5 Factors that are Affecting SMEs’ Access to Finance

Small and medium enterprises have been the lifeline of the Indian economy for a long time now. They contribute almost a third to the annual GDP of India and employ millions of people. Hence, the importance of SMEs cannot be undermined. However, small and medium scale businesses need sufficient funding on a regular basis to stay operational and profitable. And fortunately, as far as financing of business operations is concerned, the Indian government has been proactive. Several initiatives have been taken to make sure that these small and medium enterprises keep delivering for themselves and the nation.

But, are all SMEs getting easy access to finance? No.

In fact, there is a massive credit gap of USD 380 billion in the MSME space. The majority of small and medium enterprises borrow from Informal channels at huge interest rates. For SMEs, accessing the right kind of finance at the right time is usually the biggest roadblock. Read on to know about the obstacles standing in their way.
 

Factors that are Affecting SMEs’ Access to Finance

1. Lack of Credit Information

   Though a plethora of schemes has been rolled out by the government for SMEs, only a few reach the intended recipients. This is mainly due to a huge vacuum in information transfer, also known as information asymmetry problem. The details of many schemes are not understood well, and in the process, not availed of.
    

2. Inadequate Investment in Research and Development

   Often SMEs overestimate their budget to realize a certain growth trajectory. For instance, to achieve an extra 5% market share on their products and services, an SME might estimate a capital requirement of Rs 25 lakh. However, when a financial institution sits down to analyse this request from a practical angle, it concludes that Rs 10 lakhs is sufficient for a 5% increase in market share.
    
   This huge gap in the SME’s credit application estimate and the lender’s assessment is majorly due to inadequate investment in research and development. Hence, SMEs have to invest in R&D in this data-driven economy. While requesting credit, a clear business plan with proper estimations has to be in place.
    
   This will make it easy for the financial institution to back your plan with confidence and also provide backend support for business operations in the future. This way, you will be able to build a mutually beneficial partnership culture.
    

ALSO READ: Impact of Covid-19 on Indian SMEs And Strategy To Reboot The Sector
 

1. Credit Scores

   They are an integral part of the credit disbursement process. Roughly 40% of SMEs rely on informal credit sources, and thus, do not possess a strong credit history. Though SME loan interest rates are much lower than informal credit options, businesses cannot avail them due to limited or non-existent credit history.
    
   Besides, many SMEs belong to the unorganized sector and do not possess any data on their transactions. This prevents them from providing a concrete road map to financial institutions, when they wish to secure an SME business loan. The absence of these records causes financial institutions to perceive SMEs as risky borrowers.
    

2. Location

   Enterprises which are located in economically and financially better zones have easier access to finance. After all, the ease of doing business is synonymous with acquiring funds to do business.
    
   In 2019, Andhra Pradesh grabbed the No.1 spot when it came to implementing Business Reforms Action Plan or BRAP, among all the 36 states and Union territories. This means, it emerged as the state where doing business is the easiest. For union territories and states that ranked much below in this list, getting access to credit, electricity, and land for business can be challenging.
    

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1. Not Leveraging Technology

   In a world driven by data and technology, it is imperative for SMEs to be tech-savvy. Hence, small businesses have to leverage technology and use the latest software to keep track of their expenses, coordinate their supply chains, and deal with their customers on a real-time basis. They can automate the process of invoicing and settlement and use cloud-based accounting tools, so that business operations become smoother and more efficient. This way, SMEs can easily convince financial institutions that they are eligible and showcase important facts and figures without putting in manual effort to create reports.
    
   Small businesses will also need to go online to research about various lenders, compare them and their offerings, and even apply for credit online. This will save a lot of their time and energy, which they can devote to core business objectives. SMEs can also download mobile apps of financial institutions to apply for loans and track the same conveniently.  
    

Other Factors that Affect SME Finance

Insufficient Documents

One of the major issues with small business owners is that they do not keep accurate financial records. As the SME segment in India is still unorganized, businesses in towns or small cities generally overlook the importance of a profit and loss statement, balance sheet, and cash flow statement.
 
These financial statements are crucial documents that inform lenders about how your company has performed over time. If your financial records show a good profit, you will have no trouble obtaining business financing at favorable interest rates.
 

Lack of Business Plan

Another common factor that affects SME finance is a business plan. Many small businesses choose any lender for their loan applications without having a well-researched plan. This often results in the rejection of the loan application. If the loan amount is substantial, the lender may request your business sales forecast, revenue projections, expansion plans, and other information.
 
The lenders may also be interested in learning about the areas where you will deploy the funds availed. The whole point of doing this is to analyze the risk of lending to your business.
 
Apart from that, have a proper repayment plan in place. Let’s assume your company has previously received funding from private investors and multiple financial institutions. Thus, you may already be having several existing debts and would be making EMI payments on them. In this case, the lender may ask you to detail how you will manage the new debt EMI while reviewing your debt-to-revenue ratio.
 

Lack of collateral

Term business loans are an unsecured form of financing. However, due to poor business credibility and a higher debt-to-revenue ratio, there is a possibility that your lender may reject your loan application. In this case, providing valuable business assets as collateral is the best way to obtain funds. It guarantees lenders that if you default, they will be able to recover their losses by selling your pledged assets. 

Benefits of SME Financing

1. Access to Working Capital

   SME loans provide access to working capital, which is essential for businesses to meet their day-to-day expenses, such as payroll and inventory. You can either apply for working capital finance or a term loan. 
    

2. Diversification of Funding

   SME loans provide an alternative source of funding, allowing businesses to diversify their sources of financing and reduce their dependence on a single source. You don't have to rely on angel investors or private equity to arrange funds for business, and you don't have to give the lender a holding right.
    

3. Improved Credit Score

   Repaying an SME loan on time can improve a business's credit score, making it easier for you to access significant credit in the future.
    

4. Increased Competition

   The availability of SME loans increases competition among lenders, resulting in more favourable terms and rates for borrowers.
    

5. Customised Products

   SME lenders provide tailored products to meet a variety of funding needs. For example, if you own a manufacturing company and need to purchase plant or machinery that is classified as a capital asset, you can obtain an equipment finance loan.
    

Why is Business Finance an Important SME Loan?

There are numerous reasons why business loans are a preferred option for MSMEs. Some of the prominent ones are as follows:
 

• A business loan does not require you to provide security to obtain funds.
• You may use the funds obtained through a business loan for any business purpose you see fit. 
• You are free to choose the repayment tenure, which allows you to save on interest payments.

 
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How to obtain an SME loan?

You can apply for SME finance offline at a lender's branch or through DSA. However, this is a time-consuming process. The best alternative is to go the online route.
 

• Research different online lenders and compare their qualifications, interest rates, and terms.
• Gather necessary documentation such as financial statements, tax returns, and identification.
• Fill out the online loan application, including information about your business and its finances.
• Submit the application and wait for a decision, which takes several minutes. 
• If approved, review and sign the loan agreement.
• Once the loan is funded, use the money to grow and support your business.

 
Note: It is always important to carefully review the terms and conditions of any loan, including the interest rate, fees, and repayment schedule. Additionally, it is important to consider how the loan will impact your credit score and overall financial situation. And also, you may need to provide collateral or guarantees for the loan, depending on the lender's requirements.
 

To conclude

Hopefully, you now have a fair understanding of the factors that prevent SMEs from accessing affordable finance. The challenges discussed above have been persistent for years. And they have to be addressed in a time-bound manner to alleviate any further distress to small and medium businesses.
 
Disclaimer: This post was first published on 1st December 2020 and has been updated for the latest information, freshness and accuracy.