Financial analysis is the most exciting part for many bankers. Evaluation of ratio trendlines, NWC availability or future cash flows is logical & fun way to credit decisioning. Possibly the next best thing to being an oracle! Who can counter argue when nos. show the future?
Here is what spoils the fun: In most geographies, compliances for SMEs are often simplified. Add to this, limited/informal sources of capital, costly professional book-keeping, bundling of personal & business expenses and temptation to ‘save’ tax.
Result: Unreliable documentation, unverified cash sales, half-baked cash flows or overcooked financials, ‘customised’ to bank’s needs!
Bottomline: Risk evaluation is much beyond Financial analysis. Depending on segment, financials may be a ‘good indicator’ or ‘absolutely irrelevant’.
Therefore, building a comprehensive ‘Credit Risk model’ is key to success in SME lending. Its nuanced. Relating industry risks to business, building surrogate data points/references and enhanced skill to probe during personal discussions are some of the building blocks. Weight of each is determined by market dynamics and strategic clarity on Risk-Reward matrix.