What is the role of financial ratios in credit analysis?

• A. They are meaningless in credit analysis.
• B. They serve as indicators of the customer's financial health and performance.
• C. They only measure liquidity shortfalls.
• D. They replace the need for cash flow analysis.

Answer: (B)

Financial ratios function as indicators of a borrower's financial health and performance. They condense financial statement data into comparable measures that reveal profitability, liquidity, leverage, and efficiency, making it easier to spot trends and assess the ability to generate cash flow to meet debt obligations. Ratios are useful tools that complement cash flow analysis and other due diligence; they help quantify risk, but they do not replace cash flow analysis, since cash flow shows timing and magnitude of cash that ratios alone can miss. They are not meaningless, and they do not capture only liquidity; they provide a broader view of financial strength across multiple dimensions.