A ratio (division) between two linked elements in a company’s financial accounts is referred to as a financial ratio. Its goal is to compare and quantify magnitudes objectively in order to better visualize corporate performance and make decisions based on certain goals.

For example, the ratios that reflect the profitability and stability of the company help partners and investors to determine the convenience of buying shares, while those that present the solvency and liquidity are key in the credit analysis to define the viability of granting financing for a company.

What are the most important financial ratios?

Multiple variables or indicators affect the financial performance and economic situation of a company. Therefore, there are several ratios that you can measure and compare in groups with a high degree of correlation. However, the most traditional and influential in decision-making are:

Debt Ratio

As its name implies, this data provides a view of the amount of debt of the company against its net worth. Provides insight into the amount of financial leverage and risk the company has acquired.

The formula is:

Debt ratio = (Liabilities / Equity)

Another piece of information that you should consider is the financial expense coverage ratio, which allows you to assess the ability of companies to meet their obligations and maintain income generation.

The formula is:

Coverage of financial expenses = EBITDA / financial expenses.

Profitability ratios

As the name implies, the indicators in this area seek to determine the performance of the profits generated during a given time.

The formula with which you calculate it is:

Profitability = Gross Profit / Total Net Assets.

Liquidity ratios

They are closely related to the solvency or capacity that companies have to meet some financial obligation.

The most important among all of them is the general liquidity ratio, also known as the current ratio, because it helps you identify the amount of debts that the company can cover with current assets.

The formula to calculate it is:

General Liquidity = Current Assets / Current Liabilities

Importance of financial ratios in credit analysis

• By visualizing the company’s performance and financial status, you may conduct a more thorough credit analysis based on important financial data.

• All ratios have an impact on the evaluation’s outcomes, but those measuring liquidity and solvency are more important for determining credit risk. This is due to the strong relationship between these indicators and the capacity to pay obligations and operating costs.

• Even if a business is not profitable, it is more likely to pay its debts on time if it has strong liquidity ratios than a successful business with poor cash flow. The study should, however, use as many ratios and indicators as is practical.

Of course, examining the overall liquidity ratio and other crucial ratios needs a lot of work and access to a lot of corporate data. The service from CRiskCo, which combines artificial intelligence and an API, makes it very simple to perform credit risk assessments in a matter of minutes.

Leading accounting systems like Quickbooks and Xero hosts the financial data of your clients, which the CRiskCo API consults, analyses, and uses to generate a credit risk analysis that takes into consideration a number of different indications and deliver you a thorough and trustworthy financial report.