working capital lendiing operations Archives

Working Capital Lending Risk Assessment: Best Practices & Pitfalls

In the current financial year, businesses are expected to require Rs 11.2 lakh crore in working capital, up from Rs 8.7 lakh crore in the previous year. As a result, businesses will need more capital to meet their operational expenses, such as inventory purchases, salaries, and other expenses. As the lending sector becomes increasingly competitive, it is also crucial for lenders to understand the importance of risk assessment in working capital lending.

In this article, we will discuss the meaning of risk assessment in working capital and the best practices and pitfalls to avoid when assessing risk in working capital lending.

What Is Working Capital?

Working capital is the amount of money needed to run a firm on a daily basis, such as paying for goods, employees, rent, and other operating expenses. It is the sum of a company’s current assets and current liabilities.

Cash, accounts receivable, inventory, and other short-term assets comprise a company’s current assets, while current liabilities comprise accounts payable, short-term loans, and other debts due within one year.

Working capital lending is borrowing funds to support a company’s short-term operational needs, such as wages, rent, and inventory purchases.

Why Do We Need Working Capital Loans?

Here are some of the reasons why working capital lending is necessary:

Managing cash flow

Cash flow changes are expected in businesses due to a variety of factors such as seasonality, economic cycles, and unanticipated expenses. Working capital lending assists businesses in managing their cash flow by giving access to funds when needed.

Supporting growth

As they expand, businesses may need to invest in additional inventory, equipment, or personnel. Working capital lending assists in financing these expenses, allowing businesses to develop without depleting their cash reserves.

Keeping operations running

Unexpected expenses or a decrease in revenue may occur in various instances. Working capital lending helps bridge the gap between income and expenses, allowing firms to continue operating despite tough times.

Avoiding cash shortages

Businesses that lack sufficient operating capital may struggle to pay their payments on time, resulting in late fees, penalties, and lowered credit scores. Working capital lending allows businesses to avoid cash constraints and maintain a solid financial status.

How Does Risk Assessment Work in Working Capital Lending?

Risk assessment in working capital lending is the process of evaluating a borrower’s creditworthiness and determining the possibility of payback of a loan used to finance the company’s operations.

The assessment examines several aspects that may affect the borrower’s capacity to repay the loan, including their financial situation, credit history, collateral, and industry/market trends.

Risk assessment aims to assist the lender in determining the right amount of credit to issue to the borrower and to reduce the chance of default.

A lender, for example, may utilise risk assessment to examine a small firm that requires a loan to purchase inventory. To estimate the likelihood of repayment, the lender may examine the company’s financial statements, credit history, and industry/market trends.

What Are the Best Practices for Risk Assessment in Working Capital Lending?

Working capital loan risk assessment is a process that evaluates a borrower’s creditworthiness and determines the right amount of credit to offer.

The steps involved in risk assessment in working capital financing are as follows:

Initial Screening

The first phase in the risk assessment process is to screen the borrower to see if they match the lender’s basic eligibility requirements. Verifying their identity, business registration, and creditworthiness are all part of this process.

Data Collection

The lender then gathers information on the borrower’s financial situation, credit history, collateral, and industry/market trends. Examining financial documents, credit reports, and collateral values is part of this process. In addition, the lender may undertake site visits and interviews with the borrower’s employees.

Risk Analysis

Lenders analyse the borrower’s creditworthiness, credit scores, collateral values, and industry/market trends to evaluate the borrower’s creditworthiness and potential risks. Additionally, the lender assesses the borrower’s ability to generate cash flows and repay the loan.

Credit Decision

Based on the risk analysis, the lender makes a credit decision on whether to approve or deny the loan application. If the loan is accepted, the lender calculates the right amount of credit to offer and the loan’s terms and conditions.

Monitoring and Reporting

Once the loan has been disbursed, the lender will conduct continuous monitoring and reporting to ensure that the borrower is abiding by the loan’s terms and conditions.

Examining financial documents, credit reports, and collateral values is part of this process. The lender also monitors the borrower’s credit history and any changes in their financial situation.

The overall risk assessment in working capital lending involves gathering and analysing data to determine a borrower’s creditworthiness.

Avoid These Common Risk Assessment Pitfalls in Working Capital Lending

In the lending industry, risk assessment is critical to working capital lending, but if not conducted thoroughly, it can lead to significant pitfalls, including:

Over-reliance on collateral

To secure the loan, the lender should not rely primarily on collateral. In the event of a default, collateral may not be adequate to cover the loan amount.

Ignoring market and industry trends

The lender should not overlook market and industry trends. Failure to consider industry and market developments may result in lending to a company with limited future possibilities.

Inadequate financial statement analysis

The lender should not depend simply on the borrower’s financial statements without undertaking a thorough examination. Inadequate analysis may result in a loan being made to a company that cannot repay it.

Failure to undertake site visits

Without site visits, the lender should not depend exclusively on the borrower’s financial statements. Site visits allow you to learn about the borrower’s operations and management procedures.

