Q: What is considered a good Debt Capacity Coverage Ratio? Does that Ratio differ depending on the loan amount?
A: In general, the Debt Capacity Coverage Ratio should be linked to the prospects that all accrual revenue will be converted to cash. In theory, if there is absolute certainty that all accrual revenue will be collected in cash during the period, then a 1 to 1 ratio works. Since there is never absolute certainty that such a complete conversion will happen, we need to set the coverage ratio higher as the certainty decreases.
One indicator of the borrower’s performance is a review is the borrower’s experience with bad debts and how well that experience matches the bad debt provisions. If actual write-offs exceed the estimate of bad debts, then the Debt Capacity Coverage Ratio should increase because such a performance indicates that a lower portion of accrual revenue is actually being collected in cash for use in the business.
The Debt Capacity Coverage Ratio doesn't need to vary with size since it is generally written as a percentage rather than as a dollar amount.
Note that setting a Debt Capacity Coverage Ratio is very subjective and requires that the lender know his or her borrowers.
Course overview: Cash Flow Proxies, Debt Capacity, and the UCA Cash Flow Statement