Term loan appraisal explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Before a lender sanctions a term loan, it asks one question in many forms: will the business generate enough cash, year after year, to pay the interest and the instalments? The debt service coverage ratio (DSCR) puts that question into a single number for each year of the loan. A borrower who computes it first knows how much loan the business can carry, which repayment pattern fits, and where the weak year is.
DSCR = cash available for debt service ÷ (interest + principal repayment due in the year). Interest coverage = operating profit ÷ interest. Both are read year by year and on average, and the loan size, tenor and moratorium are the levers that move them. Lenders define the cash figure in different ways, so fix one definition, state it, and use it for every year. This guide is for owners and finance heads preparing a term loan request.
What the lender is testing, and why you should test it first
A term loan is repaid from future cash, not from the asset it buys. So the appraisal looks at four things: how much the promoters put in, how much cash the project throws off, how quickly the loan is repaid, and how much cushion is left if sales come in lower than planned. Doing the same arithmetic on your own figures before the application gives you a defensible request instead of a negotiation on the lender's numbers. Banks follow their regulator's directions and their own credit policy; those are not covered here, and nothing below is a rule of any lender.
The data you need is a projected profit and loss account and cash flow for the loan period (see projected financial statements for a bank loan), the proposed loan size, interest rate, moratorium and repayment pattern, and the promoters' own net worth. If you are still preparing the project report, our project report for bank loan service covers the projections lenders read first.
The measures and their formulas
| Measure | In words | In symbols |
|---|---|---|
| Cash available for debt service (CADS) | Profit after tax + depreciation + interest on the term loan (the definition used in this article) | CADS = PAT + D + I |
| Debt service | Interest for the year + principal instalment for the year | DS = I + P |
| DSCR | CADS ÷ debt service | DSCR = CADS ÷ (I + P) |
| Average DSCR | Total CADS over the loan life ÷ total debt service over the loan life | ΣCADS ÷ ΣDS |
| Interest coverage | Operating profit (profit before interest and tax) ÷ interest | EBIT ÷ I |
| Debt-equity after the loan | Term debt ÷ net worth | Debt ÷ Equity |
Some lenders add other non-cash charges to the numerator, some deduct changes in working capital, some use a simple average of the yearly ratios instead of total over total. None is wrong, but they give different answers on the same projections, so ask which definition applies and keep your own consistent.
Worked example: a small fabrication unit
Invented facts, all assumed: a fabrication unit wants a term loan of ₹90 lakh for machinery and a shed extension. The assumed interest rate is 10 per cent a year, charged on the opening balance of each year. Repayment is in five equal yearly principal instalments with no moratorium. Total net worth after the project is assumed at ₹100 lakh. Amounts are in ₹ lakh, rounded to two decimals; ratios are rounded to two decimals.
Step 1: the repayment schedule. Principal each year = 90 ÷ 5 = 18.00. Interest = 10% of the opening balance. (For the mechanics of schedules, see loan amortisation.)
| Year | Opening balance | Interest | Principal | Debt service |
|---|---|---|---|---|
| 1 | 90.00 | 9.00 | 18.00 | 27.00 |
| 2 | 72.00 | 7.20 | 18.00 | 25.20 |
| 3 | 54.00 | 5.40 | 18.00 | 23.40 |
| 4 | 36.00 | 3.60 | 18.00 | 21.60 |
| 5 | 18.00 | 1.80 | 18.00 | 19.80 |
| Total | 27.00 | 90.00 | 117.00 |
Step 2: cash available and DSCR. The projected PAT and depreciation are the unit's assumptions.
| Year | PAT | Depreciation | Interest | CADS | Debt service | DSCR |
|---|---|---|---|---|---|---|
| 1 | 12.00 | 14.00 | 9.00 | 35.00 | 27.00 | 1.30 |
| 2 | 16.50 | 12.00 | 7.20 | 35.70 | 25.20 | 1.42 |
| 3 | 21.00 | 10.50 | 5.40 | 36.90 | 23.40 | 1.58 |
| 4 | 25.50 | 9.00 | 3.60 | 38.10 | 21.60 | 1.76 |
| 5 | 30.00 | 8.00 | 1.80 | 39.80 | 19.80 | 2.01 |
| Total | 185.50 | 117.00 | 1.59 |
The average DSCR = 185.50 ÷ 117.00 = 1.59. (A simple average of the five yearly ratios would be 1.61: another reason to state the definition.)
