Starting Your Entrepreneurial Journey? Build Your Credit History Along The Way.

There has probably never been a better time to start a business in India. Multiple positive developments in the recent past have laid the foundation for a thriving entrepreneurial ecosystem for years to come. Some Governmental initiatives such as “Make in India”, “Startup India” etc., have indicated that at the highest level of policy-making, there is now a strong desire to support new businesses. Increasing digitization and improving infrastructure means that even the youngest of businesses can now reach out to millions of potential customers.  The brightest minds in the country are now being drawn away from previously coveted corporate jobs and are opening up to the challenge of executing an indigenous endeavour from ground-up. These are exciting times.

These young businesses can bring significant value to the Indian economy. At their helm are smart, passionate entrepreneurs with products or services which cater to tangible demands in the market. With the right support and nurturing, many of these ventures can grow into successful businesses. However, far too often, we see many of these budding entrepreneurs failing to realize their true potential. While there can be many reasons why a young business fails to scale up, research globally has identified a clear obstacle – lack of appropriate and timely credit.

The problem of the “Missing Middle” in developing economies is well documented. Such economies have a large number of micro-firms, some large firms but very few medium-sized firms. The absence or the paucity of medium-sized enterprises isn’t because these businesses lack the potential to be profitable, but because access to finance is traditionally a cumbersome process. In India, less than 1/4th of the financing demand of SMEs is met by formal institutional supply. Small businesses fail to benefit from the leverage which debt financing provides and is essential for propelling growth. As a consequence, SMEs contribute to only 8% of the Indian GDP – a stark contrast with the 40%+ contribution made by small businesses in developed economies.

This is not to say that the financing needs of SMEs are being completely ignored. For more than two decades lending to small businesses has been a priority agenda item for policy makers and regulatory bodies. A host of initiatives have been launched but on-ground progress has been slow. A key bottleneck is that these small-medium sized businesses are unable to furnish adequate credit history.

In a country like India, with a thriving informal finance ecosystem, most small businesses do not build credit records in their initial days as they can access finance through informal lending channels. As the size of their operation increases, so does their financial need. At this point, they are unable to turn to formal means of credit supply due to the lack of universally recognized documentation. At this stage, their growth is stunted as the informal market is unable to provide required financing at reasonable rates.  It is a perfect Catch 22 scenario – to get credit you need to have prior history but to have prior history you need to secure credit!

Building credit history with a bureau, e.g. CIBIL, takes time. Start small, be patient and build it over time. In India we now have personal as well as business credit scores available separately, though the former continues to be the more dominant decision input to most underwriting models. The credit worthiness of the promoter of a small business is crucial since the fortunes of the business are so closely entwined with his personal credit standing. It is thus vital to establish and grow your personal credit score. Start with small loans and service them in a timely fashion. If you are unable to get unsecured financing (e.g. a credit card), you can potentially start with a secured loan (e.g. auto loan) or a loan which is backed by a guarantor. Do not over-leverage your self – having multiple loans outstanding and/or high utilization on your existing limits negatively affect your score. Avoid such credit behaviour. Most of these points apply to business credit scores as well – start small and diligently service re-payments.

The entrepreneurial journey can be a deeply rewarding one. Focus on building your credit history along the way to help achieve your goals.

vaibhav

Vaibhav has over seven years of experience in the financial services industry across analytics, sales and trading. He has worked across major financial centres in Asia managing equity portfolios of large institutional investors across the region. In his last role prior to joining CF, he was a member of the Program Trading desk at Deutsche Bank’s Sydney office. He holds a Bachelor’s and Master’s degree from IIT Kharagpur in Electronics Engineering and is a CFA Charterholder. 

Vaibhav heads Business Development at Capital Float. 

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Implications of GST on Manufacturing

GST — the unified tax system that is set to revolutionize indirect taxation in India— is finally here. Some of its key proposed advantages are streamlining of tax payments, reduction in tax frauds, and ease of doing business. Here is a look at how these will play out in the manufacturing domain.

Make In India & Manufacturing

The manufacturing sector in India contributes a mere 16% to the overall GDP. However, the potential to make this a high-growth and high-GDP sector is huge. The “Make in India” campaign by Prime Minister Narendra Modi makes this possibility real, by giving impetus to the sector. Furthermore, PwC estimates that India will become the fifth largest manufacturing country in the world by the end of 2020. It would be interesting to know how the Goods and Services Tax or GST impacts this roadmap.

Impact of GST on Manufacturing

GST is one of the key policy changes that will have a direct impact on manufacturing establishments. So far, the existing complex tax structure has been a dampener, resulting in the slow growth of the sector. GST is expected to liberate the sector by unifying tax regimes across states.

