Hi, I have a problem which is as follows;

Contracts with lenders, such as bonds typically place restrictions on the financial statement ratios. Two commonly used ratios are the current ratio and the debt-to-equity ratio. Why is it that these appear as restrictions, that is, do they protect the lenders?

I am unable to understand how financial ratios can "protect" the lenders. As far as my understanding goes, these ratios are supposed to indicate, comment on the performance of a company, how these affect the lenders to a business enterprise cannot be deciphered.

Please help.

Thanks

Most of the financial ratios we use,for instance Current ratio(an indication of efficiency of the firm to discharge short term liabilities normally within one accounting year) and debt equity ratio/capital structure( portion of owners'capital and outsiders' liabilities used to finance the total assets of the firm) are just for getting a clue about the financial performance of a firm.

Debt equity ratio is of enormous help to lenders, because this ratio can provide information about total of long term and short term loan(from different lenders) used in the firm, so that in case the firm wants further loan, it is easier for a new lender to know about any restrictive covenants already put by other lenders.

Similarly current ratio gives some clue about the present status of short term loans to be discharged.