Ratio Analysis for Credit Appraisal

Overview

A financial ratio is a mathematical comparison. There are literally hundreds if not thousands of ratios analysis that can be calculated. They help to determine the overall financial condition of a customer’s business. Ratios are also useful for making comparisons between a customer and other businesses in an industry. 

They’re also key financial ratios for the credit department. As ratio analysis is an important method in helping credit professionals to make informed decisions. These can be about whether to extend credit to customers, how much credit to extend, and what terms of sale are appropriate. 

The key is for credit professionals to select ratios that they believe are either: Indicative of a customer’s ability to pay its debts as they come due and the customer or applicant’s long term viability.  

Credit professionals can use the many financial ratios to chart trends in a customer’s financial performance. To find trends, and point to potential problem areas that requires additional scrutiny by the credit manager. 

When it comes to the ratio analysis for credit appraisal there’s a credit ratio also known as the Debt-to-income ratio. It basically is the percentage of your income that’s taken up by your debt obligations.  

Lenders look at this percentage to help them decide whether or not you’re a good credit risk. If applying for a mortgage, lenders look for certain defining financial characteristics about you. 

The Payables turnover ratio analysis is one of importance to creditors. The formula is: Cost of sales divided by trade payables. This number reveals how quickly a company under review pays its bills. The payables turnover ratio reveals how often payables turn over during the year. A high ratio means there’s a relatively short time between purchase of goods and payment.