When EVERYONE delays, NO ONE gets paid in time
The below article authored by our co-founder Pawan Bindal, was featured recently in Financial Express. Click here to check
It is a well-established fact that Micro, small & medium enterprises (MSMEs) suffer from delayed trade payments. Delayed payments mean that MSMEs are usually struggling for liquidity, and this constrains their growth prospects. And the common understanding is that MSMEs don’t get paid on time by large corporates (who naturally have greater negotiating power).
At TimePay, we decided to dig deeper into the real issues behind why MSMEs don’t get paid by their customers in time. More specifically, we wanted to test if the size of the customer / supplier had a bearing on whether it made / received payments in time.
We studied financial data relating to 300+ businesses from the Ministry of Corporate Affairs. We divided the sample into four segments – micro (turnover ~ INR 1 crore), small (turnover ~INR 11 crore), medium (turnover ~ INR 60 crore), and large (listed companies, turnover > INR 1000 crore). We then computed the time taken to pay suppliers (i.e. median days payable) and time taken to receive payments from customers (median DSO – i.e. day sales outstanding) for each of these segments. The results were startling.
Small businesses pay their suppliers slower, large businesses pay faster: Our research shows that smaller businesses are more likely to delay payments to their suppliers, whereas the larger companies pay much faster. Specifically, large businesses are paying their suppliers within ~86 days, whereas micro businesses take much longer (~119 days) to pay their suppliers. The below graph illustrates that with increasing size, a business will pay faster to its suppliers.
The larger business may be able to pay suppliers faster simply because they have access to cheaper bank finance. The larger business may also be having greater awareness about the MSME law, which requires them to pay their micro and small suppliers within 45 days.
In fact, most of the large companies in our study reported that they had nil “dues over 45 days to micro/small suppliers”. This suggests that compliance for the MSME law is on the rise.
Small businesses get paid slower, large businesses get paid faster
We also examined how quickly various businesses received sales dues from their customers. This was done by calculating the median day sales outstanding (DSO) for each size segment. The results tend to corroborate what we see in the previous analysis. Larger businesses receive their sales dues quickly (~21 days). On the other hand, micro, small and medium businesses must wait over 70 days to get payments from their own customers.
This suggests that large businesses get their sales dues faster and hence, have the cash flows to make supplier payments faster. Smaller businesses get their dues late, and in turn are forced to delay payments to their suppliers. This seems to generate a chain reaction or a vicious cycle of delayed payments in MSME space.
Delayed payments problem: MSME-MSME trade should be the focus
Estimates suggest that trade transactions between MSMES number more than 80% of all trade transactions. The research findings thereby imply that it is the MSME customers that (mostly) delay payments to their MSME suppliers.
On the other hand, the implementation focus of the MSME law (45 days rule) is mainly on the larger firms. Thereby, bulk of the trade (i.e. MSME to MSME, where delayed payments is a greater issue) gets ignored while tackling the problem.
The delayed payments issue is causing increasing number of MSMEs to seek finance. While finance to MSMEs is welcome, much of this credit growth is coming through NBFCs. The share of NBFCs in MSME credit grew from 13% (in 2013) to 21% in 2018 (Ref: SME Pulse Report – CIBIL TransUnion). A recent Bloomberg article goes further to suggest that this credit growth may have been fuelled through riskier credit products such as ‘Loan against Property’ and represents a worrisome fault-line.
Need for finance = Need for transparency
The 45-day rule for payments exists, and actively enforcing it for MSME customers buying from MSME suppliers could be an option. However, active legal enforcement of this rule to MSME customers would be highly impractical. There already exists a huge pendency (~70%) of delayed payment cases (refer: Samadhaan portal).
Importantly, there needs to be a greater understanding of why MSME to MSME payments are being delayed, so that appropriate solutions could be found. For example, in our research, we observed that many MSMEs have started to wait for the GST credit (which can usually take 1-3 months) to appear before they make the full payment to the (MSME) supplier.
The other obvious reason for MSMEs delaying payments is that they find it difficult to obtain trade finance in India. We hence need a more vibrant eco-system of MSME-MSME trade finance in India, whereby MSMEs source finance in lieu of invoice flows. The opportunity is huge - the UK factoring market is currently estimated to be about 100 times bigger than that of India.
We do have initiatives like TReDS to facilitate invoice discounting. However, such initiatives and most new fintechs are also focused on B2B trade where the buyer is usually a large corporate (and as the research suggests, this is not the real problem). This is because the financial players cannot ‘credit rate’ the MSME buyers.
MSME-MSME trade finance cannot grow unless the MSMEs themselves become more credit-worthy and financially transparent. Initiatives like GST have spurred greater transparency among MSMEs, but this may not be enough. We need an information eco-system that encourages positive payment behaviour. The banking sector has credit bureaus for financial credit, and we need to have similar bureaus for trade credit.
MSMEs are considered as the growth engine of the Indian economy. But delayed trade payments are causing this engine to choke and splutter.
Most small business owners want that their customer payments should come on time. When their customers delay payments, business owners in turn, delay payment of their suppliers. And this leads to chain reaction, a vicious delayed payments cycle that chokes the growth engine.
And fixing this vicious cycle needs to be a top priority for the new government.