Credit appraisal involves the use of the key ratios which offer better insight into the financial stability of an applicant.
Considering what creditors look for in credit applications from organisations, such as liquidity, how efficiently the business operates and profitability, it would help to become familiar with these ratios.
Doing this enables the applicant to prepare themselves for what to expect. This way, they are able to improve where necessary.
Ratio analysis for credit appraisal includes an assessment of:
The total amount of the loan is divided by the appraised value of collateral. If the appraised value is higher, this is favourable for lenders. This is because a lender wants to ensure that they can sell an asset for a value high enough to cover the balance of the loan in the event that a borrower is no longer able to service the loan.
This essentially determines ability to repay debt. It assesses the amount of money that a business has, to cover debts.
This is a comparison of capital invested by business owners versus the amount of funds provided by funders. It’s vital to keep in mind that too much debt puts the business at risk. By dividing total business liabilities by total business equity, an organisation is able to assess its exact level of reliance on debt. By paying debts down, the ratio will be lowered too. If a business has too much debt, this ratio will indicate this.
This includes a comparison of expenses to revenue. Increased efficiency is indicated by a decreasing ratio. The more revenue a company has, the better it will be for the credit appraisal process.
By examining the Return on Assets, an organisation is able to measure the ability to turn assets into profit. A high ratio is good. In addition to this, an assessment of Operating Self-Sufficiency looks at how much of a business’ expenses are covered by core business functioning and how much it is able to function sans grant support.