DSCR Calculation: Two Methods (CFADS vs. EBIT in the numerator)
I've been sent two project finance spreadsheets, with conflicting DSCR calculations. I'm looking for help on what is right. and in the DSCR calculations, I've noticed a conflict. In the first sheet, DSCR is calculated as Net Operating Income (EBIT) / Principal + Interest. The second sheet, DSCR is calculated with CFADS, which is EBITDA - Taxes - Working Capital + Interest Income + Use of Working Capital Reserve.
This is for project finance, a single asset (a natural gas pipeline). Which method is correct?
NOI/Debt Service
Thank you. Any explanation for why Corality, who are experts in Project Finance, define DSCR as follows: "In a typical project finance model, the cash flow available for debt service is calculated by netting out revenue, operating expenditure, capital expenditure, tax and working capital adjustments. CFADS is preferred over EBITDA in determining gearing and lending capacity because this measure does not take taxes and timing of cash flows into consideration. EBITDA is a common metric in corporate finance but in project finance the focus is on actual cash flow."
Is the difference simply between a corporate finance vs. project finance approach?
I'm not an expert in any way but I would argue that since DSCR is a measure of how many times you can pay your debt services, the numerator should be the cash flow available to pay your interest payments and principal. If that should be NOI, CFADS or whatever would not be that important to me or my bosses. Just footnote why CFADS is a better measure than NOI if that is the case, and why. That would be my take on it.
I've never encountered anyone who didn't use NOI/DS. That's as common an industry practice as there is. If you're from a corp fin background, it's the equivalent of an EBITDA / fixed-charge coverage ratio (sometimes EBITDA-Capex/DS). Even in corp fin, you usually see CADS (AKA discretionary CF available to pay down debt) used to flow through your debt schedule in order to get revolver drawdown / (paydown) numbers and optional repayments on your other pieces of debt.
NOI/DS is the way to go but be careful on the definition in your credit agreeement
In fact, the Sponsor might have calculated a modified DSCR because some expenses are junior to the Debt Service (letting fees, admin expense, pm expenses etc...)
Thus in our BP and committees (I work in a RE debt fund), we usually display a classic DSCR and a modified DSCR that is based on the credit agreement and its calculation definition
concurring the above answer.
don't over complicate it. Simply, what is the DSCR meant to show? the project's abilitiy, BEFORE DEBT P or I payments, to cover it's debt obligations. See Below:
Rev = 200 Exp = 100 NOI = 100 CapEx = 10 Debt = 60
The most COMMON way to calculate DSCR would be NOI - Capex and then divide by debt. aka 100 - 10 = 90 / 60 = 1.50x DSCR.
As mentioned above, make sure you read the operating agreement. It will most certainly define how revenue/expenses/NOI and DSCR is calculated...
Mostly everyone backs out capex from NOI before hte coverage calc, though sometimes it's pure NOI, no reserve deduction.
Again, the goal here is to calculate how much the PROJECT's OPERATIONS can cover the debt service on said project. The covenants in the loan agreement will oftentimes stipulate a minimum DSCR the project must obtain - meaning that below said level, you are potentially in default. If nothing else, you are well below the level of NOI that the bank assumed you would be earning - which isn't good for anyone.
Another, perhaps more advanced, item to consider is how the debt part of the DSCR is calculated. You may have an interest only loan. However, PER THE LOAN DOCS, dsc may be calculated using the outstanding loan balance, but with a stated amortization term and rate. because yes, calculating DSCR on an interest only loan is a bit pointless.
Make sure you understand whether capital reserves are included or excluded from the numerator.
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