Clipped from: https://www.thehindubusinessline.com/opinion/quick-ratio-a-timely-shift-in-mse-lending-norms/article69838560.ece
Establishing the quick ratio as a core benchmark for micro and small enterprises would represent a timely and strategic move by financial institutions, more accurately reflecting real-time solvency
The current framework undeniably marks an impactful beginning towards securing timely receivables for India’s vital Micro and Small Enterprise sector | Photo Credit: JOTHI RAMALINGAM B
The current ratio is a widely understood financial metric, familiar even to those with a basic knowledge of banking and finance. It is routinely used by bankers during the credit appraisal process for working capital loans, as it reflects a firm’s ability to meet short-term obligations using its current assets.
It is computed by dividing current assets by current liabilities. However, its close counterpart — the quick ratio or acid-test ratio — often remains on the sidelines. Despite offering a more prudent assessment of liquidity by excluding inventory and other less liquid assets, it continues to receive limited attention, even among lenders. In an evolving regulatory and business environment that increasingly emphasises real-time liquidity and timely payments, the quick ratio deserves a relook.
India continues to adhere to the widely accepted recommendations of the Tandon Committee (1974), which prescribed a minimum current ratio of 1.33:1 for borrowers. This benchmark was introduced by the committee in 1975 to ensure a prudent liquidity buffer in working capital financing and remains an integral part of credit appraisal norms in Indian banking practice.
Why the quick ratio works in the West
However, lenders and financial analysts in the US and the European Union have traditionally placed greater emphasis on the quick ratio compared to their Indian counterparts. This preference stems from the relatively mature financial ecosystems in these regions, where the underlying assumptions of the quick ratio — particularly that receivables and cash are readily available to meet immediate obligations — are more reliably upheld. Several factors contribute to this reliability, including: robust legal frameworks such as the Prompt Payment Act (USA) and the Late Payment Directive (EU); effective enforcement mechanisms; a strong culture of contractual compliance; and well-developed credit information systems.
India’s historical hurdles
In India, this assumption was weaker. Historically, in India, payment delays were common, enforcement mechanisms were weak, MSMEs struggled with cash flow uncertainties and receivables often became overdue or even bad debts. In the widely respected Indian banking book, ‘Credit Appraisal, Risk Analysis and Decision Making’, the author DD Mukherjee, a key authority among Indian bankers, says: “From an Indian perspective, the analytical efficacy of the Quick Ratio suffers from a severe limitation. The assumption that receivables are more readily realisable than the inventory held by an enterprise may not hold good in India.”
He concludes that “the significance of the Quick Ratio or Acid-Test Ratio remains largely theoretical in the Indian context.” This view historically held merit: Indian businesses often struggled with long receivable cycles, poor enforcement of payment terms, and unreliable debtors. In contrast, inventories were tangible, more controllable, and often readily marketable.
Financial ecosystem in transition
With three major recent regulatory changes, the Indian financial ecosystem, especially for Micro and Small Enterprises (MSEs), is rapidly gaining maturity and transparency in payment receivables.
Firstly, effective April 1, 2024, Mandatory Payment & Tax Disallowance (Sec. 43B(h)) compels buyers to pay Udyam-registered MSEs (which are manufacturing units or service providers) within 15-45 days. Crucially, if buyers delay payments, the unpaid amount is disallowed as a tax deduction until actual payment, creating a strong financial incentive for promptness.
Secondly, Compulsory Half-Yearly Disclosures (MSME Form I) mandate companies to report outstanding dues to MSEs suppliers exceeding 45 days. This enhances transparency and public accountability, with penalties for non-compliance, deterring payment delays.
Finally, the Non-Waivable Compound Interest (3x RBI Bank Rate), stipulated by the MSMED Act since 2006 for MSEs, now gains real enforcement power. The Section 43B(h) Income Tax Act amendment provides the “teeth” by making tax disallowance a direct consequence, significantly penalizing buyers. These reforms collectively ensure robust financial protection and greatly improve the collectability and liquidity of MSE receivables.
Section 43B(h): A game-changer
While the recent insertion of Section 43B(h) into the Income Tax Act represents a monumental step towards ensuring prompt payments to MSEs, its primary mechanism acts as a robust disincentive for outstanding dues specifically at the close of the financial year. It significantly compels buyers to clear these year-end payments within statutory timelines to claim tax deductions.
Despite this provision’s year-end tax consequence, mid-year payment delays still cause liquidity challenges for MSEs. This indicates a clear need for more stringent enforcement and continuous policy vigilance. While ongoing issues exist, the current framework undeniably marks an impactful beginning towards securing timely receivables for India’s vital Micro and Small Enterprise sector.
Why the shift matters now
Nevertheless, lenders have conventionally relied on financial year-end numbers when assessing a borrower’s health as balance sheets are drawn. Consequently, establishing the quick ratio as a core benchmark for MSEs would represent a timely and strategic move by financial institutions, more accurately reflecting real-time solvency. Indeed, any ongoing policy initiatives aimed at guaranteeing prompt and timely payments to MSMEs will progressively incentivise lenders to further shift their focus towards the quick ratio as a key liquidity indicator.
Globally, a quick ratio of 1.0:1 or higher is generally considered healthy, with 1.2 to 1.5 being preferred by lenders in more developed markets like the US and EU. For MSEs, this benchmark can vary by industry — service-based firms may achieve higher ratios than those in manufacturing or trading. As India’s receivables environment matures, aiming for a minimum quick ratio of 1.0 could become a reasonable and prudent benchmark.
India is finally building the institutional backbone needed to make receivables truly liquid assets for MSEs. As timely payments become the norm rather than the exception, it is time for lenders to recalibrate their assessment tools. Embracing the quick ratio is not just prudent — it is necessary.
The writer is AGM, IDBI Bank. Views are personal
Published on July 21, 2025
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