Member Article

SME risk and opportunity: Four key data categories lenders should consider

In the current economic climate, the year ahead will likely continue to be testing for UK small businesses and also to those who lend to them. The last few years have presented major challenges for UK SMEs, from increasing Brexit-related bureaucracy, to rising inflation and major increases in energy costs. But the good news for lenders is that, almost in spite of these tough macro-economic conditions, many UK businesses remain steadfastly resilient.

But although many SMEs continue to show resilience in the face of rising business costs, this is not, unfortunately, the case for all SMEs in all sectors. From my perspective, there are a few key categories of data that lenders should be looking out for in small businesses in order to make the best commercial lending decisions through these challenging times.

1. Credit Risk

The current economic conditions are impacting different business sectors in a multitude of ways. We can see this through defaults rising at a much faster rate for accommodation, food services, retail, logistics, manufacturing, and other energy intensive companies compared to other sectors of the SME market. Additionally, we are seeing a demand for loans being impacted in these industries in particular, partly due to lack of confidence among lenders.

As a result, certain customers, and prospects are likely to have significantly higher credit risk profiles. Conversely, the opportunities to identify and onboard ‘low-risk’ customers are far greater for SME sectors less affected by higher energy prices, such as agriculture businesses and providers of support services, postal and land transport services. If lenders hone-in on these areas, they can continue to identify significant market opportunities and grow their portfolios sustainably.

2. Survivability

Experian’s SME Survivability score shows us that 11% of UK SMEs will likely fail in the next year, increasing to 16% over the next three years. Professional services, retail and food services being the sectors with the highest numbers likely to fail within a year. With only 8% of SMEs likely to stay in business 11 years or more, this tells us that this is a measurement that lenders should keeping a close eye on particularly through current economic turbulence.

Lenders need to take into consideration the life expectancy of the business – particularly looking into the track record of success. This may be supported by factors such as how a small business has established themselves in their market, fought off competitive elements and made the necessary course corrections.

3. Growth

Furthermore, the measurement of growth potential of small businesses is extremely important for lenders to take into consideration. This includes factors such as the market opportunity, the business’s competitive advantage, and the management team. When lenders are analysing a small business – it’s important that the lender feels that that they have a good chance of growing and generating more revenue in the future on a long-term basis.

4. Affordability

Lastly, it’s key to know the measure of a business’s ability to afford further lending. With it not being mandatory for all small, limited companies to file profit and loss figures, the use of core bureau data to assess their capacity to take on further debt is paramount in determining whether to approve additional financing. Sometimes, individual customers are impacted by factors that are difficult to understand and factor into lending decisions.

Moving forward

It’s key for lenders to recognise that there are still genuine opportunities to lend profitably and successfully to small businesses. Afterall, our insight highlights remarkable resilience since Jan 2020 with a net surplus of 750,000 more newly incorporated businesses compared to insolvencies and average business credit scores only dropping 6% from 45.3 to 42.5.

These four data considerations provide lenders with a far richer picture of small businesses. Using these measures, new opportunities, and risks – hidden from view when using business credit scores alone – appear clearly.

Through the combination of data from the SME market with customer financial information and broader economic forecasts, lenders can create a full view of credit risk to protect their portfolio and business for the long term. SMEs with the right profile that are, undoubtedly, excellent prospects for those that can find them.

This was posted in Bdaily's Members' News section by Gareth Rees .