SME Credit Score Factor

Definition

An SME Credit Score Factor is any indicator, attribute, characteristic that can be used (usually after being converted to a numerical form) as input in the construction of a numerical SME Credit Score as part of an SME Credit Scorecard building procedure. These factors typically serve as predictors of Borrower behaviour in SME Lending

Conceptual Categories

There is a large variety of possible Credit Data sources (and it keeps expanding with the availability of Alternative Credit Data). Therefore a grouping of data inputs that can be used as credit risk factors into conceptual categories is useful as an organizing principle.

Using Five Cs of Credit

The Five Cs Of Credit Analysis applies to SME Lending and help the conceptual organization of various possible credit factors:

Capacity, an SME borrower's ability to repay their debt, on the basis of their projected income profile and their other expenditures (including other debt)
Capital, the asset base (net worth) of the borrower and the degree to which it is committed to support a given amount of debt
Character, a borrower's overall behavioural profile towards repayment of debt
Collateral, any assets the borrower pledges as security for their borrowed funds
Conditions, referring to both the lending conditions and the business conditions

Variable Types

The nature of variables used as inputs can vary significantly. The following is a list of some relevant dimensions:

Quantitative versus Qualitative Risk Factors is a major dichotomy. Qualitative risk factors will typically be captured in text, have an element of subjectivity and in general can be hard to process with quantitative methods
In turn Quantitative data can be separated into
- Financial (Accounting) Data (that have traditionally been the backbone of credit analysis) versus Non-Financial Quantitative Data
- Numerical (with a continuous range) versus Categorical Data (discrete category choices)

NB: It is important to distinguish qualitative assessments from categorical data. The primarily issue with the former is the potentially uncontrolled Human Judgement involved and the format in which it is delivered (while keeping in mind that numerical or categorical data may also suffer and hide subjectivity)

Other possible classifications that are more relevant at the modelling stage:

Using Absolute Values versus Peer Group assessment
Using Absolute Values versus Ratios or Percentages

List of SME Credit Score Factors

The following sections have indicative list of factors that have been discussed in the literature. A subset of these factors are formalized and documented in the SME Credit Data table.

Identification

Date of incorporation (or significant acquisition/ merger)
Type of firm

Business Track Record

Markets in which the company operates and their position in the business life-cycle
Positions vis a vis competitors and their competitive strength
Nature of the competitive advantages (cost, differentiation/ distinctiveness of products, quality/innovation/technology, dominant/ defensible).
Years the company has operated in the actual core business

Financial Statements Based Factors

Data extracted from financial accounts and typically (but not necessarily) converted into ratios

Earnings and Profitability: net income, EBITDA, etc.
Repayment ability: Interest expense etc.
Solvency: own funds / equity / total balance sheet, etc.
Liquidity: working capital, liability maturity profile
Turnover and Activity Ratios

Business Positioning

Location (Geographic) Advantage
Quality of the client base
Quality of perception in the market
Industry and Macroeconomic Assessment
Government Policies
Marketing Network

Business Strategy

Strategic plans
Business plan
Growth forecast
In case a business plan has been developed, the stage of strategy implementation
Proportion of assets/ investments not strategically linked to the company’s business
Extraordinary transactions (revaluations, mergers, divisions, transfers of business divisions, demerger of business) and their objective

Management Factors

Degree of involvement in the ownership and management of the company
The overall assessment of management’s knowledge, experience, qualifications and competence(in relation to competitors)
Key Person Risk
Quality of Management information systems
Bank-customer relationship (proprietary information)

Internal Behavioural Data

Number and size of transactions
Maximum/ minimum balances, Variances
Length of the relationship, past litigation
Violation of credit lines

Quality of Available Information

Information submitted on company’s results and projections
Considerations released by auditors on the quality of budgetary information
Negative signals in the relationship history

Externally Sourced Information

Acquired from credit bureaus, Credit Referencing agencies

Addresses
Court judgements
Payment histories

Stylized Facts

Behavioural predictors apparently work well for shorter periods whereas accounting data work better over longer periods.

