- Recognize the ratios creditors use to analyze a set of financial statements.
In this section, we examine the different ways in which creditors and owners look at a set of financial statements. Creditors are more balance sheet oriented. Owners and managers are more income statement oriented.
Ratios examined by banks for short-term loans
Short-term creditors are primarily interested in the balance sheet, which shows the firm’s current financial condition. These six ratios are commonly used for this purpose:
- Liquidity ratios such as the current ratio
- Cash and equivalents plus trade receivables to current debt
- Receivables to average day’s net sales
- Inventory turnover or supply in days
- Debt to (tangible) net worth
- Net fixed assets to (tangible) net worth
Lenders and creditors are concerned with two things: the borrower’s ability to repay and the security in case the borrower cannot repay.
Given these facts, how does a creditor view financial information? The answer depends upon whether we are dealing with short-term or long-term debt.
- When a company applies for a “short-term” bank loan, the ratios that the loan officer is most likely to base the loan decision on are
- Profit ratios.
- Liquidity ratios.
- Stock market ratios.
- All ratios.
Ratios examined by banks for long-term loans
The importance of the income statement increases with the length of the loan. Bankers place more emphasis ...