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Creditworthiness indicates whether a firm can purchase a business property, expand its business, or start a new one. However, the historical information used to assess it does not always indicate a clear image.
Affluence affects businesses on different fronts. It doesn’t matter whether they’re planning to expand to new markets or renovate/develop their property; organizations need a way to demonstrate to creditors they’re worth the loan risk.
Equally, when creditors extend loans, they want to be sure that they’ll be repaid within the specified time. Lenders utilize the SBA loan lookup process and readily available financial data to determine whether or not a business has wealth soundness.
Facing The Challenging Reality
There is no single procedure or formula for determining a business’s solvency. Different lenders depend on multiple data points to measure their risk. According to research conducted by various institutions:
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27% of businesses claim that they weren’t able to get the funding they required according to NSBA. For these companies, 1-in-4 businesses, the primary impact that a lack of finance had was stopping them from growing.
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20% of business loans are denied as a result of business credit, this is according to NSBA’s Small Business Access to Capital Study.
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According to Small Business by Demand Media, many lenders consider a credit score of 75% as acceptable. That means those with lower credit scores will not qualify for a loan.
Limited Access To Credit
Economic conditions throughout the last several years have created tremendous barriers to entry for small and medium business owners looking to access new lines of credit. Rising interest rates to combat inflation have been one of the biggest pain points for the majority of small and medium-sized enterprises, often resulting in banking stress and the closure of regional banks.
Struggling to find additional financing is further prolonging the scalability progress for SMBs. According to one survey conducted by the global investment bank, Goldman Sachs, 77 percent of respondents felt confident about their access to capital back in 2022. This has however changed in recent months, with the same percentage citing concern over their limited accessibility.
Higher interest rates have increased the volatility in the wider economy, and with SMBs relying on smaller regional banks, amid a time when many of them are coming under severe scrutiny, as with the case of Silicon Valley Bank, many are disproportionately losing their source of funding or have limited options to work with.
Finding Affordable Credit
Looking to start or scale a new project has become harder as interest rates remain historically high, and finding affordable credit is now more challenging due to the economic turbulence experienced throughout the last several years.
For the majority of SMBs credit utilization has continued to be one of the most accessible, and perhaps affordable ways of funding new business-related activities. Credit utilization often takes into consideration the total of all business debts divided by the sum of its credit card limits.
Basically, creditors will use these figures as a way to determine whether a business has maxed out its current lines by assessing a company’s unused credit. One positive thing to consider is that those businesses that are not able to use their full lines of credit across multiple cards are often seen as more likely to repay their debts.
However, this metric puts companies that don’t have credit cards at a huge disadvantage and incentivizes application for multiple credit lines. According to data published by Enigma, credit score details alone do not offer a holistic view of whether the firms are able to repay their loans. Instead, lenders are turning to alternative financial data sources to measure the wealth soundness of businesses.
The lack of affordable credit and capital, usually found within mainstream sources such as regional or multinational banks may lead SMBs to apply for more credit, often at a higher rate of capital compared to non-mainstream sources. These activities further place a financial burden on business owners to consider their scalability and overall success of projects and limit their business activities.
Consumer and Industry Activity
When accessing capital structures, SMBs are placed under immense scrutiny as this allows lenders to revise the purpose of the loan against the general economic climate under which the business is operating.
Additionally, economic environments specific to the industry of the company applying for the loan and the overall state of the economy of the country factor massively into the decision to approve and award a loan.
The reality is that those businesses in a thriving industry during a period of economic growth and stability - technology, finance, fintech - would usually have a higher chance of being approved for a loan by their lender.
The current economic climate has meant that many lenders have increased their assessment requirements, looking to minimize their risks, and grading SMB loans based on economic factors and the overall health of the industry in which the business is operating.
According to industry insights, SMB loan approval percentages at major banks - those with more than $10 billion in assets - have steadily been on the decline since the fourth quarter of 2023.
Between September and October, loan approval percentages declined from 13.1% to 13%, respectively. Similar approval percentage readings were seen during November, with approval ratings stalling at 13%, according to the Biz2Credit Small Business Lending Index.
Approval ratings are still below industry estimates and have been struggling to regain performance since before the pandemic.
On the other hand, things have started to pick up at smaller banks, with approval percentages rising from 19.3% in September to 19.5% in October, and in November, approvals increased to 19.7%, marking a consecutive increase since June 2023.
These improvements shed more light on the fact that SMBs remain dependent on smaller regional lenders to fund their activities. However, the challenging environment under which many regional banks have been since the collapse of Silicon Valley Bank early last year is forcing many small-time lenders to reevaluate their assessment criteria and broader economic indicators.
When a lender decides to invest the loan into a business to help fund activities such as expanding its market or purchasing assets, chances of approval tend to be slightly higher, than if a business is planning to use the funds to generate more expenses.
