TOOL L6
| Cash Available for Debt Service | |
| EBIT | |
| EBITDA (see Note 3) | (adjust for Minority Interests) |
| EBITDAL (see Note 4) | |
| plus/minus | Any non cash or non operating items dealt with in the Income Statement before EBIT (see Note 5) |
| minus | Cash taxes paid |
| plus/minus | Changes in net working capital requirement |
| minus | Cash spent on provisions (see Note 8) |
| minus | Non-discretionary capital expenditure |
| Finance Charges | |
| Net Interest or Gross Interest | (see Note 6) |
| plus | Capitalised Interest |
| plus | Op. lease payments |
| plus | Preferred Dividends (see Note 7) |
| plus | Current Maturities of Long term debt |
| plus | Any short term debt which had to be repaid |
Notes
- As you go down each column so the ratio/covenant gets stronger from the Banks point of view
- The definition is designed for historical DSC – it considers cash that has been generated and debt service obligations that have fallen due during a period of time that has already ended
- Use rolling NOT annualised EBITDA
- EBITDAL should only be used instead of EBITDA when operating lease payments are included under Finance Charges
- Some accounting systems still allow non-cash or non-operational items to be included in EBIT for example “Earnings from Associates” or “Provisions”. A good understanding of the clients accounting policies is necessary to ensure the true effectiveness of this covenant.
- “Net” interest is often preferred by clients, however this assumes that interest income is both continuing and immediately available to pay interest expenses. As a minimum, cap the interest received amount in the calculation
- Preferred Dividends are not “true” debt service obligations but have many debt like characteristics. Payment may be at a fixed rate and not dependent on the generation of profit. Ordinary dividends may also be included under “DSO” or the covenant may be used to establish a “hurdle rate” (minimum level) which must be exceeded before dividends can be paid (often known as a “dividend lock-up”)
- Inclusion of this item extends control over cash flow but clients will object to its non operational nature
- Beware of the treatment of realised (i.e. cash) FX losses on foreign currency debt. If identifiable these should be included in Finance Charges
- Exercise separate control over Capex and dividends when there is a cash sweep
- When negotiating the definition of a DSC covenant, focus on what is really important for your client’s cash flow. Only use terms that are understood by the client and your lawyer
