Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Debt Service Coverage Ratio

What it is:

A company's debt service coverage ratio refers to its ability to meet periodic obligations on outstanding liabilities with respect to its net operating revenue.

How it works (Example):

The debt service coverage ratio (DSCR) measures how effectively a company's operations-generated income is able to cover outstanding debt payments. The DSCR is calculated by dividing a company's total net operating revenue during a given period by its total required payments on outstanding debts in the same period:

DSCR = net operating revenue / total payment on outstanding debt

A DSCR of one indicates that a company's revenue is just sufficient to cover its periodic debt service payments. In this respect, DSCR values greater than one are preferable and correlate more strongly with a company's ability to repay its outstanding debts. Conversely, values of less than one indicate that a company is unable to generate income sufficient enough to cover its payments.

To illustrate, suppose that in a given quarter, company XYZ generates $1m in net income. Its payments on outstanding debts due in the same quarter amount to $900k. XYZ's DSCR would be calculated in the following manner:

DSCR = $1,000,000 net income / $900,000 debt payment 
= 1.11
In this instance, company XYZ generated 11% more income than it needed to meet its liability payments for the quarter.

Why it Matters:

Lenders use the DSCR in order to evaluate applicant companies' current cash flows as an indication of the companies' ability to repay a loan.

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