The financial ratios lenders look at: EBITDA, leverage, gearing, interest cover and liquidity

This guide is for business owners and finance teams preparing a loan application who want to see their accounts the way a credit analyst does. The financial ratios lenders look at most are EBITDA and its trend, leverage (debt to EBITDA), gearing (debt against equity), interest cover, debt service cover, the current and quick ratios, and working capital days; together they answer three questions: is the business profitable, can it afford more debt, and can it pay its bills on time? Smart Funding Solutions is a broker, not a lender. We arrange business finance from around £10,000 to £500,000+, with larger facilities available in suitable cases, and we work through these ratios with clients before approaching lenders. More guides are in our knowledge hub.

01The financial ratios lenders look at, in one table

Lenders group ratios into profitability, debt capacity and liquidity, and no single ratio decides an application on its own. The table summarises each one; the sections that follow explain how lenders read them.

Ratio	Simplified formula	What the lender is asking	Better when
EBITDA and EBITDA margin	Operating profit + depreciation + amortisation; EBITDA ÷ turnover	How much cash profit does trading generate?	Higher and stable or rising
Leverage	Total debt ÷ EBITDA	How many years of earnings would repay the debt?	Lower
Gearing	Total debt ÷ shareholders' funds (or debt ÷ debt plus equity)	How much of the business is funded by lenders rather than owners?	Lower
Interest cover	Operating profit (EBIT) ÷ interest	Can profits pay the interest bill comfortably?	Higher
Debt service cover (DSCR)	Cash available ÷ capital and interest due	Can cash flow meet full repayments?	Higher
Current ratio	Current assets ÷ current liabilities	Can short-term assets meet short-term debts?	Higher, within reason
Quick ratio	(Current assets less stock) ÷ current liabilities	Can bills be paid without selling stock?	Higher, within reason
Debtor, creditor and stock days	Balance ÷ turnover or cost of sales × 365	How quickly does cash move through the business?	Depends on sector norms

These ratios support the wider judgement a lender makes about character, capacity, capital, collateral and conditions, explained in our guide to the five Cs of credit. For how the whole assessment fits together, see how lenders assess business loan applications.

02EBITDA: the starting point for most lenders

EBITDA (earnings before interest, tax, depreciation and amortisation) is the profit figure most lenders use as a proxy for the cash a business generates from trading. It strips out financing costs and accounting charges so that businesses with different debt levels and asset bases can be compared.

Lenders rarely accept reported EBITDA without adjustment. They commonly look at:

• Adjusted EBITDA. Genuine one-off costs may be added back and one-off income removed. Each adjustment needs evidence; a long list of add-backs makes a credit team cautious.
• Director remuneration. If owners take low salaries and high dividends, some lenders deduct a market-rate salary to reflect the true cost of running the business.
• EBITDA margin. EBITDA as a percentage of turnover shows whether growth is profitable. Rising sales with a falling margin can be a warning sign.
• The trend. Three years of figures tell a lender far more than one. A dip followed by recovery, with an explanation, is often acceptable.

Trend matters in practice. In one of our cases, we arranged a £50,000 business loan for a dental laboratory despite a historic loss, because the lender could see improved trading since.

03Leverage: debt measured against earnings

Leverage expresses total debt as a multiple of EBITDA, which tells a lender roughly how many years of current earnings it would take to clear everything the business owes. It is the main ratio lenders use to size cash flow lending, particularly for acquisitions.

Total debt normally includes bank loans, asset finance, commercial mortgages, director loans that are due for repayment and the new facility being requested. Some lenders also count invoice finance balances; others treat them separately because they are repaid from specific debts. Net leverage deducts surplus cash from total debt first.

Acceptable leverage depends heavily on the sector, the quality of earnings and whether the lending is secured. A business with long contracts and recurring income can usually support a higher multiple than one reliant on a few one-off projects. There is no universal ceiling, which is why the same leverage can be accepted by one lender and declined by another.

EBITDA (earnings before interest, tax, depreciation and amortisation) is the profit figure most lenders use as a proxy for the cash a business generates from trading.

