FIN367 – Sub-Topic 3.2 Notes : Evaluation of SME Lending Applications

Mapping the Evaluation of SME Lending Applications

End–to–end process links SME application documents to lending outcomes.
Core documents collected:
- SME Application Form
- Business Plan (BP)
- Historical & in-house Financial Statements
- Key Information Set (borrower, industry, market)
Information flows through three analytical blocks
1. Credit-Request / Borrower Analysis (non-financial focus)
2. Business Plan Analysis (strategic & operational focus)
3. Financial Analysis (quantitative focus)
Desired quality chain
1. Credit analysis quality → accurate 5Cs / CAMPARI assessment
2. Credit decision quality → “accept good, reject bad” applications
3. Credit-portfolio quality → low NPL, high profit, sustainable ROE
Non-financial characteristics = character, management competence, business model viability, industry conditions.
Financial characteristics = leverage, profitability, liquidity, cash-flow adequacy.
“Apply some norms” → internal scorecards, sectoral benchmarks, regulatory requirements.

Credit-Request Analysis (3.2.1.1)

Purpose: verify applicant legitimacy, ownership, purpose & structure of facilities requested.
Standardised vs non-standardised forms
- Banks (e.g. Maybank) publish both to suit borrower sophistication & product mix.
- Key focus areas (Berry et al., 1993)
  • Borrower & type of business: confirm SME eligibility & capacity
  • Purpose of borrowing: genuine financing need
  • Type of finance required: matching facility to business needs
Typical Credit Facility Summary items
• Facility type • Purpose • Amount • Rate • Tenor/repayment • Security
Maybank Philippines SME Loan (extract)
- Requires disclosure of Beneficial Owner, waiver of confidentiality, consent for information sharing.
- Documentary checklist (15+ items): 3-yrs AFS & ITR, SEC/DTI docs, GIS, permits, 3–6 m bank statements, customers/suppliers list, principals’ resumes & IDs, land titles, tax receipts, floor plans, etc.
- Application captures: company profile, capital stock, paid-up capital, facilities requested (RCL, DL, LCTR, Term, DBPL), plant location & size, employee count, sales mix, ownership table, banking lines & collateral.

Business Plan Analysis (3.2.1.2)

BP is mapped directly to the 5Cs; findings migrate into the Credit Report.
Investment-criteria literature
• Mason & Stark (2004); Tuyon et al. (2012): bankers favour clarity, realism, management quality.
Credit Report must later contain
- Borrower background, facility purpose & utilisation, transaction/project details, ownership/top management profiles, business operations, economy/industry/market review, historic + forecast financials, collateral evaluation, risk & mitigation, final recommendation.

BP Detailed Structure & Content

Introduction
- Cover letter & Executive Summary (financing request, terms, venture overview).
Company & Industry Review
- Company background (legal form, registration, start-up vs expansion, strengths/weaknesses & mitigation).
- Owners’ background (qualifications, experience, shareholding).
- Business location & advantages.
- Industry review & opportunities (life-cycle, PEST, sustainability).
Marketing Plan
- Product/service description (unique features, sustainability fits).
- Market analysis: target market, size, sales forecast (best/moderate/worst), market share goals.
- Competitor analysis: main rivals, SWOT, differentiation strategy.
- Marketing mix: product, pricing, promotion, place/distribution.
Operations Plan
- Process description & flow-chart; production schedule & breakeven.
- Material, manpower, machinery & equipment requirements; layout & budget (fixed/variable costs).
Organisational Plan
- Mission, vision, SMART objectives (incorporate sustainability).
- Organisation chart; manpower planning; task & responsibility schedule.
- Remuneration schedule, office equipment list, admin budget.
Financial Plan
- Project cost & funding requirement (working capital, CAPEX) and funding sources.
- Existing banking facilities summary.
- Pro-forma statements (cash-flow, P&L, balance sheet) under scenario simulation; depreciation & loan amortisation schedules.
- Break-even, payback, ratio analysis: liquidity, profitability, efficiency, solvency.
Conclusion
- Viability summary, key risks & mitigants, long-term expansion outlook.
Appendices / Banker checklist
- Incorporation docs, licences, tenancy, audited accounts, valuation reports, supplier quotes, machinery catalogues, inventory list, asset list, CVs, IDs, certifications.

