5 Reasons Why Cash Flow Lending Analysis is Necessary for Small Business Lending

Micro, small, and medium enterprises (MSMEs) account for around 30% of the economy, making them one of the most important sectors in India.

These businesses also play an important role in safeguarding the cultural heritage of different communities, driving innovation, and generating jobs. With more than 600 lakh MSMEs spread across the country, cash flow lending analysis in the small business lending sector has become paramount to ensure sustainable growth of small businesses and financial stability.

This article explores the importance of cash flow analysis in small business lending and why it is important to lenders.

Let us first touch upon what we mean by cash flow analysis.

Understanding Cash Flow and Cash Flow Analysis

Cash flow, as the name suggests, is the cash that comes into and leaves a business. As per latest estimates, more than 68% of businesses fail to succeed due to cash flow-related challenges.

Cash flow analysis determines the liquidity and solvency of a business. A cash flow analysis statement primarily consists of cash flow from investing, financing, and operating activities. Lenders use this to assess where the cash is coming in, where it is being spent, the borrower’s ability to repay loans, and more.

Different versions of cash flow analysis offer different insights to help lenders make informed decisions and get a better understanding of their financial health.

Why is Cash Flow Lending Analysis for Lenders?

A business needs to earn more than they spend to sustain and be profitable. That is the thumb rule of running a business; earn more than you spend. This is exactly why cash flow lending is important for all types of businesses. This section highlights the importance of cash flow lending analysis for small businesses:

Detect Financial Barriers

Similar to how an X-ray or a CT scan helps us detect potential health problems, a cash flow lending analysis aids lenders detect unexpected or unforeseen financial issues.

For instance, a significant surge or drop in revenue or repeated defaults from certain borrowers. Lenders can leverage insights drawn from cash flow lending analysis to proactively respond to looming challenges and avoid bad debts in the future.

Better Decision-making

Lenders can make better and more informed decisions if they understand the cash flow across different channels. Cash flow lending analysis helps them examine a borrower’s capability to repay a loan and fulfil the debt obligations.

This also helps lenders understand the overall operational efficiency and profitability of a business, making it easier for them to approve loans, and determine the loan amount, loan period, and other details. 

Risk Mitigation

A significant chunk of small businesses are seasonal, which means their income keeps fluctuating depending on the time of the year.

Additionally, lenders also take into account the market volatility coupled and the economic situation while assessing loan applications. This analysis allows them to mitigate risks by defining relevant and applicable terms and conditions of the loan.

Improved Financial Management

Cash flow analysis paves the way for better financial management as it encourages lenders to stay abreast with the latest developments and respond accordingly.

A thorough and systematic cash flow analysis allows lenders to track their financial records get an idea about borrower behaviours, analyse their cash flow, and craft strategies to improve cash flow stability. It is also a great way to nurture and build long-lasting lender-borrower relationships.

Personalised Financial Products and Services 

More than 70% of lenders believe they can build better customer relationships by offering personalised financial products and services. At present, personalisation is one of the key differentiating factors that allow lenders to gain a competitive edge and enhance their customer portfolio.

Lenders can analyse a business’s cash flow, repayment and income patterns to provide personalised products, services, and repayment requirements. This creates a win-win scenario for both; lenders and borrowers since it is tipped to reduce the chances of defaulting on a loan.

Significance of Cash Flow Lending Analysis for Borrowers

Cash flow analysis paints an accurate picture of a business’s past success and prospects. It also gives a fair understanding of how the loan will help the business and ultimately generate more revenue.

However, lenders need to be confident about the business’s current cash flow before they can determine the loan amount, repayment terms, interest rates, and other details.

Businesses must also be able to justify the loan and how it will impact income and expenses in the future. A cash flow analysis allows lenders to understand your business’s cash cycles before they agree to approve your loan based on your income and revenue assumptions.

Parting Notes

Tech-driven platforms and tools are revolutionising the Indian financial sector primarily focusing on improving financial accessibility, enhancing customer experiences, and laying the foundations of sustainable economic growth for lenders and borrowers.

Cash flow lending analysis equips lenders with useful insights into a borrower’s financial health, ability to default and repay the loan, and also define apt repayment terms and conditions.

As mentioned before, it creates a win-win situation for lenders and small businesses as it allows businesses to justify their loan applications, and lenders to assess whether they can repay the loan on time.

As a cloud-based analytics platform for finance companies Precisa offers tech-driven solutions including bank statement and credit report analysis to help lenders determine a borrower’s creditworthiness and encourage data-driven decision making.

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