04Gearing: who funds the business

Gearing compares the money lenders have put into the business with the money owners have left in it, shown on the balance sheet as shareholders' funds or net assets. High gearing means lenders carry most of the risk; low gearing means owners have more at stake.

There are two common versions: debt divided by equity, and debt divided by debt plus equity. Check which a lender is using, because the same company produces very different numbers. A company with negative net assets, often caused by past losses or large dividends, has gearing that cannot be meaningfully calculated, and lenders will want to understand how and when the balance sheet will be rebuilt.

Gearing matters more to lenders taking a long-term view, and it is where retained profit, director loans left in the company and any equity funding show their value.

05Interest cover and debt service cover

Interest cover shows how many times operating profit covers the interest bill, while debt service cover shows whether cash flow covers interest and capital repayments together. Interest cover is the older, simpler test; DSCR is the stricter and more common one for amortising loans.

Interest cover is useful where loans are interest-only or capital is repaid at the end, as with some property and acquisition facilities. It is also a quick check on sensitivity to rising rates: if interest cover is thin, a rate increase on variable borrowing quickly squeezes profit.

DSCR is explained in detail, with worked examples, in our guide to the debt service cover ratio, and you can test your own figures with the DSCR calculator.

£50,000A transaction we arrangedHistoric loss. Improving numbers. £50K secured for dental growth.Several lenders focused on the previous year's numbers. We focused on what had changed.

06Liquidity ratios: current ratio and quick ratio

Liquidity ratios test whether a business can meet obligations falling due within 12 months from assets that will turn into cash in the same period. They matter most to lenders providing working capital and to anyone assessing short-term risk.

• Current ratio divides current assets (cash, debtors, stock) by current liabilities (creditors, short-term loans, tax due, overdraft). A figure below 1.0 means short-term debts exceed short-term assets.
• Quick ratio, sometimes called the acid test, removes stock, because stock can take time to sell and may not realise its book value.

Very high liquidity ratios are not automatically good: they can mean cash is sitting idle or stock is building up. Lenders compare the figures with sector norms and with the business's own history. Arrears with HMRC show up here too, as a growing tax creditor; our page on HMRC loans explains the funding options for tax bills.

07Working capital days: debtor, creditor and stock days

Working capital days measure how long cash is tied up in the trading cycle. Debtor days show how long customers take to pay, creditor days how long the business takes to pay suppliers, and stock days how long goods sit before they are sold.

Lenders watch the direction of travel. Debtor days lengthening year on year may point to weak credit control or a struggling customer. Creditor days stretching may mean the business is using suppliers as an informal lender. Both increase the risk that a new loan is quietly funding a cash shortage rather than the purpose stated. Our guide to calculating working capital covers the underlying sums.

08A worked example across the ratios

Illustration only. A hypothetical wholesale business has turnover of £2,000,000, operating profit of £150,000 and depreciation of £50,000, so EBITDA is £200,000 (a 10% EBITDA margin). It has total debt of £400,000 and pays £30,000 a year in interest. Shareholders' funds are £500,000. Current assets are £600,000, of which £200,000 is stock, and current liabilities are £400,000. Debtors are £330,000.

Ratio	Calculation	Result
Leverage	£400,000 ÷ £200,000	2.0x
Gearing (debt ÷ equity)	£400,000 ÷ £500,000	80%
Interest cover	£150,000 ÷ £30,000	5.0x
Current ratio	£600,000 ÷ £400,000	1.5
Quick ratio	£400,000 ÷ £400,000	1.0
Debtor days	£330,000 ÷ £2,000,000 × 365	About 60 days

If the business now asks for a further £200,000, leverage rises to 3.0x and gearing to 120% before any profit from the new investment appears. A lender would look closely at what the money will earn, how quickly, and whether the 60 debtor days could be shortened or funded separately, for example through invoice finance.

09Ratio checklist before you apply

Running your own ratios before a lender does lets you explain weaknesses rather than have them discovered. Use this checklist.

10How Smart Funding Solutions can help