Why Ratio Analysis Matters in CMA
Ratio analysis converts raw financial figures into comparable, standardised measures. A credit officer reviewing 50 loan files a week cannot deep-dive into every P&L line — ratios give them a 30-second scorecard of financial health.
In a CMA submission, ratios are computed for every year — historical and projected. Banks look for:
- Consistency with historical performance (no sudden unexplained improvement)
- Alignment with industry benchmarks for the borrower's sector
- Year-on-year improvement trend in projections
- No ratio falling below the bank's internal threshold in any year
1. Liquidity Ratios
Liquidity ratios measure the ability to meet short-term obligations. These are the most scrutinised ratios for working capital (CC) limit applications.
| Ratio | Formula | Bank Benchmark | What It Shows |
|---|---|---|---|
| Current Ratio | Current Assets ÷ Current Liabilities | ≥ 1.33 (RBI minimum) | How many rupees of CA cover each rupee of CL. Below 1.33 means bank is over-financing; RBI mandates action. |
| Quick Ratio (Acid Test) | (CA − Inventory − Prepaid) ÷ CL | ≥ 1.00 preferred | Stricter liquidity — excludes slow-moving inventory. Important for trading businesses with high stock holding. |
| Absolute Liquidity Ratio | (Cash + Bank + Short-term investments) ÷ CL | ≥ 0.50 preferred | Immediate payment ability without selling any assets. Low values flag cash management issues. |
2. Profitability Ratios
Profitability ratios tell the bank whether the business generates adequate returns — and therefore whether it can sustain debt repayment long-term.
| Ratio | Formula | Benchmark | What It Shows |
|---|---|---|---|
| Gross Profit Margin | Gross Profit ÷ Net Sales × 100 | Industry-specific (15–40%) | Core business profitability before overheads. Must be consistent with industry norms. |
| EBITDA Margin | EBITDA ÷ Net Sales × 100 | ≥ 10% for manufacturing | Operating cash generation before financial costs. Low EBITDA makes debt service difficult. |
| Net Profit Margin (PAT %) | PAT ÷ Net Sales × 100 | ≥ 3–5% sustained | Bottom-line profitability. Persistently negative or near-zero margins raise viability concerns. |
| Return on Capital Employed (ROCE) | EBIT ÷ (Net Worth + Long-term Debt) × 100 | ≥ 15% | How efficiently capital is being used. ROCE below cost of debt means the business destroys value. |
| Return on Net Worth (RONW) | PAT ÷ Net Worth × 100 | ≥ 10–12% | Return to equity shareholders. Very low RONW suggests promoters would do better in fixed deposits. |
| Return on Total Assets (ROTA) | PAT ÷ Total Assets × 100 | ≥ 5% | Asset productivity — how much profit each rupee of asset generates. |
3. Solvency & Leverage Ratios
Solvency ratios tell the bank how much of the business is funded by debt vs equity. Highly leveraged businesses are riskier — any revenue decline directly impacts debt servicing ability.
| Ratio | Formula | Benchmark | What It Shows |
|---|---|---|---|
| Debt-Equity Ratio (D/E) | Total Long-term Debt ÷ Net Worth | ≤ 2:1 (services), ≤ 3:1 (mfg) | How much borrowed money backs every rupee of equity. Higher ratio = higher risk for the bank. |
| TOL/TNW (Total Outside Liabilities / Tangible Net Worth) | (Total Liabilities − Net Worth) ÷ Tangible Net Worth | ≤ 4:1 | Broader leverage measure including all creditors, CC, TL. Banks use this as a ceiling for total exposure. |
| Interest Coverage Ratio (ICR) | EBIT ÷ Total Interest | ≥ 2.0 | How many times operating profit covers interest charges. Below 1.5 is a serious concern. |
| Debt Service Coverage Ratio (DSCR) | (PAT + Dep + TL Interest) ÷ (TL Principal + TL Interest) | ≥ 1.5 (term loans) | Repayment capacity for term loans. The most critical ratio for any TL application. |
| Net Worth / Equity Ratio | Net Worth ÷ Total Assets × 100 | ≥ 25% | What proportion of assets is funded by owner's equity. Very low equity ratio signals over-leverage. |
4. Efficiency & Activity Ratios
Efficiency ratios measure how well the business manages its assets and working capital cycle. They also validate the working capital day assumptions used in Form IV.
| Ratio | Formula | What It Shows |
|---|---|---|
| Inventory Turnover Ratio | Cost of Goods Sold ÷ Average Inventory | How quickly inventory is sold. Higher = better asset utilisation. Compare to industry peers. |
| Inventory Holding Days | 365 ÷ Inventory Turnover | Average days to sell inventory. Must match Form IV working capital day assumptions. |
| Debtors Turnover Ratio | Net Credit Sales ÷ Average Debtors | How quickly receivables are collected. Low ratio means slow collection — liquidity risk. |
| Debtors Collection Days | 365 ÷ Debtors Turnover | Average days to collect payment from customers. Must match debtor day assumptions in Form IV. |
| Creditors Turnover Ratio | Net Credit Purchases ÷ Average Creditors | How quickly the business pays its suppliers. |
| Creditor Payment Days | 365 ÷ Creditors Turnover | Average days to pay suppliers. Very long creditor days may suggest stretched payables — a risk signal. |
| Fixed Asset Turnover | Net Sales ÷ Net Fixed Assets | Revenue generated per rupee of fixed assets. Low ratio suggests underutilised capacity. |
| Total Asset Turnover | Net Sales ÷ Total Assets | Overall asset productivity. Manufacturing businesses typically have lower ratios than trading businesses. |
| Working Capital Turnover | Net Sales ÷ Net Working Capital | How efficiently working capital generates sales. Very high ratio may indicate over-trading (too little WC). |
Ratios That Trigger Bank Queries
These specific ratio combinations consistently generate queries from credit officers:
Current Ratio below 1.33
Automatic query — bank must either reduce CC or ask for NWC infusion before processing further.
Debtor days in ratios ≠ debtor days in Form IV
Inconsistency between ratio analysis and working capital assumptions raises immediate questions about data integrity.
ICR below 1.5 with high TL outstanding
Operating profit barely covers interest — any revenue dip makes the account NPA-prone. Bank will require additional collateral or reduce sanction.
TOL/TNW above 5:1
Extreme leverage — most banks have an internal ceiling beyond which they will not sanction additional facilities regardless of other ratios.
Net profit margin negative in any projection year
A projected loss year means the business cannot service debt from operations — bank will ask how the EMI will be paid that year.
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