Business loans are a crucial tool for small businesses to cover regular business expenses and emergency spends, as well as to finance long-term growth plans. Micro, small and medium enterprises (MSMEs) have historically been overlooked by the formal lending system, but now they are increasingly being included into the ambit of financial services. They have options like business loans offered by fintech non-banking financial companies (NBFCs), which provide unsecured loans to them by implementing tech-led decisioning methodology.
One caveat that applies even to collateral-free loans made available to MSMEs is that they can still run into trouble for defaulting on loan payments. One possibility is that of an EMI bounce, which occurs when the borrower’s account has insufficient funds to service the business loan EMI. Let’s explore what the implications of such a situation can be for a small business owner.
Here are a few factors that all MSME business owners should keep in mind when they opt for a business loan:
Business Loan Requirement: Business owners should consider the loan amount they need before applying for a business loan. They can arrive at this number by carefully considering the specific requirements that they have and estimating the amount that would efficiently cover those needs.
Lender Credibility and Terms: The credibility and reputation of the lender are of critical importance when opting for a business loan. MSME entrepreneurs should do their due diligence and find a lender with a good market reputation offering terms that suit them.
Ability to Service a Loan: MSME owners should take stock of their finances before applying for a loan in order to ensure that they have the ability to service it. If they fall short of funds in repaying the loan, they can face negative consequences including penalties.
Consequences of EMI Bounce: Business owners should keep in mind that in case of an EMI bounce, they will be faced with EMI bounce charges. In addition to this, it may have a negative impact on their credit score, hindering them from accessing credit in the future.
An EMI or Equated Monthly Installment is the stipulated amount a borrower pays every month to pay off a loan. It includes part of the principal amount and the interest levied for the given period. An EMI bounce takes place when a business does not have sufficient funds in its account to cover the scheduled loan payment. This can be a result of various factors, including delayed payments from customers, unexpected cash flow disruptions, or lack of proper financial planning. When an EMI bounce occurs, the lender is notified that the payment could not be processed due to insufficient funds, and in turn informs the borrower about the same.
Once an EMI bounce occurs, the borrower faces immediate consequences like penalties and additional charges imposed by the lender, as per their loan terms. It’s important to keep in mind that repeated EMI bounces can accumulate significant costs on top of the outstanding loan amount. This can worsen the financial situation of the business, and take a major toll on its long-term success. Aside from the immediate penalties, there are also long-term consequences of EMI bounce. It can have a detrimental impact on the business’s credit score, and in turn, its creditworthiness. Many lenders continue to use credit scores to assess the risk of lending to a business. When a business’s credit score is negatively affected by bounced EMIs, it becomes a red flag for lenders, hindering its ability to access loans in the future.
While one incident of EMI bounce might not immediately negatively impact the credit score of a business, consistently missing EMI payments can definitely take a toll. It signals to lenders that the business may be struggling with financial management and may be unable to repay the loan. Being tagged as a high-risk borrower often results in future loan applications being declined, resulting in a lack of easy access to capital. EMI bounce, resulting in a poor payment track record, can also lead lenders to impose more stringent terms for any future loans that are granted. They could also impose higher interest rates to offset the risk.
Regular repayment of business loan EMI is the only way to maintain a healthy business credit score. A damaged credit score can have long-term repercussions, as it remains on the business’s credit history for years. This can affect the business’s ability to negotiate favourable terms with suppliers, partners, and investors, all of whom may consider the credit score as a factor in their decision-making process. Therefore, it is evident that consistently missing repayments or occurrences of EMI bounce not only strains the business’s current financial situation but also limits its future growth opportunities.
The only way to avoid facing the negative consequences of EMI bounce in terms of EMI bounce charges and your credit score being impacted, is to ensure that you stay on a regular repayment schedule. Here are a few strategies to ensure that no payments are missed:
Borrow within your Means: Calculate your business loan EMI prior to taking the loan and ensure that you have the capability to repay the loan amount in monthly installments to prevent EMI bounce.
Track Cash Flow Management: Efficiently manage your cash flows to ensure that there is enough left in your business account on the EMI date to cover the payment.
Check your Account Balance: Prior to the repayment date each month, check your bank account to ensure that there are sufficient funds to service the EMI payment.
Set up Auto-debit for EMIs: If you think you might have trouble remembering the repayment date, set up auto-debit for the EMI payment on your bank account.
Set a Reminder for Yourself: As an alternative, you can set a reminder for yourself to make the EMI payment each month. Kinara Capital, a fintech NBFC specializing in business loans for MSMEs, eases this process for its customers through reminder calls each month.
Business loans are a lifeline for MSMEs, but EMI bounce can take a significant toll on their finances. It can incur significant penalties, while also impacting the business credit score, and in turn, the chances of getting a loan on favourable terms in the future. It is critical for MSMEs to understand the consequences of EMI bounce, and avoid defaulting on loans by adopting effective strategies to stay on top of repayment. Some lenders like Kinara Capital make the process easier for MSMEs by sending EMI reminders so that they can stay on schedule and avoid the negative consequences of an EMI bounce.
