Why Cash Flow Based Lending Makes Sense for Banks and SMEs?

For SMEs in India, cash flow based lending makes better sense can be based on the expected income from the business

Opinions expressed by Entrepreneur contributors are their own.
You're reading Entrepreneur India, an international franchise of Entrepreneur Media.

As a small business owner, the challenges to growing a business are many. Small business owners are faced with issues on a continuous basis that can sometimes hinder their very core of functioning. To add to their woes, the complications in obtaining capital that they need to operate and evolve a sustainable business is another story.


But what many are not aware of is that there is much promise in lending to the small-business market in India. And because SMEs classically do not have fixed holdings that can be used as collateral, cash flow based borrowing makes sense as the ideal approach for banks to lend to SMEs. This is true for a vast majority of the SME sector in India that prefer cash flow-based loans to asset-based loans to expand their business.

Plan of Action

SMEs are vital to our economic growth, and because they help generate employment, they are also significant contributors to overall output. For SMEs in India, cash flow based lending makes better sense can be based on the expected income from the business. The most potent rationale that can aid bankers to transform their opinion towards cash flow based lending is the profitability that can be gained from the SME loan investments.

There is a need to change the traditional mindset of collateral-based lending techniques to SMEs. And for this to happen it is imperative to understand the SME segment and the way they operate their businesses.

Every small business enterprise is required to present documented cash flow and its credit rating, when applying for a loan, in order to determine its borrowing capacity. But, this is precisely where SMEs struggle and falter. Many a small business in India are unable to profile themselves better, be it through loan applications, or organised and audited balanced statements or even long-term business plans. Because they are unable to supply the requisite data to support their fund application, they shy away from asset-based loans. Most banks are considering cash flow based lending and are eagerly eyeing it as a new opportunity to build relationships.

Financial Technologies

When cash flow lending becomes widely accepted, lenders may want to consider assessing the SME's potential in meeting loan obligations by training staff to collect relevant data and build a dependable financial statement. With banks increasingly being at the forefront of embracing newer technologies, new banking models can offer better choices to the SME sector.

As banks assign and instruct their staff to collaborate with SMEs, they will be able to evaluate the SME’s ability to repay the loan reasonably. This could call for on-site visits to the business, understanding how the business functions, conversing with the owner to receive verification in evaluating the SME’s capability to generate capital.

Cash-based loans provide a small business with the much-needed capital to market and advertise their goods or services, improve their inventory or even increase their workspace and hire experienced staff. It can give them the competitive edge to boost their business, while the revenue they make can help their ventures to repay the loan and fortify their cash flow position.

When all is said and done, only cash can pay back a mortgage. And in the same breath, it can be said that the significance of cash flow to a small business is momentous; it is their very lifeblood that calls for their survival.