Financial Analysis is not Credit Risk Assessment (SME Lending Models 2)

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.

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