When applying for a business loan, understanding your company’s financial health from your lender’s perspective can significantly improve your chances of approval.
While commercial lending is often seen as complex, much of it comes down to data-driven financial analysis. At the heart of that analysis are lending ratios, which are critical tools that banks use to assess a borrower's risk.
In this article, we’ll explore three of the most important credit ratios lenders evaluate, why they matter, and how your business can monitor them. We’ll even share the formulas for them to stay financially strong.
Why Do Lending Ratios Matter?
Banks are in the business of managing risk. Because they operate on thin margins and are highly regulated, lenders must be cautious with how they deploy funds, particularly when lending depositor and shareholder money. To reduce the likelihood of loan defaults, lenders use financial ratio analysis to:
- Evaluate your company’s ability to repay debt
- Benchmark your business against industry norms
- Identify financial trends and potential red flags
Understanding these credit analysis ratios can give you a clearer picture of your business’s financial condition and help you better prepare for conversations with lenders.
1. Debt-to-Cash Flow Ratio (Leverage Ratio) Loans
The debt-to-cash flow ratio, often referred to as the leverage ratio, measures how many years of cash flow it would take to pay off your company's total debt.
Formula:
Total Debt ÷ Cash Flow (typically EBITDA)
This ratio gives lenders insight into your company’s ability to generate sufficient earnings to cover debt over time. A lower leverage ratio generally signals lower financial risk and a more stable debt profile. High leverage, on the other hand, may prompt lenders to scrutinize your capital structure and debt strategy.
What Lenders Look For & Consider Healthy:
- A ratio below 3.0x is often considered healthy, though this varies by industry.
- High leverage may raise red flags, especially in volatile markets.
2. Debt Service Coverage Ratio (DSCR) Loans
The DSCR is one of the most common covenants in commercial lending agreements. It measures your company’s ability to cover its debt obligations — both principal and interest — from operating income.
Formula:
Net Operating Income ÷ Total Debt Service
Lenders may calculate DSCR slightly differently based on whether they include EBITDA, EBITDAR, lease payments, or guarantees. For a helpful breakdown of DSCR methodology, the Corporate Finance Institute offers a comprehensive guide.
What Lenders Look For & Consider Healthy:
- A DSCR of 1.25 or higher is commonly preferred.*
- A DSCR below 1.0 means the company is not generating enough income to cover its debt obligations—a major concern for lenders.
*A debt service coverage ratio greater than 1.0 indicates that a company has enough income to cover its debt obligations. Most lenders prefer a buffer, often requiring a DSCR of 1.25 or higher to ensure a margin of safety. This ratio is frequently included as a covenant in business loan agreements, and breaching it can trigger lender scrutiny or penalties.
3. Quick Ratio (Acid-Test Ratio) Loan
The quick ratio measures a company’s short-term liquidity and its ability to pay current liabilities using quick assets — those that can be converted to cash within 90 days.
Formula:
(Cash + Marketable Securities + Accounts Receivable) ÷ Current Liabilities
This ratio excludes inventory, which may not be as readily convertible to cash, giving a more conservative view of a company's liquidity position. Maintaining strong liquidity is particularly important during periods of economic uncertainty or when preparing for expansion or investment.
What Lenders Look For & Consider Healthy:
- A ratio above 1.0 suggests a company can meet its short-term obligations without relying on selling long-term assets.
- A ratio below 1.0 might signal cash flow issues or ineffective working capital management.
Using Ratio Analysis to Strengthen Your Business
Beyond helping lenders make decisions, credit ratio analysis is an essential internal tool for business owners and financial leaders. Regularly monitoring these ratios can help you:
- Spot early warning signs of financial trouble
- Inform strategic decisions (e.g., debt management, growth planning)
- Benchmark performance against industry peers
Using a well-rounded approach to financial health monitoring, including the key lending ratios, can lead to better business outcomes and stronger lender relationships.
Let Us Help You Strengthen Your Financial Position
Understanding and managing your lending and credit ratios isn’t just about getting approved for a loan — it’s about building a financially sound business.
At Kreischer Miller, we help private companies improve transparency, reduce risk, and optimize financial performance. Whether you're seeking financing, evaluating expansion, or just want a clearer picture of your financial position, we can help.
Explore our Audit & Accounting Services to learn how we support businesses like yours in building lasting value.