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