Summing Up!

Risk assessment in working capital lending is critical for lenders to ensure timely repayment of loans. Analysing the borrower’s financial accounts and reviewing the borrower’s credit history are effective practices for risk assessment. Effective risk assessment strategies can help prevent defaults and reduce losses for lenders.

Fintech tools can help in risk assessment by leveraging advanced algorithms and machine learning techniques to analyse large amounts of data, identify trends and patterns, and generate insights that can help lenders make informed decisions.

Finezza is a fintech tool that offers risk management services to banks and NBFCs, enabling them to offer their customers a complete, fast, and error-free lending solution. Providing end-to-end loan management and credit evaluation solutions for lending businesses,

Finezza’s advanced document identification and verification capabilities you can easily extract information from verification documents such as PAN cards, balance sheets, and much more. In addition to saving time, this automated feature increases workflow speed with no chance of human error.

Hence, financial institutions can better anticipate financial and non-financial risks, such as strategic, funding, legal, political, etc.

Easy Tips to Secure a Working Capital Loan

Lending Lifecycle Management

Running a small business is not an easy feat. One has to manage finances, ensure product fulfilment, and manage customer service. Seasonal fluctuations or drops in sales lead to a host of challenges, many of which need a working capital loan to be resolved.

A working capital loan provides businesses with financial assistance to stay afloat. It helps fund daily expenses, pay employee wages, purchase inventory, and pay overhead. However, a loan application can be challenging and time-consuming.

What is a Working Capital Loan?

A working capital loan is used to finance a business’s short-term expenses, such as wages, rent, etc. A financial organisation or lender provides this type of loan.

Small to medium-sized companies that cannot meet their day-to-day operations avail of this loan. The loan tenure is six to 12 months, and the interest lies between 11-16%.

Below are the features:

Loan amount: The amount varies for each business and depends on the business’s requirements, preferred tenure, etc.
Interest rate: The interest rate varies depending on the bank and lending organisation.
Collateral: The loan can be secured or unsecured, i.e., you may or may not be required to pledge collateral to obtain the loan.
Loan applicant: Entrepreneurs, private or public companies, sole proprietors, self-employed people, MSMEs, and partnership firms can apply for the loan.

5 Tips for Securing a Working Capital Loan

Filling out loan applications can be tedious and time-consuming. The loan-granting process takes even more time. So, read the following tips to improve your chances of obtaining a loan.

1. Know the Different Working Capital Loans

There are several working capital financing options. You must be aware of them and select them based on your business needs.

Short-term or long-term loans – Short-term loans have a tenure of 96 months, whereas long-term loans have a tenure of up to 8 years.
Unsecured loans – They don’t require collateral.
Secured loans – They require collateral such as property, assets, etc.

2. Ensure Your Credit Scores Meet the Lender’s Requirements

A credit score is a number that rates a person’s creditworthiness and represents the business’s capacity to repay the loan. While sanctioning loans, lenders check the business’s credit score. Most lenders prefer a credit score above 750.

The following factors decide your credit score:

Credit history
Payment history
Unpaid debt

Other factors, such as the age of the business and cash flow, also make a difference. For example, if your company has existed for more than two years and you have a consistent cash flow, you can avail of the loan.

To improve your business’s credit score, pay your bills on time, ensure the business debt is low, pay EMIs on time, and keep credit balances low.

3. Prepare Your Bank Statements and Other Documents

Lending organisations check bank statements to assess the financial position of your company. They analyse the cash inflows and outflows to check your repayment ability. They also check your finances to know whether you maintain cash reserves in your account.

Moreover, bank statements provide the transaction history, including withdrawals, deposits, credit card payments, bank service fees, etc. The lender will analyse the transaction history based on the bank statements to assess your ability to repay the loan.

In addition to the bank statements, the lender will ask for other documents, such as:

Application form

2 Valid identity proof

Address proof
Latest ITR

The documents you’ll require will vary based on the type of business. So, check with your lender for the documents you’ll need for the loan application. Then, keep these documents ready to speed up the application process.

4. Have a Clear Reason for Taking the Loan

A business may require a working capital loan for several reasons. Some examples include:

Meet day-to-day business operations
For purchasing inventory or increased operation costs
Hiring new employees to grow the team
Replace broken equipment and tools with new ones
Pay rent and moving costs
Cover marketing costs

5. Maintain Cash Flow

A lender chooses a loan applicant who is more likely to repay the loan on time. Your cash flow figures reflect if you can repay your debt.

Here are some tips for managing your cash flow:

Reduce unnecessary expenses
Pay bills and debts on time
Send invoices quickly and include terms related to late payment
Offload inventory that doesn’t sell
Pay invoices in your business’s name
Incentivise customers with discounts for paying before the time

Bottom Line

The tips above will help you qualify for a working capital loan to accomplish your goals. Additionally, you should have a loan repayment strategy to maintain a good credit history.

