The formulas
- PV = sum of expected cash flow_t / (1 + effective interest rate)^t
- Allowance = amortized cost - PV
How it works
In a discounted cash flow approach, expected cash flows (after expected defaults and prepayments) are discounted at the loan effective interest rate. The shortfall from amortized cost is the allowance.
Use the rate that was set when the loan was recognized, not the current market rate. A negative result means the discounted expected flows exceed amortized cost, so this method indicates no allowance. Do not book a negative allowance unless expected recoveries of amounts previously written off support it. Cash flows here are annual and end of year, so refine them if timing is quarterly or monthly.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
Which discount rate applies?
The effective interest rate of the loan. For variable-rate loans, follow the entity documented policy for how the index is treated.
Are these contractual or expected cash flows?
Expected, meaning contractual flows reduced for expected credit losses.
Can I model monthly flows?
This tool is annual. Use a spreadsheet for monthly timing.
Formulas on this page are the standard definitions.
Runs in your browser. The figures you type are not sent to CORAA or stored. Check the result against your firm's methodology before relying on it.