The four ratios the bank works out

The credit team turns your accounts into a handful of ratios. A ratio just compares one number with another. Here are four of the main ones. Each bank works them out a little differently and sets its own limits, so check your facility letter for the exact wording.

Interest cover

How many times profit covers the interest bill. It's usually EBIT divided by interest. EBIT is earnings before interest and tax: profit before tax with the interest added back.

If EBIT is $300,000 and interest is $100,000, interest cover is 3 times. The higher it is, the further profit can fall before the farm can't pay its interest.

Debt service cover

Interest isn't the only thing you pay. Loan principal, the part that pays the loan off, comes out too. Debt service cover compares the cash the business earns with interest and principal together. One common way is EBITDA less drawings, divided by interest plus principal. EBITDA is EBIT with depreciation added back, and drawings are the family's living costs.

Below 1 time means the year's cash didn't cover the repayments. That's why it's the stricter test.

LVR

The loan to value ratio is how much you owe against what the security is worth, as a percentage. Security is what the bank can call on if the loan isn't repaid, usually land under a mortgage.

If you owe $2 million against land valued at $5 million, the LVR is 40%. The bank uses its own valuation, not the price you'd hope to get. If land values fall, your LVR goes up even if you haven't borrowed another dollar.

Equity ratio

Equity is what you own less what you owe. The equity ratio is equity divided by total assets, as a percentage. ABARES, the Australian Government's farm research bureau, uses an equity ratio under 70% as one marker of a farm with less room to borrow more. That's a research measure, not a bank rule. Each lender sets its own levels.

Read them together

No single ratio tells the whole story. A farm with a high LVR but strong, steady cash can still be a good borrower. A farm with little debt that loses money in average years can still worry a bank. The bank looks at three or four years of results, and at what happens in a poor season.

Before the review, work out your own ratios so nothing surprises you. The bank ratio check does the sums, and the bank ratios card has the formulas on one page.