Small business financial risks: How to define & prevent them

business risk

SMEs are unique in many ways when it comes to risk exposure compared to their larger, more established counterparts.

They may lack in the areas of capital resources and financial management resources that are available at their disposal. This would mean that they would be more vulnerable to closure much faster than larger businesses can survive while on a poorly performing bottom-line.

Lending businesses in particular have a higher exposure to risk as they are dealing with clients whose financial wellbeing and their ability to repay also depends on many other factors. This raises one type of financial risk referred to as credit risk.

Credit Risk

In a broad perspective, credit risk is viewed as the potential that a borrower or will fail to pay up their obligation as had been earlier agreed on the loans terms. There is also a credit risk carried by the lender in terms of acceptances, and the extension of commitments. These also increase the processing time if there is no small business loan software aiding the credit manager’s routine. By SMEs loan software mean certain lending software, for example, Turnkey Lender, which operates credit risks, manages clients and helps to get maximum profit.

In simple words, there are many things that come into play making it uncertain for people to pay back (even if they have a good credit rating) and that may include eventualities such as death, unwillingness and a sudden change in income.

To minimize the credit risk, the lenders traditionally chose to offer loans at a higher than normal interest rate if they usually deal with a target market that is high risk.

They may rate a client according to their existing credit scores, surety of their income, and history of transactions with the firm and in some cases, the reason why they are borrowing. Borrowers who take loans to pay other loans are usually viewed as a high risk account.

A lot of credit risk is influenced by the relationship that the borrower has with other lenders. For example, if people receive their loans through a third party money transfer app, some inefficiency with that cash transfer channel can lead to the borrower not receiving the intended money even after it has been disbursed by the lender.

Transactional risk – Using manual records can lead to errors and delays

In cases where there has been a cash disbursal but the transaction on the receiving end has been unsuccessful, there remains a problem on the part of liability.

Who should be responsible for paying up the money to the borrower? Does the borrower have to pay back the money if the lender records show that he that he was paid but the transacting company denies so?

In situations like that, there is probably a good chance that the error is due to faulty system design or faulty system usage. Switching from a manual loans book to SMEs loan software reduces that likelihood of conflicting records about one account.

Settlement risks – The clearing house dilemma

Consider a small business having to send US dollars to a borrower who wishes to deal with British pounds. When dealing with some online lending portals, there may be restrictions in the kind of currencies that are accepted for payment. Most will in that sense; charge a different commission rate for converting currencies. A bigger problem arises when changes in the exchange rate usually affect the total value received long after the loan requests have been approved. Settlement risk is closely associated with credit risk but the main difference is the fluctuating exchange rate and the influence of information movement between clearing houses.

Risks of deliberate fraud

Just like there are risks that arise to failure of systems or any sudden changes in the economic conditions of the day, there are plenty that come about as a result of deliberate sabotage and fraud by an employee.

Small businesses are always at a constant risk of being victims of deliberate fraud as they have a barrage of information to process about a borrower but may not easily verify the information they get in good time.

The extra smaller businesses usually endure a higher risk especially when the systems are mostly manual and there is very little monitoring of the accounts. Deliberate fraud is a common practice when borrowing loans as people sometimes falsify their earnings to have a higher chance of getting their loans approved.

Some non-deliberate but fraudulent activity from employees may still be viewed as deliberate by stakeholders outside the enterprise.

These may be in form of unconscious non-compliance with legal requirements, a bad customer experience taken too far or data manipulation by an incompetent employee. Unlike using Balancing accounts using a manual system can lead to many errors on people’s accounts in case of a minor keying in error.

In accounting lingo, people talk about how a missing zero can alter a lot while still making it harder to understand where the problems in the balance sheet are arising from.

Fraud risk can be partly solved if accounting software is deployed and good security updates are in place. Automating some key parts of the accounting routine for using a trusted SMEs loan software brand also bears the advantage of cross-compatibility.

Cross compatibility can solve the problems by letting the software from different departments or two businesses share homogenous information between each other.

They could even collaborate on making certain reports so that any few changes from one side are visible from the other party. While at it, there can be

How to Prevent the Financial Risks?

With all the various kinds of financial risks that are naturally tied to the small loans business, it is wise to have a way to merge all the fragmented information. Small financial providers do not source their information from a single place and that places them at a disadvantage when in need for reliable data.

Customer loans information can be gathered from underwriters and credit managers of the organization and reconciled in one database for quick referral or quick processing. With SMEs loan software, there is a benefit on both the borrower’s and the lender’s side because there is more efficiency reached in processing accounts, disbursing loans, monitoring and accounting for payments. The borrower gets loans processed faster while the credit manager reduces the risks that come with scattered or incomplete information about borrowers.

Author: Vit Arnautov is a Chief Product Officer at TurnKey Lender Pte. Ltd. with special interest in Fintech, Credit Scoring, Investments.