Blog

Introduction

Effective credit management is critical for Indian startups and MSMEs (Micro, Small, and Medium Enterprises) to build a strong financial foundation and ensure business sustainability. In India, where access to capital is often limited, proper credit management can make the difference between thriving and struggling. Whether it’s extending credit to customers, managing debt, or maintaining cash flow, startups and MSMEs need to balance growth ambitions with prudent financial practices. A Chief Financial Officer (CFO), even in a consulting or fractional role, plays a pivotal part in guiding businesses through this essential aspect.

This blog explores how Indian startups and MSMEs can strengthen their financial position through better credit management and how CFOs can provide the strategic oversight needed to ensure that growth is supported by financial stability. Actionable insights are also provided to help businesses improve their credit practices.

 

1. The Importance of Credit Management for Startups and MSMES

Credit management involves overseeing a company's credit policies, managing outstanding debts, and ensuring that cash flow remains sufficient to meet day-to-day operational needs. For Indian startups and MSMEs, efficient credit management is even more crucial because:

• Limited Access to Capital: Startups and MSMEs in India often face challenges in securing loans or external funding, making it essential to maintain healthy cash flow through effective credit practices.
• Dependence on Credit Sales: Many small businesses extend credit to customers to remain competitive. However, without proper credit policies, this can lead to delayed payments and cash flow crunches.
• Cash Flow Sensitivity: Startups and MSMEs are more vulnerable to cash flow disruptions. Poor credit management can lead to an inability to meet financial obligations, delaying growth initiatives or leading to insolvency.
• Risk of Bad Debts: Poor credit decisions can result in unpaid invoices and bad debts, which can have a lasting impact on financial health.

To tackle these issues, Indian startups and MSMEs must adopt a robust credit management system that balances growth with risk mitigation.

2. Key Areas of Credit Management

A comprehensive credit management strategy involves several key areas, each requiring careful attention and management. Let’s look at how startups and MSMEs can strengthen their financial foundation in these areas:

a. Establishing Clear Credit Policies

One of the first steps in effective credit management is establishing clear, well-defined credit policies. These policies should outline the terms and conditions under which credit is extended to customers, including payment terms, credit limits, and penalties for late payments.

• Creditworthiness Assessment: Before extending credit, it’s essential to assess a customer’s creditworthiness. This includes conducting background checks, reviewing financial statements, and analyzing payment histories with other suppliers. A CFO can implement tools such as credit scoring systems to automate this process.
• Payment Terms: Define payment terms that are favourable to your business while still being competitive. Standard terms include "net 30" (payment due within 30 days) or discounts for early payments, such as "2/10 net 30" (2% discount if paid within 10 days).
• Credit Limits: Set credit limits based on the customer’s financial health and payment history. Avoid overextending credit to any single customer to minimize risk exposure.

Actionable Insight: Develop a credit approval process that requires a thorough review of a customer's credit history before extending significant credit. Use data analytics tools to monitor customer payment behavior and adjust credit limits accordingly.

b. Managing Accounts Receivable

Once credit is extended, managing accounts receivable (AR) becomes a critical task. Poor AR management can lead to delayed payments, increased working capital requirements, and potential bad debts. Implementing efficient AR practices ensures that payments are collected on time, improving cash flow.

• Invoicing and Payment Follow-Up: Implement an automated invoicing system to ensure invoices are sent promptly and accurately. Regular follow-up with customers for payments is necessary to minimize delays.
• Aging Reports: Regularly review accounts receivable aging reports, which categorize outstanding invoices based on the length of time they have been overdue. This helps identify which customers are slow to pay and allows the company to take proactive steps to recover overdue amounts.
• Collections Process: Develop a formal collections process that escalates actions based on the age of unpaid invoices. This might include sending reminder emails, making phone calls, or engaging a collections agency for long-overdue payments.

Actionable Insight: Set up automated reminders for overdue invoices. This helps maintain a steady cash flow by prompting customers to pay on time without the need for constant manual follow-up. Additionally, consider offering payment plans for customers who may be struggling with liquidity but have a history of reliable payments.

c. Managing Supplier Credit

Supplier credit, or trade credit, is a valuable resource for startups and MSMEs. It allows businesses to delay payments to suppliers, freeing up cash for other uses. However, improper management of supplier credit can strain relationships with key suppliers and result in cash flow problems.

• Negotiating Favourable Terms: Leverage your relationship with suppliers to negotiate extended payment terms, which can provide breathing room for cash flow management. Additionally, explore opportunities for early payment discounts that could reduce costs.
• Supplier Diversification: Avoid over-reliance on a single supplier, which can create pressure if payment terms are unfavourable. Diversifying suppliers not only increases your bargaining power but also ensures you have alternative options in case of disruptions.
• Payment Scheduling: Implement a payment scheduling system that prioritizes payments based on due dates, supplier relationships, and your company’s cash flow situation.

Actionable Insight: Use a supplier scorecard to assess supplier performance and reliability. This can help in negotiating better credit terms, improving cash flow, and building stronger supplier relationships.

d. Monitoring Cash Flow

Effective credit management cannot happen in isolation; it needs to be part of broader cash flow management practices. Startups and MSMEs must maintain clear visibility over cash inflows and outflows to avoid liquidity crises.

• Cash Flow Forecasting: A CFO can help develop cash flow forecasts that take into account expected customer payments, supplier obligations, and operational costs. These forecasts allow businesses to anticipate periods of cash shortfall and take corrective measures.
• Working Capital Optimization: Working capital is the lifeblood of any business. Proper management of receivables, payables, and inventory ensures that a company has enough liquidity to cover its short-term obligations while still investing in growth.

