Key Financial Ratios for Credit Analysis

Key Financial Ratios for Credit Analysis

Credit analysis involves a wide variety of financial ratios. These are just some of the most commonly used financial ratios. 

A ratio analysis 

It’s a quantitative analysis of information contained in a company’s financial statements. Ratio analysis is used to evaluate various aspects of a company’s operating and financial performance such as its efficiency, liquidity, profitability and solvency. 

Ratio analysis is a useful management tool that will improve understanding of financial results and trends over time, and provide key indicators of organisational performance. Managers will use ratio analysis to pinpoint strengths and weaknesses from which strategies and initiatives can be formed. 

Profitability ratios 

Profitability ratios are arguably the most widely used ratios in investment analysis. These ratios include the universal “margin” ratios, such as gross, operating and net profit margins.  

These ratios measure the firm’s ability to earn an adequate return. When analysing a company’s margins, it’s always prudent to compare them against those of the industry and its close competitors. 

Margins will vary among industries. Companies operating in industries where products are mostly “commodities” products easily replicated by other firms will typically have low margins. Industries that offer unique products with high barriers to entry generally have high margins. In addition, companies may hold key competitive advantages leading to increased margins. 

Debt-to-assets ratio 

The debt-to-assets ratio is the most basic solvency ratio, measuring the percentage of a company’s total assets that is financed by debt. The ratio is calculated by dividing total liabilities by total assets. A high number means the firm is using a larger amount of financial leverage, which increases its financial risk in the form of fixed interest payments.  

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