How financial ratios assist credit assessment

How financial ratio analysis can assist credit assessment?

Without doubt, the most useful tools of going-concern assessment are the traditional financial ratios, tried and tested by time. By using financial ratio analysis we can have a reliable overall picture of the financial performance of an organisation and also can pinpoint particular areas of concern, sometimes with uncanny accuracy.

However, there are some serious problems associated with the use of financial ratios:-

(i) since they are calculated from accounts, a delay in those accounts will deny the usefulness of the ratios just when they are needed, for delayed accounts are the oldest trick of an organisation in trouble.

(ii) accountancy is an art, not a science, and despite accounting standards, accounts become an abstract art in the results of an organisation in trouble, which again throws reliability into question.

(iii) interpretation is subjective and the value of one ratio on its own is doubtful - and sometimes positively dangerous. Proper interpretation will alert the observer to trouble spots. Ratios will not on its own infallibly predict corporate failure but they will arouse anxiety.

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