In the realm of community banking, credit underwriting is not just a process—it’s an art. It’s a
testament to your expertise, requiring a keen eye for detail and a deep understanding of financial
metrics to paint a true picture of a borrower’s fiscal health. Today, we spotlight six key income
statement ratios that serve as the linchpins of insightful credit analysis, where knowledge is
paramount.
- Gross Profit is the difference between sales or Revenue and the Cost of Goods Sold. This
equation provides the margin after cost. As a ratio used in a comparison analysis, it can give you
or the company an indication of whether their pricing is being maintained compared to their cost.
Gross Profit = Sales – Cost of Goods Sold - Operating Profit is the amount of money remaining after a company pays all its operating
expenses before taxes.
Operating Profit = Sales – Cost of Goods – Operating Expenses – Other Day-to-Day
Expenses - Operating Cash Flow indicates whether a company can generate sufficient positive cash flow
to at least maintain its operation. If the company cannot, financing for capital expenditure may
be warranted, or it identifies a financial problem with the company.
Operating Cash Flow = Operating Profit + Depreciation-Taxes-Change in Working
Capital
(No caps here.) WE DO NOT USE EBITDA BECAUSE IT IS NOT A RECOGNIZED
METRIC IN USE BY THE INTERNATIONAL FINANCIAL REPORTING STANDARD OR
THE UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES - Free Cash Flow is the money the business has to repay debt or dividends to the investors or
shareholders.
Free Cash Flow = Operating Cash Flow – Capital Expenditures - Net Profit is the income that is made after paying all operating expenses.
Net Profit = Total Revenue – Total Expenses - Debt Service Coverage Ratio is a metric utilized to measure a company’s cash flow versus
its debt obligations. It gauges a company’s ability to pay current debt obligations and take on
additional financing if necessary. The ratio we commonly see during loan reviews:
Debt Service Coverage Ratio = Global Operating Income – Taxes + Depreciation +
Interest / Annual Debt Obligations
These ratios are the magnifying glass through which savvy credit analysts like you view a
borrower’s financial statements. They are not mere numbers; they are the narrators of stories
told in dollars and cents, of opportunities seized, and of risks mitigated. They reveal the nuances
of financial performance and risk that might otherwise remain obscured, underscoring the
importance of your role in credit underwriting.