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Loan Evaluation: Financial Ratios and Loan Decisions

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As a practitioner-researcher, you will apply knowledge to real-life situations. In the following scenario, assume you are a loan officer for a bank and the owner of a small business approaches you regarding a loan. Consider the following questions as you formulate your decision:

- What financial ratios would you examine and why?
- Is there other information, in addition to the ratios, you would want to obtain from the business owner before making your decision on the loan?
- How would your answer change if it were a larger company seeking the loan?

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Solution Summary

Financial ratios and loan decisions for loan evaluations are discussed.

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Loan to Small Business
Ratio analysis helps in collection of important statistics about the company based on which the soundness of business can be accessed. For a small business special emphasis should be on accounts receivables and current liabilities. Receivables should not be tying to an undue amount of business's assets. If the receivables turnover ratio is too high it points to problem with company's collection practices. It could impact company's ability to generate cash. Current ratio is an indication of current assets which are used to pay off current liabilities. It helps in evaluation of how the company uses its cash. A low ratio would indicate inability to meet working capital requirements; a general pointer to short-term financial adequacy.
Return on asset ratio indicates how well the company manages its assets. ...

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