Question

Which ratios would a banker be most interested in when considering whether to approve an application for a short- term business loan? Explain.

Answer 1

Leverage ratio

The debt-to-cash flow ratio or leverage ratio measures the number of years of cash flow it will take for the borrower to retire the debt, and is calculated by dividing the borrower’s debt by its cash flow. The leverage ratio is applicable and important across almost any lending sector. A lower number is more attractive to the banker

Debt service coverage ratio

it is acommon financial covenant in many credit facilities. The DSCR measures a company’s ability to service its current debts by comparing its net income with its total debt service obligations. To calculate the DSCR, net operating income is divided by the total debt service. There is latitude in which items (e.g EBITDA, EBITDAR, capital leases, guarantees, etc.) are included in the ratio. Lenders may look for a DSCR of 1.25 or more as the higher the ratio, the greater the ability of the borrower to repay the loan.

quick ratio

It is also called the acid test ratio, is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets. Quick assets are current assets that can be converted to cash in the short-term (typically within 90 days). Cash, cash equivalents, short-term investments or marketable securities, and current accounts receivable are considered quick assets. If a company has enough quick assets to cover its total current liabilities, the company more likely will be able to pay off its obligations without having to sell any long-term or capital assets.