Debt Service Coverage Ratio
Debt Service Coverage Ratio

See also:
Operating Income (EBIT)
Financial Ratios
EBITDA Definition
Loan Agreement
Time Interest Earned Ratio Analysis
Net Income
Benchmarking
Fixed Charge Coverage Ratio
Times Interest Earned Ratio
Free Cash Flow

Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) is a financial ratio that measures the company’s ability to pay their debts. In broad terms the DSCR is defined as the cash flow of the company divided by the total debt service.
A DSCR > 1.0 indicates that the company is generating sufficient cash flow to pay their debts. A DSCR < 1.0 should be a cause for concern because it indicates that the company is negatively cash flowing.

Debt Service Coverage Ratio formula:

DSCR calculation = EBIT divided by (interest + (principal/ 1-tax rate)
In some cases in calculating the debt service coverage ratio EBITDA is used instead of EBIT since EBITDA is a closer approximation of cash flow. When calculating the debt service ratio denominator leases should be included along with other debt service costs.

Debt Service Coverage Ratio (DSCR) example:

Assumptions:
Net Income = $643,800 Interest Expense = $240,000 Taxes = $331,655 Principal Payments = $300,000 Tax Rate = 34%
DSCR numerator = EBIT = $643,800 + $240,000 + $331,655 = $1,215,455
DSCR denominator = interest + (principal payments / (1-tax rate)) = $240,000 + ($300,000 / (1-34%) = $695,545
DSCR = $1,215,455 / $695,545 = 1.75

Uses of Debt Service Coverage Ratio:

The DSCR is used as a financial tool for trend analysis. By following the increase or decrease of the DSCR over time a company can determine if they are building liquidity in the businessBenchmarking the DSCR against other companies in similar industries is useful in setting goals for the corporation to attain.
Finally, the DSCR is often used in loan covenants for triggering a default if deteriorating financial results occur.
debt service coverage ratio

ARTICLES YOU MIGHT LIKE

The Accounting Gap Between Large and Small Companies

The Accounting Gap: It’s unfortunate, but true. A large gap exists between the accounting departments of large or publicly traded companies and smaller or private companies. In our past 25 years of consulting we’ve noticed that more often than not, these smaller/private companies will fill the gap with Bookkeepers, rather than the degreed Accountants/CPAs they

Read More »

The Struggles of Private Company Accounting

Building your Accounting Department… When I meet a business owner operating at a successful $10+ mil in revenue I often hear them say “My CPA…” and I immediately know they are referring to a tax CPA. One thing ALL entrepreneurs have in common is that they have to file a tax return. So from day

Read More »

Financial Ratios

See also:Quick Ratio AnalysisPrice to Book Value AnalysisPrice Earnings Growth Ratio AnalysisTime Interest Earned Ratio Analysis Use of Financial Ratios Financial Ratios are used to measure financial performance against standards. Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). The most useful comparison when

Read More »

JOIN OUR NEXT SERIES

Financial Leadership Workshop

MARCH 28TH-31ST 2022

THE ART OF THE CFO®

Financial Leadership Workshop

Days
Hours
Min

June 12-15th, 2023

SHARE THIS ARTICLE
WIKI CFO® - Browse hundreds of articles