When Australian businesses need to raise money, loans are one of the most straightforward ways to do it. The trouble is that a rejected application can hurt your chances the next time you ask for a loan, so you should only apply if you are confident that you will be approved. That means you need to know what the banks are looking for when they review your documents. When it comes to your company’s finances, there are several ratios which help them predict whether you will pay them back. Here are some of the most common ones.
Debt-to-income ratio
Whether you are applying for the best loans in Sydney from Pronto Funds or a small loan from the local bank in a little town, you can be certain that they will calculate the debt-to-income ratio. Sometimes in business, this is known as the debt service coverage ratio, but it measures the same thing no matter what it is called. It looks at how many times your company can pay its debt obligations with its current income.
Each lender will have their own idea of what this number should be, but 1.25 is a good minimum to aim for.
Credit score
While some lenders will offer no credit check loans to startups, most business loan applications are subject to a credit check. While not a ratio, your credit score is calculated from many different numbers. These include how consistent you have been when making payments and how much debt you have altogether. What constitutes a good credit score depends on the reporting agency the lender uses, but aiming for 700 will put you into the ‘good’ category for the most common ones.
Quick ratio
This gives lenders a rough idea of whether a company could repay its debts if sales suddenly declined. It subtracts your current liabilities – debts that your business owes within the next year – from your liquid assets. These are assets which are already in cash form or which can be converted into cash within 90 days. It does not include things like inventory or property. If this ratio is less than one, it suggests that your business would struggle to pay its short term obligations if sales do not perform as expected.
Debt-to-equity ratio
It is helpful for lenders to know if they can recoup some of their money if the business collapses. For this they use the debt-to-equity ratio. This is all of the company’s liabilities divided by its shareholders’ equity. If the company goes under, shareholders’ equity will be used to pay off the debts. If the debt figure is much larger than the equity figure, then a lot of lenders are not going to get their money back. The acceptable level of this ratio varies by industry, but generally anything over 2.5 puts you into risky territory.
Conclusion
Wise lenders cannot rely only on promises and projections. They need to see how these stack up against your business’s historical performance, and ratios are essential tools for making sense of the numbers. They can also help you gain a better understanding of your business, and improving them will help make your business more financially resilient as well as helping you access more funding.
