Training and Development


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This is a ratio beloved in leveraged finance and corporate transactions and is often referred to simply as the “leverage ratio.” Unlike other covenants such as the DSCR or ICR which directly measure serviceability of debt, leverage ratios are more of a proxy for debt repayment. It is the number of years it would take for a company to repay its debt if taxes and interest did not exist. It is also an indicator of by how much a business could increase its debt without experiencing distress.

Brendan WalpoleDebt / EBITDA
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Reserve life cover ratio

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The Reserve Life Cover Ratio (“RLCR”) is used only for mining and oil & gas projects (inclusive of fossil fuel generators tied to a particular mine/gas development).
Unlike the other covenants we’ve looked at, the RLCR does not look at any cash flows or balances. This makes it easy to calculate and means you don’t need to try and forecast commodity prices (although you’ll be doing that elsewhere in your financial model anyway).

Brendan WalpoleReserve life cover ratio
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The challenge with gearing, is that when a banker mentions it, you don’t actually know what they’re talking about as it has a couple of different versions which result in very different results. In principle, it always relates to the proportion of debt that is used to fund the development of a business, but the methodology varies. We cover three below, but there are others that will occasionally rear their head. Lenders use this ratio as it is an indicator of how much “skin in the game” the investors have in the business – high ratios indicate that debt is largely funding the business, and equity does not have much to lose if the business fails, and is therefore seen as less likely to stay involved and fix any problems that may arise.

Method 1

Debt / (Debt + Equity)
Brendan WalpoleGearing
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Cashflow versus profit

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“Turnover is vanity, profit is sanity, but cash is reality,” or more simply, “cash is king.” This is especially true when banks are assessing and monitoring loans. Banks have had plenty of experience in seeing seemingly profitable businesses experience distress or become insolvent through not managing their cashflow properly.
For this reason, a number of financial covenants will be based on cashflow rather than profit. These include the DSCR, LLCR, and sometimes an ICR.
Project finance loans focus almost entirely on cashflow covenants. Leveraged finance transactions usually have a combination of profit and cashflow covenants. Larger corporate transactions rely heavily on profit covenants. SME transactions could be anywhere on the spectrum. But why the difference?

Brendan WalpoleCashflow versus profit
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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.

Brendan WalpoleCalculating an average
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Net Present Value by first principles

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Formulas discussed: NPV, XNPV
The workbook used throughout this article is available here.

In a previous post we looked at how Excel calculates NPVs and IRRs and some of their weaknesses. In this post we’ll show you how you can manually calculate an NPV so that you have greater flexibility and control, and know exactly what kind of answer you’re getting.

The first part of the workbook is a refresher on how NPV and XNPV produce different results, based on their different assumptions of the start date. XNPV is useful if you are not dealing with constant, annual periods, and means you don’t have to separately calculate a discount rate for the particular period length if you start with an annual rate.
screenshot NPV annual

Brendan WalpoleNet Present Value by first principles
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