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MSME Payment Terms 2024

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In the business world, effective payment terms are crucial for maintaining healthy cash flow and fostering strong relationships between buyers and suppliers. Optimizing payment terms for Micro, Small, and Medium Enterprises (MSMEs) is paramount to ensure business sustainability and growth.

MSME payment terms refer to the agreed-upon conditions and timeframes for payment between MSMEs and their customers. These terms outline when and how payments should be made for the goods or services provided by the MSME. Payment terms commonly include the payment due date, payment methods, late payment penalties, and applicable discounts or incentives.

MSME Payment Terms

The following quote justifies our discussion on “MSME payment terms.”

“The biggest hitch for an MSME today is longer credit periods and hurdles in getting bank finance.”

Before delving further into this regard, let us understand what we mean by micro, small, and medium enterprises (MSMEs).

The MSMEs are classified as manufacturing and service enterprises.

(a) Manufacturing enterprises: Falling under this domain are enterprises that are engaged either in the manufacture or production of goods about any industry specified in the first schedule to the Industries (Development and Regulation) Act, 1951; or utilizing plant and machinery as value addition to the final product.

(b) Service enterprises: The enterprises engaged in providing or rendering services in terms of investment in equipment are defined as service enterprises.

The Micro and Small Enterprises Facilitation Council (MSEFC) has warned that delayed payments for supplies received from the MSMEs would invite heavy penalties against defaulting buyers.

Recently, the MSEFC Chairperson, Shri. Anoo Malhotra has issued a circular, the contents of which are as follows:

“In case the buyer fails to make payment as required under Section 15 of the Micro Small and Medium Enterprises Development Act, the buyer is liable to pay compound interest with monthly rests to the supplier for a delayed period beyond 45 days, on the amount, payable at three times the bank rate notified by Reserve Bank of India as provided under Section 16 of the MSMED Act, 2006.”

The earlier discussed circular directed buyers, including government departments, public sector undertakings, autonomous bodies, agencies, or other industrial units “in their interest” to “release the due payments of Micro and Small Enterprises well within 45 days of acceptance of goods to avoid a penalty in the shape of interest at the rate of three times the rate notified by the RBI for the period of delay.”

In light of our earlier discussion, it is crystal clear that payment to the MSMEs registration should be on time.

MSME Payment Terms

Our government has attached high priority to the MSMED Act for protecting and developing MSMEs. Consequently, MSMEs enjoy protection from delayed payments under the MSMED Act.

Establishing clear and favourable payment terms is crucial for MSMEs to ensure steady cash flow and financial stability. Well-defined payment terms help MSMEs manage their working capital efficiently, enabling them to pay suppliers, cover operational costs, and invest in growth initiatives. Additionally, well-structured payment terms build trust and foster long-term customer relationships.

Delayed Payments to MSMEs

Assuming that any micro or small enterprise with an MSME registration supplies any goods or services, the buyer must pay on or before the agreed-upon date between the buyer and the micro or small enterprise.

However, in any case, a payment due to a micro or small enterprise cannot exceed 45 days from the day of acceptance or the day of deemed acceptance.

Quantum of Penal Interest to be paid on Delayed Payment to MSMEs

Suppose a buyer deliberately ignores payment on the specified time. In that case, the buyer is obligated under the provisions of the law to pay compound interest with monthly interest rates to the supplier on that amount. In this regard, the penal interest chargeable for delayed payment to an MSME enterprise is thrice the bank rate notified by the Reserve Bank of India.

It is pertinent to note here that as per the current provisions included in the Income Tax Act, the penal interest paid by the buyer (or payable by the buyer) cannot be claimed as a tax deduction, thus making the burden even higher for the buyer.

Table 1 includes different scenarios concerning the payment date to an MSME.

Table 1. Credit period in terms of acceptable payment frequency

Serial No. Scenarios Deciding dates Payable within (days) Credit periods
1 No agreement, no query Day of delivery (deemed acceptance) 15 of the delivery date 15
2 No agreement but a query Acceptance (15 days from, i.e., 30 days delivery) 15 + 15 days (from the day of delivery) 30
3 Agreement but no query 45 days from delivery 45 days of maximum delivery 45
4 Agreement and query Maximum of 45 days from deemed acceptance (15 days from delivery) 15 days + 45 days 60

Payment of interest (Section 16)

Suppose any buyer fails to honour payment to the supplier, as required under Section 16. In that case, the buyer shall, notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force, is obligated to pay compound interest with monthly rests to the supplier on that amount from the appointed day or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified by the RBI (i.e., 8.75%´3=26.25%).