Overall, GST is expected to have a positive impact and boost manufacturing.  Here is why:

  • Removal of multiple valuations will create simplification: The old tax regime subjects manufactured goods to excise duty, which is calculated differently in different states. While some states calculate excise duty based on transaction value, others calculate it based on quantity. Most manufactured goods’ excise duty is currently considered on MRP valuation. This creates great confusion in valuation methods. GST will usher in an era of transaction-based valuation, making calculation of tax much simpler for the manufacturer.
  • Entry tax subsummation will reduce cost of production: The subsuming of the entry tax for inter-state transfers is a key reason for reducing cost of goods and services. For example, a supplier of cement from Maharashtra to Karnataka was earlier required to pay entry tax when the supply crossed the interstate border. For Karnataka, the entry tax rate was 5% of the value of the goods. The supplier would pass on this additional cost to the customer, resulting in increase in selling price. With entry tax being subsumed, the supplier need not pay the entry tax rate amount and consequently, not charge the customer this amount either.
  • Improved cash flows: Under the new tax laws, manufacturers can claim input tax credit on input goods, which seems to be a positive sign for cash flow. SMEs are keenly observing the time difference between input tax credit and the credit being available.
  • Single registration process will provide ease of registration: The old regime required manufacturers to register each manufacturing facility separately, even those in the same state. GST will simplify the plant registration process by allowing single registration for all manufacturing entities within the same state. Previously, if a brick manufacturer had factories in Bangalore, Hubli and Dharwad, each unit had to be registered separately. Under GST, all of these factories would be jointly registered under the state of Karnataka. Of course, different state-entities will require separate registrations under GST too.
  • Removal of cascading will lead to lower cost-to-consumer: The old tax regime does not allow manufacturers to claim tax credit on inter-state transaction taxes such as octroi, central sales tax, entry tax etc. This results in cascading of taxes—an extra cost to the manufacturing company. Manufacturers end up passing on these extra costs to the consumer. The unified GST regime will eliminate multiple taxes and thus lower cost of production; this, in turn, will mean lower pricing for the consumer. For example, prior to 1 July 2017, SMEs in manufacturing used to pay Excise Duty, Central State Tax and sometimes VAT too at 12.5%, 2% and 5.5% respectively. With GST in effect, they are required to pay 18% in taxes.
  • Restructuring of supply chain: To align with the GST law, businesses will be required to realign their supply chains. However, this is a blessing in disguise. Till date, most supply chain structuring has been designed around how to manage tax regimes. With a single tax regime, this will change, and supply chain structures will focus on driving business efficiencies. An example is that of warehousing. The old regime demands that warehouse management be based on arbitrage between varying VAT rates across states. This is expected to change to bring in economic efficiencies and more customer-centricity going ahead.

Manufacturers, however, are concerned about the following aspects:

  • Increase in immediate working capital requirements: Branch transfers and depo transfers will be treated as taxable under GST; IGST will be applicable on these transfers. This increases the requirement for immediate working capital. Another reason for increased working capital requirements is that the receipt of advance is taxable as per GST rules. Also, stock transfers are treated as “supply” and hence are taxable under the GST regime.
  • More stringent and elaborate transaction management: GST aims to achieve better tax compliance. To make this possible, manufacturers must work towards streamlining existing transactions; this means additional resources and costs. For example, under GST, credit in respect to an invoice can be taken only up to one year of the invoice date. Also, the provision of reverse charge means that the liability to pay tax falls on the recipient of goods/services instead of the supplier. The payment of reverse charge is dependent on the time of supply (30 days from the date of issue of invoice by the supplier in case of goods and 60 days for services).These changes will require manufacturers to carefully assess and track their supply processes, especially the timelines. This may mean hiring a better skilled compliance workforce, and better systems and software. More legal considerations will also mean more costs.
  • Lack of clarity on local exemptions: Despite GST being proposed as a unifying platform for indirect tax, all the components for manufacturing are not yet clear. One such area is localized area-based exemptions. The old structure provides certain exemptions for certain goods in specific states (for example the North East or hilly states). Under GST, most of these exemptions are likely to be removed, resulting in a negative cost-impact on these manufacturers. Such companies must reassess their financial position in view of such likely changes.

Overall, one can say that the impact of GST on the manufacturing sector is positive. It provides a unique opportunity to streamline business operations to become more compliance and profitability-oriented, rather than tax-oriented. It puts power in the hands of business leaders to bring about positive change and steer their enterprises on a growth path, powered by GST-compliance.

Read more of our content on GST by clicking here.

