For Eric, who wants to apply for credit, he is unaware of just what is involved in the credit appraisal process. With the stringent requirements of many banks and other financial institutions currently put in place, there are various ways of analysing credit applications before approval.
One of these ways includes using ratios, which are used for analysing financial statements for the purpose of granting credit. They are used by credit analysts to work out if individuals are in a good position to afford credit repayments. .
Before Eric is approved for any form of finance, the credit provider will do their due diligence, by doing background checks on the applicant. To back this up, ratio analysis comes in handy.
These calculations provide accuracy and allow for less room for error. If the numbers predict that an applicant has a poor credit record, this is a good time to take heed.
The numbers can also be used to predict future behaviour. For instance, if an applicant already has a home loan and they come into some financial trouble, chances are that this loan will be prioritised. Lenders are then able to work out which applicants are less likely to give them any trouble.
More about ratio analysis
They are typically classified into four categories, each examining the following:
Liquidity
Leverage
Efficiency
Profitability
During the application process, Eric should keep in mind that Liquidity Ratios tend to be regarded as a vital part of the process. They serve as reliable indicators of how able he is to pay his short term debts off.
Ratio analysis is a great way of getting the truth about a company’s financial performance. It can also be ideal for comparison to similar organisations.
They can make it easier to make decisions about providing credit to the right people or organisations.
During the credit appraisal process, which includes quantitative and qualitative methods, ratio analysis offers great insight into Eric’s creditworthiness.