LDP 5.3 Debt Service Coverage Measures Flashcards
Two types of debt service coverage measures:
1) Profit-based
2) UCA Cash Flow-based
Profit-based Debt Service Coverage Measures
Definition:
- Profit-based measures directly relate the cash flow of potentially highest quality, which is cash from operating income, to the requirement of most concern: the repayment of the loan.
Benefits:
- Facilitate communication with the borrower
- Remind us of the importance of real, sustainable income as a component of cash flow
Limitations:
- Imply that all net income has equal cash potential
- Do not account for major demands on cash flow such as taxes, dividends, fixed-asset expenditures, and working capital required because of sales growth or declining efficiency.
- Imply that loan repayment will have a first claim on cash flow
UCA Cash Flow-based Debt Service Coverage Measures
Definition:
UCA cash flow-based measures isolate cash interest and principal payments, allowing the measurement of operating cash flow before considering interest and principal.
Benefits:
- Show accurate measures of cash available to service debt
Limitations:
- Borrowers unfamiliarity with the UCA cash flow statement make it difficult to discuss the measures with a borrower and include them as loan covenants in a credit agreement
Look for these margins of protection as you compare available cash flow and required debt service:
- The excess of available cash flow over required debt service
- The stability and quality of the sources of cash flow
- The stability and predictability of cash flow demands and the ability to curtail them without
reducing the company’s effectiveness
Interest Coverage Ratio
PROFIT-BASED
Earnings before Interest and Taxes (EBIT) / Interest Expense
- Measures the ability to cover interest expense with profits after expenses.
- The higher the interest coverage ratio, the greater the margin of protection within profitability to meet interest expense. I
Fixed-charge Coverage Ratio
PROFIT-BASED
EBIT + Lease and Rental Expense / Int. Exp. + Lease and Rental Exp. +Prior-year CMLTD
- The ratio measures the ability to cover fixed charges (interest, lease/rent expense and CMLTD) with
profits after expenses. - When the fixed-charge coverage is one, a company has just enough profitability to pay interest, lease and rental
expenses, and CMLTD, but nothing left over to provide a margin of protection or to pay dividends
Debt Service Coverage Ratio
PROFIT-BASED
Net Profit after Tax + Deprec. + Amort. + Depletion / Prior-year CMLTD
- Measures how many times CMLTD is covered by the current year’s net profit after tax adjusted for non-cash expenses (depreciation, amortization and depletion).
- A ratio greater than one means the company generates enough adjusted profit to pay loan payments.
EBITDA to Principal and Interest
PROFIT-BASED
Net Profit before Tax + Int. + Deprec. + Amort. / Prior-year CMLTD + Interest Expense
- Measures the ability to cover principal and interest with the current year’s net profit before tax plus interest adjusted for non-cash charges (depreciation, amortization and depletion).
Debt Service Principal and Interest Coverage Ratio
CASH FLOW BASED
Net Cash after Operations / Cash Paid for Int. +CMLTD + Current portion Capital Leases
- Measures the ability to cover interest, principal loan payments, and current capital leases with
net cash after operations.
Interest Coverage from Operating Cash Ratio
CASH FLOW BASED
Net Cash after Operations / Cash Paid for Interest
- Measures the ability to cover interest payments from net cash after operations.
EBIT
EBIT is the amount of profit left after satisfying all expenses except interest and taxes.
Profit-based Coverage Measures
1) Interest Coverage Ratio
2) Fixed-charge Coverage Ratio
3) Debt Service Coverage Ratio
4) EBITDA to Principal and Interest
Cash Flow-based Coverage Measures
1) Debt Service Principal and Interest Coverage Ratio
2) Interest Coverage from Operating Cash Ratio
