The financial ratios lenders check first

Why ratios come before the narrative

A loan proposal usually arrives with a business plan, a pitch, and a story about growth. Underwriters read all of that, but the first pass through most credit appraisal processes is mechanical: a set of ratios pulled from the financials, compared against internal benchmarks and against similar businesses in the same industry. A strong story sitting on weak ratios rarely overcomes the numbers; a modest story sitting on strong ratios often sails through faster than expected.

Liquidity: can the business meet its short-term obligations

The current ratio — current assets divided by current liabilities — is usually the first number an underwriter looks at. It answers a simple question: if every short-term liability came due at once, could the business's short-term assets cover it? Most lenders look for a ratio comfortably above one, though the exact comfort level varies by industry, since businesses with fast inventory turns can operate safely at a lower ratio than those with long working capital cycles.

Why current ratio alone can mislead

A current ratio can look healthy while hiding slow-moving inventory or ageing receivables that will never actually convert to cash on time. This is why underwriters often pair it with a look at receivable ageing and inventory turnover, rather than relying on the headline ratio alone.

Leverage: how much of the business is funded by debt

Total outside liabilities to tangible net worth (TOL/TNW) and the debt-equity ratio both measure leverage, but from slightly different angles. TOL/TNW captures all outside liabilities — including trade creditors and other current liabilities — against tangible net worth, giving a fuller picture of how much of the balance sheet is funded by outsiders rather than promoters. The debt-equity ratio narrows this to funded debt specifically. Both are compared against industry norms, since capital-intensive sectors naturally carry higher leverage than trading businesses.

For secured term loans: the fixed asset coverage ratio

Where a term loan is secured against plant, machinery or property, lenders separately look at the fixed asset coverage ratio — broadly, the value of fixed assets offered as security compared with the loan outstanding. This ratio sits alongside, not instead of, DSCR: DSCR tells a lender whether cash flow can service the loan in the ordinary course, while the fixed asset coverage ratio tells the lender what cushion exists if that ordinary course does not play out as expected. A business with adequate DSCR but thin asset coverage may still see a lender ask for additional collateral, and the reverse is equally true. Valuations used for this ratio are typically obtained from an approved valuer and are periodically refreshed, so a coverage ratio calculated from an old valuation can understate or overstate the actual position.

Servicing capacity: can the business actually pay the instalments

The debt service coverage ratio (DSCR) and interest coverage ratio measure whether operating cash flow is sufficient to cover debt obligations, not just whether the business is profitable. A company can show healthy accounting profit while having a thin DSCR, if depreciation, working capital movements, or one-off income are distorting the cash-flow picture. For term loans in particular, DSCR across the full repayment period — not just the current year — is central to the appraisal.

Why these ratios are read together, not one at a time

No single ratio decides an outcome, and it is a mistake to try to optimise one in isolation. A business can improve its current ratio simply by delaying a supplier payment at year-end, but that same action leaves leverage and the operating cycle unchanged, and an experienced underwriter will typically look past a ratio that appears to have been managed for a single reporting date rather than reflecting genuine, sustained improvement. The combination — liquidity, leverage, and servicing capacity, read together across at least two to three years — is what actually shapes an underwriter's view, far more than any single ratio in a single year.

Profitability and scale: is EBITDA growing in the right direction

EBITDA margin trends, alongside absolute EBITDA relative to debt obligations, help a lender judge whether the business generates enough operating cash to support both existing and proposed facilities. A single strong year is treated with more caution than a steady multi-year trend, particularly if the strong year includes one-off income that will not recur.

For working capital proposals specifically: the working capital gap

For cash credit and overdraft assessments, lenders also look closely at the working capital gap — the difference between current assets and current liabilities other than bank borrowing — since this, alongside the operating cycle length, largely determines the assessed limit under most working capital assessment methods used by Indian banks.

Questions worth asking yourself before you approach a lender

• Has the current ratio been stable across the last three years, or does it swing sharply at specific reporting dates?
• How does leverage compare with at least one or two comparable businesses in the same industry, rather than against an internal sense of what feels reasonable?
• Would DSCR still comfortably cover obligations if the newly proposed facility were added on top of existing debt, not just the existing facilities alone?
• Is there a clear, defensible explanation ready for any ratio that looks weaker than the rest of the picture, rather than hoping it goes unnoticed?
• Are the figures being used for these ratios drawn from audited financials, or from provisional numbers that a lender may still query?

Working through these questions before a formal application is submitted rarely changes the underlying financial reality, but it does mean that when an underwriter raises a query, the business already has a considered answer ready rather than needing to construct one under time pressure. That difference alone often shapes how smoothly an appraisal proceeds, and it costs nothing beyond an afternoon with last year's financials and a calculator.