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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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