Step 3: interest coverage in year 1. With an assumed tax rate of 25 per cent, PBT = 12.00 ÷ 0.75 = 16.00. EBIT = 16.00 + 9.00 = 25.00. Interest coverage = 25.00 ÷ 9.00 = 2.78 times.
Step 4: debt-equity. Term debt 90.00 ÷ net worth 100.00 = 0.90.
Step 5: the lender's own test. Suppose this invented lender wants a DSCR of at least 1.25 in every year (its own term in this example, not a general rule). Year 1 at 1.30 passes, but the cushion is thin. CADS can fall to 1.25 × 27.00 = 33.75 before the test fails, a fall of 1.25, which is 3.57 per cent of 35.00 (3.6 per cent rounded).
Step 6: a one-year longer tenor. Six equal instalments of 90 ÷ 6 = 15.00. CADS for years 1 to 5 is held as before (the small change in tax from the extra interest is ignored); year 6 CADS is assumed at 40.50.
| Year | Interest | Principal | Debt service | CADS | DSCR |
|---|---|---|---|---|---|
| 1 | 9.00 | 15.00 | 24.00 | 35.00 | 1.46 |
| 2 | 7.50 | 15.00 | 22.50 | 35.70 | 1.59 |
| 3 | 6.00 | 15.00 | 21.00 | 36.90 | 1.76 |
| 4 | 4.50 | 15.00 | 19.50 | 38.10 | 1.95 |
| 5 | 3.00 | 15.00 | 18.00 | 39.80 | 2.21 |
| 6 | 1.50 | 15.00 | 16.50 | 40.50 | 2.45 |
| Total | 31.50 | 90.00 | 121.50 | 226.00 | 1.86 |
The answer: on the five-year schedule the weakest year is year 1 at a DSCR of 1.30 and the average is 1.59; stretching to six years lifts the weakest year to 1.46 and the average to 1.86, at an extra interest cost of 4.50 (31.50 − 27.00). The owner decides whether the extra cushion is worth that cost, or whether a short moratorium on principal would do the same job for the early years.
What improves a weak ratio
- A longer tenor lowers each year's instalment, as above, but raises total interest.
- A moratorium on principal during the first months protects the year in which the new machine is still ramping up.
- More promoter money or a smaller loan reduces both interest and principal.
- Instalments that follow the cash pattern, such as lower instalments in the early years and higher later, if the business earns more as the project matures.
- Revisiting the projections themselves: a margin that depends on an aggressive price or full capacity from day one will not survive a careful reading.
Common mistakes
- Using one year's strong cash flow to judge a loan whose weak year is year 1.
- Mixing definitions between years or between the ratio and the covenant that will later be tested against it (see loan covenants).
- Counting depreciation and then ignoring the capital expenditure needed to replace the machine.
- Leaving out the working capital the project will absorb, which competes for the same cash.
- Ignoring that the loan may be used only for the purpose sanctioned; see the CARO 2020 post on term loan use and defaults.
Where law touches the topic
Borrowing powers, charge registration and the auditor's reporting on loan use are covered in the linked posts; this article is about the arithmetic only.
Need help with your term loan request?
If the numbers above are the ones you need for your own unit, we can build the projections, test the ratios under different assumptions and prepare the application. See our project report for bank loan page for what that involves.
Key takeaways
- DSCR = cash available for debt service ÷ (interest + principal due in the year); read it year by year, not only on average.
- State your definition of the cash figure once and keep to it; lenders differ.
- Interest coverage and debt-equity after the loan complete the picture.
- Tenor, moratorium, loan size and promoter money are the levers; each has a cost.
- Test a thin year by asking how far cash can fall before the lender's own threshold is reached.
Read next
- Project cost, means of finance and the feasibility study for a new unit
- Sole banking, multiple banking and consortium lending compared
- Term loan sanction letter and loan agreement explained for borrowers
- How to build a financial model
Disclaimer: The figures, rates, multiples and names in the worked example are invented for illustration and are not market data. Where the article refers to law, it is based on the Companies Act, 2013 (MCA consolidated text) and the rules and live guides linked, as consulted on 6 October 2026; valuation for income-tax and FEMA purposes follows its own rules. This article is general information, not valuation, lending or legal advice; check the official text before acting.