Ratios for Bank Lending/CMA Ratios

Banks have certain parameters to lend money to its customers. These are in the form of ratios and banks would require its customers to maintain ideal ratios. This eliminates the risk of default in repayment of loans and hence becomes very vital in lending process. It is also in the interest of borrowers to have a sound financial ratios in order to obtain credit from banks with ease.

Few important ratios for consideration

Debt to tangible net worth
1. This ratio compares a company's total debt outstanding relative to the value of its total assets minus intangible assets.
2. Ideally this ratio should be less than 1.0X.
3. If it exceeds 1.0X , that would be viewed as a potential red flag and a cause for concern to lenders in terms of the perceived credit risk.

Net Debt to EBITDA
1. It is a measure of a company financial leverage.
2. Calculated as (Interest bearing liabilities less cash & cash equivalents)/EBITDA
3. Ideally this ratio should be <3.0X.
4. If it exceeds 3.0X , that would be viewed as a potential red flag and may be the company will be financially distressed in the future

Debt to Equity
1. It is a measure of a company financial leverage.
2. Calculated as total liabilities/shareholder equity
3. Ideally this ratio should be <2.0X.
4. If it exceeds 2.0X , that would be viewed as a potential red flag as the company could move towards bankruptcy.

Current Ratio
1. It is a measure of a company liquidity ratio which shows company ability to meet short term liabilities.
2. Calculated as Current Assets/Current Liabilities
3. Ideally this ratio should be >2.0X.
4. If it lower than 2.0X , is a cause of concern as the company will not be able to meet its short term liabilities.

Debt service coverage ratio
1. It is a measure of company's cash flow available to pay current debt obligations.
2. Calculated as Monthly Income(before taxes)/Monthly Debt
3. Ideally this ratio should be >2.0X.
4. Most lenders prefer ratio between 1.2X to 1.4X.

Return on Equity
1. It is a measure of profit earned for each equity a company owns.
2. Calculated as Net income/Shareholders Equity
3. Ideally ratio depends on sector to sector. Generally 15% to 20% is considered good

Interest service coverage ratio
1. It is a measure of company’s ability to pay interest on its outstanding debt.
2. Calculated as EBIT/Interest expense
3. Ideally this ratio should be >2.0X.
4. Ratio of less than 1 indicates the firm is struggling to generate enough cash to repay its interest obligations.