2 min read
25 May 2021

Small and medium-sized enterprises (SMEs) play an important role in the growth of the Indian economy. As per the latest government data, the share of Micro, Small & Medium Enterprises (MSMEs) as a percentage of GDP stands at 30.74%.

Businesses need funds to meet their needs. They borrow from external sources such as Non-Banking Financial Corporations (NBFCs) to keep operations running smoothly. The share of NBFCs and housing finance companies in the total credit was 18% in FY17, recording a growth of 28% over FY16. They have emerged as the vital source of finance for SMEs.

Knowing the importance of business loans, visionary SME owners make all the right moves to borrow.

What can we learn from successful SMEs?

1. Having Adequate Cash Flow is Vital

Before extending business loans, lenders peruse the company’s liquidity to understand whether it can service the loan. They assess the liquidity ratios to know whether their loans can be repaid if the company’s business plan fails to take off. The two most important current liquidity ratios are:

  • Current Ratio = Current Assets / Current Liabilities
  • Debt-Service Coverage Ratio (DSCR) = Net Operating Income/Total Debt Service

Some of the current assets include cash, short-term investments, inventory and payments due from clients. The significant current liabilities are bills, salaries, and loans.

The liquidity ratio differs across industries. Growth-oriented SMEs maintain the ratio as per the norms of their domain to easily avail the loan at nominal business loan interest rates.

2. High credit score is the key to a smooth loan approval

A credit score is a very important consideration for the loan approval process. SMEs do not want any red flags to become the spanner in the wheel of their expansion. They keep a credit report and monitor it regularly to pre-empt any fall in the credit score. Some ways of maintaining proper financial hygiene are:

  • Clearance of all dues in time and no loan defaults
  • Maintenance of the 30% rule of credit utilisation (as the case may be)
  • Quick redressal of negative customer remarks

Credit reports are available with credit information companies such as Crisil, Equifax, Experian, TransUnion CIBIL and CRIF High Mark.

3. Opting for a Flexi business loan is beneficial

A Flexi business loan allows the borrowing company to avail finance without utilising the entire loan limit to fund their business needs. This keeps their liabilities low since they do not have to pay interest on the whole loan. For example, if a business knows that it will record profits in three years, it can take a business loan for a term of three to four years and repay the principal at the end.

Alternatively, it can repay only the loan interest in EMIs, and maintain a low current liability. This method prevents the current ratio and credit score from going down. For example, ABC company avails a loan of Rs. 5 lakh at 20% interest for three years. The interest for this tenor comes to Rs. 3 lakh. The company pays Rs. 8,334 per month and repays the principal at the end of the tenor.

4. Keeping the right documents ready is important

Visionary SMEs keep their documents neatly filed. Missing key documents does not fit their work culture. They can furnish all the details that the NBFCs ask for. Some important documents include a business vintage proof, KYC and financial statements.

5. Money begets money

One needs to pay to reap monetary benefits. In business loans, there is a commitment to repay the loan amount with interest. Business loans help the company earn profits. Thus, money draws money.

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