3 Things To Do When Applying For Business Loans

The growth of the SME (small and medium enterprises) segment, which contributed nearly 40% of India’s exports, has been restricted by the lack of access to timely finance. Only 4% of 57.7 million small business units in the country have access to formalized finance, leaving many to rely on informal lenders, who charge exorbitant interest rates. Requirements like collateral and detailed documentation as well as the long processing and disbursement time of loans deter SMEs from approaching traditional financial institutions. Thus continues the huge gap between the need for funds by SMEs and the amount of funds actually approved as loans.

This severe shortfall needed to be addressed, especially given the importance of SMEs to India’s economy. This is where FinTech companies like Capital Float have risen to the occasion, offering new business loans that are aligned to address specific needs of the SME sector. While cutting-edge technology is being deployed to make innovative financial products available to smaller businesses, SMEs must be aware of the available finance options to take make an informed decision.

SMEs make some common mistakes when applying for secured and unsecured loans. As a result of these mistakes, their loan applications may get rejected. Here are some tips for small businesses to avoid rejection of their business loan applications.

Be organized

Banks and other lending institutions would require certain documents to verify the claims made by a business. The decision to sanction a loan is taken by the lender after evaluating the prospects of a business, its ability to repay the loan amount and its previous credit record. This is done by checking various documents certifying the presence and existence of a business, its financial statements, taxes paid by it and other documents that indicate the financial standing of the business and the business owner(s). To ensure speedy approval of its loan application, a business must organize its documents and submit these in an orderly manner to the lending firm.

Any kind of delay in submitting the desired documents may be viewed negatively by the lender and could even derail the whole process. So, every business seeking a short term loan needs to be organized about its documentation. All the papers should be ready for submission when applying online for a loan. Your swiftness in providing the necessary information along with requisite documents can speed up the approval process.

Be Mindful of Your Credit Profile

The credit profile of the business owner or owners plays a key role in the ability of the SME to secure a business loan. Ensuring a good credit profile is not difficult. This is possible by ensuring that all your credit card and bill payments are made on time. The timely repayment of all due amounts including the ones relating to any existing loans helps improve the credit score.

Often business owners ignore their credit score thinking that it would not impact their ability to secure a loan for their business. They fail to understand the significant negative impact this can have on their business. It is important for business owners to regularly check their credit scores and take the necessary steps to improve them. Such efforts can ease the process of securing finance for the business in the future. In some cases, the credit scores do not even reflect the true situation. Regular monitoring can help business owners rectify the errors in the scores and boost their chances of getting loans on time.

Have A Firm Business Plan

Seeking loans without any kind of business plan may result in the loan application being rejected. A business plan is a reflection of the goals, the purpose of a business and ways to achieve them. It shows how a business intends to operate and how much funds are needed and at what time. A clear business plan not only helps a small business to ease the process of loan application, but also to determine the specific amount of funds required. This in turn enables the business to apply for a business loan well in advance besides providing the lender clarity into the purpose for which the loan is sought.

Thus, a well laid out business plan helps a business provide answers to questions like:

  • How much loan is required and for what purpose?
  • How quickly are the funds required and for what duration?
  • What is the current financial standing of the business and when will the business be able to repay the borrowed amount?
  • Does the business need secured or unsecured loans?

With FinTech lenders like Capital Float offering an array of innovative products, small businesses also need clarity to enable them to choose the loan that is most appropriate for them. A business plan would also help with this. In the absence of a business plan, the screening process may take longer and the chances of rejection of the loan application are also higher.

A business seeking a loan should not borrow from the first lender it comes across. Instead, it’s advisable to do thorough research and compare the loan terms offered.

Capital Float helps small businesses seeking loans to identify the right type of loan for their working capital needs, besides offering multiple repayment options. The use of advanced algorithms helps to underwrite businesses uniquely, check the repayment ability in absence of credit scores and develop customized lending solutions to suit the individual requirements of potential borrowers.

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Implications of GST for Trading

India is amongst the fastest growing economies of the world, with retail trade contributing an estimated $600 billion+ to the economy. The impact which GST, the unified indirect tax structure introduced by the Government of India on July 1 2017, brings on such a major economic lever will be highly significant.