Finezza’s lending lifecycle management platform and credit evaluation system help lenders optimise their lending operations so they can offer faster loans to businesses. Finezza’s solutions will help you organise and streamline your lending operations.

The Loan Management System and Loan Origination Software help lending organisations process KYC documents and loan applications. Contact our team today for more details.

7 Reasons Why Your Working Capital Lending Operation Needs to Be Updated

Lending Lifecycle Management

Technological advancements have changed lending significantly – banks are integrating fintech and modern loan origination software in their legacy systems. And automation has enabled small players to compete with banks by offering loans at competitive rates. However, since technology keeps changing, you’ll need to update your working capital lending operation to stay relevant.

While automation has helped lenders improve productivity, efficiency, and speed of making decisions, it also requires you to stay aware of changes in technology and customer behaviour.

Let’s further understand why your working capital operation needs to be updated regularly.

7 Signs Your Working Capital Lending Operations Need To Be Updated

The lending market has become competitive; hence your lending operations need to be updated to meet consumer demands and achieve business goals. Keep reading to find out if your lending operations need to be updated or not.

1. Not able to achieve business goals

Are you unable to convert loan applications while your competitors are moving ahead? If yes, your marketing software may not correctly integrate with your loan origination software. To run your working capital lending operations smoothly, your loan software should allow seamless third-party integrations.

Finezza’s loan origination software easily integrates with different APIs for a faster exchange of information and provides an end-to-end solution to achieve your business goals.

2. Lack of credit assessment tools

Credit assessment is an essential process for successful lending. However, usually, lenders manually collect and analyse borrowers’ information to assign a credit score. This process is prone to errors and time-consuming as it can take days or weeks.

With the right automation tool, you can scale the loan processing while ensuring that the decision is accurate. Finezza’s loan origination system uses credit assessment tools to analyse Bank Statement Analysis and Financial Statement Analysis. It also uses a unique scoring model to predict how successfully the applicant will repay the loan.

3. Frequent data security breaches or hacks

With rising cybersecurity threats, breaches, and hacks, data security has become essential. If your lending software is outdated, it will not be able to detect threats, which will lead to frequent breaches.

Since, as a lender, you have a large amount of confidential data, such breaches can affect your business operations and tarnish your reputation. Hence, you need to upgrade to software that complies with all data security regulations and has several checks in place.

Finezza’s uses in-built threat detection features to identify and classify different transactions.

4. Lack of good customer support channels

With the emergence of chatbots and customer support tickets, customers expect quick resolution of their problems. Hence, a contact us page or phone number will not do the job. Customers might get annoyed if they don’t have access to a proper communication medium.

If your customers are annoyed as their issues are not being addressed on time, you need to upgrade to a lending software, which makes it easy for them to communicate with you. Plus, customers should be able to contact you regardless of the medium they use – phone, email, messenger, etc.

5. Lack of end-to-end solutions

Your working capital operations can be affected if your software provides partial solutions. In this case, you’ll have to use several different tools to manage other processes, which can lead to miscommunication.

Hence, opt for lending software that provides end-to-end solutions, such as underwriting, origination, reporting, etc. In addition, it will help you integrate various processes so that your working capital lending operations are automated while requiring minimum input.

6. Your lending software is not user-friendly

There is cutthroat competition with small players competing with banks to offer loans. In this market, the lending software you use for your working capital lending operations needs to be user-friendly.

The borrower will likely leave if the website or app is not easy-to-navigate. The software you use for your lending operations should be easy-to-use, and the features should be easy to understand. Opt for a software that has a simple and intuitive UI and UX, and the user should be able to learn about the features in less time.

7. Not using alternate credit scoring

Alternate credit scoring is used to provide a credit score to first-time borrowers to bring these sections of society within the lending fold. However, since first-time borrowers don’t have previous borrowing history, traditional banks consider their application risky.

On the other hand, modern lenders use alternate scoring techniques to underwrite loan applications of first-time borrowers. Alternative credit scoring tools use machine learning and deep neural networks to analyse the purchase habits of such applicants to identify their creditworthiness.

If you are not already using alternate credit scoring tools, you need to upgrade to identify applicants who seem risky to traditional banks.

Wrapping Up

Lenders with time-consuming, manual, and lengthy working capital lending operations are likely to churn out loans slowly and provide a bad customer experience. Hence, you should regularly update your processes to ensure they are optimised and timely.

Suppose you are not able to achieve your business goals. If you experience frequent security threats and manual processes are slowing down your business, you should invest in a good loan origination system.

Finezza offers robust end-to-end loan origination software, which will cater to your needs and provide your customers with a great experience. Some of the key features of the LOS are automatic document identification, easy integration with APIs, loan eligibility estimator, bank statement analytics, credit assessment tools, 360-degree customer profile assessment, and threat detection checks. Get in touch with us today to learn about our loan origination software.

working capital lendiing operations