Increasing Cash flow based lending- A positive for SMEs

Many Bank and NBFCs are aggressively launching new platform /products for increasing lending to MSMEs by leveraging the cash flow. This obviates the need for collateral security, which is a positive development.

Recently I met an entrepreneur in the services sector having the business exceeding Rs 200 million. The business is well established having many large corporate clients and few of them are reputed MNCs. At any point in time, the outstanding book debts will be Rs 30 million and the value of other current assets are Rs 20 million. However, the bank facility is just Rs 13 million. The business is grossly underfinanced. As a result, there is always a mismatch in the cash flow leading to major events like cheque bouncing. Though they are clearing the dues of such bounced cheques, it is affecting their credit scoring otherwise what is generally referred to as CIBIL scoring. Also, the reputation in the market has gone very bad due to delayed payments. Because of the lower CIBIL score, their attempts to secure short-term business funding from Banks/ NBFCs are not fructifying.

If we analyse the proposal, it is very clear that business is growing and the cash flow is stable. The inability to raise bank loan commensurate with turnover can be attributed to the unwillingness among the bankers to consider loan against the cash flow rather they were insisting to bring more collateral security, which the entrepreneur does not have.

He is not alone. Most SMEs in India do not have much collateral to offer and have therefore suffer the pain of under-financing or never accessed loans from the formal banking sector.

It is a commonplace complaint among the entrepreneurs in India that their business is not growing to the level of its potential due to the paucity of debt finance as banks and NBFCs are willing to lend to those who arrange the security of fixed assets.

The scenario is changing:

The lending market is evolving. Many new entrants are entering the market with an innovative model to capture the market rapidly. Also, the existing players are having a relook at their operational model. One of them is Cash Flow based Lending(CFL).

Focusing on Cash Flow Based lending (CFL) is one of the business strategies which is gaining traction in the aftermath of deficiencies reflected in the asset alone backed. While in asset-based lending, the valuation of collaterals offered mainly to decide the loan amount and tenor, in CFL it is the net cash flows of business which are the key focus and based on their availability for repayment, the loan amount and tenor are decided. In several studies, it has been supported that CFL is considered to be a more appropriate strategy for MSME sector given that non-availability of collaterals by borrowers in this industry.

Under CFL, lenders can ring-fence the entire cash flows of the clients leaving no room for diversion of funds. One of the deficiencies experienced under the asset-backed lending strategies has been the diversion of cash flows to unrelated areas. Hence, when the key area of monitoring becomes cash flows instead of collateral, it is but obvious that no compromise would be allowed on any leakages on this front. Many new generation lenders seek to enter into company’s supply chain to keep a check on the flow of funds in and out of the company. Within the context of CFL, it can be well appreciated that cash flow access is paramount.

CFL is not new. The scope is expanding:

Cash flow based lending is not new. It is in vogue for many large infra projects. Banks are already familiar with the Escrow Account and Trust & Retention Account (TRA) structures. These structures are being adopted with firm belief and focus on fully controlling the cash flows of the borrower.

While banks are still biased towards asset-based lending, many NBFCs have shown flexibility to build new products away from collaterals and focusing on the opportunities to tap the cash flow to secure their exposure which not only got huge potential in SME space but also more profitable to them.

With the advent of technology in the areas of data analytics, artificial intelligence, and strengthened IT infrastructure in Indian finance space,  the improved lending practices are evolving. The ability of the internet to connect seamlessly the multiple partners to transactions on a real-time basis is the key factor triggering a new wave of cash flow based lending strategies seen among NBFCs and it is the key propeller of growth of new breed of fintech companies.

What are the prerequisites to be eligible to attract the CFL loans?

Raising finances on CFL platform makes SMEs raise loans at the quicker phase and without any collateral. However, the very nature of products demands that SMEs improve their bookkeeping practice,  Filing returns, better banking habits, unambiguous contracts records with debtors, higher Credit Scoring, etc. Better the disclosures and transparency, more the confidence for CFL lenders to extend loans.

The entrepreneurs should devote little attention to develop a robust financial plan and that will help to explore the various options keeping in view the constraints. That will culminates in a successful fundraising strategy.

Collaterals do not guarantee the safety of advance nor recovery is easy:

A closer look at lending practices of banks/ NBFCs provides that they have been basing their decision on collateral comfort while considering funding. The asset coverage ratio based on collateral forms one of the major factors in risk assessment during appraisal of financing proposals. It has been proven that despite the comfort of collaterals, recovery from NPA cases has not been easy, it requires fighting long legal battles, and despite that, the recovery percentage remains to be quite low. These results force us to a conclusion that comfort of collateral if not has been proven myth then it has also not been proven realistic also. Taking possession of an asset/property and then selling it off requires a different spirit and skill set which has not been at least forte of bankers.

While entering the transaction based on collateral, quality of assets plays an important factor and a lot of attention need to be given to the due diligence on the assets/properties offered such as title clearance, prior encumbrance, valuations etc. This process requires one to incur significant costs.

Further, the availability of collateral security makes lenders turn blind eye to capabilities of project/activity to generate cash on a sustainable basis. It is the sustainable cash that only ensures prompt repayment of loan and assessment of this is responsibility for lenders as well as borrowers.


With a shift to key focus on cash flows, lenders can better assess the repayment capacity and liquidity position of the clients. Cash flow lending is the need of the hour in order to increase the flow of credit to SME sector.  If lending to SME sector is unlocked through cash flow-based lending, it could unleash millions of entrepreneurs and lead to greater job creation.