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Guide

The Financial Ratios Banks Care About Most

Learn more about which financial ratios matter most to banks & how you can use these ratios to better understand how much loan your company can get.

Banks use financial ratios in evaluating a company’s request for financing as these provide a lens into how a business is doing and its financial situation. Most ratios can be calculated using financial statements, and they are used to analyze trends in a company’s financial performance and how it compares to others in the same industry.

Before approaching a financial institution, businesses should calculate these ratios themselves to identify areas needing improvement. This helps avoid any surprises.

“Bankers look at a number of different criteria to determine a company’s credit worthiness,” explained T.K. Wood, Business Banker with Cadence. “Business owners who do their homework and understand their company’s financial performance can have a greater chance of being funded. In general, they have a better grasp of how much loan they can handle and what to reasonably ask for.”

 

The financial ratios most often analyzed by banks include the following:

Total Debt / Total Assets

Debt ratio:

This is a key ratio for bankers, who want to see your amount of debt compared to your total assets — or in other words, how much your company is leveraged. Leverage refers to money borrowed from and/or owed to others. The lower this percentage, the better, as this means a company is using less leverage and this equates to a stronger equity position.

 

Total Loan Amount / Appraised Value of Property

Loan-to-value ratio:

This ratio is calculated by the total amount of the loan divided by the appraised value of the property. In general, banks require the appraised value to be higher than the loan amount. This provides some assurance to the lending institution in case a company defaults on the loan. If the collateral becomes the bank’s property, the bank wants to be sure it can sell it for a high enough value to recoup the full balance of the loan. When approaching a lending institution, it’s important the property’s appraised value exceeds that of the loan amount your company is requesting.

 

Annual Net Income / Annual Debt Service

Debt service coverage ratio:

The most complicated of the three, this ratio measures how much cash flow your company has to cover its current debt obligations. It’s calculated by dividing your company’s annual net income by your annual debt service, or more simply, your loan payments. Here, a bank wants some breathing space in regard your company’s ability to make its loan payments. A company with net income sufficient to cover 12 loan payments will be viewed more favorable than one that can cover only 1.75 payments, as this presents a greater risk to the bank. Being knowledgeable about this ratio will help ensure you don’t ask for a loan larger than you can manage.

 

Give yourself a leg up on the competition by becoming versed in your company’s financial performance. By calculating these key financial ratios ahead of time, you can discuss your loan application with assurance and a greater appreciation of the industry standards on which your request will be evaluated. Go forth and conquer!

 
Understanding financial ratios is just one step in your company’s growth journey. Learn how Cadence Bank customers overcame business challenges with lending solutions developed by Cadence bankers.
 

 



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