May27, 2014
Why a company with a 2 to 1 current ratio is turned down by a bank?
CA= Current assets (times)
Current liabilities
The current ratio measures the short term solvency or liquidity. The current ratio is basically checking the working capital of the company. The working capital ensures the organization is running efficiently, resulting in increase in profitability of the company and smooth cash flows. The normal current ratio is around 2:1 but this varies within different industries.
There are several other factors which affect the grant of loan by a bank, if they are not fulfilled it is possible that bank might turn down the loan request even if the current ratio of the company is 2:1. These Factors are:
1. Optimization- Paying less tax can negatively affect the company. If the profits are not shown in the balance sheet of the company, it might impose problems in securing loan.
2. Business History- Bankers want proof in written in the business plan forwarded by the company that they have all the professional and technical expertise required to make the business profitable. If the company lacks expertise it might impose risk in making profit and growth of the company.
3. Strikes against company- it’s easy for bankers to find out that in how many institutions a company has applied for loan. By checking credit bureau report a banker will get to know the list of institutions a company has applied to and it may work against the company as the banker may feel that company is to eager for loan and doubt the credit worthiness.
4. Credit rating- Credit rating of the company also offers a way to check whether company’s credit worthiness and accordingly bank will take decision. If the credit rating of company is less then bank might be apprehensive in giving loan but if the company holds good credit worthiness then bank will grant loan.
5. Other Factors- Banks also assess the profitability ratio, credit turnover ratio, debt turnover ratio and other solvency ratios of the company in order to completely be sure of the credit worthiness of the company. Other factors like the amount of loan, time period of loan, application of the client and numbers displayed in the balance sheet may also effect the bank’s decision.
