5 Factors That Are Affecting SMEs’ Access To Finance

  • KredX Editorial Team
  • 27 Jan 21
  • business
The SME sector has been an engine of growth for the Indian economy for years. In 2020, small and medium enterprises remained one of the key drivers behind economic growth, contributing 40% to exports and 45% of the total manufacturing output.  However, these entities call for sufficient funding regularly to stay operational and afloat in today's competitive market. Unfortunately, SMEs face a glaring lack of finance despite the continuous and proactive efforts of the government.  But why does this disparity exist?  Read on to find out.

Factors Preventing SMEs To Avail Funds

These pointers highlight 5 reasons why small and medium-sized firms fail to access funds -

A. From The Perspective Of A Financier

1. Low Credit Score

Figures suggest that only 16% of the small and medium enterprises receive formal credit in India. Needless to say, a majority of SMEs remain under-financed or avail financing through informal sources. As a result, these entities do not possess a reliable credit history or a healthy credit score. Additionally, most of these businesses operate in the unorganised sector and do not hold considerable data on their transactions.  Therefore, it becomes difficult for financial institutions to assess the creditworthiness of these organisations. Consequently, financiers perceive them as risky borrowers and hesitate to extend funds.

2. Location Of The Business

The ability to acquire funds by a firm is often traced to the ease of doing business in a given region. For instance, organisations conveniently placed in economic and financial hubs of India gain easier access to business funding solutions.  In 2020, Andhra Pradesh topped the state-wise rankings of 'Ease of Doing Business', retaining its position for the third subsequent year. Madhya Pradesh, Uttar Pradesh, Telangana, Gujarat, West Bengal, and Rajasthan also emerged as states where doing business is the easiest.  In other words, enterprises based in these prime locations benefit from a wide range of resources, including credit. However, this is not the case for most SMEs, which consequently miss out on several growth opportunities due to their remote location in the country.

3. Lack Of Clarity In Business Plan

While requesting credit, financial institutions require a concrete business plan to assess a company's credibility. But in most cases, small and medium enterprises fail to project a clear plan of action. At times, SMEs struggle to project a feasible growth trajectory and fail to convince financing institutions to approve their funding plea. Sometimes it is a result of an overestimation of their capital requirement to meet a specific growth trajectory. For example, to achieve an additional 10% market share, an SME may estimate a budget of Rs. 30,00,000. But, when a financial institution analyses this request from a practical perspective, it might conclude that funding of Rs. 15,00,000 is sufficient to realise a 10% increase in market share.

B. From The Perspective Of A Business Owner

4. Insufficient Credit Information

Over the years, the government has rolled out many schemes for boosting small and medium enterprises, such as Pradhan Mantri MUDRA Yojana (PMMY) and Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).  Unfortunately, there exists a vacuum in the transfer of information, referred to as an information asymmetry problem. As a result, only a handful of these schemes ultimately reach the intended recipients. 

5. Lack Of Technological Upgrade

The dot-com bubble of the present world requires businesses to be tech-savvy in order to operate and flourish. However, when it comes to business expansion and growth, SMEs are losing position by not utilising technological advancements adequately.  Additionally, contrary to popular belief, top technological trends are not just developed for larger businesses and can be easily scaled according to the user's needs. For instance, an SME can use cloud-based accounting tools for optimising its invoicing and settlement processes. It can also expand its market reach by offering peer-to-peer (P2P) payment options through mobile wallets and applications.  It will also prove useful for SMEs to keep their financial papers clean by eliminating the lack of financial footprint, thereby convincing financial institutions of their credibility.  The factors mentioned above discourage small and medium business owners from availing adequate finances, thereby hindering business growth. However, an SME can always opt for other sources of funds, such as invoice financing. It allows businesses to raise funds against their outstanding invoices within 24 to 72 hours*. Furthermore, small businesses can leverage the internet to look for different lenders in the market, compare their offerings, and then make an informed decision.

Bottom Line

SMEs in India are mushrooming in a myriad of sectors, such as manufacturing, agriculture, and the service industry. Through easy access to finance, these enterprises can further accelerate their growth and become self-sustainable in the long run.