Small businesses often face delayed payments from government agencies, resulting in financial strain. Unlike other entities, these agencies are exempt from filing income tax returns, compounding the issue. Efforts to address prompt payments have fallen short in the past, necessitating more effective solutions.
Delays in Payments to Small Businesses Create Financial Strain
Challenges Faced by Small Businesses
The issue of delayed payments to small and medium enterprises (SMEs) by larger companies and government agencies continues to persist, despite efforts to address the problem. The recently introduced law, which disallows companies from treating payments to registered micro, small or medium enterprises (MSMEs) as an expense beyond 45 days, aims to drive prompt payments. However, it falls short of providing a definitive solution to this pervasive issue.
Impact of New Legislation
Under this law, any payment beyond the stipulated 45-day period would not be recognized as an expense by tax authorities. Consequently, companies would be required to include these delayed payments in their income and earnings, potentially incurring income tax on these outstanding payments. The implication of this could lead companies to reevaluate their approach to making timely payments to vendors for goods and services supplied.
Ramifications of Delayed Payments
When companies prolong payments to suppliers, they essentially benefit from interest-free credit for the duration of the delay. This incurs a cost to the suppliers, particularly MSMEs, who generally face higher credit costs. Previous initiatives aimed at expediting payments to MSMEs have proven ineffective, indicating a need for more robust measures to address this issue.
Previous Interventions and Challenges
Notably, the requirement to make payments within 45 days was among the initial legal interventions. Subsequently, corporate buyers and their suppliers were instructed to register on the electronic factoring platform, TReDS (Trade Receivables electronic Discounting System). This platform enables financial intermediaries to manage receivables and provide upfront cash to suppliers by applying a discount on the invoice total.
Distinguishing Factoring and Bill Discounting
It is important to note the distinction between factoring and bill discounting, wherein the credit relationship differs between the parties involved. In factoring, the financial intermediary assumes control of the receivables for an invoice and facilitates early payment to the supplier. Conversely, in bill discounting, the credit relationship is established between the financial entity advancing funds and the supplier, who remains responsible for collecting payments, with credit costs determined by the supplier’s risk profile.
Understanding Factoring in Financial Transactions
In the process of factoring, a financier acquires the receivables from suppliers related to the buyer of the goods, on whom the original invoice has been issued. The credit transaction involves the financier and the company that purchased goods from small-scale manufacturers. This form of financial arrangement provides an efficient way for suppliers to obtain immediate cash for their outstanding invoices.
Implications of Factoring on Credit Relationships
Upon the purchase of receivables, the financier provides upfront cash to the suppliers against the invoices issued to the buyer. However, the responsibility to settle the debt incurred in clearing the suppliers’ dues rests on the buyer of the goods. The associated cost of credit is reflective of the buyer’s superior credit rating compared to that of the small-scale suppliers.
Government Initiatives and Challenges in Payment Delay
Efforts to encourage factoring through the TReDS platform faced resistance in compliance. In response, the government enacted a law in 2023 that disregards expenses resulting from delayed vendor payments exceeding 45 days. This legislation is set to take effect when companies file their tax returns for the current financial year ending on March 31.
Impact on Small Industries and Potential Workarounds
Small industry representatives highlight that major delays in payments originate from various government departments at the central, state, municipal, and panchayat levels, including non-income tax-filing entities such as the Railways, defense, Public Works Department, and electricity agencies. While this law may not affect non-income tax-filing entities, public sector enterprises would be subject to its provisions.
However, proponents of extended credit terms could strategize to mitigate the impact of the law. They may delay acknowledgment of goods receipt to extend the 45-day payment window, thus influencing the payment process.
Considerations for a Better Credit Rating System
Integrating suppliers’ payment promptness into credit ratings presents a viable solution. Penalizing companies for delayed payments to suppliers through credit rating adjustments could affect their ability to secure high credit ratings essential for loan qualification.
Conclusion
Efforts to address delayed payments to MSMEs are ongoing, and while the new legislation marks a step forward, further measures may be necessary to ensure timely payments and alleviate financial strain on small businesses.
Factoring remains a critical aspect of financial transactions, influencing credit relationships and payment dynamics between buyers and suppliers. Effective government initiatives, integrated with credit rating considerations, are vital for promoting prompt and fair payment practices within supply chains.
