Debt Service Coverage Ratio: Definition, Formula, Examples

Debt Service Coverage Ratio (DSCR) is a common term used in corporate, government, and personal finance. It’s mostly used to measure the cash flow of a business and gives investors an idea of how well a company can pay its debts. The higher the DSCR, the better.

In this article, we’ll be discussing what Debt Service Coverage Ratio is, how it works, how to calculate it, and a few examples. So if you are interested in learning more about Debt Service Coverage Ratio (DSCR, then keep reading.

What is Debt Service Coverage Ratio

Debt Service Coverage Ratio (DSCR) is a number that shows how well a company can pay its debts and other financial obligations. It is a very important number for both investors and creditors. It can determine whether a company will be able to get new loans or not.

It indicates whether or not a company has a healthy cash flow and is generating enough income to cover its debt payments. As many businesses take on debt to finance their operations, it’s critical to have a high DSCR.

How debt service coverage ratio is calculated

So now that we know what is Debt Service Coverage Ratio, let’s discuss how it’s calculated

The formula for DSCR is pretty simple

DSCR = Net Operating Income / Total Debt Service

Let’s take a look

  1. Net Operating Income: This is the company’s income after taxes and expenses have been deducted. In simple words, this is the money that a company has left after it pays all of its expenses.
  2. Total Debt Service: This is the total amount of money that a company has to pay towards its debts every year. This includes interest payments, principal payments, and any other fees associated with the debt. Most businesses have more than one type of debt, so this number can be quite high.

Examples of debt service coverage ratio

Now that we know what Debt Service Coverage Ratio is and how it’s calculated, let’s look at a few examples.

Example 1

Let’s say a company named ABC has a Net Operating Income of $1 million and a Total Debt Service of $500,000. This means that the company’s DSCR is 2.

This is a good DSCR because it means that the company has twice as much income as it does debt. This means that the company should have no problem making its debt payments on time. In addition, investors and creditors would like to invest more in the company.

Example 2

Now let’s say a company named XYZ has a Net Operating Income of $1 million and a Total Debt Service of $2 million. This means that the company’s DSCR is 0.5.

This is not a good DSCR because it means that the company doesn’t have enough income to cover its debt payments. This would be a red flag for investors and creditors. The company may have trouble getting new loans or refinancing its existing ones.

Conclusion

So there you have it. This is everything you need to know about Debt Service Coverage Ratio. We hope that this article was helpful and informative and helped you understand how the debt service ratio works. It is really important to understand this concept if you are interested in corporate finance or investing. Thanks for reading.

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