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Oct 24, 2018

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Budget 2017: Giving SMEs a stronger footing

SMEs play a crucial role in the economic development of India. They contribute to 45% of the industrial output, 40% of the exports and 42% of the employment in the country. Although these enterprises are highly significant to the economy, they are regularly challenged by policies, laws and processes In recognition of this, the Union Budget 2017 gave start-ups and SMEs a lot to cheer about.

Increasing Financial Viability with a Lower Tax Burden

Finance Minister Arun Jaitley announced a reduction in corporate tax from 30% to 25% for SMEs with an annual turnover of less than ₹50 crores. Moreover, the presumptive tax rate for SMEs with an annual turnover of up to ₹2 crores has been lowered from 8% to 6%. Both these measures would increase the bottom-line of SMEs. These enterprises work on low profits, and their survival is often threatened by even minor fluctuations in the business. The enhanced financial viability would increase the survival rate of SMEs.

At the same time, Budget 2017 has tried to align with the broader objective of increased digitalization. The proposed reduction in presumptive tax is applicable only for a firm’s gross receipts that are received via digital transactions. Also, no cash transaction above ₹3 lakhs would be permitted going forward. Both these measures have been designed to increase transparency and widen the tax base through digitalization.

Much Needed Breaks

Start-ups need maximum support during their initial years. From the next fiscal year, start-ups would have to pay taxes for only three out of seven years, up from last year’s exemption limit of five years, if they recorded profits. This is a great opportunity for start-ups and the economy. While a huge percentage of start-ups fail, these enterprises are responsible for introducing the most innovative products and services. The tax break announced by the Finance Minister would give start-ups a better fighting chance of survival and encourage more innovative ideas to be executed well.

Loans, Financing & Funding

The Finance Minister doubled the lending target to ₹2.44 lakh crores for the next fiscal year, making more credit available to small businesses to finance their working capital needs. Prime Minister Narendra Modi had already announced, on December 31, an increase in government credit guarantees for SMEs from ₹1 crore to ₹2 crores.

The FIPB (Foreign Investment Promotion Board) is to be abolished in the upcoming fiscal year. This would significantly liberalize policy related to FDI (Foreign Direct Investment). This is expected to boost retail and ecommerce in the country. Mr. Jaitley mentioned that further FDI relaxations were under consideration.

Most traditional banks are unwilling to give loans to SMEs due to the fear of defaults. Tax concession on provisions for non-performing assets (NPAs) and capital infusion of ₹10,000 crores for state-owned lenders would make loans more accessible to SMEs.

To encourage more investments into start-ups, the condition of continuous holding of 51% voting rights has been relaxed for carrying forward of losses by start-ups, provided the founder remains invested in the business.

Building on Digital India

While saying the almost 125 lakh people had adopted the BHIM digital payment app, the Finance Minister announced two new schemes – cashback for merchants and referral bonus for individuals.

Aadhaar Pay, the merchant version of the Aadhaar Enabled Payment System (AEPS), is to be launched shortly. This app would enable consumers to make payments without using cards, e-wallets or even mobile phones, since the merchant’s device would be linked to an Aadhaar biometric reader. More than a billion people in India already have Aadhaar cards, and this system would make most financial transactions simple, fast and traceable. It would be a boon for raising loans, enabling fintech lenders to link repayment to payments received by the SME.

The government would be targeting ₹2500 crore digital transactions in FY18 through BHIM, Aadhaar Pay, IMPS and debit cards. The Finance Minister indicated that banks would have to introduce 10 lakh new point-of-sale (PoS) terminals by March and 20 lakh Aadhaar-based PoS terminals by September, allowing more digital transactions, which would enhance financial inclusion and transparency.

Infrastructure

For the upcoming fiscal year, the Finance Minister announced a step-up in the total allocation for infrastructure development to an all-time high of ₹3.96 lakh crores, including increased allocations for railways, road and shipping. Infrastructural development eases a huge bottleneck faced by SMEs in transporting their goods to other regions in a timely and cost-effective manner. Better infrastructure would give confidence to SMEs to expand their markets farther and reduce wastage and spoilage during transportation.

Moreover, the roll out of GST (Goods and Services Tax), which the Finance Minister indicated was tracking as planned, would further increase the ease of doing business in other states.

An allocation of ₹10,000 crores towards the Bharat Net project was announced. This would increase access to high-speed broadband across India, facilitating communication and allowing SMEs to reach out to clients located in various corners of the country in a cost-efficient way. The geographic scale achieved will help SMEs to break physical boundaries and leverage bigger opportunities for growth.

