By Dr Vishnu Ramachandran
Credit and Finance for MSMEs: Small and Medium Enterprises (SMEs), the backbone of the Indian economy are hemmed in between the large corporate and retail segments in terms of loan ticket size and have the least credit penetration. This is because non-incorporated SMEs are subject to relatively relaxed financial disclosure norms to avoid burdening them with too much compliance. This results in inadequate and unreliable information about SMEs that makes it difficult to assess their creditworthiness. This, along with the inability of traditional models to assess their credit risk, hinders credit penetration to SMEs.
Digital lending fintech companies are trying to address this through innovative data aggregation for collecting unstructured data on SMEs. Additionally, now the global information infrastructure is generating a large quantum of transaction data emanating from the use of digital wallets, digital payments, B2B e-commerce, and Point-of-Sales (POS) terminals. According to McKinsey & Co, real-time payments grew by 41 per cent in 2020, and India registered $25.6 billion worth such transactions. This provides a wealth of near-real-time data for new-age credit risk assessment models to assess SME creditworthiness.
SME credit risk assessment models typically rely on the 3 Cs approach—capital, character, and capacity. Capital refers to the assets owned by the SME that indicate its financial strength and which can be used as collateral. Character is best represented by the SME’s payment track record. Capacity is the SME’s current and future ability to meet its financial obligations from the cashflow generated by the business. With this in mind, here are some steps that SMEs can take to improve their credit risk score.
Timeliness of Payments
Ensure that bank and NBFC loans are serviced on time and credit cards payments are made before the due date to help maintain a high credit score with various credit bureaus. As the owner, keep your personal credit history clean as well; lenders monitor the credit scores of both the SME and its owner/s.
Always pay employee dues, including salaries and statutory payments such as Provident Fund on time. Do not delay relevant filings and disclosures to regulatory authorities such as the Registrar of Companies. Stay up-to-date with tax payments and return filings. File GST returns on time, as banks and NBFCs check GST filings before approving SME loans. Make timely trade payments to avoid unnecessary litigation. Having cases filed against you for issues such as cheque bouncing under section 138 of the Negotiable Instruments Act, raises red flags and causes your credit score to drop.
Accuracy and Transparency
Maintain your company’s correct legal identity and contact details across all statutory databases. Have a strong social media presence and divulge adequate information in a timely manner. If your firm has secured quality accreditations or won awards, highlight these. Address customer or employee complaints on any social media platform quickly and professionally.
Adopt digital channels for payments to ensure transparency of your transactions, as, modern credit risk models use near-real-time data from a variety of digital payment platforms to assess risk. It can also cut your transaction costs significantly.
Make sure that the owner/s and directors of your SME are compliant with statutory requirements and have a clean track record. While evaluating creditworthiness, lenders conduct background checks on owners to validate identity (KYC) and check criminal records, political linkages (PEP), and involvement in money laundering. Any negative data about the owner/s will adversely impact the SME’s credit score.
Remain within Industry Benchmarks
Ensure that key ratios (Debt-Equity, Interest Coverage Ratio, Current Ratio, and Quick Ratio) are in line with industry norms. The firm should be appropriately capitalised with adequate equity from the owner/s. Optimise working capital management and avoid large accounts receivable or accounts payable that are beyond industry norms. Inventory should be consistent with the size of your business—a bloated inventory inflates your working capital requirement.
Taking the above steps, though not always easy, will help you, as an SME enhance your creditworthiness and improve your credit score. This will not only help you borrow at lower interest rates but also strengthen your credibility with larger corporates and the trade.
Dr Vishnu Ramachandran is Co-Founder and Chief Technology & Product Officer at Rubix Data Sciences. Views expressed are the author’s own.