The Importance of Bank Statements for Credit Decisions in SME Lending
Whether you're a budding entrepreneur looking to fund your start-up or an established business seeking to expand, gathering the necessary documents for your loan application is an essential first step.
One of the most critical documents that you will submit are the business bank statements. It can be helpful to SME business owners to understand why lenders ask for bank statements and what role they play in credit decisions. We have written this blog to offer a deep dive into the use of bank statements in credit decisions for SME lending.
Assessment of Cash Flow: Bank statements provide a clear picture of a borrower's cash flow over a specific period. Lenders can analyse deposits, withdrawals, and the frequency of these transactions to understand how a business manages its finances. Positive cash flow is an indicator of a healthy financial position and the ability to meet debt obligations.
Income Verification: Bank statements serve as a source of income verification. Lenders can cross-reference the information provided in loan applications with the actual deposits into the borrower's bank account. This helps confirm the accuracy of the income and revenue figures submitted in the application.
Account Activity: Bank statements reveal a borrower's financial behaviour, including spending patterns, savings, and overall financial responsibility. Lenders look for signs of responsible financial management, as it suggests the borrower is more likely to meet their loan obligations.
Risk Assessment: Lenders use bank statements to assess the risk associated with lending to a particular individual or business. Irregularities in bank statements, such as frequent overdrafts, returned checks, or bounced payments, may signal financial instability and higher lending risk.
Debt Obligations: Lenders can identify existing debt obligations by reviewing bank statements. This information is vital in assessing a borrower's capacity to take on additional debt and still manage their finances effectively.
Cash Reserves: Bank statements also show the presence of cash reserves. Having a cushion of savings in a bank account can provide a level of comfort to lenders, as it indicates that the borrower has a financial safety net in case of unexpected expenses or business downturns.
Fraud Detection: Bank statements help lenders detect potential fraud or misrepresentation in loan applications. Discrepancies between the information provided in the application and the bank statement could raise red flags and prompt further investigation.
Seasonal Variations: For businesses with seasonal fluctuations in income and expenses, bank statements are especially useful. Lenders can assess how well the business manages its finances during both peak and off-peak seasons.
Identifying Unreported Income or Expenses: Bank statements can reveal sources of income or expenses that were not disclosed in the loan application. Lenders may need to adjust their credit decision based on this additional information.
In summary, bank statements play a crucial role in the credit review process by providing lenders with real-time, verifiable financial data about a borrower's income, expenses, cash flow, and financial behaviour. This information helps lenders make informed decisions about the borrower's creditworthiness and their ability to meet their debt obligations.