Police SWAT members put on protective gear before responding to risky situations. Similarly, lenders can protect themselves before approving commercial loans by conducting SWOT (strengths, weaknesses, opportunities and threats) analyses. Lenders also can use SWOT analyses in their discussions with borrowers on mitigating risks.
Examining strengths and weaknesses
SWOT analysis starts by identifying strengths and weaknesses from the customer’s perspective. Strengths represent potential areas for boosting revenues and building value. These may be core competencies or competitive advantages. Examples might include a strong brand image, a loyal customer base or exceptional customer service.
It’s important to unearth the source of each strength. Some may be tied to the company’s key employees or owners — for example, a CEO with a high regional profile and a multitude of community ties. This is especially common among professional practices, such as accounting, law or advertising firms. But manufacturers and retailers may rely on key people, too.
When strengths are largely tied to people, rather than the business itself, consider what might happen if a key person suddenly left the business. Ask whether the borrower has key person life insurance, signed noncompete contracts, a buy-sell agreement or a formal succession plan designed to transition management to the next generation.
Weaknesses represent potential risks and should be minimized or eliminated. Often weaknesses are evaluated relative to the company’s competitors. They might include high employee turnover, weak internal controls, unreliable quality or a location with poor accessibility.
Every business has its Achilles’ heel. But when borrowers report the same weaknesses year after year, it’s cause for concern. It’s not enough to recognize a weakness — they need to take corrective action. Ask them to present their results.
Pinpointing external influences
The second part of a SWOT analysis looks externally at what’s happening in the industry, economy and regulatory environment. Opportunities are favorable external conditions that could increase revenues and value if the company acts on them before its competitors do.
For example, one auto dealership has responded to the strong market for new car sales by adding another franchise to his offerings. The dealer now sells Toyotas as well as Fords, giving him the potential to double business.
Threats are unfavorable conditions that might prevent an unwary borrower from achieving its goals. Threats might come from the economy, technological changes, competition and increased regulation. Here, the idea is to watch for and minimize existing and potential threats.
For instance, a competitor of the auto dealer above might lower new car pricing and aggressively advertise promotions and discounts offered by his Toyota franchise to maintain his Toyota-buying customers. The dealer who has just added a Toyota franchise will need to keep an eye on this and have proactive moves in place.
Working with your customers
Have your customers completed an in-house SWOT analysis? It’s a proven management tool taught at business schools around the world. Strong borrowers will answer in the affirmative and discuss the results. But it’s important that you encourage weaker, less experienced borrowers to go through the exercise. The results may enlighten them.
Typically presented as a matrix (see the chart), a SWOT analysis provides a logical framework for understanding how a business runs. It tells what a borrower is doing right (and wrong) and predicts what outside forces could impact cash flow in a positive (or negative) manner.
Entrepreneurs love their work and rarely want to hear that their “babies” are ugly. If you have concerns about a risky borrower, a SWOT analysis can be an objective forum for discussing sensitive or negative issues.
Ask for it
Some lenders ask prospective borrowers to present the results of a SWOT analysis during the due diligence process. Take advantage of this potential weapon in your arsenal before taking decisive action on loans.