Common Financial Ratios Used in Underwriting

Underwriting decisions often turn on numbers — and among the most critical of those numbers are the common financial ratios used in underwriting. Whether a lender, investor, or business owner, understanding these ratios helps you parse risk, anticipate trouble, and make smarter decisions.

In this post we’ll walk through the major categories of underwriting ratios, how each is calculated, why they matter, and how to interpret them. We’ll also provide a simple multi-step list that shows how underwriting teams apply these ratios in practice (perfect for featured snippet visibility).

Why Ratios Matter in Underwriting

When a lender or insurer underwrites a deal, they are essentially evaluating: Can this borrower/asset/service meet the obligations? What risk do we carry? The ratios are tools to quantify that risk. According to the Corporate Finance Institute (CFI), lending ratios “are extensively used in the underwriting approval processes for loans.” Corporate Finance Institute

In short:

• Ratios help summarize complex financial statements into digestible metrics.

• They allow comparison across companies, time periods, and industry peers.

• They give underwriters benchmarks or covenant triggers (e.g., a minimum debt-service coverage ratio).

For creators, entrepreneurs, or content specialists working on finance/underwriting posts, embedding ratio definitions and practical interpretation helps satisfy Google’s E-A-T (Expertise, Authoritativeness, Trustworthiness) criteria.

Framework: Types of Underwriting Ratios

We can group the common financial ratios used in underwriting into four broad categories:

• Liquidity Ratios – ability to meet short-term obligations.

• Solvency / Leverage Ratios – structure of debt vs equity / long-term risk.

• Coverage & Debt-Service Ratios – capacity to service debt, meet interest/principal.

• Profitability & Efficiency Ratios – ability to generate returns, use assets.

Each category presents a different angle of risk. Let’s dive into each.

Liquidity Ratios

Current Ratio

Definition: Current Assets ÷ Current Liabilities. 
Interpretation: A higher ratio means the company has more short-term assets to cover short-term obligations. If it’s under 1, risk is elevated.
Underwriting use-case: A lender may require a minimum current ratio before approving a working-capital loan.

Quick Ratio (Acid-Test)

Definition: (Cash + Accounts Receivable + Short-Term Investments) ÷ Current Liabilities. BDC.ca
Interpretation: More conservative than the current ratio because it excludes inventory (which may be less liquid).
Underwriting use-case: Particularly relevant for businesses with slow-moving inventory, or for bail-out risk.

Why Liquidity Matters

Short-term shocks—unexpected expenses, delays in receivables, lines of credit drying up—can cause default even if long-term fundamentals are sound. Underwriters focus on liquidity to assess “can the borrower survive the next 6-12 months?”

Solvency / Leverage Ratios

Debt-to-Equity Ratio

Definition: Total Debt ÷ Shareholders’ Equity. 
Interpretation: Signals how much the company is financed by debt versus its own capital. A high ratio often means higher risk.
Underwriting use-case: A lender may cap debt-to-equity at a defined maximum (e.g., 2×) to limit exposure to highly leveraged firms.

Debt-to-Capital Ratio

Definition: Debt ÷ (Debt + Equity). 
Interpretation: Similar in spirit to debt-to-equity but expresses debt as a proportion of total capital.
Underwriting use-case: Used by lenders and investors to check how capital-structure risk is managed.

Solvency Ratio (Long-Term Stability)

Definition: Often computed as (Net Income + Depreciation + Amortization) ÷ Total Liabilities or similar formulations. 
Interpretation: Measures whether the company can meet long-term obligations; a lower ratio means more risk.
Underwriting use-case: For large corporate lenders and project finance, this ratio helps assess long-term viability.

Why Solvency Matters

While liquidity covers the next year, solvency covers the next decade. Underwriters must ensure the borrower or asset isn’t just afloat today but can stay afloat over time. Leverage magnifies risk when cash flows falter.

Coverage & Debt-Service Ratios

Debt Service Coverage Ratio (DSCR)

Definition: Net Operating Income ÷ Total Debt Service (principal + interest). 
Interpretation: If DSCR < 1.0, the borrower cannot produce enough cash to meet debt service – blue flag. Many lenders require DSCR ≥ 1.2 or higher.
Underwriting use-case: Critical in commercial real-estate lending, project finance, and corporate credit underwriting.

For example: If NOI = $120k, annual debt service = $100k → DSCR = 1.20 (just meets many lenders’ threshold).

Interest Coverage Ratio (Times Interest Earned)

Definition: EBIT ÷ Interest Expense. 
Interpretation: How many times the company can cover interest payments. A ratio of 3 means EBIT covers interest three times over—comfort zone; under 2 may signal risk.
Underwriting use-case: Especially used in leveraged buy-outs, corporate debt underwriting, middle-market lending.