Financial Analysis (3.2.2)

Integrated into Credit Report under 5C lenses: Capacity, Capital, Collateral.
Capacity tests
- Borrowing capacity → $\text{Gearing Ratio}$
- Repayment capacity → profitability, liquidity, $\text{Debt-to-Income}$ , $\text{TIE}$ etc.
Capital commitment → $\text{Debt-to-Equity Ratio}$ / promoters’ injection.
Collateral adequacy → availability, unencumbered status, current valuation, legal perfection.

Accounting Foundations (3.2.2.1)

Branches of Accounting

Management Accounting = internal, non-audited, flexible format.
Financial Accounting = external, audited, follows Companies Act & MFRS.

Key Accounting Principles

Dual Aspect (Double Entry) – every transaction has a debit & credit.
Entity – business distinct from owners.
Monetary – transactions recorded in monetary terms.
Historical Cost – assets recorded at acquisition cost.
Going Concern – assumes indefinite operation.
Accounting Period – life split into regular periods.
Accounting Equation – $\text{Assets = Liabilities + Capital}$ .
Accrual/Matching – revenue & associated expenses recognised in same period.
• Revenue vs Capital Expenditure (depreciation spreads CAPEX).
Realisation – revenue recognised when earned (delivery).

Accounting Policies (selection criteria)

Prudence – provide for probable losses (bad debts, depreciation).
Substance over Form – reflect economic reality (e.g., leased assets capitalised).
Materiality – policy choices must not distort fair presentation.

Understanding Financial Statements (3.2.2.2)

Audited Financial Statement package
- Statement of Financial Position (SFP)
- Statement of Comprehensive Income (SCI)
- Statement of Cash Flows (SCF)
- Statement of Changes in Equity
- Notes, Auditor’s Report, Directors’ Report.
Reading order for Credit Officer
- Auditor’s opinion (unqualified → acceptable)
- Directors’ report (asset sales, share issues, reserves movement)
- Financial statements & notes (breakdown of assets, collateral pledges, contingent liabilities, post-balance-sheet events, related-party transactions).
Linkages to operating & investment cycles: expect FS numbers to match business model.

Analysis of Statement of Financial Position

Assess assets owned → infer income-generation capacity.
Liquidity tests →
• Current Ratio $\frac{\text{CA}}{\text{CL}}$
• Quick Ratio $\frac{\text{CA – Inventory}}{\text{CL}}$
Long-term solvency → Gearing $\frac{\text{Total Liabilities}}{\text{Shareholders’ Equity}}$
• Rule of thumb: ≥50 % of long-term assets financed by shareholders/quasi-capital.
• Different risk between trade-related vs CAPEX-related gearing.
Funding mismatch risk → short-term funding of long-term assets indicates rollover vulnerability.
Efficiency measures
• Average Collection Period $\frac{\text{Avg AR} \times 365}{\text{Credit Sales}}$
• Avg Stock Holding $\frac{\text{Avg Inventory} \times 365}{\text{COGS}}$
• Average Payment Period $\frac{\text{Avg AP} \times 365}{\text{Purchases}}$
• Fixed Asset Turnover $\frac{\text{Sales}}{\text{Avg FA}}$ .

Analysis of Statement of Comprehensive Income

Focus on quality & sustainability of earnings.
Strip out non-operating/one-off gains.
Profitability ratios
• Gross Profit Margin $\frac{\text{Gross Profit}}{\text{Sales}} \times 100\%$
• Net Operating Margin $\frac{\text{EBIT}}{\text{Sales}} \times 100\%$
• Return on Assets $\frac{\text{EBIT}}{\text{Avg Total Assets}} \times 100\%$
• Return on Equity $\frac{\text{Net Profit After Tax}}{\text{Equity}} \times 100\%$
Evaluate cost drivers (raw materials, FX, oil), pricing power, sales mix dependence.