Further, the implications of this new taxation procedure on the trader will vary on the nature of the trade, i.e., wholesale or retail. In this blog, we explain the opportunities within the new tax reform that traders can leverage, and discuss how they can prepare themselves from a GST perspective. Read on to know the effects of this latest indirect tax reform for:

  1. Wholesalers
  2. Retailers
  3. Importers and Exporters

1. For Wholesalers:

The wholesale market is fundamental to extending the reach of goods and services to the interiors of the country, especially the rural markets. Most wholesalers operate in cash transactions because of which there is a good chance that some transactions are not accounted for, which was previously a concern but ceases to be one under GST.

Given below are the main advantages that GST brings to wholesalers.

  • Transparent tax management: The introduction of technology into the taxation system can be a blessing in disguise, an opportunity to bring about transparency in tax management. Rather than relying on cash transactions, wholesalers will now get an opportunity to go digital. They will also be able to avail the facility of input tax credit. Input tax credit is where the businessman will be able to claim tax on all input goods and/or services. For example, if a wholesaler is renting a tempo for transport of goods, going ahead they will be able to claim the tax paid on the rental and receive it as input credit. They will thus be able to reduce the final market price of the transported goods by making up for that amount.
  • Financial streamlining: Because the entire supply value chain including tax flows will be on GST records, wholesalers will be better connected to retailers and suppliers. For example, the payment for a consignment will reflect in the accounting records of the supplier company as well as the wholesaler, leaving no ambiguity about payables and receivables. This will make it easier to process payments and get tax returns in a timely manner, thereby improving the cash flows of traders. A reliable positive cash flow will help build confidence in the new regime, by making working capital available and aiding opportunities to grow the business.
  • Reorganization of supply chain: GST will enable high visibility and streamlining of the supply chain, providing wholesalers with a transparent view of supply movements. For example, taxation at the “place of supply” is already mobilizing FMCG companies establish fewer warehouses, the sizes of which will be larger than before. This will aid business efficiency in the long run. However, in the initial transition phase, many wholesalers may undergo de-stocking since they would have already paid VAT on their current stocks, and would like to avail of the input tax credit on the basis of the GST rules.
  • Ease of borrowing through digital lending: Because financial and tax transactions will now be recorded in the GST system, even small traders will have digital records of their company finances and credit status. These digital records will act as a ready reckoner of information when a trader opts for a loan. Financial institutions and online lenders like Capital Float can now easily assess the loan eligibility of small traders such as Kirana owners by accessing this data, and provide them quick and easy loans. Borrowing funds online and doing business will now be easier.

2. For Retailers:

Almost 92% of the retail sector in India is unorganised, operating in cash payments. They are, essentially, the tangible representation of FMCG multinationals to end-consumers; yet they are challenged by chronic issues such as the lack of technology enablement and low operating margins. A majority of the retail market consists of “kirana stores”, which are often the smallest link of the trade chain.

Here are the benefits of the new taxation system for retailers.

  • Input tax credit facility: As mentioned for wholesalers, retailers too would be able to claim taxes paid for input products and services availed. This will present a cost advantage to retailers. For example, under the previous tax regime, if a retailer purchases a refrigerator to store perishable goods, they were not able to claim credit for tax paid on it. Under GST, they will be able to claim the tax paid on the new refrigerator when they file their taxes. This will be possible due to tax connections reflecting in the GST value chain at each stage of the transaction. Availing input tax credit means financial gain.
  • Ease of entry into the market: The market is expected to become more business-friendly due to the clarity of processes related to procurement of raw materials and better supply logistics. This is a good opportunity for new suppliers, distributors and vendors to enter the market. The registration process has also become very clear under the GST, aiding entry into the market.
  • Retailer empowerment through information availability: Small retailers often do not have complete visibility into their stock receipts, payments, etc. and are forced to blindly rely on the word of the supplier. GST will streamline these supply and cost challenges and empower the retailer with readily available information through digital systems. For example, when different types of bills like invoices, credit and debit notes, etc. are stored digitally as proposed by GST using accounting software, these will provide retailers with real-time reports on sales, stock information and live balance sheets, in addition to performing error checks before placing an entry into ledgers.
  • Better borrowing opportunity: The retailer scope for business growth can be increased by increasing the retailers’ access to finance. This is where Fintech lenders like Capital Float step in – they can ease their passage to the new tax regime. Capital Float recognises the financial challenges these small business players face and strives to bridge this gap by financing them with small ticket loans. As “kiranas” move onto GSTN, Capital Float will be able to better serve this micro-entrepreneur segment, helping them overcome upcoming challenges by leveraging the GST-enabled digital footprint.