MSE Facilitation Council (Section 18)

Any party to a dispute may, regarding any amount due under Section 18, can approach the MSEFC for dispute redressal.

The MSEFC shall conduct conciliation; consequently, Sections 65 to 81 of the Arbitration and Conciliation Act, 1996, as deemed appropriate, shall apply to such a dispute.

Penalties (Section 27)

Whoever contravenes any of the provisions of Section 8 (Registration) or Section 27 (Officer/Info) shall be punishable as specified hereunder:

A maximum of ₹ 1,000 in the event of the first conviction and

Violation after that will attract a fine of up to ₹ 10,000.

The MSME data should be made available online so that once registered under the act, the status of MSME, the buyer classifies him or her as an MSME and the MSME gets paid within 45 days or for delayed payment gets paid with penal interest.

Common Challenges Faced by MSMEs in Payment Terms

MSMEs often face various challenges when it comes to payment terms. Some common challenges include:

  1. Cash Flow Constraints: MSMEs may struggle with cash flow constraints due to delayed payments, hindering their ability to meet financial obligations and invest in business growth.
  2. Lack of Negotiation Power: Compared to larger enterprises, MSMEs may have limited negotiation power when establishing payment terms, leading to less favourable conditions.
  3. Late Payments: MSMEs frequently encounter late payments from customers, disrupting their cash flow and affecting overall business operations.
  4. Inefficient Invoicing Processes: Manual and inefficient invoicing processes can lead to errors, delays, and confusion in payment processing.

Key Factors in Optimizing MSME Payment Terms

Clear and Concise Payment Policies: Establishing clear and concise payment policies is essential to optimise payment terms. These policies should outline the expectations and requirements for payment, including details such as due dates, accepted payment methods, and any penalties or incentives associated with timely or delayed payments. Clear payment policies facilitate transparency and help avoid misunderstandings between MSMEs and their customers.

Negotiating Favorable Payment Terms: While MSMEs may have limited negotiation power, it is still important to advocate for favourable payment terms during business agreements. By highlighting their value and showcasing their reliability, MSMEs can negotiate for shorter payment periods, reduced credit risks, and other favourable conditions supporting their financial stability and growth.

Leveraging Technology for Efficient Invoicing: MSMEs can significantly improve their payment processes by leveraging technology for efficient invoicing. Utilizing online invoicing platforms or accounting software streamlines invoice generation, delivery, and tracking. Automated reminders can be set up to prompt customers for payments, reducing the likelihood of late payments and improving cash flow.

Establishing Strong Relationships with Customers: Building strong customer relationships is vital for optimizing payment terms. MSMEs can cultivate loyalty and trust by fostering open communication, understanding customer needs, and delivering exceptional service. This, in turn, increases the likelihood of prompt payments and encourages customers to negotiate mutually beneficial payment terms.

Monitoring and Managing Cash Flow: Effective cash flow management is essential for MSMEs. By closely monitoring cash flow, MSMEs can proactively identify potential issues and take necessary steps to optimize payment processes. Regular cash flow forecasts, expense tracking, and contingency plans contribute to better financial decision-making and improved payment terms optimization.

Best Practices for MSME Payment Terms

Setting Reasonable Payment Periods: Setting reasonable payment periods that align with industry standards and business requirements is crucial when defining payment terms. Consider factors such as production timelines, delivery schedules, and cash flow needs when determining the ideal payment period for your MSME. Striking a balance between accommodating customer needs and ensuring timely payments is key.

Implementing Early Payment Incentives: MSMEs can consider implementing early payment incentives to encourage prompt payments. Offering discounts or other incentives for customers who pay before the due date motivates them to settle their invoices sooner, enhancing cash flow for the MSME. Communicate these incentives clearly in the payment terms to ensure customers know the benefits.

