# Debt Service Coverage Ratio (DSCR)

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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:

Where:

Net Operating Income = the company's net income before debt service payments

Debt Service Obligations = the company's total debt payments, including principal and interest payments

Generally, the debt service coverage ratio can be also 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.

## Debt Service Coverage Ratio Interpretation

A high DSCR indicates that a company has sufficient net operating income to comfortably meet its debt service obligations, while a low DSCR indicates that a company may struggle to meet its debt obligations.

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.

The DSCR is an important metric for lenders, as it provides insight into a company's ability to repay its debt obligations. Lenders may use the DSCR as part of their credit analysis when evaluating loan applications, as it provides a clear picture of a company's debt repayment ability.

A negative Debt Service Coverage Ratio indicates that a company's net operating income is not sufficient to meet its debt service obligations. In other words, the company is not generating enough cash flow from its operations to repay its debt obligations, including interest and principal payments. A negative DSCR can be a warning sign for lenders and investors, as it suggests that the company may struggle to meet its debt obligations in the future. In such a scenario, the company may need to find additional sources of funding, such as equity or debt financing, in order to repay its debts.

It's also worth noting that a negative DSCR can be caused by a variety of factors, including declining revenue, increasing costs, or increased debt obligations. In order to address a negative DSCR, a company may need to take action to improve its net operating income, reduce its debt obligations, or both.

How does the Debt Service Coverage Ratio (DSCR) depend on the size of the company?

The Debt Service Coverage Ratio (DSCR) can be influenced by the scale of a business, but the impact can vary depending on the specifics of each business.

For larger businesses, a lower DSCR may be more easily absorbed due to their greater financial resources, larger revenue streams, and more diverse operations.
Because the company may be better able to produce enough cash flow to pay its debt commitments down the road, lenders may be more eager to lend to a corporation with a lower DSCR in these circumstances.

Smaller companies, on the other hand, may have fewer financial resources, revenue streams, and operational scale, making a lower DSCR more worrisome to lenders.
In these circumstances, lenders may be more cautious when lending to a company with a lower DSCR because the company might not be able to generate enough cash flow in the future to pay off its debts.

### See also

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, 10 December, 2014
Quote
is there a corelation between Debt/EBITDA and DSCR?

There is some correlation between Debt/EBITDA and Debt Service Coverage Ratio (DSCR), as both ratios are used to evaluate a company's financial health and its ability to repay its debt obligations. However, they provide different perspectives and focus on different aspects of a company's financial performance.
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.
Quote Guest, 2 June, 2016
What is the ratio if your debt is zero?  Do you set the debt at \$1 artificially so you are dividing by zero?
Quote Guest, 1 June, 2017
If a company has zero debt, the DSCR would be undefined because dividing by zero is mathematically undefined. In this case, the ratio should be virtually meaningless because it is designed to measure a company's debt burden and its ability to generate cash flow to service its debt obligations. It is not common practice to artificially set the debt to \$1 in order to avoid dividing by zero, as this would not provide meaningful information about the company's financial health or ability to repay its debt obligations.
Quote PRASAD R, 4 July, 2018
why we are considering PAT instead of PBT for calculation of DSCR ?
Quote Guest, 27 July, 2019

In the calculation of DSCR, the numerator is typically defined as the company's net operating income, which can be represented by either Profit After Tax (PAT) or Profit Before Tax (PBT).

The choice of using either PAT or PBT as the numerator in the DSCR calculation can depend on various factors, such as the company's financial reporting practices and the purpose of the analysis.

Using Profit After Tax (PAT) in the DSCR calculation provides a measure of the company's net operating income after all taxes have been paid. This provides a more accurate representation of the company's ability to generate cash flow from its operations, as taxes can significantly impact a company's net income.

On the other hand, using Profit Before Tax (PBT) in the DSCR calculation provides a measure of the company's net operating income before taxes have been paid. This provides a measure of the company's gross operating income and can be useful for comparing the company's performance to industry benchmarks.

Quote , 25 March, 2020
Thanks for great explanation...
Quote Guest, 12 June, 2020
Is this correct thinking?  If you want to measure how an entity performed for the last fiscal year,  the denominator would be interest expense plus principal repaid during the last fiscal year.  If you want to measure prospectively, the denominator would be interest expense plus current maturities of long term debt. Thank you!

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