 

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Roadmap to Working Capital Management:

For small businesses, especially MSMEs, timing is crucial, especially in working capital management. The challenge arises when they are waiting for customers to pay but still need to pay suppliers and cover operating costs. This gap in cash flow forces owners to either have overdraft agreements or resort to personal savings and credit cards, incurring financial costs and personal stress in the process.

Understanding Your Working Capital Position:

Initiate Comprehensive Analysis:

• Gain insight into your company's current working capital position.
• Conduct a thorough analysis of short-term assets and liabilities associated with day-to-day operations.

‍Asset and Liability Management:

• Assess cash reserves, accounts receivable, and inventory.
• Scrutinize short-term liabilities, focusing on accounts payable turnover and short-term borrowing.
• Utilize the cash conversion cycle to measure the days between cash outlays and collection from customer payments. Compare with industry peers for insights.

Improving Relations with Suppliers:

Strategic Supplier Collaboration:

• Foster close relationships with strategic suppliers to negotiate improved credit terms, directly impacting working capital management.

Extending Accounts Payable Periods:

• Negotiate for extended accounts payable periods, allowing the company to retain cash for a longer duration, reducing dependence on external financing for operational funding.

Flexibility Benefits:

• Emphasize the flexibility benefits to the company in terms of managing cash flow, responding to market demands, and strategically investing in key areas.

Supply Chain Financing for Early Customer Payments:

Explore Innovative Platforms:

• Utilize supply chain financing platforms 
• Secure early payment on outstanding invoices from large corporate buyers.

Alternative Credit Scoring:

• Use alternative credit scoring models to advance cash to suppliers based on the creditworthiness of major customers.

Competitive Working Capital Financing:

• MSME businesses can access working capital financing at competitive rates, avoiding extended waiting periods for invoice settlement.

Bridging Capital for Operations:

• This bridging capital supports growth, inventory builds, or receivables until eventual customer payment.

Alleviate Cash Flow Strains:

• Supply chain transparency and short-term financing help alleviate cash flow strains, especially when dealing with major companies with extended payment cycles.

Efficient Working Capital Management:

• Leveraging emerging fintech platforms provides an efficient way for suppliers to manage working capital needs in coordination with customers across their supply network.

To Wrap Up

‍Understanding the intricacies of working capital, fostering robust supplier relations, and exploring innovative supply chain financing platforms present a transformative journey for MSMEs. This roadmap not only aids in navigating financial hurdles but also positions these enterprises to thrive amidst uncertainties, contributing to the overall resilience of the sector. In the dynamic landscape of MSMEs, adept working capital management is not merely a financial strategy; it is the gateway to enduring success and growth.