Utilizing Partial Payments and Milestone-Based Payments: Consider implementing partial or milestone-based payments for larger projects or long-term contracts. Breaking down the total payment into smaller increments tied to project milestones or specific deliverables helps distribute cash flow and reduce risks. It also ensures that the MSME receives payment for completed work, providing financial stability throughout the project.

Implementing Late Payment Penalties: To discourage late payments, MSMEs can implement late payment penalties. Clearly define the penalties for late payments in the payment terms, specifying the additional charges or interest rates that apply. This incentivizes customers to meet payment deadlines and compensates the MSME for any financial costs incurred due to late payments.

Maintaining Clear and Transparent Communication: Maintaining open and transparent communication regarding payment terms is essential. Communicate payment expectations, deadlines, and any changes to the terms to avoid misunderstandings. Address concerns or disputes promptly and professionally to maintain positive customer relationships while ensuring timely payments.

Corporate Thinking

It is observed that corporate buyers have two lines of thinking toward payments to MSMEs, as listed hereunder:

  1. Taking into account the importance of MSMEs on the overall economy and then paying within 45 days is part of Corporate Social Responsibility (CSR) and
  2. Renegotiating the terms and conditions with MSMEs as mutually agreed upon and paying them within 45 days.

Low awareness: The majority of the MSMEs do not know that there exists such an act. Moreover, many MSMEs are registered but do not know their rights. Regrettably, many of the MSMEs are aware of their rights, but they do not claim them. However, it is also to be noted that many of the MSMEs claim their rights, but the buyer neither makes the payment on time nor he or she pays any interest.

To sum up, the credit rating agency Credit Rating Information Services of India Limited (CRISIL), in a study, says, “If all the MSMEs are paid within the limits prescribed under this act, then their profitability shall go up by 15%.”

Conclusion

Optimizing MSME payment terms ensures healthy cash flow, fosters strong customer relationships, and supports overall business growth. By understanding the intricacies of payment terms, leveraging technology, and implementing best practices, MSMEs can enhance their payment processes and establish a solid foundation for financial stability. By adopting clear communication, negotiation strategies, and effective cash flow management, MSMEs can navigate the complexities of payment terms and drive their businesses towards success.

Related Services

Income Tax Return Filing Online

Sole Proprietorship Registration

Private Limited Company Registration

FAQs

What are the typical payment terms for MSMEs?

Typical payment terms for MSMEs vary depending on industry standards, business size, and customer agreements. Common payment terms include net 30 (payment due within 30 days of invoice), net 60, or net 90. However, it is essential to customize payment terms based on individual business needs and cash flow requirements.

How can I negotiate favourable payment terms with my clients?

Negotiating favourable payment terms with clients involves showcasing the value your MSME provides, highlighting your reliability, and understanding your clients’ payment preferences. Emphasize the benefits of shorter payment periods, offer early payment incentives, and explore mutually beneficial solutions that align with your client’s financial capabilities.

What are the risks associated with offering longer payment terms?

Offering longer payment terms can expose MSMEs to increased credit risks and cash flow constraints. It may result in delayed payments, affecting the MSME’s ability to cover operational expenses and invest in growth initiatives. It is essential to carefully assess the financial implications and establish safeguards such as late payment penalties to mitigate these risks.

Is it common for MSMEs to offer discounts for early payments?

Yes, offering discounts for early payments is a common practice for MSMEs. Early payment discounts incentivize customers to settle their invoices promptly, improving the MSME’s cash flow and reducing the risk of late payments. Communicate these discounts in the payment terms to encourage customers to take advantage of the incentives.

How can I handle late payments from customers?

Handling late payments requires a proactive approach. Implement a clear late payment policy specifying overdue invoices’ penalties or interest rates. Follow up with customers promptly and assertively, sending reminders and escalating the matter if necessary. Consider offering flexible payment options or negotiating repayment plans to facilitate resolution.

What are the consequences of consistently late payments for MSMEs?

Consistently late payments can have severe consequences for MSMEs. It can strain cash flow, impede growth opportunities, and create difficulties in meeting financial obligations such as paying suppliers or employees. In extreme cases, consistent late payments can lead to insolvency or the need for expensive borrowing to cover operational costs.

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