Non-conventional funding sources help MSMEs reduce cash conversion cycle

Cash conversion cycle refers to time taken to sell inventory, collect receivables and pay suppliers

CRISIL’s analysis of the cash conversion cycle (CCC) of MSMEs it rates shows significant variations, even within the same industries. It also shows that slow CCC is plaguing the entire sector. CCC refers to the time taken to sell inventory, collect receivables and pay suppliers.

As reflected in the chart, those in the higher quartile have more than twice the median CCC in the auto components, engineering & capital goods, and textiles sectors, whereas for electricals and pharma, the variation is only marginally less.

To be sure, the variation within an industry is a function of the bargaining power that MSMEs have with customers and suppliers on credit terms and inventory management. Entities in the higher quartile are facing greater challenges in managing receivable days, which are as high as 100+ days.

Traditionally, MSMEs have lacked control on inventory and receivables, so they often resort to stretching payments to suppliers, thereby inflating their procurement cost. The burden of a slow CCC ultimately falls on either the suppliers, to whom payments are delayed, or the lenders.

Interestingly, for one in every three entities in the higher quartile, receivables are due from middle and large corporate buyers. Looked at another way, this is an opportunity for MSMEs to reduce their dependence on conventional sources of funds, and convert their receivables into liquid funds using tools such as receivables-centric supply chain financing, where the buyer’s procurement funding becomes the source.

Also, newer institutional mechanisms such as the Trade Receivables Discounting System (TreDS) or supply chain financing through the Blockchain technology can ensure faster realisation of receivables.  It is for the larger counterparts to extend a helping hand by allowing MSMEs to adopt these innovative funding tools.