Much of the terminology and mathematical basis for tax increment financing is drawn from accounting, particularly municipal bond accounting.
PRINCIPAL: Principal is the amount of money borrowed to finance the project. The principal is usually repaid in specified (but not necessarily equal) increments over the life of the bond issue.
INTEREST: Interest is the price a borrower has to pay a lender for the use of money. In the case of bonds, interest (or "coupon rate") changes over time, usually increasing the longer the debt is held. In addition, bonds may be offered at any time during the year. Bonds pay interest every six months; by convention, a bond offered before July 1 begins paying interest in the second half of that first year.
DEBT SERVICE: Interest payment due, plus principal repayment (if any). Unlike most debt service, bond debt service is not set up in equal annual amounts.
INVESTED SURPLUS EARNINGS: Usually a lender likes to see a "cushion" of surplus funds which can protect the debt repayment from unforeseen events. Prudence dictates that this surplus should not be left idle, but should be invested so it can produce a return while it is being held in readiness. The program on the worksheet defines invested earnings as INVESTMENT RATE X PRIOR CUMULATIVE SURPLUS.
CUMULATIVE CASH SURPLUS: This is the total "cushion" which protects the lender's investment. The project may include some funds to cover early interest expenses; the bond may have been larger than was needed for the direct costs of the project. This surplus is called "capitalized interest." Cumulative cash surplus for any given year is any remaining capitalized interest or prior surplus, plus any investment earnings and any tax increment revenues, minus the debt service payment for that year.
DEBT COVERAGE RATIO: Debt coverage ratio is a measure of the security of the investor's interest. It is the ratio of cash on hand (tax increment revenue and invested surplus, plus any cash surplus remaining from the prior year) to the required debt service payment.
© 1996 A.J.Filipovitch
Revised 11 March 2005