5 Key Accounting Ratios Lenders Use to Assess Business Viability

Share this:

When seeking a loan for your business, lenders will assess various financial metrics to determine your viability and the appropriate interest rate based on risk. 

Understanding these key accounting ratios can help you present your business in the best possible light. 

Here are five crucial ratios you should be aware of:

1. Total Debt to Equity Ratio

What It Is: This ratio compares your business’s total debt to its equity. It’s a measure of how leveraged your business is — essentially, how much of your business is financed through debt versus owner investment.

Dept to Equity Ratio

Why It Matters: Lenders use this ratio to gauge the risk involved in lending to your business. A high debt-to-equity ratio might indicate that your business is taking on too much debt, making it riskier for lenders. On the other hand, a lower ratio suggests that your business has a solid financial foundation with more owner’s equity, making it a safer bet for lenders.

Dept to Equity Ratio

2. Gross Profit Percentage

What It Is: This percentage shows how profitable your business is after accounting for the cost of goods sold (COGS). It’s calculated by dividing your gross profit by your total revenue and then multiplying by 100. 

Gross Profit Percentage

Why It Matters: A higher gross profit percentage indicates that your business is generating more profit from its sales, which is crucial for covering other expenses and making loan repayments. It also can indicate how much an additional investment in the business can increase sales and hence have additional funds to service interest Lenders look for businesses with strong profitability to ensure that there will be enough return on the loaned funds.

Gross Profit Percentage

3. Current Ratio

What It Is: The current ratio measures your business’s ability to meet its short-term liabilities with its short-term assets. It’s calculated by dividing current assets by current liabilities.

Current Ratio

Why It Matters: This ratio provides a quick look at your business’s liquidity. A current ratio of 1 or higher suggests that your business can cover its short-term obligations, which reassures lenders that you’re capable of managing immediate financial responsibilities.

Current Ratio

4. Interest Cover Ratio

What It Is: Also known as the times interest earned ratio, this measures how easily your business can pay interest on outstanding debt. It’s calculated by dividing your earnings before interest and taxes (EBIT) by your interest expenses.

Interest Cover Ratio

Why It Matters: Lenders use this ratio to see if your business generates enough income to cover interest payments. A higher interest cover ratio means your business is more likely to manage interest expenses without financial strain. Additionally, lenders may look at the ratio of (amortisation payments and interest) to EBITDA to get a sense of your ability to cover debt repayments beyond just interest.

Interest Cover Ratio

5. Loan to Value (LTV) Ratio 

What It Is: This ratio compares the amount of your loan to the appraised value of the collateral (such as property) securing the loan. It’s calculated by dividing the loan amount by the appraised value of the collateral and then multiplying it by 100.

Loan to Value Ratio

Why It Matters: Lenders prefer a lower LTV ratio because it means there’s a higher equity cushion in case of default. A lower LTV ratio indicates that the collateral’s value exceeds the loan amount, making the loan less risky for lenders.

A good loan-to-value ratio is usually lower than 80%. An LTV above 80% is considered high, making it riskier for lenders and therefore more expensive for the borrower.

Loan to Value Ratio

Conclusion

Understanding these key accounting ratios and how they impact your loan application can greatly improve your chances of securing financing and improving your rate. By presenting strong financial metrics, you can assure lenders of your business’s viability and ability to repay the loan. If you need further advice on improving these ratios or preparing for a loan application, feel free to reach out to us.

Need help? Let's chat!
crossmenuchevron-down