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Working capital challenges faced by Indian vendor ecosystems

By Annapoorna

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Updated on: Feb 16th, 2022

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3 min read

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Small companies in India face numerous hurdles during their business, especially with regard to unpaid invoices from clients. Challenges with regard to working capital prove to be relatively taxing, placing doubts on their survival in the long run.

Cashflow cycle for an MSME

  • Procurement of raw materials

The procurement of raw materials from suppliers is normally done on a credit basis by the MSMEs. These raw materials thus purchased help the company enjoy a credit period of 30-60 days. The longer the credit period offered by the suppliers, the shorter the cash conversion cycle.

  • Production of goods

The raw materials purchased on credit are used in the production process to manufacture the final product. There is an outflow of cash in the form of expenses involved in the production process.

  • Delivery to large buyers

The finished goods are then sold to large buyers in bulk deals. However, most of these deals are large-sized orders and will be in credit sales rather than cash sales. The credit policy, opted by the MSMEs, plays a crucial role in the availability of working capital funds.

  • Payment

Since goods are sold on credit, the payment from the clients and customers will be delayed and is usually paid after an average of 30 to 60 days. The shorter the credit period offered to the customers, the faster the collection period and the quicker the cash conversion cycle.

Role of credit period in the creation of working capital challenges

Generally, the credit period granted to customers tends to impact the working capital levels of the business. More often than not, Indian vendors normally have a 30-60 day waiting period to receive their payment after delivering the goods to the customers. This creates a cash crunch, especially in the case of bulk orders, since the business is handicapped until they receive their payment, which can sometimes take up to two months.

While discussing the credit period, a few factors have to be considered as well.

  • Industry norms

The length of the credit period is also dependent on which sector or industry the business operates. Operating cycles and the length of the credit period differs with different industries.

  • The creditworthiness of the clients
    • Do your clients have a decent credit score and credit history?
    • Are they able to pay their dues on time?
    • Do they have a history of defaulting on payments?

It is important to know your clients in this regard to structure your credit policy accordingly. This protects the business from any potential losses.

Supply chain is put at risk

In India, businesses can conduct their operations in a small and efficient manner, provided they face no problems with the availability of working capital. If the credit period adversely affects the working capital levels, the business may not have sufficient cash to carry on its daily operations. As a result, the entire supply chain could be put at risk. If the conversion of credit sales into cash takes longer than expected, the business could face a serious liquidity crunch. As a result of this, manufacturing and sales will take a hit.

Moreover, the business may not be able to pay the suppliers their dues after purchasing raw materials from them. In extreme cases, the businesses may go bankrupt as well. Therefore, it is of utmost importance that working capital management is seen as a priority.

About the Author

I preach the words, “Learning never exhausts the mind.” An aspiring CA and a passionate content writer having 4+ years of hands-on experience in deciphering jargon in Indian GST, Income Tax, off late also into the much larger Indian finance ecosystem, I love curating content in various forms to the interest of tax professionals, and enterprises, both big and small. While not writing, you can catch me singing Shāstriya Sangeetha and tuning my violin ;). Read more

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