Financial Ratio Analysis for Bank Loans — Current Ratio, Quick Ratio, Debt-Equity, TOL/TNW, DSCR, Interest Coverage, Turnover and Profitability Ratios, the Benchmarks Banks Apply in CMA Appraisal, and How to Improve a Ratio Before You Apply
1.33
Current ratio banks expect for working-capital limits (Tandon second method)
≤ 3–4
TOL/TNW — total outside liabilities to tangible net worth — the leverage ceiling most banks apply to MSMEs
≥ 1.5
Average DSCR over the loan tenure for a term loan (not below 1.25 in any year)
≥ 2
Interest coverage (EBIT ÷ interest) that keeps a proposal out of the watch list
Guide by BookMyCA's Chartered Accountants · pan-India serviceLast verified against official guidelines on 6 September 2026.
Video Explanation & Insights
Ratio analysis — all the ratios, worked practically
4 videos on this topic
Liquidity ratios — can you pay this year's bills?
| Ratio | Formula | Benchmark | Reading |
|---|---|---|---|
| Current ratio | Current assets ÷ current liabilities | 1.33 for working-capital limits (1.25 accepted for some MSMEs; 1.0 minimum) | Below 1: the unit is funding long-term assets with short-term money; well above 2: idle stock or uncollected debtors |
| Quick (acid-test) ratio | (Current assets − inventory) ÷ current liabilities | About 1 | Shows whether debtors and cash alone cover payables |
| Net working capital | Current assets − current liabilities | Positive, and ≥ 25% of current assets under Tandon II | The margin the promoter funds |
| Cash ratio | Cash and bank ÷ current liabilities | No fixed norm | Used for units with erratic collections |
Banks reclassify before computing: term-loan instalments due within a year become current liabilities; group-company advances, slow debtors above 90–180 days and dead stock are removed from current assets; unsecured loans from promoters are treated as current unless subordinated. Compute the ratio the bank's way, not the auditor's.
Leverage and solvency — how much of the business is borrowed?
| Ratio | Formula | Benchmark | Reading |
|---|---|---|---|
| Debt-equity | Long-term debt ÷ tangible net worth | ≤ 2:1 for term loans (up to 3:1 for capital-intensive units) | Higher than the norm needs more promoter contribution |
| TOL/TNW | Total outside liabilities (all borrowings + creditors + provisions) ÷ tangible net worth (capital + reserves − intangibles − group investments) | ≤ 3 for most MSMEs, up to 4–5 for traders | The single most-cited ratio in MSME rejections |
| Proprietary ratio | TNW ÷ total assets | ≥ 25–30% | Owner's stake in the assets |
| Interest coverage | EBIT ÷ interest | ≥ 2 (≥ 3 comfortable) | Ability to service interest from operations |
| DSCR | (PAT + depreciation + interest on term loan) ÷ (interest on term loan + principal instalments) | Average ≥ 1.5, minimum 1.25 in any year | The term-loan ratio; computed year-wise from projections |
Quasi-equity: unsecured loans from promoters and relatives are added to net worth (and removed from TOL) only if the lender signs a subordination undertaking that the money stays in the business for the loan's tenure. A ₹40 lakh family loan reclassified this way can move TOL/TNW from 4.5 to 2.8 without a rupee changing hands — the commonest legitimate repair.
Turnover ratios — how fast money moves
| Ratio | Formula | Typical range | Reading |
|---|---|---|---|
| Inventory holding (days) | Average inventory ÷ cost of sales × 365 | 30–90 manufacturing; 15–45 trading | The days of stock the bank finances; excess is dead stock |
| Debtor collection (days) | Average receivables ÷ credit sales × 365 | 30–90 (bank finances debtors up to 90–120 days) | Collections slower than the credit period signal weak buyers |
| Creditor payment (days) | Average payables ÷ credit purchases × 365 | 30–60 | Very long creditor days flag stretched suppliers — and the 43B(h) 45-day MSME rule |
| Working-capital cycle | Inventory days + debtor days − creditor days | Product-specific | Drives the working-capital requirement in the CMA |
| Asset turnover | Sales ÷ total assets (or fixed assets) | 1.5–4 | Capacity utilisation and pricing |
Profitability ratios — is the business earning enough?
| Ratio | Formula | What banks compare it with |
|---|---|---|
| Gross margin | (Sales − cost of goods sold) ÷ sales | Industry norm; a sudden jump in the projection year is questioned |
| Operating (EBITDA) margin | EBITDA ÷ sales | Must cover interest and depreciation with room for drawings |
| Net margin | PAT ÷ sales | Consistency across years matters more than level |
| Return on capital employed | EBIT ÷ (net worth + long-term debt) | Should exceed the loan's interest rate |
| Return on equity | PAT ÷ net worth | Compared with the promoter's alternative use of money |
| Cash accruals | PAT + depreciation | Source of term-loan repayment and of the promoter's margin in later years |
A manufacturing unit, read the bank's way
| Figure (₹ lakh) | Amount | Ratio | Result | Bank view |
|---|---|---|---|---|
| Sales / cost of sales | 600 / 480 | Gross margin | 20% | In line with the industry |
| EBIT / interest | 54 / 18 | Interest coverage | 3.0 | Comfortable |
| Current assets / current liabilities | 240 / 165 | Current ratio | 1.45 | Passes 1.33 |
| Inventory / debtors | 90 / 110 | Days | 68 / 67 | Acceptable; debtors over 90 days excluded |
| Term debt / TNW | 120 / 95 | Debt-equity | 1.26 | Passes |
| TOL / TNW | 285 / 95 | TOL/TNW | 3.0 | At the ceiling — subordinate the ₹30 lakh family loan to bring it to 2.0 |
| PAT + depreciation + TL interest / TL interest + instalments | (30 + 12 + 10) / (10 + 24) | DSCR | 1.53 | Passes 1.5 |
- •Improve the current ratio: convert a portion of the cash-credit limit into a working-capital term loan, collect old debtors, write off dead stock (it was inflating both sides), or bring in margin.
- •Improve TOL/TNW: subordinate promoter loans, retain profits instead of drawings, convert loans to capital, pay down creditors before year end.
- •Improve DSCR: lengthen the tenure or moratorium, reduce the loan by increasing margin, phase capital expenditure, or show the incremental revenue of the new asset separately.
- •Never improve a ratio with fictitious entries — the bank's stock audit, GST returns and the auditor's report cross-check every one of them.
Ratio analysis: questions we are asked
Current ratio (1.33) and TOL/TNW; the bank finances 75% of the working-capital gap and wants the promoter's 25% visible as net working capital.
DSCR year-wise and average, then debt-equity and interest coverage; the projections must show cash accruals covering instalments with a cushion.
Not necessarily — MSMEs are often accepted at 1.25 or even 1.0 with justification, but you should show how the margin will be built up over two years.
Only when subordinated in writing to the bank's loan and not withdrawn during the tenure; otherwise they are outside liabilities.
Two to three audited years plus the estimated current year and the projected years in the CMA — trends matter as much as levels.
Yes — as part of every CMA and DPR, recast the bank's way, with the repairs planned before submission.