Literature Survey

Country	Year	Authors	Variables
United States	1968	Altman	EBIT/assets; retained earnings/assets; working capital/assets; sales/assets; market value MV equity/book value of debt
Japan	1982	Ko	EBIT/sales; working capital/debt; inventory turnover 2 years prior/inventory turnover 3 years prior; MV equity/debt; standard error of net income
Japan	1984	Takahashi et al.	Net worth/fixed assets; current liabilities/assets; voluntary reserves plus unappropriated surplus/assets; interest expense/sales; earned surplus; increase in residual value/sales; ordinary profit/assets; sales ) variable costs
Switzerland	1973	Weibel	Liquidity (near monetary resource asset ) current liabilities)/operating expenses prior to depreciation; inventory turnover; debt/assets
Germany	1988	Baetge et al.	Net worth/(total assets ) quick assets ) property and plant); (operating income + ordinary depreciation + addition to pension reserves)/assets; (cash income ) expenses)/short-term liabilities
Germany	1984	von Stein and Ziegler	Capital borrowed/total capital; short-term borrowed capital/output; accounts payable for purchases and deliveries/material costs; (bill of exchange liabilities + accounts payable)/output; (current assets ) short-term borrowed capital)/ output; equity/(total assets ) borrowed capital; (operational result + depreciation)/total capital borrowed liquid result + depreciation)/net turnover; (operational result + depreciation)/short-term assets ) real estate); equity/(tangible property ) real estate); short-term borrowed capital/current assets; (working expenditure ) depreciation on tangible property)/(liquid assets + accounts receivable ) short-term borrowed capital); operational result/capital; (operational
England	1979	Marais	Current assets/gross total assets; 1/gross total assets; cash flow/current liabilities;
England	1982	Earl and Marais	(funds generated from operations ) net change in working capital)/debt
Canada	1981	Altman and Lavallee	Current assets/current liabilities; net after-tax profits/debt; rate of growth of equity ) rate of asset growth; debt/assets; sales/assets
The Netherlands	1979	Bilderbeek	Retained earnings/assets; accounts payable/sales; added value/assets; sales/assets; net profit/equity
The Netherlands	1978	van Frederkslust	Liquidity ratio (change in short-term debt over time); profitability ratio (rate of return on equity)
Spain	1988	Fernandez	Return on investment; cash flow/current liabilities; quick ratio/industry value; before tax earnings/sales; cash flow/sales; (permanent funds/net fixed assets)/ industry value
Italy	1994	Altman et al.	Ability to bear cost of debt; liquidity; ability to bear financial debt; profitability; assets/liabilities; profit accumulation; trade indebtedness; efficiency
Australia	1984	Izan	EBIT/interest; MV equity/liabilities; EBIT/assets; funded debt/shareholder funds; current assets/current liabilities
Greece	1988	Gloubos and Grammatikos	Gross income/current liabilities; debt/assets; net working capital/assets; gross income/assets; current assets/current liabilities
Brazil	1979	Altman et al.	Retained earnings/assets; EBIT/assets; sales/assets; MV equity/book value of liabilities
India	1988	Bhatia	Cash flow/debt; current ratio; profit after tax/net worth; interest/output; sales/ assets; stock of finished goods/sales; working capital management ratio
Korea	1995	Altman et al.	Log(assets); log(sales/assets); retained earnings/assets; MV of equity/liabilities
Singapore	1988	Ta and Seah	Operating profit/liabilities; current assets/current liabilities; EAIT/paid-up capital; sales/working capital; (current assets ) stocks ) current liabilities)/EBIT; total shareholders’ fund/liabilities; ordinary shareholders’ fund/capital used
Finland	1988	Suominen	Profitability: (quick flow ) direct taxes)/assets; Liquidity: (quick assets/total assets); liabilities/assets
Uruguay	1988	Pascale	Sales/debt; net earnings/assets; long-term debt/total debt
Turkey	1988	Unal	EBIT/assets; quick assets/current debt; net working capital/sales; quick assets/ inventory; debt/assets; long-term debt/assets

Issues and Challenges

Deciding on factors relevant and useful for SME credit analysis
In practice collecting the quantitative and qualitative information to underpin an acceptable credit analysis may be more challenging for an SME than a larger corporate entities. Two key handicaps (as discussed in the SME Credit Gap):
- Lack of market listing
- Lack of detailed Financial Statements