State of Cash Flow Based Lending in India

Irrespective of the type of business you run, you will need regular access to cash reserves to perform a variety of activities, thus subsequently ensuring the success and profitability of your business. Compared to individual borrowers, businesses typically have access to a wider range of lending instruments offered by financial and non-banking financial institutions across the country; however, one common eligibility criterion they share is measuring verticals which doesn’t accurately capture the potential or creditworthiness of a business at all times.

For instance, a common vertical assessed by most business lenders is the present assets of the business, be it in the form of office space or machinery. Although at first glance this might appear to be a fair approach, however, in reality, more often than not, businesses do not have enough assets at hand, which automatically makes them ineligible for a business loan.

A visual representation of this on ground reality can be realized in Statista’s recently released metric, which shows a negligible 0.7% growth in MSME credit growth from January to March 2020.

This and several other indicators are proponents of the fact that a majority of MSMEs across the country shows a lack of credit growth since most of them fail to meet the traditional evaluation criterion established by banks.

To address this setback, multiple lenders across the country are disrupting the industry with a new offering termed as Cash Flow Based Lending; but what does it exactly mean and what potential does it hold for the future of a bustling economy which is home to more than 65 million MSMEs and growing.

Let us understand in today’s post.

What Is Cash Flow Based Lending?

In layman terminology, cash flow based lending can be understood as a subset of credit assessment wherein a business entity (the borrower) borrows a certain amount of funds from a lender based on their forecasted cash flow into the future.

By leveraging the past cash flow reports of a business and via the use of advanced predictive analytics, lenders can forecast future cash flows of the business and thus subsequently attest a risk rating on the loan. Combined with the previously established credit rating of the business, the lender is now in a better position to decide whether to grant the loan or not. Along with this, since this method of credit assessment rules out the need for assets and other traditional verticals, even newly established businesses would be eligible to borrow if they have sufficient cash flow into the future.

How Does Cash Flow Based Lending Work?

The concept of cash flow based lending is simple to understand when your fundamentals of predictive analytics are solid; however, luckily for us, there is an easier way to understand its mechanisms.

Take, for instance, that there is a company A with a vintage of 3 years. Company A is an MSME registered company servicing OEMs with the maintenance of their machines and warehouse equipment. The company has 5 regular clients and picks up additional contracts at least two times a year. Before expenses, the company has generated an average revenue of ₹5 lakhs every quarter for the past three years. However, since the company mostly rents out equipment for servicing its orders, they naturally do not qualify for an asset backed loan.

However, if the company were to apply for a cash flow based loan, chances are they will get qualified.

In this scenario, the company will need to submit a cash flow report since its inception leading to the day of the application to the lender, the data from which will further be analyzed by advanced algorithms to predict future cash flow. These algorithms or computer programs take into account everything from the number of regular customers the company has and their average transaction value all the way to ageing and receivables summary to accurately predict what the next few quarters (until the end of the typical loan tenure) will appear to be for the business in terms of its cash flow.

Simply put, in cash flow based lending, lenders make use of historical data to predict the future, thus rendering the business as qualified for a loan if certain benchmarks are met.

Major Disruptors of Cash Flow Based Lending in India

Although the concept of cash flow based lending is not new to India, the industry is still in its early stages meaning there are only a few pioneers of this frontier at the moment. Some of the most significant of them are as follows.

  1. Rupifi

Bengaluru based Rupifi was established in 2018, and the company is building a Lending as a Service (LSE) model for MSMEs across the country, the working hypothesis of which lies in the established theory of cash flow based lending.

Spearheaded by Mr Anubhav Jain and his colleagues, the firm has successfully closed Series-A investments from seasoned venture capitals, including Cloud Capital and Cred’s Kunal Shah.

Check out Rupifi by Clicking Here [Link].

2. Credflow

Primarily an automated collection engine built on the Tally Platform, Credflow is the second company pioneering cash flow based lending in India. Based out of New Delhi and spearheaded by Mr Kunal Agarwal, the company raised $2.1 Mn in 2021 from seasoned investors.

Although the official product launch is yet to be announced, sources close to the development indicate an early release by Q4 2021.

Check out Credflow by Clicking Here [Link].

3. CredoChain

Third, in line for disrupting the MSME loan ecosystem in India is Vaibhav Anand and Shivani Sharma’s CredoChain. Based out of New Delhi and established in 2018, CredoChain is a member of Financial Inclusion Lab’s cohort of startups who are working towards increasing financial inclusion in India.

The company is enabling businesses to become eligible for cash flow based lending by pioneering a model which captures GST data to analyze the financial health of the business and subsequently matches them with lenders meeting their requirements.

Check out CredoChain by Clicking Here [Link].

4. FundFina

Last but not least on our list is Bikram Bajaj and Rahul Tripathy’s FundFina, a member of the exclusive and prestigious list of #InclusiveFintech50. Started in 2017 and based out of Maharashtra, FundFina is developing proprietary technology termed TrueScore, which captures the actual financial health of MSMEs who do not have a footprint on traditional credit bureaus. Developed on the working hypothesis of cash flow based lending, FundFina provides MSMEs across India affordable access to credit through its financial inclusivity platform.

Check out FundFina by Clicking Here [Link]

Risks of Cash Flow Based Lending and How Experts See Its Future

As with all new disruptive technologies, there is a substantial amount of risk in cash flow based lending, and a government panel set up by the RBI in 2019 takes note of this fact. The subsequent report published by RBI in BloombergQuint notes that since there is no collateral involved in cash flow based lending, promoters of this financial instrument need to pioneer financial technology which provides them with early signals of default and is able to track the borrower in real-time to facilitate the demarcation of a bad loan.

Ending Lines: The Impact of Cash Flow Based Lending in India

As MSMEs across the country continue their growth in contributing a significant portion to the country’s GDP, the RBI panel and subsequent observers in the industry continue to note the fact that disruptive technologies such as cash-based lending will provide a much-needed boost to the sector, as it will bring in new borrowers to the ecosystem who previously lacked footprint across the traditional credit bureaus.

As Md Sahnewaz Sanu, PhD student of economics at Assam University, Silchar notes in his research paper, if India is to touch its projected growth of becoming a 5 trillion economy by the end of 2025, credit growth from MSMEs need to reach above and beyond the present 1.1% and cash flow based can catalyze this, better than any other disruptive technology.

Reference[s]

  • Cash flow-based lending is the next big thing in credit [Link]
  • Cash Flow Based Lending Helps Facilitate Access to Credit [Link]
  • SBI to shift to cash flow-based lending by April 2020 [Link]
  • Cash management: Asset-based lending. [Link]
  • Performance of Asset-Based and Cash-Flow Based Loans in Uganda: A Case Study of Finance Trust Bank Limited [Link]
  • Government Panel Suggests A Cash Flow-Based Financing Model For MSMEs [Link]
  • Financial Inclusion Lab announces the 4th cohort of startups building innovations for the underserved [Link]
  • Credflow Raises $2.1 Mn To Foray Into Cash Flow-Based Financing, Payments [Link]
  • How to understand cash flow lending [Link]
  • Monthly credit growth of micro, small and medium enterprises in India from January to March 2020 [Link]
  • MSMEs and Inclusive Growth in India: Current Scenario and Future Prospective [Link]

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Arpan Sarma

Arpan Sarma

Simplified Finance for Every Indian.