The importance of technology in invoice discounting: An effective fundraising tool for SMEs

By Kamal Mehta Promoter Director Parrami Finance Private Limited,

Revenue is vanity, profit is sanity but cash is the king. In the dynamic landscape of small and medium-sized enterprises (SMEs), maintaining a healthy cash flow is paramount in today’s era to meet the compliances and continue with the business growth. It is true that whenever you ask a MSME about their funds, you may receive a reply of running out of cash etc however it’s a universal truth that they are the billionaire and owns good house, luxurious cars etc.

Small enterprises manage their cash while borrowing from friends, relatives and after achieving some milestones to sustain continues growth they are opting for Invoice discounting, a form of short-term borrowing against unpaid invoices to manage the liquidity for the growth of their business. Essentially in invoice discounting, a business sells its accounts receivable (invoices) to a third-party financier (usually a bank or a specialized invoice discounting NBFC company) at a discount. The financier then advances a significant portion of the invoice value—often around 80-90%—to the business almost immediately. Once the customer settles the invoice, the financier pays the remaining balance to the business, after deducting a fee for the service. This financial tool provides SMEs with immediate access to funds tied up in outstanding invoices, allowing them to bridge the gap between the issuance of an invoice and the receipt of payment. Here’s an in-depth look at invoice discounting and how it serves as a powerful fundraising option for SMEs. Traditional financing options can be cumbersome, time-consuming, and sometimes inaccessible to smaller businesses. However, invoice discounting has emerged as a viable and efficient solution for SMEs to raise funds quickly. The integration of technology into invoice discounting has revolutionized this process, making it more accessible, transparent, and efficient.

Introduction of Factoring:

Invoice discounting or in other words factoring industry in India has evolved significantly over the past few decades. During 1990s factoring services started to gain some attention with the establishment of the first specialized factoring company in India, the SBI Factors and Commercial Services Ltd., a subsidiary of the State Bank of India (SBI), in 1991. This period marked the beginning of formal factoring services in the country and then around early 2000s saw the Reserve Bank of India (RBI) starting to recognize the importance of factoring as a financial service. The RBI issued guidelines to regulate the factoring industry, which helped in building confidence among businesses and financial institutions. The introduction of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act in 2005 allowed banks and financial institutions to better manage non-performing assets (NPAs), indirectly supporting the growth of the factoring industry by improving the overall financial ecosystem. Introduction of Factoring Regulation Act, 2011 provided a comprehensive legal framework for the factoring industry in India, including definitions, registration requirements, and the rights and obligations of parties involved in factoring transactions. The Act aimed to enhance the credibility and reliability of factoring services which has helped factoring industry to have huge growth however industry started witnessing NPAs up to around 26% due to multiple factors and one of the main factors is the authenticity of the invoice.In 2014 The RBI introduced the Trade Receivables Discounting System (TReDS), an electronic platform for financing trade receivables of MSMEs through multiple financiers however according to MSE chamber “Many MSMEs are NPA victims of corporates, who are buying from them and not dealing through the TReDs platform. Most of the corporates and multinational companies are forcefully insisting on deregistering from the Udyam Portal and insisting not to deal through the TReDs platform,” and as per the media report, this industry body also urged the finance minister to consider providing Rs 5 crore loans under the “Differential Rate of Interest” scheme for micro and small enterprises. hence it is true that even after having TREDS market has a huge demand of invoice discounting and integration into technology will help MSMEs in a certain extent.

There are several instances of failure in establishing the authenticity of Invoices, even after due care resulting in defaults in payments to the financing institutions. Technological advancements would eliminate such failures and transform the entire invoice discounting process and system. The technology would streamline the flow of authenticated information such as verification of supply of goods through an E-way Billing system, data fetching from Centralised Invoicing system, accounting software of the sellers, and the automated intimations of invoice approval from the buyers’ system.

Automation and Efficiency: Streamlined Processes: Technology automates the invoice discounting process, reducing the time and effort required to manage invoices manually. This includes automatic verification of invoices, assessment of creditworthiness, and seamless fund transfer. Speed: SMEs can quickly access funds, often within 24 to 48 hours, thanks to the rapid processing capabilities of automated systems.

Enhanced Security and Transparency: Blockchain and Smart Contracts: These technologies ensure secure, transparent, and tamper-proof transactions. Blockchain can provide a decentralized ledger of all transactions, enhancing trust and reducing the risk of fraud. Real-time Monitoring: Advanced platforms offer real-time tracking of invoice status and payments, providing SMEs with up-to-date information and greater control over their finances.

Data Analytics and Credit Assessment: Predictive Analytics: Data analytics tools can predict payment behaviors and assess the creditworthiness of debtors more accurately. This allows for better risk management and decision-making. Credit Scoring Models: Technology-enabled platforms use sophisticated algorithms and machine learning to evaluate the credit risk of invoices, ensuring that only reliable invoices are discounted.

Accessibility and Inclusivity:Digital Platforms: Online platforms and mobile applications have made invoice discounting accessible to a broader range of SMEs, including those in remote or underserved areas. SMEs can easily upload invoices and receive funds without needing to visit a bank or financial institution. Global Reach: Technology enables cross-border invoice discounting, allowing SMEs to access international markets and investors.

Cost Efficiency: Reduced Costs: Automation reduces the operational costs associated with invoice discounting. This translates into lower fees for SMEs, making it a more cost-effective financing option. Competitive Rates: Technology increases competition among financiers, leading to more competitive discount rates and better terms for SMEs.

Technology has transformed invoice discounting into a powerful and effective fundraising tool for SMEs. By leveraging automation, data analytics, blockchain, and digital platforms, SMEs can overcome traditional financing barriers and improve their cash flow management. As technology continues to evolve, the invoice discounting process will become even more efficient, secure, and create a bridge for difficulties faced by MSMEs for availing credit facilities and the lack of approach by the financial institutions towards enhancement of credit flow to the MSME sector.As SMEs navigate the ever-changing economic landscape, tools like invoice discounting can play a pivotal role in sustaining and accelerating their growth. For businesses looking to enhance their financial flexibility, invoice discounting stands out as an effective and valuable fundraising tool.