Analysis of Statement of Cash Flows

Three sections & interpretation
1. CFO – day-to-day operations (adjusted for non-cash items & NWC changes). Persistent negative CFO flags structural issues.
2. CFI – investing activities. Large negative may signal growth CAPEX; positive may imply divestment.
3. CFF – financing activities. Positive = new debt/equity; negative = repayments/dividends.
SCF must reconcile with SCI & SFP for completeness test.

Quantitative Analysis of Financial Statements (3.2.2.3)

Combine historical trend & forecast projection.
Ratios: liquidity, leverage, efficiency, profitability, cash-flow coverage.
Forecast testing
- Validate assumptions, perform sensitivity (best/moderate/worst).
- Adjust key variables (volume, price, margin, interest, FX) to stress repayment capacity.
Collateral/guarantor quantitative check: net-realisable value, guarantor net worth & DSCR.

Qualitative Analysis & SWOT (3.2.2.4)

Internal Factors (Strengths/Weaknesses)
• Management quality & succession
• Supplier relationships & bargaining power
• Production efficiency & technology
• Product portfolio & differentiation
• Customer base, sales channels, collection discipline
External Factors (Opportunities/Threats)
• Industry structure & rivalry
• Regulatory, political, economic trends (PEST)
• Market growth, substitution risk, entry barriers
• Sustainability & ESG considerations
Lender’s role: translate risk mapping into covenants, collateral requirements, pricing & monitoring frequency.

CAMPARI Framework (alternative/complement to 5Cs)

Character – integrity, track record
Ability – management & technical skills
Means – financial resources & capital
Purpose – legitimacy & clarity of borrowing purpose
Amount – appropriate size relative to capacity
Repayment – cash-flow adequacy, exit routes
Insurance – collateral, guarantees, risk mitigants

Ethical, Regulatory & Practical Implications

Borrower gives explicit waiver of confidentiality for credit enquiries.
Bank must comply with KYC/AML – identification of Beneficial Owner.
Documentation completeness = legal enforceability & credit-process SLA.
Accurate BP & FS vital to prevent fraudulent misrepresentation (civil/criminal liability).
Post-disbursement monitoring: covenant compliance, financial reporting frequency, site visits.

Key Formulae (LaTeX-formatted)

Current Ratio $\text{CR}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$
Quick Ratio $\text{QR}=\frac{\text{Current Assets – Inventory}}{\text{Current Liabilities}}$
Debt-to-Equity $\frac{\text{Total Liabilities}}{\text{Shareholders’ Equity}}$
Times Interest Earned $\text{TIE}=\frac{\text{EBIT}}{\text{Interest Expense}}$
Debt Service Ratio $\text{DSR}=\frac{\text{EBIT}}{\text{Interest + Principal}}$
Avg Collection Period $\frac{\text{Average Trade Debtors} \times 365}{\text{Credit Sales}}$
Avg Stock Holding $\frac{\text{Average Inventory} \times 365}{\text{COGS}}$
Avg Payment Period $\frac{\text{Average Trade Creditors} \times 365}{\text{Purchases}}$
Fixed Asset Turnover $\frac{\text{Sales}}{\text{Average Fixed Assets}}$
Gross Profit Margin $\frac{\text{Gross Profit}}{\text{Sales}} \times 100\%$
Net Operating Margin $\frac{\text{EBIT}}{\text{Sales}} \times 100\%$
ROA $\frac{\text{EBIT}}{\text{Average Total Assets}} \times 100\%$
ROE $\frac{\text{Net Profit After Tax}}{\text{Shareholders’ Equity}} \times 100\%$
Accounting Equation $\text{Assets} = \text{Liabilities} + \text{Capital}$

Real-World Connections & Recap

Evaluation chain promotes credit quality, portfolio profitability, regulatory compliance.
5Cs/CAMPARI acts as conceptual bridge tying qualitative judgement with quantitative evidence.
BP acts as narrative; Financial Statements verify & quantify; Credit Report synthesises for decision.
Continuous monitoring (financial covenants, site visits, borrower interviews) closes feedback loop.
Ethical duty: accurate disclosure protects both lender and honest SME; fraudulent filings expose borrower to legal sanctions and bank to credit, operational & reputational losses.