Credit Ratios Definition, Types & Examples

Meaning of Credit Ratio:

The process of credit analysis is helped along by several techniques, including credit analysis ratios. Analysts and investors can use these statistics to judge whether or not people or organizations are capable of meeting their financial obligations. The evaluation of credit encompasses qualitative as well as quantitative considerations. The quantitative aspect of the investigation is represented by ratios.

Type Of Credit Ratios

1) EBIT Interest Coverage

The number of times that a company's EBIT is able to pay its projected interest expenditures is one of the things that analysts may learn from this indicator. To determine this, divide the entire interest expense incurred by a company by the EBIT of that company.

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2) EBITDA Interest Coverage

The EBITDA-to-interest coverage ratio is a financial ratio that is used to assess a company's financial durability by examining whether or not the company is at least profitable enough to pay off its interest expenses using its pre-tax income. The ratio is calculated by dividing a company's pre-tax income by its interest expenses. In particular, it investigates the extent to which earnings before interest, taxes, depreciation, and amortization (EBITDA) can be applied to this objective and what fraction of those earnings can be employed.

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3) EBITDA Less Capex Investment

Based on EBITDA after capital expenditures are taken into account, the ratio is used to evaluate a company's capacity to pay interest charges.

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4) Debt To Equity Ratio

The ratio of a company's debt to its equity is one way to evaluate how well it will be able to meet its financial commitments. It basically demonstrates the state of health that a given company is in overall. In the event that the debt-to-equity ratio is larger, it indicates that the firm is obtaining a greater amount of funding through the lending of money that is exposed to risk. If the prospective debts are too high, there is a possibility that the company will go bankrupt during these times. In most cases, a higher level of leverage alerts shareholders to the fact that a company or its stocks carry a higher level of risk. However, because the appropriate level of debt for each industrial group is different, it is difficult to compare the debt-to-equity ratio of different businesses. The debt-to-equity ratio is modified by investors so that they can concentrate solely on long-term debt since the risk associated with long-term liabilities is distinct from the risk associated with short-term debts and payables.

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5) Cash flow available for debt service

Cash Flow Available for Debt Service (CFADS), which is also frequently known as cash available for debt service (CADS), refers to the amount of cash that is available to be used for the purpose of satisfying debt obligations. In order to provide an accurate depiction of a project's capacity to create cash flows and pay back debt, it takes into account a number of cash inflows and outflows from various sources. In the process of developing project finance models, financial analysts may frequently decide to make CFADS one of the most significant KPIs to employ.

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6) DSCR- Debt service coverage ratio

The debt-service coverage ratio is applicable to all levels of finance, including personal, corporate, and governmental. In the realm of corporate finance, a company's debt-service coverage ratio (DSCR) is a measurement of the amount of cash flow that is available to the company for the purpose of meeting its existing debt commitments. The debt service coverage ratio (DSCR) reveals to investors whether a company generates sufficient revenue to satisfy its obligations.

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7) Loss given default

LGD refers to the portion of an asset that is lost as a result of a borrower going into default. When a borrower goes into default, the percentage of an asset that is recovered is known as the loss given default (LGD), and the recovery rate is defined as 1 minus the LGD.

Because such losses are generally understood to be influenced by key transaction characteristics like the presence of collateral and the degree of subordination, loss given default is facility-specific. This is because the presence of collateral and the degree of subordination are examples of such characteristics.

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8) Fixed Charge Coverage Ratio

The Fixed Charge Coverage Ratio (FCCR) is a metric that determines whether or not a company has sufficient cash flows to cover fixed charges such as interest expense, required debt repayment, and lease expense.

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9) Capitalization Ratio

Capitalization ratio, abbreviated as CR, is a type of financial ratio that compares the total amount of debt held by a firm to the entire amount of equity held by that same company. This ratio is also referred to as the financial leverage ratio. The ratio indicates how dependent the company is on debt from outside sources and how much of its own equity capital is being used to fund its operations and achieve its objectives.

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10) Debt Ratio

The ratio of a company's debt to its total assets is a type of financial statistic that may be used to determine the degree to which an organization is leveraged. The ratio of total debt to total assets is the definition of the debt ratio, and it can be stated as either a decimal or a percentage. One way to think of it is as the percentage of a company's total assets that are supported by its debt obligations. If a corporation has a ratio that is more than one, it indicates that a significant portion of the company's assets are funded by debt; this indicates that the company has more liabilities than it does assets. If a corporation has a high ratio, this suggests that they may be at risk of defaulting on their debts should there be an unexpected increase in interest rates. If a corporation has a ratio that is lower than 1, it indicates that a bigger proportion of its assets are backed by equity.

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11) Debt to Capital

To determine a company's debt-to-capital ratio, take all of the company's interest-bearing debt, including both short-term and long-term obligations, and divide that number by the entire amount of capital. A company's total capital consists of all of its interest-bearing debt as well as the equity held by its shareholders. This equity may take the form of common stock, preferred stock, or minority stake.

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12) Cash Flow to Total Debt

The cash flow-to-debt ratio of a corporation is the proportion of its cash flow from operations to its total debt as a ratio. This ratio is a form of coverage ratio that may be used to evaluate how long it would take an organization to repay its debt if it used all of its cash flow to do so instead of investing in new assets or expanding its business.

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13) Liabilities to assets

The ratio of a company's obligations to its assets, also known as the liabilities to assets (L/A) ratio, is a type of solvency ratio that determines what percentage of a company's assets are comprised of liabilities. If the L/A ratio is 20%, this indicates that the company's liabilities make up 20% of its total assets.

A high ratio of liabilities to assets might be unfavorable; this implies that the shareholder equity is low and that there may be problems with the company's ability to remain solvent. Companies that are growing quickly typically have a larger ratio of their liabilities to their assets (quick expansion of debt and assets).

It is common for businesses who are showing indications of financial crisis to also have high L/A ratios. If a corporation is experiencing falling sales and weak long-term growth prospects, this will have an effect on the retained equity of the organization. Companies with low liabilities to assets ratios are likely to have little or no obligations. This is typically a positive indicator of the company's overall financial health, however there are a few significant exceptions to this rule.

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Summary of Credit Ratios