Q: In the calculation of Business Profit Coverage illustrated on Slide 58, why did you not add back depreciation expense?
A: Business Profit includes all operating costs for a business, including the replacement cost of fixed assets. Depreciation expense is the best estimate we have of that cost. Therefore, we do not exclude it from the expense or cost stream in arriving at actual Business Profit – not cash flow – available to meet debt service, i.e., to meet interest expense and repay long-term debt as scheduled.
Cash flow – even traditional "cash flow" – is very different from Business Profit. We use Business Profit along with the UCA cash flow to determine if a borrower generates a) sufficient Business Profit to meet debt service as well as b) sufficient cash flow to do so.
Once again, please keep in mind that the replacement cost of fixed assets is a real cost, and depreciation expense is the best estimate of it we have.
Course overview: Identifying and Mitigating Repayment Risks