However, like any new reform, there are certain challenges that need to be addressed. We see that both retailers and wholesalers must manage the following eventualities of GST implementation.

!  Higher costs of input services: Input services such as manpower, legal, professional services, auditor services, travel expenses, etc. will now be taxed at 18% as against the earlier bracket of 15%, leading to higher costs to the wholesaler.

! Additional costs to upgrade technology: Many wholesalers, especially rural ones, are not technology-savvy and will need to rely on help from their supplier companies to undergo a technological transformation. This means that supplier companies may need to increase commissions for wholesalers— an added cost to the company, or wholesalers and retailers themselves will need to invest in new systems, incurring additional expenses.

3. For Importers and Exporters

According to the financial reports of 2016, India is the 16th largest export economy in the world with the net value of exports contributing to one-third of the GDP. The subsuming of various local state level taxes will have a direct impact on imports and exports, a critical component of trade. For example, the Countervailing Duty (CVD- an additional import duty levied to offset the effect of concessions or subsidies, currently 0% or 6% or 12%) and Special Additional Duty (SAD- a special kind of customs duty paid on imported goods currently at 4%) have been done away with under the new GST regime. However, Basic Customs Duty continues to be applicable and importers will need to pay it as per previous rates.

Here is a look at the overall impact of GST on trade:

  • Imports Taxation: Every import will be treated as an interstate supply, and will be subject to Integrated Goods and Services Tax (IGST) along with Basic Customs Duty (ranging between 5% and 40% depending on the good imported). This implies that IGST will be levied on any imported item, based on the value of the imported goods and any customs duty chargeable on the goods (say 10%). IGST is a combination of SGST (say 9%) and CGST (say 9%). For instance, for an import item worth Rs 10,000:
Total Duties + Taxes Payable Basic Customs Duty (10%) GST (18%) GST Cess(if applicable)
₹2800 ₹1000 ₹1800 Nil

Thus, imports taxation is an added tax liability for retailers who import goods or services.

  • Exports Taxation: Exports will be treated as zero-rated supply, i.e., no GST will be charged on exports. This is in line with the “Make in India” campaign that aims to make India a global manufacturing hub, for which exports are important.
  • Import of Services: The new clause of import of services places the onus of tax payments on the service receiver when the services are provided by a person residing outside India. This mechanism is called reverse charge and will apply in certain scenarios. For example, if the assessee has no physical presence in the taxable area, then the representative of the assesse will be required to pay tax. In the absence of representation, the assesse has to appoint a representative who will be liable to pay GST. Another example is when a registered dealer is buying goods or services from an unregistered dealer. In this case, the registered dealer will have to pay the tax on supply.
  • Need for restructuring working capital: A major shift is that GST is based on “transaction value” rather than MRP. In the old system, CVD was charged as a percentage of the MRP. Under GST, IGST will be charged as a percentage of the transaction value. This will affect the cash reserves of retailers and wholesalers, and they will need to reassess their working capital needs.

On the whole, GST is expected to bring domestic players at par with large multinational corporations due to the renewed import and export norms and the rules for FMCG suppliers. This is a good sign for Indian trade and exports in general, and thus the implementation of GST shows promise to propel India onto the international trade arena.Visit our GST blog to know more about GST and keep track of latest.

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Oct 24, 2018

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The SME Lending Puzzle: Why Banks Fall Short

Let us consider the following hypothetical scenario:

ABC & Co., a small services firm, began operations in mid-2011. It reported a 40% jump in annual turnover from Rs. 5 Cr in FY 2012 to Rs. 7 Cr in FY 2013. As a startup, the company has not yet broken even and reported losses for consecutive years. The promoter is well educated, previously worked in organizations of repute for over a decade before deciding to float this venture. The short-term finance requirement of ABC & Co is about Rs. 40 lac for 90 days, but does not have any physical collateral to offer as security. At this stage, the promoter of ABC & Co. decides to approach banks and NBFCs in the market to fund this debt gap.

What would this promoter’s experience be in today’s scenario? Would he be successful in securing the necessary funds?

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According to a recent statistic, 33% of companies operating in the Micro, Small and Medium Enterprises sector have access to banks and financial institutions, while the rest remain excluded and are compelled to raise money through informal channels.

This debt gap is alarming especially in the backdrop of the fact that SME segment contributes nearly 10 percent of the country’s gross domestic product and 45% of all industrial output.

