Supply Chain Finance (SCF) enables MSMEs in the auto manufacturing and ancillary sector to receive early payment on their invoices.
11 Aug 2024 | 2250 Views | By Sundeep Mohindru, Director & Promoter, M1xchange
India's automotive industry is a powerhouse, accounting for 7.1% of GDP and 49% of total manufacturing GDP. The sector generates an annual turnover of INR 7.5 lakh crores and exports worth INR 3.5 lakh crore. Over 14,000 companies are involved in the production of automobiles, auto accessories, and components, making ...
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India's automotive industry is a powerhouse, accounting for 7.1% of GDP and 49% of total manufacturing GDP. The sector generates an annual turnover of INR 7.5 lakh crores and exports worth INR 3.5 lakh crore. Over 14,000 companies are involved in the production of automobiles, auto accessories, and components, making it an important part of the Indian economy.
With the industry on track to become the world's third-largest vehicle manufacturer by 2026, the role of MSMEs in this sector cannot be underestimated. These businesses, which manufacture auto parts and accessories, face unique financial challenges that impede their expansion. Therefore, Supply Chain Financing (SCF) has emerged as a powerful tool for mitigating these challenges and providing a lifeline to struggling MSMEs.
What is Supply Chain Finance?
Supply Chain Finance (SCF) enables MSMEs in the auto manufacturing and ancillary sector to receive early payment on their invoices. This can be facilitated by the buyer, typically large auto manufacturers, or through financial institutions such as banks, NBFCs, and fintech companies. This tool ensures liquidity by converting receivables into cash faster than traditional financing. It involves suppliers/dealers (MSMEs), buyers (large auto manufacturers), and financial institutions. Unlike traditional loans, SCF relies on the creditworthiness of the buyer rather than the supplier, making it more accessible and cost-effective for the supplier.
Need for Supply Chain Finance in the auto sector
In the auto sector's complex supply chain, MSMEs play a crucial role as suppliers of specialised parts, accessories, and components to large manufacturers and original equipment manufacturers (OEMs). Disruptions at any point in this chain can create significant challenges for all participants. For example, the working capital and product distribution strategies of OEMs are severely strained when they accumulate inventory of unfinished goods due to the unavailability or delayed availability of certain components from the suppliers.
However, MSMES face significant financial challenges that affect their operations. Cash flow issues arise from delayed payments by large manufacturers, tying up substantial working capital in receivables. Extended payment cycles further exacerbate these challenges, creating cash flow gaps that hinder operational capabilities and growth investment. Such financial constraints can disrupt the supply chain, impacting production schedules and profitability for smaller suppliers. In such a scenario SCF can provide quicker access to cash and improve liquidity by leveraging the creditworthiness of buyers, thereby alleviating these challenges, and supporting sustainable growth in the sector.
SCF offers significant benefits to MSMEs in the auto sector, addressing their key financial challenges and enhancing operational efficiency. It accelerates cash flow by providing early payment on invoices and reducing reliance on extended payment terms from large manufacturers. This improvement enables them to promptly meet operational expenses and reinvest in business growth. Moreover, it enhances the credibility of these enterprises by leveraging the credit profile of large auto manufacturers, offering low-cost financing at better terms than traditional loans. This manages immediate cash flow needs and positions them more favourably for additional financing from traditional lenders.
Additionally, supply chain finance plays a crucial role in strengthening supplier-buyer relationships within the auto sector. By ensuring timely payments, it builds trust and reliability between MSMEs and large manufacturers.
Implementation of SCF in the Auto Sector
Implementing Supply Chain Finance (SCF) in the auto sector involves leveraging the SCF ecosystem to connect buyers (anchors), sellers (vendors), and lenders (financial institutions). This connection ensures a smooth operating cycle by providing quick access to credit. New-age fintech companies are creating marketplaces where borrowers seeking working capital can find the best lenders at optimal rates. Their digital onboarding process is a cost-effective, time-efficient solution that provides immediate liquidity to OEMs, vendors, dealers, and distributors, particularly in tier 2 and 3 locations.
Financial institutions can diversify their portfolios by lending to MSMEs, with fintechs assisting them in optimizing resources through AI-powered risk assessment tools, such as real-time trend analysis reports, collection tracking, and co-lending opportunities.
One effective SCF solution for the auto sector is the RBI-approved TReDS platform, which offers easy access to credit for small businesses supplying large corporations. TReDS is a digital marketplace that facilitates the financing or discounting of trade receivables of MSMEs through multiple financiers. This platform also helps reduce the cost of goods and services, as companies can secure better deals and discounts from suppliers by enabling early payments to vendors through the discounting of trade receivables.
Another beneficial solution is Deep Tier Financing, which leverages business relationships within the supply chain to provide working capital to small downstream suppliers in tier 2, 3, and beyond. This system enhances liquidity and traceability, minimizes financing expenses and risk evaluation, and decreases the overall cost of goods.
By implementing these SCF solutions, the auto sector can achieve greater financial stability and efficiency, ensuring a more resilient and cost-effective supply chain.
Conclusion
SCF holds immense potential for MSMEs in the auto sector, addressing their unique financial challenges and fostering growth. By improving cash flow, enhancing creditworthiness, and strengthening relationships, it enables these businesses to thrive in a competitive environment. As the industry continues to grow, it will play a pivotal role in supporting them and driving the auto sector’s contribution to India’s economy. Stakeholders in the auto sector, large manufacturers, and financial institutions, should embrace these solutions to enhance financial stability and accelerate growth. Investing in this technology and collaboration will pave the way for a robust and well-positioned auto industry in India.
Sundeep Mohindru is the Director and Promoter, M1xchange. Views expressed are his own.