Debt Service Coverage Ratio

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Definition

The debt service coverage ratio (DSCR) has different interpretations in different fields. In corporate finance, for example, the debt-service coverage ratio can be explained as the amount of assessable cash flow to congregate the annual interest and principal payments on debt, not forgetting the sinking fund payments. On the other hand, as explained in Government finance, the debt-service coverage ratio refers to the requisite amount of export earnings for meeting up the annual interest and principal payments on the external debts of a country.

Personal finance, on the contrary, explains it as a ratio which is used by bank loan officers to determine income property loans. The ratio is considered to be ideal if it is above 1 thus indicating that the property is producing income which is sufficient to pay back its debts.

Calculation (Formula)

The formula used for calculating the debt service coverage ratio is:

DSCR = Net Operating Income / Total Debt Service

Generally, the debt service coverage ratio is calculated as -

DSCR = (Annual Net Income + Interest Expense + Amortization&Depreciation + Other discretionary and non-cash items like non contractual provided by the management)/ (Principal Repayment + Interest Payments + Lease Payments)

Thus, to calculate the debt service coverage ratio of a company or business entity, it is, at the first point, essential to calculate the net operating income of the company.

Interpretation

A debt service coverage ratio which is below 1 indicates a negative cash flow. For example, a debt service coverage ratio of 0.92 indicates that the company’s net operating income is enough to cover only 92% of its annual debt payments. However, in personal finance context, it indicates that the borrower would have to look into his/her personal income and funds every month so as to keep the project afloat. The lenders, however, usually frown on a negative cash flow while some might allow it if, in case, the borrower is having sound income outside.

The debt service coverage ratio is, therefore, a benchmark used to measure the cash producing ability of a business entity to cover its debt payments. A higher debt service coverage ratio makes it easier to obtain a loan.
Quote Guest, 9 April, 2013
how to find out DSCR regads j c pandey
Quote irfan ali, 15 November, 2013
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Quote Guest, 20 October, 2014
Should non operating income and expenses be adjusted to the nuemerator?
Quote Guest, 20 October, 2014
Is DCSR= EBITDA / (Principal Repayment + Interest Payments + Lease Payments) a right formula?
Quote Guest, 28 October, 2014
is there a corelation between Debt/EBITDA and DSCR?
Quote Guest, 4 November, 2014
Can DSCR be negative?? If yes, what does it mean?
Quote Guest, 18 November, 2014
Quote
irfan ali wrote:
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Quote Guest, 10 December, 2014
what should be the ideal DSCR ?
Quote Guest, 13 December, 2014
DSCR can be negative if the company shows large net losses without any material add-backs. Essentially what it means is that the company does not generate enough cash flow to cover any of its debt and would have to rely upon its liquidity and capital to make payments. In this situation, it is very likely that the financial institution would re-structure the debt and provide payment relief for the borrower. On the other side, if the borrower cannot make their payments the bank may default the loan and begin collection (liquidate any and all collateral, go after personal guarantees, etc).

There is no ideal DSCR but there are minimums that most banks impose on borrowers. In general, a DSCR of 1.25X for amortizing C&I credits is "normal" and 1.35X for IPRE type properties. It all depends on the bank you are dealing with and your industry, company size, competitive market, and leverage.

I am happy to answer more questions, i have been on the credit side of banking for a very long time at various sized commercial banks and deal with these things on a daily basis.

www.linkedin.com/in/christopherhansson

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