What is Debt Service Coverage Ratio
Debt service coverage ratio is a financial ratio that measures the available cash flow to repay the company’s liabilities. The debt service coverage ratio is a comparison between net operating income and debt service. The debt service coverage ratio value of 1.00 means the operating income is exactly equal to the debt service.
Thus, the higher value of the debt service coverage ratio (DSCR) the higher the number of cash flow available to repay debt. In contrast, the lower DSCR the lower number of cash flow available to repay debt. Furthermore, the DSCR below 1.00 could indicate that the company is facing financial difficulties (debt service excess operating income).
However, the exact number of a good debt service coverage ratio depends on the company’s industry and the company’s current stage of growth.
The higher value of the debt service coverage ratio, the higher ability to repay debt.
Normally, the debt service coverage ratio is a benchmark for the measurement of a person or a company’s ability to generate enough cash flow to cover their debt. To put it simply, in corporate finance, DSCR refers to the value of cash flow available to meet annual interest and principal payments on debt. In personal finance, DSCR refers to a ratio used by bank loan officers in determining the company’s debt servicing ability.
Debt Service Coverage Ratio Formula & Calculation
The debt service coverage ratio can be calculated by dividing the net operating income by the total debt service, or the following debt service coverage ratio formula:
DSCR = Net operating income / Total debt service
or
DSCR = EBITDA / Total debt service
Where:
- EBITDA is earnings before interest, tax, depreciation, and amortization.
- Debt service includes annual interest payments and principal payments on debt.
For example, let’s say the Feriors company has a net operating income of $100,000 and a total debt service of $10,000, the debt service coverage ratio will be 10 (100,000 / 10,000 = 10). The DSCR of 10 means the Feriors company has an operating income 10 times more than its debt service.
Note: The debt service coverage ratio (DSCR) is also known as the debt coverage ratio (DSR).
FAQs
The debt service coverage ratio (DSCR) is a financial ratio that measures the available cash flow to repay the company’s liabilities by the comparison between the net operating income and the total debt service.
The debt service coverage ratio can be calculated by dividing the net operating income by the total debt service, or DSCR = Net operating income / Total debt service
The higher value of the debt service coverage ratio, the higher the number of cash flow available to repay debt.