Till date, banks and NBFCs have not been able to finance this debt gap effectively. What has prevented or restricted them from profitably penetrating this sector? Is it due to inherent credit risk in the segment, lack of collateral, government regulation and laws, or simply because there are greener pastures elsewhere to lend money?

Lets us understand the debt requirement of the SME segment (both early-stage as well as mature entities) before we try to further dissect this issue. In our example, ABC & Co. could require financing for primarily two reasons:

1) Capex, i.e. medium to long-term finance for business expansion, product diversification, renovation of business premises, or purchase of machinery.

2) Working Capital i.e. to cover short-term immediate cash flow needs arising from day-to-day business operations.

To cater to this demand, banks and financial institutions already have specific products (both fund and non-fund based) that can be broadly categorized into two categories for the sake of simplicity:

1) Simple lending products, which would typically cater to the first requirement of SMEs for Capex. These are medium to long-term financing products in the form of equipment and machinery loans, high yield unsecured business loans, Loan against Property etc.

2) Specialised lending products, which typically include factoring, trade finance, cash management services, project finance, bank guarantee, or letters of credit, which typically cater to the second requirement of working capital finance.

As is evident from the above, it is not the lack of “products” that explains the under-penetration of finance flowing to the SME sector. Rather, it is in the design, applicability and administration of these products to the SME sector that banks have fallen short.

In an effort to go deeper, we can identify four key reasons among others, for this shortfall:

1)  Sole Focus on Financials: The current approach to SME lending in most institutions is still heavily dependent on business financials- i.e. looking at historical data to predict future creditworthiness. Typically this involves a lot of paper work and many visits to the applicant.

This approach has not been very successful in the SME sector to-date due to the fact that the financials provided by the applicant are often opaque given the cash nature of business transactions and incentives to under report income to save on taxes. ABC & Co., on this parameter alone (aside from business vintage) would be filtered out as the current financial position reflecting business losses would not be very appealing to most financiers.

2)  Bureau Reporting: There are two kinds of credit bureau reports that can be generated by member banks and NBFCs – Individual and Corporate. While individual records are provided by most bureaus, only CIBIL currently provides reports for corporate entities in India. Valid records for SME entities are still not very evolved in the country. And while the bureaus can provide data on credit worthiness of the individuals involved in any given company, they cannot give relevant insights about an applicant who is a first time borrower.

Since ABC & Co. is newly established, there would not be any bureau record on the company. The application would then have to be judged on the strength of the individual records for the promoter as well as the business viability of ABC & Co.

3)  Selective Segmentation: The implication of the above two factors is that only the “upper layer” of the medium to large enterprise segment is able to pass through banks’ and NBFCs’ credit assessment parameters, leaving aside the major chunk of “small” entrepreneurs and entities whose need for adequate finance is more pronounced. These small entities could be major links in the supply chains of large players, and their inability to access finance could have the ripple effects across the value chain.

4)  Lack of Collateral Security: Lending in India traditionally has relied on taking adequate collateral as a “risk mitigant” to cover the credit risks associated with SME lending and the ambiguity around appraising this segment. The Loan to Value ratio (LTV) becomes the yardstick to segregate and approve or reject cases based on risk. This ratio is inversely proportional to the risk perception of the applicant.

Since ABC & Co. does not have any physical collateral such as property or machinery to offer and the promoter has pitched in whatever money he had in the form of initial capital into the business, his application would be rejected by most banks and NBFCs in the market today.

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This problem of access to finance for SMEs in India is even more accentuated for early-stage companies or startups such as ABC & Co. In their case, past financial performance would be not a correct indicator of the future potential of the enterprise. After initial round of equity funding from family and friends or seed investors, working capital requirements or ad-hoc needs for short term finance would inevitably kick in and must be dealt with in a timely manner to keep the firm operational.

To conclude, traditional lending to the SME sector in India can best be described as a “One Size Fits All Approach.” The risk management techniques used by banks and other financial institutions today are invariably more suitable for medium and large corporate entities. The same set of rules when inadvertently applied to small and early-stage enterprises result in a faulty output, i.e. the systemic rejection of most SME loan applications like ABC & Co. Given the intense nature of competition in the lending industry today, the consequence is that too many banks and financial institutions end up chasing the same set of “good” customers, leaving aside a much larger untapped segment of SMEs in the process.

Watch this space for more articles on the subject as well as suggested ways to underwrite “small” and
“early-stage” entities in the SME sector.

