Page 29 - Banking Fiannce March 2018

ARTICLE

4. Clear understanding of DSCR formula: Fixed Assets Coverage Ratio is another tool used extensively
The two formulae for the bankers available to fix the by the banker for the entire repayment period to ensure
repayment and ensure proper loan to value ratio are Debt that the margin which was originally available at the time
Service Coverage Ratio (DSCR) and Fixed Assets Coverage sanction of loan, is maintained till the repayment of entire
Ratio (FACR). The formula for DSCR is time loan.

Profit after Tax(PAT) + Depreciation + Interest on Term Loan FACR = (Assets - Depreciation)/Long Term Debt outstanding
DSCR = (for the assets created out of the Term Loan)
Installment of Term Loan + Interest on Term Loan

5. What is Depreciation and how it can be used
Through this formula the banker is analyzing the profit
generated by the project and whether it is sufficient to for siphoning of the funds:
meet the payment obligation of the borrower. The PAT is Depreciation is actually a book entry to account for the
without an iota of doubt is the final cash flow available with erosion of value of fixed uses. The profit which is a real cash
the borrower after meeting all his revenue expenses. The inflow is debited to the extent of depreciation and reduced
Depreciation is nothing but a book entry to adjust the books profit is shown. On the other side to the extent of provided
of accounts as per Accounting Standards to provide for wear depreciation, the value of fixed assets is reduced. Though
and tear of the plant and machinery. Please note that there the balance sheet is tallied, the real profit has never come
is no depreciation for land which is always appreciating. down. In other words to know the exact profit generated
The interest on Term Loan is added back. in the system in real terms it is always advisable to add
depreciation back to PAT which is giving the true cash accrual
There are two reasons. In repayment terms it is clearly in the system.
mentioned that "Interest" is to be paid for the term loan as
and when debited whereas the installment is determined Depreciation as per Accounting Standard 6, is actually an
after commercial production and accrual of profits into the amount debited to P&L account and permitted to be written
system. A question may arise as to how the borrower is off with Fixed Assets value as per Companies Act to account
paying the interest till Date of Commencement of for erosion of value in the Fixed Assets due to wear and tear.
Commercial Operation, the answer is available in the fact This may be by way of Straight line method or Written Down
that there is a cost called "Interest During Construction". Value method.
This interest cost in IDC is to be checked for parlance at the
time of process/disbursement of loan. A Straight line method in simple terms is assuming a fixed
percentage of depreciation after assuming the maximum
Since the borrower is paying the interest after commercial period upto which the machinery is to be used without
production alongwith the commencement of principal replacement. Let us assume that if the machinery is going
repayment only out of real profit accrued in the system, the to serve for 5 years after which it needs replacement, then
same is added back to know the real position of the cash a flat 20% depreciation is provided.
accruals available as inflows. There is no difference of
opinion when it comes to denominator where both interest Supposing if the machinery will be having a residual value
and installment are only outflows. The average DSCR is then the same is reduced to fix the percentage of
normally expected at 1.5 as average for the entire depreciation. Written down value method is assuming a fixed
repayment period and a minimum DSCR of 1.2 for any percentage of depreciation till the machinery is replaced.
particular year. Credit Officer has to remember another
basic fact that average DSCR is averages of DSCR but Total If a machinery is bought for Rs.1,00,000 and the depreciation
inflow / Total outflow for the entire repayment period. DSCR percentage is 10% then on first year it will be provided with
is also not calculated for the moratorium period, as literally the depreciation of Rs.10000, next year Rs.9,000, followed
there is no inflow for the business entity. by Rs.8100 etc.

BANKING FINANCE | MARCH | 2018 | 29