Banks risk assessment of a Company’s ability to service bank debt

The core criteria that banks use nowadays is the concept of “free cash flow”. In the past there was great emphasis on “ebitda” (earnings before interest, tax, depreciation and amortisation). This older method did not capture all items that could be a drain on cash and the two commonly omitted by bankers was the increase in working capital and capital expenditure.


The free cash method is clear and concise and may be of interest to all companies that are evaluating their ability to take on additional borrowings.


I will outline it in tabular form:


Audited accounts 2015 Budgeted accounts 2016
Net profit before tax
+ Depreciation
+ Interest paid
Less outgoings/incomings
+/- Stock
+/- Increase in debtors
+/- Increase in creditors
– Drawings/ Dividends
– Tax
– Capex
+ Add back non recurring items
Free Cash to Service Debt
– Term Loan payments to Bank


This method is very dependent on the company having up to date audited accounts ,as very historic accounts will not give an accurate picture. In addition, it is always important to maintain accurate and up to date financial projections for one to two years ahead.

In summary, there are four large demands on the EBITDA,

  1. Unfunded reinvestment cycle (capital expenditure)
  2. Working capital growth.
  3. Taxation.
  4. Dividenda.

The Banker will critically evaluate these demands and ensure the figures in above chart are correct.

Only then is he confident that there is free cash flow to service debt commitments.




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