(Image credit: http://blog.directcapital.com/misc/small-business-loan-video/) 

Oct 24, 2018

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How GST Will impact the Hotel and Travel Industry in India

The hotel industry is one of the fastest growing domains in India, and, together with the travel segment, it was valued at $136.2 billion by the end of 2016. The implementation of Goods and Services Tax (GST) will help the hotel and travel industry largely by bringing down costs for customers, consolidating the multiple taxes into a single tax value and decreasing transaction costs for concerned business owners. However, certain challenges accompany these outcomes as well.

A look at the conditions pre- and post-GST

Similar to other industries in India, there were multiple taxes applicable to hotel industry. These were chiefly in the form of value added tax (VAT), luxury tax and service tax. For a hotel, if a room’s tariff exceeded Rs 1000, the service tax liability was 15%. With an abatement of 40% allowed on the tariff value, the actual rate of service tax was brought down to 9%. The VAT that ranged between 12% and 14.5%, as well as the luxury tax, was applied over and above this.

The GST impact on hotels and travel industry 

Under the GST regime, the hospitality domain gets the advantage of standardised and uniform tax rates. The utilisation of input tax credit (ITC) has also become simpler and better. Complimentary food (such as offer of breakfast with room) that was separately taxed under VAT will be taxed as a bundled service under the GST system.

As a positive effect of GST for hotels, the end cost to be paid by the final consumers will decrease, which will help to attract more tourists and push up the growth of businesses in this industry. Conversely, it will also increase the revenue collection of the government.

The tax rates under GST for hotel industry have been set as:

Room Tariff Per Day GST Rate
Less than Rs 1000 NIL
Rs 1000 – 2499 12%
Rs 2500 – 7499 18%
More than Rs 7500 28%

Most hotels in India follow a dynamic pricing policy, where they decide upon the tariffs manually as per the number of tourists expected in a certain season. The tariff, therefore, keeps changing according to the demand and supply forces. Since the GST rates vary for different tariff levels, hotels have to ensure that their billing software also changes the tax rate as per the room tariff throughout the distribution channels comprising travel agencies and online aggregators. Making such changes in the billing systems could take some time.

Positive aspects of GST

The Goods and Services Tax has brought some relief for the hospitality industry through:

Ease of administration 

With the implementation of GST, the multiple state and central taxes levied on the tariffs of hotels have been done away with. This has helped to trim down the burden of different procedures of tax application and has resulted in better streamlining of the entire process.
Less confusion for customers

Tourists staying in hotels and availing some special services were largely confused by the multiplicity of taxes in their bills. For most of them, it was difficult to understand the difference between VAT, service tax and luxury tax. Under the GST system, they will see only one consolidated tax on their invoice, which will give them a clearer picture of what they are paying in tariffs and what is the tax charged on them.

Enhanced quality of service 

Many tourists and hotel guests have had the cumbersome experience of waiting in the hotel lobby while their bill was being prepared. It often took longer to add the different tax components and prepare the final version of the bill to be paid by the customer. With GST, the managers have just one tax to calculate and that makes the checking-out process from hotels quicker and simpler.

Ease of using input tax credit

Entities in the hotel and travel industry can now easily claim and get input tax credit. They are entitled to get full ITC (input tax credit) on the inputs that they add. Due to the division of revenue between the centre and state governments, the multiple taxes paid before GST regime on inputs – like cleaning supplies, uncooked edibles for meals – could not be smoothly adjusted against the output. The calculation of ITC will be easier in the GST system.

Negative aspects of GST

The GST for travel industry and hotels also comes with its share of adverse impacts. With a taxation rate of 28%, the hotels charging tariffs over Rs 7500 are worst hit, as their final prices for customers will increase significantly.

Looking at the bigger picture, GST can hit the inflow of foreign tourists to India. Other Asian countries such as Japan and Singapore impose tax rates as low as 8% and 7% on their hotel and travel industry. This can become a big factor in making them more preferred tourist locations as compared to India.

Capital Float looks at GST for hotels and tourism as a mixture of simpler, smoother rules and seemingly higher costs & compliance. The trade associations of hotels and restaurants have been protesting for a lower tax rate of 5%, but it starts at 18% for a majority of them. The value of tourism industry in India is projected to grow by up to $280.5 billion in the next 10 years. How well the positive aspects of GST outweigh its negative effects is yet to be seen. Meanwhile, despite the challenges, the credit support for the development of new hotels and restaurants by an NBFC like Capital Float will continue to be consistent.

Oct 24, 2018