Underwriting 101 - Cash Flow/Availability (ability to repay)
A key component in the underwriting process is the operating company's ability to repay the debt of the asset they are trying to acquire with financing. Many lenders also look at the financials of any affiliate companies (any company in which the guarantors own 20% or more in) for repayment ability or its detraction. Most lenders evaluate a company's ability to repay their debt by using a Debt Service Coverage Ratio (DSCR). DSCR is defined as the amount of cash flow available to meet annual interest and principal payments on proposed and existing debt. The formula is:
DSCR = EBITDA + RR (Earnings Before Interest expenses, Taxes, Depreciation and Amortization + Rental expenses and Rental income, if applicable--this is also called cash available)/ Total Debt Service
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EBITDA + RR
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TOTAL DEBT SERVICE |
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| Earnings (Net Income Before Tax) |
1st Mortgage |
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+ Depreciation & Amortization
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+ 2nd Mortgage |
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+ Interest
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+ Existing Debt |
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+ Rent
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Total Debt Service |
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+ Rental Income
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Cash Available |
DSCR = Cash Available
Total Debt Service
Most lenders like to see a DSCR of 1.2:1 (also expressed as DSC of "1.2 times [x]") or better. In other words, the operating company has at least 1.2 dollars to service every dollar of total debt. At MCC, we can generally approve transactions with a minimum DSCR of 1.0x in the most recent tax year along with good (higher DSCR) numbers in the interim period (as expressed on an income statement [P&L] and balance sheet dated within 60 days of the submission date).
DSCR requirements can vary, however, especially if there is a substantial change in the business, like an expansion, consolidation or significant upward trends in revenue and net income. If your company is a start-up, it is always best to use conservative numbers when calculating projections.