The DSCR is the most relied-upon metric in credit appraisal. It is also the most misleading, because it is calculated from EBITDA, and EBITDA systematically overstates the cash available to service debt.
A borrower’s reported DSCR of 1.5x looks comfortable. Reported EBITDA of Rs 15 crore against annual debt service of Rs 10 crore. The arithmetic says the borrower can pay.
The Repayment Capacity Test recalculates the DSCR on a cash basis, subtracting from EBITDA every cash outflow that the EBITDA definition ignores but that the borrower must pay before a single rupee is available for debt service.
The cash-basis reconstruction
Reported EBITDA: Rs 15 crore.
Subtract working capital absorption. The borrower’s receivable days increased from 60 to 75 during the year. On Rs 100 crore of revenue, the 15-day increase consumed Rs 4.1 crore of cash. The borrower generated Rs 15 crore of EBITDA but used Rs 4.1 crore of it to fund the growing receivable book. That Rs 4.1 crore is not available for debt service.
Similarly, inventory days increased from 45 to 55. The increase consumed Rs 2.7 crore of cash. Payable days remained stable, providing no offset.
Total working capital absorption: Rs 6.8 crore.
Subtract maintenance capex. The borrower spent Rs 3 crore on replacing worn equipment, maintaining facilities and sustaining the current production capacity. This is not growth capex (which is discretionary). This is the minimum expenditure required to keep the business at its current output. Without this spending, the equipment degrades, the capacity declines and the revenue the DSCR is calculated on begins to shrink.
Maintenance capex is rarely disclosed separately from growth capex in the borrower’s financial statements. The test estimates it from: depreciation as a proxy (maintenance capex should at minimum equal depreciation to sustain the asset base), management inquiry (how much of this year’s capex was replacement versus expansion?) and historical patterns (what has the borrower spent on capex in years without major expansions?).
Subtract actual tax paid. The reported tax expense was Rs 2.5 crore. The actual tax paid (from the cash flow statement, not the P&L) was Rs 3.2 crore, because the prior year’s tax demand was settled during the current year. Cash taxes, not accrual taxes, determine how much cash is available for debt service.
Cash available for debt service: Rs 15 crore minus Rs 6.8 crore minus Rs 3 crore minus Rs 3.2 crore = Rs 2 crore.
Cash-basis DSCR: Rs 2 crore / Rs 10 crore = 0.2x.
The reported DSCR was 1.5x. The cash-basis DSCR is 0.2x. The borrower cannot service the debt from operating cash flow. The gap is being funded by drawing down working capital further (a finite resource), deferring capex (which degrades the asset base), raising additional debt (which increases the obligation) or requesting the lender to restructure.
Why the gap matters for the sanction decision
The credit appraisal that sanctions a facility based on a 1.5x DSCR has assessed that the borrower generates Rs 15 crore of repayment capacity. The actual repayment capacity is Rs 2 crore. The facility was sized for a business that generates seven times the cash it actually produces for debt service.
The Repayment Capacity Test, applied at the appraisal stage, would have shown the credit committee the cash-basis DSCR alongside the reported DSCR. The committee would have sanctioned a smaller facility, required additional security, structured a different repayment schedule or asked the borrower to explain and remedy the working capital absorption before sanctioning.
How to institutionalise the test
The test becomes a standard appraisal step: the CMA data includes the cash-basis DSCR alongside the reported DSCR. The credit note presents both. The sanction authority evaluates both. The facility is sized against the lower of the two.
The working capital absorption, the maintenance capex estimate and the cash tax adjustment are documented in the credit note with the methodology and the data sources. The methodology is consistent across all appraisals, so the credit committee sees a comparable metric for every borrower.
Northrop applies this test in pre-lending assessments and ongoing credit surveillance. [email protected] | +91 92899 25657.