In our previous blog, we covered what is working capital and how to identify the need for it. Here, we will be discussing how to bridge the working capital gap with the help of some winning tactics.
We believe that ‘Working Capital Gap’ should not be a showstopper in the current business model and hence, we need to figure out the right, viable solution which aligns with business needs. We would want to put forth some of the feasible options to overcome this ‘gap’ in the existing business setup.
- Cash Discount (CD) – The Percentage of Discount, a vendor/seller, has to let go to the customer for selling their goods and services, against which they can avail instant credit for the same
- Price of goods/services and credit period for one to receive funds are mostly decided by financially strong parties, between buyer and seller, and by unique/less competitive goods/services being traded.
- Buyers financial strength determines whether they want to offer CD or not.
- CD mainly is a revenue making strategy of the buyer as it adds up to the bottom line of the buyer.
- Opting for CD exposes the seller’s weak financial strength to the buyer and hence is not widely accepted by the seller/vendor.
- CD makes the cost of liquidity one-sided and in most cases is high, in spite of being the easiest and fastest way of getting cash by a seller/vendor.
Working Capital Limit from financial institutions
The existing financial system has failed to address the working capital GAP of business communities, especially SMEs and businesses in the service industry mostly due to:
- Proven track records a must
- Profitability is no compromise
- A too technical and traditional approach to risk evaluation
- Believes only in a business where there are underlying goods manufactured or traded
- Very limited good rated large companies are exposed to banking limits in the service sector
- Additional Collateral like Land and Building, FD as margin, Plant and Machinery, Hypothecation of stock and Book debts, Creation of charge in ROC
- Despite making the exposure so secured it has been unfavourable for growth-seeking companies
- Unsecured limits are available from new age NBFC’s, but it’s too small for the entire need
- Time taken is too long to set the limits
- Operational activities and cost is too high to use the limit
- Sellers/Vendors are left with no choice of going to multiple options with multiple financiers leading to spoiling the credit quality and adding to the huge amount of indirect cost which never gets measured other than the actual borrowing costs
- Impacts the balance sheet due to the bulgy loan book impacting the rating
To understand it better, let us pick a real-life instance. A week ago, we met with a company which is a pioneer in supplying important products and technology to world-renowned blue chip companies. The company relies upon financial institutions to meet the working capital needs which need hefty collaterals to sanction any credit amount.
Digging in deeper, we observed a few things about the company
- The company has been in the market from 5 years and is growing 5X year on year
- The company has signed long term contracts to supply state of the art product to the industry’s leading companies
- The company holds a strong balance sheet and hence, was able to raise credit of Rs18 crore from various financial institutions.
- In the process of raising this credit amount, the company had to keep a lot of collaterals like
- Mortgaged property of 30cr
- Hypothecation of stocks and book debts
- Creation of change in ROC
- Personal guarantee of Directors/Promoters
- Bank has spread the limit of 18Cr across OD, Pre-shipment finance and post-shipment finance
What other approaches could the company take?
- In the case of Mortgage of property, it is advisable to go for LAP instead of credit against OD/CC, pre-shipment finance and post shipment finance.
- If a company opts for LAP, its stocks and book debts will remain free to search for working capital from other alternatives.
Businesses are on the lookout and in desperate need for an alternate way of accessing liquidity with no collateral. The option should be completely un-secure and aid in nurturing the seasonal, permanent business prospects. If the structure is off-balance sheet then it acts as an icing on the cake. Cost is a significant factor and hence must be justified with less operational activity. The above parameters are an excellent substitute for businesses waiting for such avenues to access working and growth capital.
We believe that if a seller/vendor is supplying goods/services to sizeable companies with excellent credit rating, then such seller/vendor deserves to get liquidity against unpaid receivables from such blue-chip companies completely unsecured. This shall bridge the current gap of receivables from such blue-chip companies and meeting the futuristic gap too beforehand when the need arises.
Receivables from Blue-chip companies are good assets to have in the balance sheet and deserves faster liquidity against such receivables with no additional strings attached other than the debtor against which the cash has been sort for.
You can read more about how all this can be achieved and why one should not lose liquidity only due to cost in our next blog ‘How to identify the right price to unlock liquidity?’