What is the Debt service coverage ratio (DSCR)?
Debt service coverage ratio (DSCR) is the measurement that shows the cash flow of the firm and the ability to pay its debts. Investors and stakeholders can track the firm’s financial health to check whether the firm is capable enough to pay unsettled short-term and long-term debts. DSCR makes it easy for financial institutions to lend money to a particular firm; i.e., the Firm chances of getting a loan will be higher if the ratio is higher.
Explanation of Debt service coverage (DSCR)
One way to measure a company's ability to pay its debt obligations is the debt-service coverage ratio (DSCR). This ratio compares a firm’s net operating income (NOI) to its total debt service, including principal and interest payments. The net operating income is the same as earnings before interest, depreciation, tax, and amortization (EBITDA). It represents the income available to pay the debt service after deducting the operating expenses.
The total debt service is the sum of a firm's current debt obligations, such as loans, leases, and bonds. It can be calculated by adding the interest payments (multiplied by one minus the tax rate) and the principal payments. The higher the DSCR, the more cash flow a company has to cover its debt obligations.
Lenders and investors can use the DSCR to assess a company's financial health and creditworthiness. Businesses can also use it to monitor debt levels and plan capital structure. A DSCR of means that a company has just enough income to pay its debt service, while a DSCR below means that a company is unable to meet its debt obligations from its operating income. A higher DSCR means a company has excess income to pay its debt service and invest in other projects.
Calculation of DSCR
A DSCR can be calculated by using the following formula:
DSCR = Net operating income divided by debt services
Where,
Net operating income = Total revenue - All operating expenses
Total debt service = Current debt obligations