How To Keep Interest Cost Down for MSME Entrepreneur

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Small and Medium Enterprises have to borrow funds from start up stage to expansion stage. Cost of borrowed funds i.e. interest cost becomes a crucial factor for success of business or we may say to derive net profit from operating profit [EBIT]. If interest cost is high then MSME unit finds it very difficult to face the competition and even the repayment of loans may hamper loan may get converted to NPA for lending bank.

In this article factors affecting interest cost on loans from banks for MSME are discussed.

Generally MSME takes loan or funding from banks for following purposes:

  1. For Stock and Debtors i.e. normal functioning of the business. (CC/ OD Limit)
  2. For purchasing fixed assets like Plant and Machinery buying or constructing factory/ godown etc. [Term Loan]
  3. Non fund based limits like Letter of Credit, Bank Guarantee etc.
  4. LC discounting etc.

Factors affecting Rate of Interest from banks for MSME units are following:

  1. Profile of business and entrepreneur’s personal profile: – Entrepreneur should eligible and capable as per his/ her qualification, experience etc to run the business. If business is running with increasing sales and profit trends since last 3 years then it becomes easy to get fund at a low cost.
  2. Financial Discipline: – Entrepreneurs should observe and operate their bank account in a disciplined manner i.e.
  1. No diversion of funds
  2. No cheque bouncing
  3. Timely payment of Interest and Instalments
  4. Timely submission of stock statement / MSOD data
  5. Timely submission of renewal docs for CC/ OD Limits

If this step is followed properly by the entrepreneurs then marks for this disciplined activity are being considered while deciding the rate of interest.

3. CIBIL Score: – CIBIL score is now days very crucial in deciding the unit’s eligibility for loan and rate of interest. So entrepreneurs should take all the care to repay all loans in a timely manner. Any default in any of the loans may get reflected in the CIBIL report and the decision to give loan and rate of interest on it may get adversely affected at the time of financing or renewal in case of CC/ OD Limits.

4. Ratio of outside funds (Debts) to Promoters’ funds (Equity): –

Debt equity ratio is very important factor in risk rating of the project to decide the eligibility and rate of interest. Banks are comfortable with debt equity ratio up to 2.5 : 1.

A higher debt equity ratio indicates that outside funds or loans and liabilities are much more than the promoters’ funds. In such a case business may get unstable any time. If debt equity ratio is high then either the bank may refuse to finance or may take up the project at a much higher rate of interest.

5. Maintaining proper DP (Drawing Power) in case of CC Limits: –

Broad calculation of drawing power is as follows:

            Debtors –                                                           xxx

 Stock –                                                              xxx 

       Total                                                                Xxx

Less creditors –                                                 xxx

Less margin (% as decided by bank)

     D.P. –                                                                 xxx

Bank permits to withdraw funds from CC Limit account up to drawing power only. If someone is using CC limit of 1 crore (for example) and next month the Drawing power of the entity comes to be Rs. 60 lakhs then remaining Rs. 40 lakhs over and above the Drawing Power is to be deposited back else is generally charged at a much higher rate of interest. It may be equal to rate of interest charged on a clean loan. In many cases it has been seen that this rate of interest is higher by 2% to 5% p.a.

6. Risk Assessment and Rating:- Banks have to assess risk profile of the project and the proposal. If bank’s risk is low then rate of interest is low and if it is medium or high risk proposal then rate of interest will also be high accordingly. Normally banks perform risk rating exercise internally if loan amount is upto 200 akhs and if loan amount is more than 200 lakhs then risk rating is taken from external rating agencies like ICRA, Brickwork etc.

If the entrepreneur keeps in mind above discussed points and acts accordingly then he may get the bank loans at a much competitive rate of interest.

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