Capacity to repay is a subjective determination based on analysis of objective financials. Lenders examine financial statements, financial ratios and operating data to aid their decision. Lenders also look at a firm's capital in determining whether to grant a loan. The amount of capital in a business is equal to the net value of its financial obligations, including both debt capital and equity capital. Measures of capital include financial ratios such as the debt to asset ratio, the current ratio and the debt to worth ratio.
Lenders prefer low debt to asset and debt to worth ratios, and high current ratios.
These indicate financial stability. As a guarantee against nonpayment, lenders often require that borrowers make a pledge of collateral. Collateral is an asset owned by a borrower, but promised to a lender against nonpayment of a loan. If a borrower defaults on a collateralized loan, the lender takes title to the collateral, liquidates it and uses the proceeds to pay the loan. The amount of collateral required for a given loan varies from lender to lender and from borrower to borrower.