Loan-to-Value Ratio (LTV)

Definition: Loan Amount ÷ Appraised Value of Asset. 
Interpretation: Higher LTV means less borrower equity, more risk to lender. Many underwriting guidelines cap LTV.
Underwriting use-case: Real-estate, equipment financing, project lending—ensuring value cushion.

Why Coverage Matters

Even if liquidity and solvency look sound, if cash flows don’t cover required payments (interest, principal), default risk rises. Coverage ratios focus on actual cash-flow capacity rather than just book numbers.

Profitability & Efficiency Ratios

Net Profit Margin

Definition: Net Income ÷ Revenue.
Interpretation: Shows how much profit is generated from each dollar of sales. Higher margins imply stronger business model or pricing power.
Underwriting use-case: Underwriters will compare margin trends over time and relative to industry benchmarks.

Return on Assets (ROA)

Definition: Net Income ÷ Total Assets. 
Interpretation: Measures how well the firm uses assets to generate profit.
Underwriting use-case: Useful to measure how efficiently the company is operating relative to its asset base.

Return on Equity (ROE)

Definition: Net Income ÷ Shareholder Equity. 
Interpretation: How much profit is earned per dollar of shareholder investment. High ROE can signal effectiveness—but caution: extremely high ROE often pairs with high leverage.
Underwriting use-case: Underwriters evaluate whether high ROE is sustainable given risk and leverage levels.

Why Profitability & Efficiency Matter

Underwriters aren’t only concerned with “can you pay the loan back?” but also “is your business model strong enough that repayment risk stays low?” Profitability and efficiency ratios provide long-term insight into business viability and growth potential.

Putting It All Together: How Underwriters Use Ratios

Here is a concise multi-step list showing a typical underwriting workflow using ratios (intended for featured-snippet positioning):

Underwriting Workflow: Basic Steps

1. Collect latest financial statements (balance sheet, income statement, cash-flow).

2. Compute key ratios (liquidity, solvency, coverage, profitability).

3. Compare ratios to industry benchmarks and historical trends.

4. Identify red flags (e.g., DSCR < 1 ×, deteriorating margin, rising debt/equity).

5. Set covenant thresholds or pricing adjustments based on ratio results.

This 5-step list gives a clear snapshot of ratio-driven underwriting process.

Common Pitfalls & Interpretation Tips

• Ratios in isolation are dangerous: A strong ratio today doesn’t guarantee tomorrow’s performance. Trends matter.

• Industry and business-model context: What’s acceptable for retail may differ for manufacturing. Underwriters must compare peers and adjust expectations.

• Accounting differences: Variations in depreciation, inventory methods, or asset valuation can distort ratio comparability. Wikipedia

• Leverage masks risk: A company might look profitable (high ROE) but carry hidden short-term obligations, making it risky under stress.

• Coverage ratio vs book numbers: Underwriting focuses on cash-flow, not just net income, especially when assessing interest/principal payment ability.

Sample Ratio Thresholds That Underwriters Might Use

• Current Ratio ≥ 1.2-1.5

• Quick Ratio ≥ 1.0

• Debt-to-Equity ≤ 2.0 × (varies by sector)

• DSCR ≥ 1.2× – 1.4×

• Interest Coverage Ratio ≥ 3.0×

• LTV (for asset-backed deals) ≤ 70-80%

• Net Profit Margin > industry median

Note: These thresholds are illustrative. Specific underwriting criteria vary by lender, industry, geography, and risk appetite.

Why These Financial Ratios Matter to You as a Business Owner

Whether you are seeking a loan, raising capital, or managing growth, the underwriters’ lens is important to understand. If you know the common financial ratios used in underwriting, you can:

• Proactively strengthen your financial profile before engaging lenders.

• Anticipate lender questions and have ratio benchmarks in hand.

• Spot warning signs in your own business early (e.g., shrinking margins or rising leverage).

• Negotiate better terms by presenting strong ratio evidence (e.g., DSCR > 1.5).

FAQs – Quick Answers

Q: Do underwriters look at every ratio?
A: No, they focus on those most relevant to the deal type (e.g., liquidity ratios for short‐term loans, coverage ratios for long‐term debt).

Q: What’s more important: profitability or coverage ratio?
A: It depends. For a mature company with stable cash flow, coverage may dominate. For a growth company, profitability and efficiency may matter more.

Q: Can strong ratios guarantee approval?
A: Not always. Underwriting also assesses qualitative risks (management quality, market conditions, collateral value). Ratios inform, but don’t replace judgment.

Summary

In summary, the common financial ratios used in underwriting provide the building blocks for credit risk evaluation. By understanding liquidity, solvency, coverage and profitability metrics, both lenders and borrowers gain clarity on financial health and repayment ability. Whether you’re preparing a loan application or reviewing your own business’s health, mastering these ratios enhances your decision-making and improves your outcome.

Ready to strengthen your profile using underwriting-guided ratios? Download our free ratio-benchmark worksheet now and compare your business against lender expectations.