Calculating an average

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Calculating an average ratio sounds simple – add up all the ratios in every relevant period and divide by the number of periods. This is an “arithmetic average.” But this simple concept can create some misleading results.
screenshot - averages1
Here, the average DSCR of 1.80 looks quite respectable, despite three of the four years having very low DSCRs.

An alternative method is to use what some call a “geometric average” (although it doesn’t meet the mathematical definition of a geometric average, which you would use when calculating an average % return on an investment). In this method, you add up all the individual CFADS amounts over the term of the loan and divide this by the total debt service. Using the same example as above, you then get the following results.
screenshot - averages2
This method essentially “de-weights” any extreme results, whether high or low. It is also likely to produce an average DSCR that is closer to the LLCR at the same point in time.
If you don’t have any extreme results the two methods will produce very similar results. Neither method is necessarily more “correct” than the other, but as with other variations on financial covenants, you just need to be aware of what you are measuring/counting and act accordingly.

Brendan WalpoleCalculating an average

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