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Ratios for Checking your Capacity to Take More Loans

a. Interest Service Coverage Ratio
Interest Service Coverage Ratio = Income/ Interest Amount

Let us understand this with the help of an example.
Suppose you have taken a loan of Rs. 1 crore. You need to pay Rs. 10 lakhs per year as an interest and your income is Rs. 20 lakhs per year.

Your interest service coverage ratio is:

Interest Service Coverage Ratio = Rs. 20 lakhs/Rs. 10 lakhs = 2 times

So, you can easily give the interest 2 times in a year and thus, you have the capacity to take more loans. Interest service coverage ratio will be more if your income is more.

Taking the above example, if your income is Rs. 50 lakhs per year and you need to pay Rs. 10 lakhs per year, then your interest service coverage ratio is:

Interest Service Coverage Ratio = Rs. 50 lakhs/Rs. 10 lakhs = 5 times

Your capacity to take the loan increases with an increase in the interest service coverage ratio.

b. Debt Service Coverage Ratio

It is similar to the interest service coverage ratio; but, in this ratio, your loan is also serviced along with your interest.

Debt Service Coverage Ratio = Income/ Interest Amount + Principal Loan Amount

For example:
You have taken a loan of Rs. 1 crore, you pay an interest of Rs. 10 lakhs per year and you repay Rs. 5 lakh per year as the principal amount of the loan. Your income is Rs. 20 lakhs per year.
So, your debt service coverage ratio is as follows:
Debt Service Coverage Ratio = Rs. 20 lakhs / Rs. 10 lakhs + Rs. 5 lakh = 1.33 times

In the same case, if your income is Rs. 50 lakhs per year and you pay Rs. 15 lakhs per year including the interest and principal amount, then the debt service coverage ratio is:

Debt Service Coverage Ratio = Rs. 50 lakhs / Rs. 15 lakhs = 3.33 times

Your capacity to take the loan increases with an increase in the debt service coverage ratio.

c. Debt to equity ratio

It is the ratio that tells how much money an entrepreneur has raised from the market (i.e., the equity) with respect to the money he has invested in the business (i.e., the debt).

Debt to equity ratio = Debt/Ratio

For example:
If an entrepreneur has invested Rs. 100 in the business and raised Rs. 1000 from the market, then his/her debt-to-equity ratio is:

Debt to equity ratio = 1000/100 = 10 times

On the other hand, if an entrepreneur has invested Rs. 100 in the business and raised Rs. 200 from the market, then the debt-to-equity ratio is:

Debt to equity ratio = 200/100 = 2 times

Your capacity to take the loan increases with a decrease in the debt-to-equity ratio.

So, you need to take care of all these three ratios to check your capacity to take more loans. You can calculate these ratios with the help of your balance sheet and profit and loss account.

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