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Finance Terminology to Know
Working Capital Ratio
Working capital is the difference between a company’s current assets such as cash, accounts receivable, and inventory and its current liabilities, including accounts payable and short-term debt. The working capital ratio is a key measure of a company’s short-term liquidity and ability to meet its day-to-day financial obligations. Lenders use this ratio to assess whether a business has sufficient operating resources to support ongoing operations and debt obligations.
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Tangible Net Worth
Tangible net worth represents the net value of a business after excluding intangible assets such as goodwill, patents, trademarks, and intellectual property. It is calculated by subtracting total liabilities from the value of a company’s physical and financial assets, including cash, accounts receivable, inventory, equipment, and real estate. Lenders rely on tangible net worth to evaluate the true collateral strength and financial stability of a borrower.
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Debt Service Coverage Ratio (DSCR)
The Debt Service Coverage Ratio (DSCR) measures a company’s ability to service its debt obligations using operating income. It compares net operating income to total annual debt payments, including principal and interest. A higher DSCR indicates stronger cash flow and a greater ability to meet loan obligations, making it one of the most important metrics lenders use when underwriting commercial loans.
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Net Operating Income (NOI) for Commercial Mortgages
Net Operating Income (NOI) is a fundamental metric used to evaluate the profitability of income-producing real estate. NOI is calculated by subtracting all necessary operating expenses such as property management, maintenance, insurance, and taxes, from total property revenue. It excludes debt service, capital expenditures, depreciation, and amortization. In non-real-estate contexts, this concept is similar to EBIT (Earnings Before Interest and Taxes). Lenders use NOI to determine loan eligibility and maximum financing amounts.
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Triple Net Lease (NNN Lease)
A Triple Net Lease (NNN) is a commercial lease structure in which the tenant is responsible for paying property taxes, building insurance, and maintenance costs, in addition to base rent and utilities. Under a triple net lease, the landlord has minimal ongoing expenses, making NNN properties attractive to investors seeking predictable cash flow. This lease structure is commonly used in retail, medical, and industrial real estate.
The Five C's of Commercial Lending
Capacity
Capacity refers to a business’s ability to generate enough cash flow to service debt and cover operating expenses. Lenders typically look for a business to produce at least $1.25 of income for every $1.00 of debt service, creating a cushion to absorb unexpected expenses or economic downturns. This margin helps demonstrate that the business can consistently meet its loan obligations even during periods of volatility.
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Capital
Capital reflects the financial investment a business owner has in their company, including cash, equipment, and other capital assets. Lenders evaluate both the amount of capital already invested and the borrower’s willingness to commit additional resources to the transaction. A strong capital position signals confidence in the business and reduces lender risk, making it a key factor in commercial loan approval.
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Collateral
Collateral consists of assets pledged to secure a loan, such as accounts receivable, inventory, cash, equipment, or commercial real estate. Banks assess both the value of the collateral and any existing debt tied to those assets when underwriting a loan. Adequate collateral provides lenders with protection and can improve loan terms, interest rates, and approval odds.
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Conditions
Conditions refer to external factors that may impact a business’s performance, including the overall economy, industry trends, market demand, and pending legislation. While often outside the borrower’s control, these factors play an important role in how lenders evaluate risk and determine whether a loan is viable under current and projected market conditions.
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Character
Character represents the borrower’s reputation, experience, and financial responsibility. Lenders consider work history, industry experience, personal credit history, and overall integrity when assessing character. Strong character demonstrates reliability and trustworthiness, both of which are essential when a bank evaluates a borrower’s ability to honor long-term financial commitments.