In today’s fast-paced digital economy, innovation is crucial to addressing the underserved working capital needs of Small and Medium-sized Businesses (SMBs). Financial automation and Embedded Finance (EmFi), the integration of financial services into non-financial platforms, have emerged as transformative solutions for extending credit products to SMBs, enabling them to effectively manage their cash flow.
The Era of EmFi: A Revolution in Financial Services
EmFi operates at the intersection of finance and technology, breathing new life into traditional financial models. It represents a significant shift, where financial products and services are seamlessly woven into non-financial platforms. While not an entirely novel concept, it is gaining substantial traction, with numerous platform companies entering this space. Notable e-commerce giants, like Amazon, now offer loans based on transactional data to merchants through their payment acceptance platform. Similarly, ride-hailing services such as Ola and Uber offer integrated financial services including loans to buy cars and insurance to their partners.
Extending embedded financing to businesses can effectively bridge liquidity gaps and overcome challenges related to accessing affordable credit. In today’s dynamic business landscape, where agility and adaptability are key, this development could not have come at a better time. SMBs play a pivotal role in propelling India’s economy, contributing to nearly 30% of the GDP. However, they encounter substantial obstacles that impede their growth and sustainability.
Challenges of the Modern SMB
SMBs face a multitude of challenges, and among them, cash flow management is one of the most critical. Managing cash flow is akin to the diligent work of a farmer, who must ensure a consistent and sufficient supply of water to nurture their crops. Similarly, businesses must maintain a robust cash flow to sustain their day-to-day operations.
However, even in the face of increasing sales and profitability, maintaining a positive cash flow can be difficult. It is all too easy to fall into negative cash flow territory when dealing with payables, such as debts, that have due dates arriving before receivables, which include customer payments for sales made but not yet collected.
This challenge is further intensified by the slow adoption of financial automation solutions among SMBs. Astonishingly, as per the India Digital SME Credit Report 2023, a collaborative research endeavor conducted by GetVantage and Redseer Strategy Consultants, a mere 12% of SMBs have embraced digital technologies, leaving a significant number of businesses yet to harness technology’s potential to optimize their working capital and cash flow.
To put this into perspective, in the fiscal year 2022, the demand for credit from businesses amounted to a substantial USD 220 billion, out of which approximately USD 165 billion was deemed serviceable. However, there exists a significant gap where only about 33% of the overall credit demand is being met, leaving approximately 67% unaddressed. Looking ahead, the demand for credit is expected to experience a significant surge over the next five years, reaching an estimated USD 570 billion. These projections are based on the findings of the India Digital SME Credit Report 2023, a collaborative research endeavor conducted by GetVantage and Redseer Strategy Consultants. It is imperative to tackle these credit challenges and foster the digitalization of SMBs to unlock their full potential and drive economic growth.
The Financing Challenge for SMBs
Small and medium-sized businesses face a complex financing environment that is affected by various macro and microeconomic factors. At present, a combination of these factors is creating difficulties that are making it harder and more expensive for SMBs to obtain financing from external sources.
High Cost of Servicing
Traditional lending channels tend to primarily concentrate on extending credit to large businesses, often neglecting the distinctive needs of SMBs. These smaller businesses share similar fixed costs with their larger counterparts but typically require smaller loan amounts, resulting in lower revenue potential for lenders. For example, according to SIDBI MSME Pulse, during the second quarter of the financial year 2023, medium-sized enterprises in India had an average loan size of approximately INR 9.7M, while small enterprises had an average loan size of around INR 4.2M. This disparity between the needs of SMBs and the offerings of traditional lending institutions has left many SMBs struggling to access financial products tailored to their specific requirements, presenting a significant challenge in securing the necessary funding.
Emergence of New Business Models
A significant challenge that businesses face is the friction that exists between buyers and suppliers. Buyers often aim to hold onto their cash for extended periods, while suppliers prefer prompt payments. This often leads to unpredictable and irregular cash flows, which can cause operational problems and negatively impact a company’s creditworthiness.
Emerging business models, such as those seen in e-commerce and agri-tech, encounter challenges in accessing working capital due to their unproven nature and the revenue fluctuations they often experience. These businesses face substantial customer acquisition costs and frequently require working capital to manage their day-to-day operations. However, conventional financing sources may be hesitant to support them due to the seasonality of their revenues and the narrow profit margins associated with these sectors. SaaS (Software as a Service) businesses encounter similar challenges because they lack tangible assets that can be used as collateral for traditional financing, thus emphasizing the need for alternative financing solutions.
