inbound2084009338.pptx - EXPANDED UTILITY OF FINANCIAL RATIOS CHAPTER 13 FINANCIAL RATIOS AS PERCEIVED BY COMMERCIAL LOAN DEPARTMENTS Financial ratios

inbound2084009338.pptx - EXPANDED UTILITY OF FINANCIAL...

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EXPANDED UTILITY OF FINANCIAL RATIOS CHAPTER # 13
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FINANCIAL RATIOS AS PERCEIVED BY COMMERCIAL LOAN DEPARTMENTS Financial ratios can be used by a commercial loan department to aid the loan officers in deciding whether to grant a commercial loan and in maintaining control of a loan once it is granted. In order to gain insights into how commercial loan departments view financial ratios, a questionnaire was sent to the commercial loan departments of the 100 largest banks in the United States. Usable responses were received from 44% of them.
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A list of-59 financial ratios was drawn from financial literature, textbooks, and published industry data for this study. The study set three objectives: (1) the significance of each ratio, in the opinion of commercial loan officers, (2) how frequently each ratio is included in loan agreements, and (3) what a specific financial ratio primarily measures, in the opinion of commercial loan officers. For primary measure, the choices were liquidity, long-term debt-paying ability, profitability, or other. Cont.
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MOST SIGNIFICANT RATIOS AND THEIR PRIMARY MEASURE Most of the ratios given a high significance rating were regarded primarily as measures of liquidity or debt. Only two of the top ten ratios measure profitability, five measure debt, and three measure liquidity. The two profitability ratios were two different computations of the net profit margin: (1) net-profit margin after tax and (2) net profit margin before tax.
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Two of the top three ratios were measures of debt, and the other was a measure of liquidity. The debt/equity ratio was given the highest significance rating, with the current ratio second highest. We can assume that the financial ratios rated most significant by commercial loan officers would have the greatest influence on a loan decision. Cont.
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Ratios Appearing Most Frequently in Loan Agreements A commercial bank may elect to include a ratio as part of a loan agreement. This would be a way of using ratios to control an outstanding loan. Exhibit 13-3, page 556, contains a list of the ten financial ratios that appear most frequently in loan agreements, along with an indication of what each ratio primarily measures. For the two ratios that do not have a primary measure indicated, there was no majority opinion as to what the ratio primarily measured.
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Six of the ratios that appear most frequently in loan agreements primarily measure debt, two primarily measure liquidity, and none primarily measure profitability. The two top ratios, debt/equity and current ratio, were given the highest significance rating. The dividend payout ratio was the third most likely ratio to appear in loan agreements, but it was not rated as a highly significant ratio. Logically, this ratio appears in loan agreements as a means of controlling outflow of cash for dividends.
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