The latest Union Budget comes as a respite for start-ups and SMEs. The strengthening of these businesses would play a critical role in India’s transition to becoming an economic superpower.

Oct 24, 2018

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SME Financing: A Variety of Options Available to Suit Your Needs

The 2017 Union Budget underlined the significant role that Small and Medium Enterprises (SMEs) play in the development of the country, in terms of industrial output, exports and generating employment. While SMEs contribute to the growth of the country, they face challenges in raising finances due to their size and their inability to provide adequate collateral.
Many SMEs have operational problems due to improper management and as a result, the lenders are wary about extending SME finance. To cover their risk, they charge higher rates of interest, insist on proper collateral, take extra efforts during due diligence, and even try to appoint their representative on the company board. Given the extra effort required when it comes to SME lending, traditional SME finance companies take a long time to disburse the loans.

Institutional route to SME finance

SME need loans to finance their working capital requirements. SME finance for working capital requirements traditionally starts with the establishment of cash credit, overdraft and working capital limits with the banks. SME finance is also required for purchasing assets and for expanding and scaling the business. For this purpose, term loans are secured from banks and SME finance companies for purchasing assets and for meeting other incidental expenses. Apart from these sources of finance, SMEs can also secure funds from the following traditional sources:

  • Export credit to finance the pre-shipment and post-shipment export-related activities.
  • Letters of Credit (LCs) and bank guarantees to facilitate trade and meet the performance and financial obligations.
  • Bill discounting where bills of exchange which are covered by LCs or bank guarantees are discounted by banks, NBFCs or SME finance companies.
  • Leasing where the banks, NBFCs or SME finance companies buy the asset on behalf of the SME and then lease it back to the SME.
  • Factoring and securitisation where illiquid assets are used to secure advances from banks, NBFCs or SME finance companies.
  • Venture capital investments from individual investors or companies.

Government impetus to SME lending

Recognising the issues faced by small businesses and their criticality to India’s development, the Government has initiated several measures to ease the credit availability for this segment.

  • The finance minister has set the lending target for SME finance at Rs 2.44 lakh crore for 2017. In other words the directive ensures that banks and financial institutions will disburse loans to SMEs collectively worth Rs 2.44 lakh crore through this year.
  • The Government’s Credit Guarantee Scheme (CGS) under the Ministry of Micro, Small & Medium Enterprises (MSME), which secures the loans given by banks to SMEs, now has an increased outlay of Rs 2 crore from the earlier Rs 1 crore.
  • The 2017 Union Budget infused Rs 10,000 crore of capital into state-owned lending institutions to promote SME lending.
  • SMEs can continue to avail of loans under the Pradhan Mantri Mudra Yojana, where SME finance is disbursed to small businesses as working capital loans or short-term loans. The amount ranges from Rs 50,000 to Rs 10 Lakh and no collateral is required as they are covered/secured by the CGS scheme.

Alternative SME finance channels

Rapid strides in technology are changing the banking and financial industry and several new channels of credit are emerging as viable alternatives for cash-strapped SMEs.
New age FinTech companies are using advanced technology to introduce new SME lending products that have quick and easy approval processes. Companies like Capital Float have made it easier to secure SME finance. Such new age SME finance companies have introduced online portals and mobile apps that can be used by SMEs to apply for and manage loans. They have simplified and shortened the loan approval process by using big data and analytics to evaluate loan applications.
New age SME finance companies like Capital Float have also introduced innovative financial products for customised SME lending. These new SME lending solutions include:

Collateral-free financing solutions: These are unsecured loans given by the SME finance companies to SMEs who cannot or do not want to provide any security. FinTech SME finance companies like Capital Float use technology to swiftly assess the credit-worthiness of the loan applicants and speed up disbursal so that a business owner can receive the loan amount in their account within 72 hours. Capital Float also has easy and flexible repayment terms which make the loan easier for SMEs to manage.

Merchant cash advances or credit card receivables: These unsecured loans or advances can be availed of by SMEs who use Point-of-Sale (PoS) terminals. The amount advanced is dependent on the monthly credit card sales generated on the point-of-sale machine.

Online seller finance: This is a working capital loan given to e-commerce vendors for managing their day-to-day operations and leveraging business opportunities.

Supply chain finance: In this kind of financing, the SME finance company liquidates the borrower’s invoices by paying up to 80% of the invoice value to the borrower.

Capital Float is one of the leading SME finance companies that uses FinTech to create SME-friendly credit options. It provides short term unsecured loans to SMEs, and a basket of customised financial products that cater to the needs of small entrepreneurs. These include online seller finance, supply chain finance, merchant cash advance, and Pay Later, which is a revolving credit facility.

Oct 24, 2018