High-Risk Perception Among Traditional Lenders
Many SMBs also do not conform to the risk appetite of most banks. Current economic conditions marked by escalating inflation, disruptions in global supply chains, and shortages have led to increased working capital demands. SMBs, with their limited revenue streams and constantly changing business metrics, face a challenging situation.
The scarcity of unsecured loans and the absence of well-established credit histories categorize SMBs as high-risk entities in the eyes of financial institutions. To illustrate this stark reality: Out of a vast pool of 63 million SMBs, only 25 million have had the opportunity to access formal credit sources. The anticipated increase in SMB corporate entities, projected to reach a remarkable 750 million by FY 2023, will further widen the gap. Among these, an estimated 50M will comprise new-to-credit SMBs. This forecast underscores the growing concerns regarding the lack of credit histories among SMBs.
Furthermore, when loans are granted to these SMBs, they frequently carry significantly higher borrowing costs, which counteract the benefits of gaining access to credit and impose additional financial burdens on businesses.
Delays in Disbursement
SMBs often find themselves in urgent need of capital to effectively oversee their day-to-day operations. However, they are hampered by prolonged and complex lending procedures that can lead traditional banks to take 90-120 days to disburse loans. Some institutions even choose to disburse loans in phases due to their perception of higher associated risks with these businesses. These delays create additional financial pressure on cash-constrained SMBs, and may hinder their ability to maintain and expand their operations.
The Consequences of Poorly Managed Cash Flow
The consequences of the challenges mentioned above are substantial. The inability to access credit to address cash flow gaps can trigger a host of problems, including strained relationships with suppliers, unfavourable payment terms, diminished creditworthiness, and even the departure of employees seeking more stable job opportunities. Surprisingly, around 82% of small businesses that close down attribute their failure to inadequately managed cash flow.
EmFi – The Silver Bullet for SMBs
In today’s challenging landscape, EmFi addresses the prevailing supply-demand gap and provides cost-effective solutions for meeting cash flow gaps. In contrast to the conventional model of asset-backed credit, EmFi introduces a novel approach by offering SMBs access to credit-based products that align with their anticipated cash flows.
Spend automation Fintechs like EnKash – Asia’s 1st & Smartest Spend Management Platform, Happay and Zaggle are at the forefront of this transformation, forging strategic partnerships with banks to seamlessly integrate financial products into various aspects of business operations, including receivables, payables, and expense management. An essential role these companies play is that of distributors, ensuring that the financial products they offer are backed by regulated banks, thus simplifying compliance and risk management for businesses. Moreover, these solutions are delivered through a Software-as-a-Service (SaaS) model, eliminating upfront investments in technology and rendering them affordable for SMBs.
The Dual Power of Financial Automation and EmFi
These platforms offer a two-fold advantage:
Digitizing Core Financial Workflows
Businesses streamline their operations by automating processes such as collections, supplier payments, and employee expenses. This digitization not only simplifies manual tasks but also offers visibility into cash flow and spending patterns, which can be leveraged to make lending decisions.
Access to Financial Products
These providers utilize data such as receivables, invoice information, and payment history to offer a variety of financial products, including working capital loans, credit cards, and invoice discounting. Similar to how Amazon simplifies payment management and extends loans based on transactional data, EmFi providers offer financing based on revenue, cash flow, and spending analytics. This approach reduces the costs associated with customer acquisition, distribution, and risk assessment for banks, making it more viable for financial institutions to offer loans tailored to the specific needs of SMBs.
EmFi in Action: Enabling SMB Growth
EmFi is gaining momentum across various sectors, with tailored use cases designed to address the unique financial requirements of businesses. These include credit card bundling with payables for collateral-free credit, financing for large purchases and purchase orders, expense management tools, supply chain financing, invoice financing and factoring, receivables financing, and working capital financing. These solutions empower SMBs to overcome cash flow challenges and seize growth opportunities.
Access to timely and adequate credit can be a game-changer for SMEs, enabling them to seize growth opportunities, invest in innovation, and scale their operations. Emfi can empower entrepreneurs to navigate obstacles and fuel their success.
Shikha Bhatia is an independent contributor and is a strategic marketing professional with 15+ years of experience in strategic marketing roles in the telecom and fintech industries.