Actionable Insight: Integrate cash flow forecasting software with your accounting system to get real-time updates on your financial health. This allows for quicker decision-making and better handling of credit-related issues.

e. Managing External Credit (Loans and Debt)

For startups and MSMEs, managing external credit is equally important. Taking on debt to fund growth is often necessary, but it needs to be done in a way that balances expansion with financial stability.

• Assessing Debt Capacity: A CFO plays a crucial role in determining how much debt the business can safely take on without jeopardizing its financial health. This involves calculating key financial ratios (e.g., debt-to-equity ratio, interest coverage ratio) to assess the company’s leverage.
• Choosing the Right Debt Instruments: Not all debt is created equal. A CFO can help identify the most appropriate forms of debt for the company’s needs—whether it’s a short-term working capital loan, a long-term term loan, or venture debt. Additionally, startups should explore government-backed loan programs like the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) that provide favourable terms for MSMEs.
• Debt Repayment Planning: Managing debt also requires a clear repayment plan to ensure that obligations are met without putting undue strain on the business. A CFO ensures that debt repayments are aligned with cash flow forecasts, reducing the risk of default.

Actionable Insight: Consider refinancing high-cost debt with lower-interest loans when available. Regularly review loan agreements and interest rates to ensure that the business is getting the best possible terms.

​​​​​​​3.The CFO’s Role in Strengthening Credit Management

For startups and MSMEs in India, the CFO is instrumental in developing and executing a strong credit management strategy. A CFO brings financial discipline, data-driven insights, and strategic foresight to ensure that credit practices support long-term business growth. Here’s how a CFO adds value:

a. Implementing Financial Controls

A CFO implements financial controls to monitor and manage credit risks. This includes setting up approval processes for extending credit, ensuring compliance with company credit policies, and developing early warning systems to detect potential payment issues.

• Credit Control Teams: For larger MSMEs, a dedicated credit control team can be established to manage credit decisions, follow up on payments, and escalate collections when necessary. CFOs oversee these teams and ensure that they operate efficiently.
• Credit Insurance: CFOs may also explore credit insurance as a way to protect the business against non-payment from customers. While this adds to costs, it can be a useful tool for de-risking the business when dealing with high-value transactions or new customers.

Actionable Insight: Implement a real-time credit monitoring system that integrates with your accounting software to track outstanding receivables, customer payment behavior, and credit risk on an ongoing basis.

b. Developing a Credit Risk Management Framework

CFOs develop frameworks for managing credit risk, which includes setting risk tolerance levels, conducting regular reviews of customer creditworthiness, and developing contingency plans in case of payment defaults.

• Risk Assessment Tools: CFOs use credit scoring models, financial statement analysis, and customer risk profiles to assess the creditworthiness of potential clients. They may also use external credit rating agencies to supplement internal assessments.
• Risk Mitigation Strategies: To minimize risk, CFOs implement strategies such as diversifying the customer base, requiring upfront payments for large orders, or working with customers on payment plans to mitigate potential credit losses.

Actionable Insight: Regularly update credit risk models with current market and customer data to ensure that credit decisions are based on the most relevant information. This helps the business stay proactive in managing risks.

c. Aligning Credit Management with Growth Strategy

Finally, CFOs align credit management with the company’s overall growth strategy. They balance the need for extending credit to fuel sales growth with the need to maintain financial stability.

• Balancing Growth and Risk: While extending credit can boost sales, it also introduces risks. CFOs ensure that the credit policies align with the company’s long-term financial goals, balancing the desire for expansion with the need for prudent financial management.
• Scaling Credit Operations: As startups and MSMEs grow, their credit management practices must evolve. CFOs implement scalable credit systems that can handle larger volumes of transactions while maintaining tight controls over risk.

Actionable Insight: Periodically review your company’s credit management policies to ensure they align with evolving business strategies and market conditions. This helps to stay agile in a rapidly changing environment.

​​​​​​​4. Conclusion

Building a strong financial foundation through effective credit management is essential for Indian startups and MSMEs aiming for sustainable growth. Poor credit management can lead to cash flow problems, bad debts, and financial instability, while well-managed credit practices can strengthen customer relationships, improve cash flow, and reduce risks.

By implementing robust credit policies, managing accounts receivable efficiently, monitoring cash flow closely, and leveraging the strategic insights of a CFO, startups and MSMEs can position themselves for long-term success. CFOs not only bring the financial expertise to guide businesses through credit-related challenges but also provide the strategic foresight needed to balance growth with financial stability.

​​​​​​​5. Actionable Insights Summary:

5.1 Develop clear credit policies with defined terms for creditworthiness, payment periods, and penalties for delayed payments.

5.2 Use technology to automate invoicing and payment reminders, reducing manual follow-up and improving collection efficiency.

5.3 Monitor accounts receivable aging reports to identify overdue invoices and implement a structured collections process.

5.4 Negotiate favourable payment terms with suppliers to extend payment timelines and ease cash flow pressure.

5.5 Maintain accurate cash flow forecasts to anticipate potential shortfalls and align credit decisions with liquidity needs.

5.6 Regularly assess credit risk by using credit scoring models and reviewing customer financials to make informed credit decisions.

5.7 Align credit management with overall growth strategy, ensuring that credit policies evolve as the business scales.

By implementing these CFO-led strategies, Indian startups and MSMEs can build a stronger financial foundation, ensuring that credit management becomes a tool for growth rather than a source of risk.