This is the second article in a series of blog posts in which we introduce the concepts of knowledge-based lending for SME business. In this article, we focus on the steps to assess an SME’s business model, strengths and weaknesses as well as the business potential it might provide to a financial institution. The tools presented here are all part of Q-Lana, the digitization platform for knowledge-based lending. We have developed Q-Lana as a comprehensive, fully customizable and intuitive, filled with smart tools and analytics to support financial institutions. For more information about Q-Lana, please read below and contact us
In our first blog entry, we have claimed that providing financial services to small- and medium sized enterprises (SMEs) is among the most interesting and most challenging business areas for traditional financial institutions. Financial services for SME clients require specific understanding of the way those companies conduct business, the entrepreneur’s personality, strengths and weaknesses.
SMEs need Financial Institutions as Business Partners
Independent from the macroeconomic environment, SMEs always feel the challenge of economic developments. SMEs desire banking relationships which help them manage and grow their businesses during times of stability and times of turbulence. SMEs rank cash flow management, credit facilities, financial planning and budgeting tools, cash management services and business growth advice as top financial needs. Forward thinking financial planning advice is critical to SMEs. A smart financial institution provides those services and converts the banking relationship into a business partnership, providing more than just punctual lending or transactional services.
Such a business partnership is best built on structured information collection and the ability to provide value added advise to the client based on expertise and experience. Traditionally, financial institutions have engaged in the assessment of the risk profile of a client only at the time of a credit request. This was both tedious and reactive. It was difficult to monitor a client’s development as the information was split across sequential loan applications.
Splitting up Information in main categories
Best practice breaks with this this sequential information collection process in two ways: it splits the collected information in four main categories and it allows to build knowledge independently from an actual loan request. The four main categories are:
- Individuals, such as borrowers, guarantors, employees of borrowers, contractors etc.
- Companies, borrowers and guarantors, independent from whether they operate as legal entities or as unincorporated ventures
- Facilities, the actual loan products, based on contractual agreements and subject to terms and conditions
- Collateral, which can have various forms, including real estate, other tangible assets, cash, guarantees, etc.
Often, loan officers collect information about borrowers from scratch, every time a new transaction is proposed, the digital platform simplifies this process by making past information available and by providing contextual intelligence about sector, portfolio and comparable companies.
Information about companies can be maintained and assessed, independently from the actual exposure. This also allows a simplified workflow during the application phase and improves the data quality through consistency.
Understanding a Client’s Business Activities
Successful Individual/SME lending is based on long-term client relationships. In order to build a trustful relationship and to be able to provide value added advise beyond the lending activity, it is important to develop a thorough understanding of the client’s business activity, the short and long-term goals. Loan officers can develop a knowledge base about the economic development of the target clients. By creating a professional relationship with borrowers, the loan officer is also cultivating the client’s improved willingness to pay.
Q-Lana provides several tools which can be customized for the specific purposes of the financial institution. Those include
- SWOT Analysis. The analysis identifies a client’ strengths and weaknesses. The strengths relate to core competencies, whereas the weaknesses could lead to poor performance. It also examines opportunities and threats in the wider environment, coming from market, industry and more general trends. A SWOT analysis does not give specific answers. It organizes information as a basis for developing business strategy & operational plans. The simplicity of preparing a SWOT analysis can be beneficial as well as challenging. The following steps should be followed to prepare a useful SWOT:
- List any issue you can think of that might affect the business. Those issues can be subjective as well as objective.
- Sort the issues based on the SWOT categories
- Sort each category first by relative importance and then by likelihood
- Use a reduction process to limit each list to no more than five factors. For that purpose, remove duplicates and prioritize the items
- Collect feedback from senior staff and others
- Abbreviated Business Plan. Every company needs a plan about where and how the business is developing. A business plan can summarize this information. Depending on the potential of a client and the importance of the relationship with the financial institution, the loan officer can support the development of an abbreviated business plan. The purpose of the plan is to set out the strategy and action for the business over the next 1 to 3 years. It is aimed to inform outside parties, such as potential lenders, investors, and staff about the plans of the company. The content of this plan needs to be short, as the details can be left to a more structured and complete plan. It is important that the plan is based on reality. The main sections of an abbreviated business plan are:
- Business and Products: explain the currently offered products and services, as well as the history of the business. Cover topics such as current ownership, description of the products, factors that make the products and services different and beneficial for the clients. Cover the planned new product developments.
