If you approach a bank or fi nance company for a loan for your business,
they will check the net profi t margin. They are likely to feel more comfortable
if it is stable or growing than if it is falling!
The object of the game when approaching a bank or fi nance
company for a business loan is to make them feel as comfortable
as possible in lending your business money. They will want to be
reassured that the business is making progress and can afford to
repay the loan.
Interest cover
This is an important ratio if you need to borrow money from a bank or
fi nance company as it will help convince them that your business can
afford to repay the loan.
Interest cover is calculated as follows:
Net profi t plus interest expense, divided by interest expense
Let’s look at an example to illustrate how to calculate the ratio and
what it means in the context of your business borrowing money from a
bank or fi nance company:
XYZ Pty Limited
$
Sales 100,000
Gross profi t 80,000
Interest expense 5,000
Other expenses 45,000
Total expenses 50,000
Net profi t 30,000
Interest cover (see formula above) = $30,000 plus $5,000 divided by
$5000
Result = 7 times cover.
This means that XYZ Pty Limited is covering its interest costs seven
times, which indicates a very strong performance. Generally a bank or
fi nance company will be looking for a minimum of 1 to 1.5 times cover.
ACCOUNTING FOR NON-ACCOUNTANTS 49
Accounting DiZign.indd 49 15/2/06 9:51:58 AM
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