Top Three Financial Ratios Banks Will Look At In Your Financial Statements
Are you an entrepreneur? Are you a businessperson who had never dealt with a lending institution?
Well, you probably assume that securing a property loan will be a cakewalk for you because your books reflect profits in the past. It may be true that your prospective income statements show that you will make profits in the future as well. Unfortunately, 'profit' is not the only criterion that banks rely on while assessing your financial health.
To get a clear picture of your financial health, banks look at other key ratios too. It is important that you know the ratios that banks look at while assessing your eligibility for a property loan.
MakaanIQ lists the top three financial ratios that lenders look at in your financial statements.
Debt Service Coverage Ratio (DSCR)
If you are a businessperson, you can be certain that the lender will assess the 'Debt Service Coverage Ratio'. DSCR calculates the repayment capacity of the borrower. In other words, this ratio determines the cash profit available to repay the debt, including the interest component. DSCR is very important from the lender's point of view because it reflects the repaying capacity of the entity that applies for a loan.
DSCR is very important while assessing loan eligibility because it is ascertained for the entire term of the loan.
If the DSCR is less than one, this reflects the inability of the firm's cash profits to serve its debts. If the DSCR is greater than one, this reflects the firm's ability to service the loan and pay dividends at the same time. Higher the DSCR, better is your firm's debt servicing capacity.
The DSCR of a company is calculated by deducting Profits after Tax (PAT), Non-cash expenses (like depreciation), interest and instalment for the current year, and lease rentals paid during the current year from the company's financial statements.
Please understand that the lender is not calculating this ratio just to arrive at a number. They interpret this ratio.
The acceptable range of the DSCR is from 1.5 to 2.00.
The other side of DSCR also says that if there is a negative perception about the repayment capacity of the company, the bank will not just count on this ratio. The bank will also look at the profit-generating capacity of the company along with the business/product demand in the market. The DSCR can also be improved by increasing the tenure period of the loan.
Debt to income ratio
Many businessmen believe that if they have sufficient assets as collateral, banks will certainly sanction their loans. This is not true. Every business has to make ample money to cover its operational expenses and repay the debt they owe to lenders.
The Debt to Income ratio calculates how much of a person's income is spent on his/her debts. If the ratio is too high, this means that much of the applicant's income is being used in repaying debt and that there is less/no scope for a new loan. If a fresh loan is extended, the applicant may find it difficult to pay the monthly instalments.
Debt to income ratio is low when the applicant has no obligations running.
The best way to improve the debt to income ratio is by increasing the net profit. This gives you more funds to repay your debt.
Another way to improve the debt to income ratio is to choose a loan with a longer tenure period.
Make sure that you always maintain a good debt to income ratio. This will make it much easier to finance your property purchase.
Debt to equity ratio
This is a very important leverage ratio. It reflects the ability of a company to make payments associated with long-term debt.
The debt to equity ratio helps to ascertain the company's long-term financial position. A higher debt to equity ratio indicates that more creditor financing (bank loan) is being used in running the business than investor funding (owner's funds). The fact is that no matter how bad sales/earnings are, every business has to service the debt. When the earnings are low, the owner's funds can provide cushion to meet the administration and operational expenses and also make debt payments at the same time.'
Debt-to-Equity ratio reflects the risk appetite of the company. The ratio is considered very industry specific.