What financial ratios are important for loan approval?

Before lenders approve a loan, they review different financial ratios to determine your business' creditworthiness as well as the capability to pay back the loan. These ratios also provide a snapshot of your business' financial position and help lenders assign risk in an objective manner.

Some of the important financial ratios include the following:

1. Debt to Income Ratio: Indicates the percentage of your income is used to pay your existing debt; the lower the percentage, the better the debt position.
2. Debt Service Coverage Ratio (DSCR): Indicates your ability to pay loan payments from net operating profit; generally speaking, lenders prefer a DSCR above 1.
3. Current Ratio: It compares current assets to current liabilities. If the current ratio is greater than 1 the company can pay off its current liabilities.
4. Profit Margin Ratio: It is the percentage of each dollar meant for revenue that actually is profit which measures the efficiency of the business' operations.
5. Interest Coverage Ratio: Indicates how easily a business can pay interest on their debt; measures earnings before interest and taxes (EBIT) coverage of interest.
6. Turnover Ratios: This refers to inventory turnover and receivables turnover; it measures how efficiently the business is managing its assets and collection.

In addition to financial ratios, lenders may also review the overall net worth of the business, trends in cash flows and its historic financial results. It is critical to maintain good ratios backed up by clear and precise financial statements in order to gain approval on a loan. Regularly reviewing your financials and taking meaningful actions to improve, can greatly enhance your opportunities for receiving financing for your business.