
Manu 
Hi Vinu! 

Vinu 
Hi Manu! I was about to call you! Thank god, you had come! 

Manu 
Regarding? 

Vinu 
I want to understand about one important ratio. It’s for my friend. He approached Bank for Long Term Loan for his company. 

Manu 
Ok! 

Vinu 
Bankers were quoting DSCR ratio is too low and hence they cannot support. My friend is also novice like me! So only you should help us! 

Manu 
Sure Vinu! DSCR is acronym of Debt Service Coverage Ratio. Mainly used by Bankers. 

Vinu 
Ok. Why bankers calculate this ratio?  
Manu 
Bankers calculate this ratio to know whether the borrower has got repayment capacity to service back the loan with interest. 

Vinu 
Ok! Please tell me how it is calculated. 

Manu 
Sure Vinu! If you want to repay loan, what is important? Is it profit or cash? 

Vinu 
Profits!!! 

Manu 
No Vinu! 

Vinu 
How’s that? 

Manu 
Let say you have high level of depreciation and noncash expenses in a year. In that year, your
But, still you would have generated cash from operations. 

Vinu 
Yes! Yes! 

Manu 
So, the focus of the bankers will not be on your Book Profits but will be on Cash Profits. 

Vinu 
Acha! 

Manu 
Cash Profits are also called as Cash Accruals. 


Vinu 
Ok. How to calculate this cash accrual? 

Manu 
It’s very simple. When you take a term loan, what will be your obligations to bankers? 

Vinu 
It will be payment of interest and principal. 

Manu 
Good! So you should identify the cash profits which are available for paying both. 

Vinu 
Ok! 

Manu 
So which profit you will give your cash profits? PAT? PBT? PBIT? PBDIT? 

Vinu 
Hmmm???? I cannot take PAT because it is after paying interest. I want to know the profit available for paying interest. So I should go with Profit Before Interest and Tax (PBIT). Is that right Manu? 

Manu 
You are partly right, in the sense, you are starting with Profit before Interest. From this profits, you can pay interest. But you have missed one aspect. 

Vinu 
Hmmm…? Manu, why not we shall have some number to understand? 

Manu 
Ok. This time I’ll give you the numbers. 

Vinu 
Ok. 

Manu 


Vinu 
Ok! What about Loan repayment? 

Manu 
Ok! Assume Principal repayment as 10 Cr. You already have interest figure in Income Statement. 

Vinu 
Ok. 

Manu 
Now tell me, which profit should be considered as cash profit available for servicing loan obligations? 

Vinu 
It is PBIT of Rs.30. 

Manu  
Vinu 
Why? It is the profit before Interest and from this portion only, interest is paid and the balance for repaying principal. 

Manu 
No Vinu! 

Vinu 
Ok! Ok! I should consider Profit before Depreciation ALSO – right? i.e., I should consider PBDIT (Profit before Depreciation and Interest) right? 

Manu 
Partly right! 

Vinu 
Again partly? Where the hell I am missing? 


Manu 
That you can find by yourself. 

Vinu 
How? 

Manu 
Check whether you can pay your interest and principal from PBDIT. 

Vinu 
Ok. PBDIT – 50 That is my source.
Interest – 10 & Principal – 10 are my uses. 

Manu 
Stop! Do you think, entire PBDIT is available for paying interest and loan repayment? 

Vinu 
Yes! Why not? From PBDIT only interest is paid and we derive PBT. 

Manu 
Yes! I agree. But from PBT you are going to pay tax also!!!!!!!!!!! 

Vinu 

Oooppsss!!!! I missed the tax component. I have to pay tax of Rs.6 Cr and it will not be available for paying loan obligations. You are right! 

Manu 
Yes! So understand, your entire PBDIT is not available for servicing loan. You have to shell out portion of your PBDIT for tax and only the balance will be available for servicing. 

Vinu 
Correct. So it should be


Manu 
Yes! Alternatively you can also arrive Cash Profits (Accruals) in reverse method.
Both the approaches gives you the same result. 

Vinu 
True! So, from this cash profits, we have to divide loan obligations – is that right? 

Manu 
Yes! DSCR = Cash Accruals / Loan obligations (Principal + Interest) 

Vinu 
Ok! In our case, Cash Accruals = 44 Loan obligations (Principal 10 + Interest 10) = 20
DSCR = 44 / 20 = 2.2 Times 

Manu 
Excellent. 

Vinu 
Thank You. What does this ratio communicates? 

Manu 
It tells you, whether you have sufficient profits to pay your loan obligations. (Principal + Interest) 

Vinu 
Is it calculated for every year? 

Manu 
Yes! It is calculated for each and every year of loan period to know whether you can service the loan without any difficulty. 

Vinu 
Ok. What is the ideal DSCR? 

Manu 
Ideal DSCR is 1.75 Times 

Vinu 
What does that mean? 

Manu 
It means you have cash profits 1.75 times of loan obligations. 

Vinu 
Why 1.75 Times is required? Why not mere 1 Time? 

Manu 
Vinu! Understand, you are not going to run your business just to make profits exactly equivalent to your loan obligations. As an owner you should have some profits – right? 

Vinu 
Yes! Yes! Forgot that! 

Manu 
Apart from that, you need some more profits to support your operations.
Remember you current ratio of 1.33
It means, owners should contribute 25% to the operations of the company.
It will not be possible for the owners to contribute from their pocket every time in the form of capital.
Instead, they can make use of profits for supporting operations.
For that you should have some profits, after paying you term loan obligations.
That’s why, 1.75.
Meaning, after using 1 Time of your resources for paying loans, you will still have 0.75 times of cash profit for your operations.
This will ensure liquidity in operations. 

Vinu 
Correct Manu.
In our case, we had cash profit of 44.
Whereas repayment was only 20.
So after paying 20, we are left with cash profits of 24 which may be used for supporting operations. 

Manu 
True! For this reason only, Bankers will be insisting on DSCR of 1.75 or more. It is only in your interest so that you don’t suffer liquidity strain by taking a long term loan. 

Vinu 
Yes Manu! How good our Bankers are??? 


Manu 
Yes! Enjoy two Saturday holidays of Bankers! 

Vinu 

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