Lesson No. 18 – Discussion on Ratio Analysis Continued…

Lesson no 18 – Discussion on Ratio Contd.

Let us continue our 

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In Term Loans and DPG appraisal we study long term ability of a concern to repay the loan availed this is called in banking parlance SOLVENCY.
The following ratios are studied
1 Debt Equity Ratios
i) DE = Long Term Loan or TL/TNW
The ratio of 2:1 is a standard one.The meaning is that an entrepreneur can make enough profits from his Re1 invested to repay long term loans of Rs2.
ii) Another common measure is =
Total Outside Liabilities / TNW
TOL=TL+CL ; the ratio of 4:1 is a thumb rule , however for MSME or small borrowers some banks allow up to 6:1 on case to case basis.This is observed in projects by technocrats/first gen entrepreneur/startups.The entrepreneur has an ability to generate Rs 4( or 6) in long term say 5 years out of his own investment of Re1 and utilising the assets of the unit.
(A simple form is TNW = TTA - Outside Liabilities; Total tangible assets ie FA+CA).
2 Debt Service Coverage Ratio - DSCR, is often calculated to judge the ability to generate sufficient Cash from operations to repay the Term Liabilities during the proposed repayment period.
DSCR 
= PAT+Deprician+Interest on TL/ TL instalment+ Interest on TL
Numerator is the cash available for repayment.
Denominator is total of all long term loans due during the year plus the Interest due.(may be replaced by EMI or EQI or EYI).
The DSCR is calculated for each year of proposed repayment period and average is worked out.The Average should be 1.5:1 as a thumb rule ie Cash available in pocket is Paisa150 whereas due is Paisa100.
This ratio help us to fix repayment schedule; say Ratio is 2.5 then repayment period can be reduced; suppose ratio is 1.2 then we may increase the repayment period so that EMI will be reduced. Of source this is subject to bank rules.(,We will study more later).
3 Interest Coverage Ratio= PBDIT/Annual Interest payments
We find profit before Depreciation, INTEREST and Tax as tax is payable on profits, interest is taken as amount available for repayment and depreciation amount is not going out. This ratio of 2:1 ,ie interest repayment is twice covered by cash flow is accepted.
4 Return on Investment
A business man invests funds ie money for profits. Higher the ratio higher will be his earning and hence the interest in the enterprise.
The two ratios are
a) Return on Total Assets =
(PBIT/Total Tangible Assets) %
TTA = CA+FA
This gives an insight into how much a Rupee invested in assets fetches cash profits.
b) Return on Net Worth = (Net Profit/TNW)%
It shows how much a rupee invested will pay to the entrepreneur.

An increasing trend of both these ratios show healthy sign.
I am closing with this.
Thanks.