How Investors and Lenders Evaluate Your Business
Posted by Tom Craig in Business Loans SBA
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If you are writing your business plan for the purpose of borrowing money or raising capital for your new or existing business, you need to understand how potential lenders or investors will look at your business plan. Financial professionals use several ratios to help them understand the viability of your business.
Here is a list of the most popular ratios used according to the U.S. Small Business Administration - SBA:
Cash ratio. A measure of the amount of cash available to offset current debt (Cash + Total Current Liabilities). A ratio below 0.5 may mean you are having cash flow problems, possibly because of a significant backlog in accounts receivable.
Quick ratio. A measure of the amount of liquid assets available to offset current debt (Cash + Accounts Receivable + Current Liabilities). A healthy enterprise will always keep this ratio at 1.0 or higher.
Current ratio . A measure of the degree to which current assets cover current liabilities (Current Assets + Current Liabilities). A high ratio indicates a good probability the enterprise can retire current debts. A ratio of 2.0 or higher is a comfortable financial position for most enterprises.
Current liabilities to net worth. A measure of the extent to which the enterprise is using creditor funds versus their own investment to finance the business (Current Liabilities + Liabilities + Equity). A ratio of 0.5 or higher may indicate inadequate owner investment or an extended accounts payable period. Care should be taken not to offend your vendors (creditors) to the extent it affects your ability to conduct day-to-day business.
Total liabilities to net worth. A measure of the extent that the net worth of the enterprise can offset the liabilities (Total Liabilities + Liabilities + Equity). A ratio greater than 1.0 should be avoided, since it indicates the creditors have a greater stake in the business than the owners.
Fixed assets to net worth. A measure of the extent of an enterprise’s investment in non-liquid and often over-valued fixed assets (Fixed Assets + Liabilities + Equity). A ratio of 0.75 or higher is usually undesirable as it indicates possible over-investment and causes a large annual depreciation charge that will be deducted from the income statement.
Fixed assets to total assets. A measure of the extent to which fixed assets are financed with owners equity (capital) (Fixed Assets + Total Assets). A high ratio, 0.5 or higher, indicates an inefficient use of working capital, which reduces the enterprise’s ability to carry accounts receivable and maintain inventory and usually means a low cash reserve. This will often limit your ability to respond to increased demand for your products or services.
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