How can you incorporate debt service into your financial models?

Debt service is the amount of money that a borrower has to pay back to the lender, including principal and interest, over a given period of time. It is an important factor to consider when building financial models, as it affects the cash flow, profitability, and solvency of a business. In this article, you will learn how to incorporate debt service into your financial models using some common methods and tools.

1 Debt Schedule

A debt schedule is a table that shows the details of the debt obligations of a business, such as the type, amount, interest rate, maturity, and repayment schedule of each loan. It is usually linked to the income statement, balance sheet, and cash flow statement of the financial model, so that any changes in the debt assumptions are reflected in the other statements. A debt schedule helps you calculate the debt service for each period, as well as the outstanding balance and the leverage ratios of the business.

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Keight Khendi

Results-Driven CPA | Financial Strategist | Expert in Automation & Compliance | Transforming Financial Landscapes
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As a finance expert, I find this method of inclusion to be the best. Here is why; 1. You are able to monitor debt progress and plan the business effectively 2. It is not easy to miss out on deadlines regarding debt repayment.

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2 Interest Expense

Interest expense is the cost of borrowing money, and it is calculated as the product of the interest rate and the outstanding debt balance. It is usually deducted from the earnings before interest and taxes (EBIT) on the income statement, as it reduces the taxable income of the business. Interest expense is also a component of the cash flow statement, as it represents a cash outflow from the operating activities of the business. To incorporate interest expense into your financial models, you need to link it to the debt schedule and the income statement.

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Brian Gross, CPA, MBA

Chief Financial Officer at Controltek
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When considering how to incorporate interest expense into a financial model, depends on the goal of the model. Interest expense is not a productive expense of the business, but it is a useful indicator of the company's current liquidity and could be a sign of trouble if it continues to rise. The best place to include interest expense is in a cash forecasting model rather than one focusing on financial results.

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3 Principal Repayment

Principal repayment is the amount of money that a borrower pays back to the lender to reduce the outstanding debt balance. It is usually a fixed or variable amount that depends on the terms and conditions of the loan agreement. Principal repayment is not an expense on the income statement, but it is a cash outflow from the financing activities of the business on the cash flow statement. To incorporate principal repayment into your financial models, you need to link it to the debt schedule and the cash flow statement.

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Keight Khendi

Results-Driven CPA | Financial Strategist | Expert in Automation & Compliance | Transforming Financial Landscapes
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With principal repayment model, the business is able to capture the periodic financing cost instead of the accumulated cost heaped in one period.

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4 Debt Service Coverage Ratio

Debt service coverage ratio (DSCR) is a measure of the ability of a business to generate enough cash flow to cover its debt service obligations. It is calculated as the ratio of the operating cash flow (or EBITDA) to the total debt service (interest expense plus principal repayment) for a given period. A higher DSCR indicates a lower risk of default and a higher creditworthiness of the business. To incorporate DSCR into your financial models, you need to calculate it using the data from the debt schedule, the income statement, and the cash flow statement.

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5 Scenario Analysis

Scenario analysis is a technique that allows you to test the impact of different assumptions and variables on the financial performance and viability of a business. It is useful for evaluating the sensitivity and uncertainty of the financial model, as well as for exploring different possibilities and outcomes. You can use scenario analysis to incorporate debt service into your financial models by changing the inputs and parameters of the debt schedule, such as the amount, interest rate, maturity, and repayment schedule of the loans, and observing how they affect the other financial statements and ratios.

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Keight Khendi

Results-Driven CPA | Financial Strategist | Expert in Automation & Compliance | Transforming Financial Landscapes
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While most of the others can be strict on amendments, the ability to change the inputs in scenario analysis gives you the privilege to choose whether to take up a debt or not.

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6 Excel Functions and Tools

Excel is a powerful and versatile tool that can help you incorporate debt service into your financial models with ease and efficiency. Some of the useful functions and tools that you can use are:

- PMT : This function calculates the periodic payment for a loan based on a constant interest rate and a constant repayment schedule.

- IPMT : This function calculates the interest payment for a specific period of a loan based on a constant interest rate and a constant repayment schedule.

- PPMT : This function calculates the principal payment for a specific period of a loan based on a constant interest rate and a constant repayment schedule.

- Goal Seek : This tool allows you to find the value of an input that makes a formula result match a desired value. For example, you can use it to find the interest rate that makes the DSCR equal to a target value.

- Data Table : This tool allows you to create a table that shows the results of changing one or two variables in a formula. For example, you can use it to create a table that shows the DSCR for different combinations of interest rate and principal repayment.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Isaac Soto

Chief Of Staff
(edited)
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In my opinion I think it’s important to consider the following key factors:  1. Identify Debt Obligations: Determine the specific debt obligations that need to be accounted for in the financial model. 2. Calculate Debt Service Payments. 3. Include Debt Service in Cash Flow Projections. 4. Adjust Financial Statements. 5. Consider Debt Covenants: if applicable, consider any debt covenants or restrictions imposed by lenders. 6. Evaluate Sensitivity Analysis: Conduct sensitivity analysis to assess the impact of changes in interest rates or other variables on the debt service obligations. This helps in understanding the potential risks associated with the debt and its impact on the financial model.

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How can you incorporate debt service into your financial models?

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1 Debt Schedule

2 Interest Expense

3 Principal Repayment

4 Debt Service Coverage Ratio

5 Scenario Analysis

6 Excel Functions and Tools

7 Here’s what else to consider

Corporate Finance

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