Showing Loan Servicing

Sat 12th, Mar 2022 @ 01:55pm

Showing Loan Servicing ("Capacity")

There are a number of different methodologies for demonstrating the ability for a business to service debt.

All credit providers apply different logic and scoring models, so what follows is a lot simpler than the reality.  However, the components of loan serviceability are still supported by some key fundamentals.

A few of these are outlined below.

Interest Cover Ratio (“ICR”)

A measure of how easily a business can pay interest on its outstanding debt. Most lenders will not add back depreciation and amortisation when looking at this measure.  Using the example this is calculated as:

Total EBITO ($848,000) / Total Interest ($78,000) = 10.87

When a trading company's interest coverage ratio is 2.0 or lower, its sustained ability to meet interest commitments may be questionable, especially if there is uncertainty around the reliability of the future income.

ICR is also commonly applied for assessing consistent yield assets. For example, rental income on a commercial investment property.  Expect ICR’s to be lower in these examples where there is no trading income to support servicing.

Debt Service Ratio (“DSR”)

A measure of how easily a business can pay total debt repayments on its outstanding debt. Using the example this is calculated as:

Total EBITDAO ($862,500) / Total Repayment Obligations ($700,000) = 1.23

Where this ratio is 1.0 or lower, cash flow will be negative!  So how close it goes to 1.0 times depends on the quality and certainty of the income of the business.

DSR can be a more relevant measure of liquidity, unlike ICR it includes the actual cash commitment to reducing debt.  Where strong amortisation is needed, the gap between DSR and ICR can be very wide.

Payback (Debt) Ratio

A measure of how quickly total debt can be repaid out of EBIT and cash reserves.  Using the example this is calculated as:

Total Debt ($3,520,000) - Cash ($120,000) / Total EBITO ($848,000) = 4.01

The greater the uncertainty around future earnings, the more quickly the business may want to retire debt. This is mitigated too by the price of the debt, where there may be great returns from deploying cash elsewhere.

Consider the actual Payback Ratio result, but also the variation from period to period too.

Multiple of Earnings

A less commonly communicated but valid test of borrowing capacity is to apply a multiple limit to the adjusted EBITDAO.

This has become increasingly popular in assessing borrowing capacity for service firms in particular.  Using the example this is calculated as:

Total EBITDAO ($862,500) x Maximum Multiple of 3.0 = $2,587,500 (Indicative Borrowing Capacity).

Usually an appropriate method where consistency of EBITDAO is evident.  It is also increasingly relevant where the lending is not supported by tangible security.

More Information?

E -