We’ve discussed the micro- and market environment risks which are, largely, known and already in place and are, to some degree therefore, historical.
However, in the macro-environment, new risk factors are constantly appearing and they are much more difficult to identify, both for the managers of the business as well as for bankers.
The major changes or developments in the macro-environment are usually outside the business’ control. It’s essential that the managers of the business are able to anticipate the impact of these changes on either the business itself or on its market before they actually happen, so as to be able to adjust the business’ products or processes accordingly.
As part of our credit risk assessment we must ensure that the management of the business is aware of possible changes in its macro-environment since failure to do so may result in the business losing any competitive advantage that it might have had and compromising its very existence.
Note that when the business is operating across-borders and revenues and cash flows come from foreign sources you would need to consider these factors in those countries as well as in your home country.
The acronym PESTEL is used to describe the components of the business’ macro-environment. Each of these components comprises a number of factors that can positively or negatively affect businesses of all sizes although it should be noted that most businesses and/or industries will not be affected by all the factors simultaneously or to the same degree as others.
The idea is to consider each of these factors in turn and the changes that are taking place in these environments and to determine whether, and to what extent, the business that we are assessing will be affected by the changes.
Let’s take a look at each one in some detail;
- Political; In this environment we consider political, but not legislative, issues. We are not only concerned with local and foreign governmental activity here, but also the activities of organisations (such as NGO’s) and special-interest groups and the pressure they bring to bear on government policy. We should also consider the government’s general policies, plans and attitudes towards economic development in the country over the medium to long-term. Also, consider the possibility of elections and the possible outcome, whether peaceful and whether a political transition may take place.
- Economic; This environment, perhaps more than any of the others, is the one that most influences business decisions, especially in developing economies that are prone to sudden and significant economic shocks from external sources. Businesses can be affected directly by some economic changes (e.g. interest rate changes on a business that borrows significant amounts) or indirectly (e.g. interest rate changes affecting the disposable income of the consumer).
- Social; In this environment we consider the business’ broader market, i.e. its customers and their changing attitudes and values and the general trends that affect the way the market buys products and services.
- Technology; The way in which technology has become more influential in all our lives is well known. However, how has it influenced the way in which businesses connect with their customers? Obviously, the rise of the Internet has changed the way many businesses deliver their products to the end-user and, indeed, there are many businesses that only now exist because of the presence of a suitable technology like the Internet. In this environment we should consider the impact that the possible changes in technology will have directly on the business – perhaps in the way it manufactures its products, in the level of competition that it might encounter from businesses that were not in the same market place in the recent past, or, as mentioned above, in the way in which it delivers its products or services to the customer.
- Ecological; There are two aspects to this environment. Firstly, the ecological issues have to be considered and, of course, not all businesses are affected by these concerns. In this part of the analysis we should consider the ecological impact of the business’ operations, remembering that negative public perceptions can have a significant impact on a business’ reputation and, ultimately, its level of sales. Secondly, there are some issues regarding the way in which the business treats its physical environment – not in an ecological sense – but in the way in which, for example, it plans its operations so that disturbance and noise are minimised.
- Legal; This environment is similar to the political environment which we discussed earlier but analysis is restricted to only legislative issues, especially focusing on the effect that up-coming legislation may have on the business. This would include both changes to existing legislation and completely new legislation. Mostly, changes in this environment would have a direct impact on the business.
In our e-book, Business Lending Essentials Part 1; Assessing Business Risks, we set out some background to this analysis and provide some tools and techniques to enable analysts to apply a logical approach to the assessment of a business. The ebook is free and can be downloaded from www.businessbankingcoach.com by clicking here.