Ratios are tools that can be used to assess financial conditions. They may also be best for making comparisons of companies within an industry.
The use of ratios is useful for making decisions about whether to grant credit or not. In addition to assessing affordability, creditworthiness is also a major factor for lending institutions when making credit granting decisions.
Key ratios to analyse creditworthiness must be useful for indicating a customer’s ability to pay their debts, as well as the viability of providing credit.
Using them is ideal for predicting problem areas.
A benefit of using ratios is that they offer more accurate insight into the finances of an individual or organisation.
Liquidity Ratios are most useful as an indicator of how easy it will be to turn current assets into cash.
The Quick Ratio, also known as the Acid Test is a tougher measure of financial health because of its exclusion of inventories when counting assets.
Leverage ratios indicate how much money has been loaned to the company. If it is relying on too much credit, then it’s unlikely that it will qualify for additional credit. This prevents the possibility of over-indebtedness.
Efficiency ratios measure productivity and utilisation of resources. By analysing how well a business uses what it has, as well as how hard it works at being productive can give better insight into how likely it is that the organisation will repay its loan.
Good reasons to use key ratios to analyse creditworthiness:
- They indicate trends
- They show how the company is doing in comparison to peers
- Lending decisions must be based on a cash basis and ratios provide the most authentic financial outlook