- Market and Competition: define the target markets, including information about the size of the market, market share, market trends and potential drivers affecting the market segment. Explain the competitive situation, including the competing products and services as well as their advantages and disadvantages.
- Marketing and Sales: this section answers the questions about the positioning of the products in the market, the pricing policy, promotion strategy, sales channels, and general selling strategy.
- Marketing and Personnel: here, the structure and key skills of management and staff are identified. If necessary, the related recruitment and training plans need to be confirmed. The overall workforce needs to be analyzed including information about qualification, motivation, retention rate, productivity, and salary levels.
- Operations: the capacity and efficiency of the operations and the planned improvements need to be described. What kind of offices/production space is available? How is the production organized? What technology and information systems are in place? What is the competitive advantage of the production?
- Financial Performance: describe the historical financial information for the last years, with a focus on sales per products, gross margins, and overhead expenses. Calculate the key ratios with regards to the components of working capital. List the major capital expenditures for the next periods. Provide a forecast for the next years, including a clear explanation about the assumptions. If possible, carry out a sensitivity analysis with regards to the sales, and the profit margins.
- Business Canvas is a strategic management and lean startup template for developing new or documenting existing business models. It has been developed by Alexander Osterwalder and Yves Pigneur[*]. The Business Model Canvas is a visual chart with elements describing a company’s value proposition, infrastructure, customers, and finances. It assists companies in aligning their activities by illustrating potential trade-offs. The nine building blocks of the canvas are listed in the following, including some key questions to develop the content of those blocks:
- Customer Segments – Which customers and users are you serving? Which jobs do they really want to get done?
- Value Propositions – What are you offering them? What is that getting done for them? Do they care?
- Channels – How does each customer segment want to be reached? Through which interaction points?
- Customer Relationships – What relationships are you establishing with each segment? Personal? Automated?
- Revenue Streams – What are customers willing to pay for? How? Transactional or recurring revenues?
- Key Resources – Which resources underpin your business model? Which assets are essential?
- Key Activities – Which activities do you need to perform well in your business model? What is crucial?
- Key Partnerships – Which partners and suppliers leverage your model? Who do you need to rely on?
- Cost Structure – What is the resulting cost structure? Which key elements drive your cost?
- Sector Checklists. Aside from understanding the company and its activities, it is also useful to assess the company within the sector it is operating. Q-Lana provides sector assessment checklists which can be fully customized at the initial use and updated over time. This helps in assessing the positioning of a company within a specific sector.
Using the tools as described above as well as number of additional instruments, such as Porter’s five forces model or five factors of production will help the financial institution to achieve the goal of better understanding the client and to build a business relationship with him. This process is independent from the actual lending activity and serves as a basis for the development of future business. In the next articles of the blog we will go deeper into the assessment of the clients credit risk, through the use of additional innovative tools and concepts.
About the author:
Christian Ruehmer is the Co-Founder and CEO of Q-Lana. Christian has over 25 years of experience in finance working for several large international banks in the areas or Risk Management, Credit Portfolio Management, and Investment Management. Christian has been an advisor in this sector, working with over 75 MFIs, banks, and international organizations, primarily in developing countries. He is the head of Risk and Compliance at Bamboo Capital Partners and sits on the board of several companies in the finance sector.
Q-Lana provides a digital platform to transform traditional lending into a knowledge-based, risk focused process. By digitizing the initial assessment, application and approval, monitoring and portfolio management process, as well as the collection, the financial institution generates significant knowledge about the performance and the credit quality of the target clients. This can be used to improve lending decisions, avoid losses and provide advanced support to the clients. Q-Lana replicates the existing lending process and allows for modifications to apply best practice. In addition, Q-Lana provides intelligent reporting and customized risk advisory. Q-Lana is based on a SaaS model that integrates well with existing core banking software and can be implemented within a 3-4 month timeframe.