Suppose a person approached Bank for a Loan.He asks bank for a loan of 5000000 @ 12% p.a.
He says that from this loan, he will take start a business where he will earn every year Rs 400000
Will bank give him loan?View Answer
Interest on Loan every year =500000@12%=600000
Profit earned every year=400000
With the new business, he will not be able to earn even that much profit that he can repay interest.
Hence bank will not give loan
What are Coverage Ratios
Ratios which are used to calculate whether compay has the profitability to repay loan is repayable is called coverage ratos
It measures how many timed of repayment the business is to be repaid
Profit After Tax+Dep+Interest/Total Amount Repaid
If this ratio is less than 1,no bank will give loan
This ratio should be ideally atleat 1.5
Higher the ratio,the better