Debt Management in MSMEs: A Practical Guide to Growth, Risk, and Financial Resilience

Introduction

In many micro, small, and medium enterprises (MSMEs), particularly those operating in smaller cities, borrowing is often seen as an essential catalyst for progress. Debt can enable a business to move beyond modest operations and build larger capabilities, whether by expanding production capacity or widening a retail footprint. When used thoughtfully, borrowing can enhance credibility and signal intent to scale; however, the boundary between prudent leverage and a crippling burden is delicate and context-dependent.

There is no one-size-fits-all threshold for what constitutes “too much debt.” The safety of a debt level shifts with prevailing interest rates, market demand, and how efficiently a company manages its receivables and cash collection. A debt load that is manageable in one sector or business model could sink another with the same nominal numbers. Practically, the key is to assess debt in relation to real cash flow, not just top-line numbers or asset size.

Productive borrowing versus Defensive borrowing

Debt should primarily serve investments that create new value and increase future cash flow. When funds are used to acquire productivity-enhancing assets—such as a CNC machine that raises output or an ERP system that reduces waste—the loan becomes an asset that helps the business generate more revenue and eventually repay itself. This kind of borrowing typically includes a clear end point when the asset remains but the debt is fully settled.

In contrast, defensive borrowing occurs when funds are borrowed to cover ongoing, non-growth expenses—like tax dues, statutory obligations, salaries, or settling old supplier dues. These loans do not generate fresh income; they merely sustain an existing operation. Such debt tends to accumulate costs without creating a path to higher profitability, increasing the risk of a slow, unproductive expansion that traps the business in a cycle of payments.

The Turnover trap and the EMI pitfall

A common misstep among MSMEs is chasing rising turnover while neglecting liquidity. High sales can coexist with cash shortages if money is tied up in receivables or effectively frozen in inventory. Lenders often push debt based on turnover metrics, but the real health measure is how quickly cash returns from operations—the cash conversion cycle.

Similarly, the popular “Monthly EMI Test”—where a business feels safe if monthly profits exceed the EMI by a small margin—can be dangerously optimistic. Markets fluctuate, input costs can spike, and delayed payments from clients may disrupt cash flow. A prudent standard is that operating profits should comfortably cover debt service, ideally with a generous cushion of 1.5 to 2 times the EMI, so the business can weather cyclical downturns.

When turnover looks impressive but liquidity is weak, the business risks a fragile balance that collapses under even modest stress. The focus should be on preserving flexibility in the balance sheet and ensuring that the debt supports sustainable growth rather than masking underlying cash-flow problems.

Warning signs of over-leveraging

Over-leveraging often whispers its presence rather than shouts. A key red flag is the heavy reliance on overdraft (OD) or cash credit (CC) facilities that reach their limits and stay exhausted, with the account rarely solvent. If a business frequently seeks temporary enhancements to maintain operations, it signals that debt has crossed into a chronic liquidity problem rather than a short-term need.

Another warning is the elongation of suppliers’ credit terms and delayed payments to suppliers to prioritize meeting bank obligations. This behavior erodes market reputation, damages supplier relationships, and can raise procurement costs as lenders and suppliers become wary of the credit risk.

When a business starts diverting short-term, high-interest loans from informal sources to service formal debt—essentially borrowing to pay existing creditors—it indicates a debt trap. Rather than supporting growth, the debt stack has begun to control daily decisions and strategy.

The personal cost: collateral and peace of mind

For many Tier-II entrepreneurs, business is inseparable from family and home. A large portion of MSME lending is secured by personal assets, such as residence, gold, or land. When debt grows too large, the risk extends beyond the office to the home and family dynamics, generating constant fear around EMI payments and future liquidity.

The psychological burden can erode the promoter’s ability to take calculated risks or pursue long-term opportunities. A healthy business, therefore, should be structured so that even a meaningful drop in revenue does not imperil the promoter’s basic living standards. Debt should be a tool for growth, not a source of ongoing stress that limits strategic thinking.

Strategic correction: steering back to safety

If over-leverage is evident, the first corrective step is to catalog every liability—banks, formal loans, and informal borrowings—along with interest rates. High-cost, short-term debt should be targeted first for repayment or refinancing. A common misalignment is using short-term funds to finance long-term assets; correcting this by switching to longer-term, lower-interest facilities can provide breathing room to fix operations without increasing risk.

Second, strengthen internal efficiencies before seeking new finance. Evaluate working capital components such as inventory and receivables: reduce dead stock, accelerate collections, and extend payables where feasible if it improves overall cash flow. Improving the cash conversion cycle—even by modest margins, such as a few days—can unlock liquidity that reduces the need for additional borrowings.

Finally, reflect on debt structure and purpose. Distinguish between debt that enables expansion and debt that merely sustains current operations. This clarity helps in designing a more disciplined financing plan and prevents a drift toward perpetual borrowing, which can erode profitability and strategic flexibility in the long run.

Conclusion: toward sustainable, cash-driven growth

There is no universal debt threshold that guarantees safety; instead, persistent stress, reduced operational flexibility, and constant reliance on fresh funds to cover old obligations signal danger. Sustainable growth rests on building financial resilience through disciplined cash-flow management and selective, value-adding borrowing. The overarching message is to reframe debt from a default solution to a carefully calibrated instrument that amplifies value when used strategically and scales back when it threatens stability.

In short, debt, when wielded with discipline, can help a business reach higher peaks. But it ceases to be a helpful ally when it becomes the primary driver of daily decisions. The emphasis should be on achieving profitability that is robust enough to withstand shocks, preserving the promoter’s peace of mind, and ensuring a viable path to long-term prosperity.

Author note

Thought leadership on MSME finance emphasizes balanced debt governance and prudent liquidity management, underscoring that growth hinges on cash flow efficiency as much as on asset accumulation. This synthesis reflects the core ideas of responsible leveraging for growth, with practical guidance for leaders navigating financial risk in dynamic markets.

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