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We often receive questions from retail lenders on small business lending and many in regard to the decisions process.  This post discusses a few of these related questions…

  • What are the most important financial characteristics used to make decisions about small business applicants?
  • My underwriters who make decisions about consumer applicants now have to make them about small business applicants.  How can I train them?
  • Our underwriters make decisions on 100% of our small business applicants.  Is this most cost effective way to make approval/decline decisions and set lines?
  • When there is no data to make a decision about a small business applicant and the exposure is really small, what’s my alternative to time consuming financial spreading?
  • My small business lending process is under the commercial bank umbrella, but I think it would be best served by what I have learned in the retail bank.  How do I start?

Many of us bring consumer credit experience to our small business lending roles.  Management thinks our consumer credit experience will serve us well because they believe small business lending is more similar to consumer lending than corporate or large company lending.

This is partially true.  Most small businesses are owned by a few individuals, so the personal credit background of the owners is a key consideration.  Why do small business lenders place so much weight on the owners’ personal credit histories?  Why not use a business credit report?  Business reporting agencies generally have more complete files on larger companies and little or no information on small businesses.  Plus, there is a strong correlation between how people pay their personal debts and how they handle their business credit.

As a result of the owners’ personal credit histories being a key underwriting factor, many small business scoring models are built on consumer or a blend of consumer and small and medium enterprise (SME) data elements.  However, remember we said earlier that it is only partially true that small business lending is more similar to consumer lending than corporate lending.  Here are elements that factor into SME decisions that are more similar to corporate or large company lending.

  • Profit and loss (P&L) statements:  One of the biggest differences between small business and consumer credit is small business credit looks at formal P&L statements instead of debt-to-income ratios.  Evaluating a business’ revenue and expenses determines the business’ profit margin and its ability to repay loans and withstand tough economic times.
  • Business plan: A business plan provides an overview of the business and a picture of how the business operates and how it expects to succeed.  It is a requirement for most small business loans.
  • Bank statements:  Bank statements allows lenders to analyze the business’ average daily balance and determine its cash flow.  A positive monthly cash flow is a good indicator that the business is profitable and able to repay the loan.
  • Collateral: Collateral requirements vary greatly and are controlled by management policy.  Some loans may not require collateral while others involving high risk factors require substantial collateral.

Determining whether to extend credit to a small business is challenging.  Historically, decisions have been made by analyzing income statements, balance sheets, and subjective measures.  Complicating the issue is the fact that small business financial statements are often not audited or fully complete.  Therefore, tools such as scores, indexes, and scoring services using application, financial, consumer bureau and business bureau data have been created to help small business lenders make better decisions.  Developing a plan to combine the best practices of scoring approaches and tool use will help guide your credit decisions and allow you to monitor results.

Dive deeper into Small Business Lending with Simulation training for retail lenders.

Have a question about Small Business Lending?  Contact us!