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Anita Roddick, a British businesswoman and founder of The Body Shop, once quoted, “If I had learned more about business ahead of time, I would have been shaped into believing that it was only about finances and quality management.”

She pins down two key factors that drive business growth for entrepreneurs and understanding of ‘finance’ being the first one. Other growth factors like quality management, strategy, people, operations, risk management, customer centricity etc., may also be relevant.

However, in this article, we will focus on the significance of finance and transactions as a tool for sustainable and profitable growth.

Finance Related Challenges Faced By MSMEs

Businesses can’t grow fast without the adequate capital, right form of financial backing and at the right time. Finance is necessary for the establishment of the business and to carry out the day-to-day business operations. Capital is required to purchase the plant, land, building, furniture, machinery, etc., which are called as fixed assets.

Funds are also necessary for the purchase of raw materials, maintaining adequate inventory, payment of salaries or wages, credit to buyers, to fulfil the routine expenses etc., and is called as working capital.

India’s growth as an economic power globally has been fuelled by Micro, Small and Medium Enterprises (MSME) sector.

It contributes about 8% of India’s GDP, 45% of the manufacturing output, 40% of the exports and employs close to 40% of our total workforce. Deepali Pant Joshi, Executive Director, Reserve Bank of India, speaking at the launch of credit scoring model for MSMEs by Canara Bank on May 8, 2017 said that this sector with high employment elasticity has reduced its growth and potential for creating more jobs. The deceleration in the sector has been marked and is a cause of great concern.

One of the primary issues has been the MSMEs are run as unorganised entities or family businesses that may not necessarily maintain strict compliance standards. These businesses lack sufficient documentation and avail their working capital finance from local moneylenders, leading to insufficient credit history, thereby hindering their attempts to avail finance from formal financiers.

The traditional underwriting practices with high administrative / transaction cost have prevented them from effectively underwriting these segments leading to higher interest costs.

Steps Initiated By The Government

The implementation of Goods and Services Tax (GST), however, helps introduce MSMEs into the formal business and create digital trails.

For instance, an MSME registered under GST files documentation that reveals their sales trajectory, income sources, inventory sold, credit cycles etc. Recent steps like setting up small finance banks (SFBs) like Ujjivan, Equitas, AU etc., will provide basic banking service of acceptance of deposits and lending to sections of the economy not being served by other banks, such as small business units, small and marginal farmers, micro and small industries and unorganised sector entities.

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New-age Fintech lenders like Capital Float, LendingKart, Kinara Capital, Indifi Technologies etc., leverage technology to originate loans and for credit assessments, sanctions and disbursals face myriad challenges.

The Government has established MSMEs as a priority sector and further provides banks with MSME lending targets. Banks are becoming increasingly keen to attain these targets without incurring high operating costs. Banks along with Non-Banking Financial Companies (NBFCs) also realise the massive credit gap in the market and want to diversify their loan book by adding different types of MSMEs to their client base.

SFBs and Fintech lenders possess customized finance products, the expertise and the technology to help scheduled commercial banks achieve these goals. Collaboration between them becomes an obvious outcome.

Other Challenges Ahead

Nonetheless, despite the priority sector lending incentives and target, there is still a considerable credit gap which needs to be bridged.

The access to timely and adequate credit from banks is critical for the sector. The ability of MSMEs (especially those involving innovations and new technologies) to access alternate sources of capital like equity finance, angel funds/risk capital is extremely limited.

The objective of government’s nationalisation of banks in 1969 was to ensure adequate credit delivery to smaller firms. For instance, large companies accounted for 58% of total bank credit of INR 65.47 Tn at March 2016. Therefore, about 50 years later, we need to ascertain the reasons for deviations from our noble intention.

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With large Non-Performing Assets (NPAs), multitude of financial scams, low employee morale, poor salaries and outdated infrastructure etc., public sector banks (now controlling about 70% of the banking credit) have very little incentive to offer credit to MSMEs. Credit is a crucial input for promoting growth of particularly, the MSME sector, in view of its limited access to alternative sources of finance.

At present, there is almost negligible flow of equity capital into this sector despite the specialised presence of government undertakings like Small Industries Development Bank of India (SIDBI). This poses serious challenge to development of knowledge-based industries, particularly those that are promoted by first-generation entrepreneurs with the requisite expertise and knowledge.

In the absence of alternate sources of finance, the MSMEs’ reliance on debt finance is very high. The high reliance on debt, combined with high cost of credit adversely impacts the financial viability of start-ups, particularly in the initial years, thereby threatening their long-term survival and sustainability.

What Is Needed?

Various estimates on the credit availability to the MSME sector, however, indicate a serious credit gap. They also need to access to a diverse range of finance options, including non-bank lending. The scale is small currently but they should, over time, bring additional choice and greater competition to the lender thereby structurally bringing down the cost of finance for the MSMEs. These need to be addressed at the earliest so that India can continue on its remarkable growth journey.

Transactions are also important for driving growth. These could include alliances in the form of strong supplier relationships and preferential credits. In addition, as the business grows, mergers and acquisitions may offer the potential to achieve a step change in growth, or facilitate entry into a new geographical market or a complementary service area.

Starting from the investment to commencement of the business, finance takes a dominant role in the business scenario. Awareness of various fund raising options and its related cost are of prime importance to entrepreneurs. Finance is the life blood of any business, irrespective of the size of the business, whether it is small, medium, large or extra-large. Understanding its essence in relation to the business is vital for the business success.

Note: The views and opinions expressed are solely those of the author and does not necessarily reflect the views held by Inc42, its creators or employees. Inc42 is not responsible for the accuracy of any of the information supplied by guest bloggers.