5 Great Ways to Determine Your SME Customers Creditworthiness
Whether you’re a bank, an alternative lender, or some other financial institution, you want small and medium-sized enterprises to take out and repay loans. Though you can make money by collecting interest and fees on the given loans, lending funds to the wrong applicant will result in losing money. So how you can determine whom to approve for a loan.
Underwriting is the process a financial institution uses to decide which business applicants to accept or deny and what terms to offer on its loans. In a nutshell, it is the process of determining a borrowers’ creditworthiness.
Since providing loans to small and medium-sized businesses can be risky, it’s vital to gather and analyze data from a variety of sources before making a decision.
What Factors do Lenders Look At When Determining SMEs Creditworthiness?
Get Information from the Application
When SMEs submit a loan application, they provide lenders with a variety of information such as name, address, annual revenue, business history, and more. You can use this data to help identify your borrowers’ identities and pull their credit reports.
Some of these metrics are a great way to determine an SME’s creditworthiness. For example, you can compare an SME’s annual revenue to its monthly debt obligations from credit reports and an SME’s monthly rent and utility payments to determine the income to debt ratio. This ratio could help it decide how much additional debt a business can afford to take on.
Credit Score
Your borrower’s personal and business credit score is one of the most important factors to determine creditworthiness. A credit score shows a business bill payment history, current debt, and other financial information. It is a summary that tells you of how a business has handled credit accounts in the past.
You can use credit scores to check the ability of a business to repay the borrowed amount. Since a credit score affects whether a business can qualify, the amount you receive, and the repayment terms and interest rates, you can provide better loan products.
Collateral
If an SME has applied for a secured business loan like an SBA loan, term loan, or long-term business line of credit, you will also consider information about the personal or business assets your borrowers are using as collateral.
If you’re offering a secured loan, you can determine the creditworthiness of a small business by knowing the current market value of given collateral. Real estate, equipment, inventory, outstanding invoices could be important factors in determining if you should provide the loan to a business or not.
Credit Bureau Data
Your business customers’ credit report contains information about their history with loans and other credit. You can use this information directly from their credit report to determine their creditworthiness.
Your customers’ credit reports could also impact their loan applications because most generic credit scores are based entirely on the information on their credit scores. However, these bureaus are starting to look at futuristic data as well.
Forward-Looking Cash Flow Data or Alternative Data
Last but not least — forward-looking cash flow and alternative data is the best way to check an SME creditworthiness. Forward-looking cash flow data doesn’t just help small business owners visualize how money is moving in and out of a borrowers’ business, it also allows lenders to determine the creditworthiness of business owners, particularly for those without credit histories.
While in the conventional lending underwriting process, lenders only considered a few metrics like income, credit score, business history, and collateral. Lenders today, using forward-looking cash flow data, can look at an entrepreneurs’ entire business life and their vast financing footprint to determine how likely they are to default.
Besides, lenders can collect and analyze alternative data on creditworthiness based on information readily available in the digitized form such as online rankings, utilities, and mobile phone data, social media and internet data, and more.
Today, many fintech companies are creating lending APIs that lenders can use to access various financial, accounting, banking, cash flow predictive data, and alternative data. In the future, this data and information will help SMEs to obtain fast and easy funding and lenders to better determine the borrowers’ creditworthiness, offer the right loan products, and make informed lending decisions.