Lenders typically take into consideration several main factors during their routine assessment:
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Length of time in business.
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Any relevant political, economic, and social forces that could easily affect the business.
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Supplier or customer concentration.
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Dependence on changes in consumer preferences and taste.
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Attractiveness and size of the market.
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The number and strength of competitors.
These factors, are to some extent, a way for lenders to evaluate a business, however, the current consumer climate, which has seen buyers pulling back on discretionary spending could create more challenges further down the line for SMBs looking to tap into new capital opportunities.
Inequality And Systemic Burdens
Even before the pandemic, researchers from the Joint Center for Political and Economic Studies found that minority-owned businesses typically have a harder time accessing new capital. In fact, their research found that around six in ten Black business owners often encounter various challenges when obtaining new capital, while over a third of Hispanic business owners face the same problems.
Additionally, the same research suggests that minority business owners, especially those of color have a harder time accessing startup capital funding, growth funding, and loans with affordable interest rates.
Similarly, the U.S. Federal Reserve has found that female business owners and people of color often experience greater challenges with accessing affordable credit from traditional sources, including big banks and big-league lenders.
Many minority business owners, including women and persons of color, are often evaluated as having a higher credit risk. New credit and capital lenders will determine the validity of their risk in part by lower owner wealth, lower business revenue, and being unable to deliver a sufficient credit history.
Similar to individual credit scores, businesses also have credit scores. Landers calculate these scores based on different factors, including compliance management background, debt service track record, credit history length, credit utilization, and payment history. These elements of data often help lenders determine the risk of borrowers and indicate a business’s solvency.
This problem, however, isn't only confined to minority business owners, including people of color. One research study from the Urban Institute found that young Black and Hispanic consumers tend to have lower credit scores compared to other racial groups.
Between 2010 and 2021 nearly a third of 18 to 29 years olds in majority Black communities witnessed a decline in their credit scores. Similarly. 26% of Hispanic consumers saw their credit scores decline, while only 21% of those in majority-white communities experienced a decrease in credit scores.
The seemingly cyclical conditions create a chain reaction that leaves persons of color, and potentially large parts of the female population excluded from attaining affordable capital, either to fund new business ventures or scale their activities.
How Business Owners Can Benefit From Up-To-Date Credit Information
Correct assessment of accurate and up-to-date credit data allows lenders to determine businesses to which they will offer their products and services. This significantly minimizes the risk of financial loss. If lenders use accurate and up-to-date data to assess a company’s creditworthiness, they can be able to enjoy these key benefits:
Competitive Advantage
Businesses can gain a much-needed competitive advantage by simply recognizing consumer solvency. Deeply understanding the effect that a business’s credit score has on its ability to obtain loans and buy services and goods is vital for any company looking to determine potential clients.
Additionally, having access to accurate and up-to-date data enables organizations to establish marketing strategies tailored toward businesses in different credit tiers. Doing so helps establish targeted campaigns explicitly formulated for those interested in certain services or products. This boosts efficiency when it comes to reaching desired markets.
Businesses can then extend their reach into underbanked segments while, at the same time, mitigating some risks associated with offering alternative lending solutions or payment plans.
Enhanced Risk Management
Organizations and businesses need to implement enhanced risk management practices. Businesses can make more informed decisions in terms of affluence as well as related risks by taking proactive steps toward understanding their consumers better.
By employing the right strategies, a lender may be well-equipped to accurately assess creditworthiness while at the same time mitigating any potential losses as a result of fraud or non-payment.
Increased Revenue
Increased revenue is a popular and widely accepted business practice. Businesses can make data-driven decisions about companies they would like to do business with. This helps them maximize their revenues by sidestepping unnecessary losses.
Additionally, companies can benefit from enhanced customer relationships as a result of better communication practices depending on the assessment results. This significantly boosts trust between the two sides, leading to improved loyalty that translates into higher revenues for organizations.
Driving Change & Finding New Opportunities
Accessing affordable capital remains a long-lived challenge for small and medium-sized businesses. These obstacles are preventing many from scaling their operations or reaching new markets.
Though these circumstances may be temporary, considering the current economic climate, business owners are left having to choose from a limited number of available or affordable options.
Without the proper resources or guidance, SMBs are continuously relying on smaller regional lenders for their capital needs, however, these alternatives remain a short-term solution in comparison to the larger picture.
Yet, many of these challenges remain rooted within the financial system. However, change is possible, as more and more business owners are seeking to find alternative sources of funding that allows them more freedom to expand and the ability to foster new relationships.
Fixing the problem isn’t a one-size-fits- all scenario, but instead takes on to bring into question how every small and medium enterprise can help drive change, and establish a more progressive business environment.