Debt service coverage

Debt service coverage
See also
Long-term financing Ebitda ratio Fixed-Charge Coverage Ratio Fictitious asset Non current liability Total capital Advance funding Solvency ratios Capital dividend account

In general, coverage ratio can be described as included in any of a group of financial ratios that are used in order to calculate the capacity of all the companies to repay their financial obligations. The ratio which is higher points out a major ability of the companies to fulfill their financial obligations. The ratio which is lower marks this ability as a minor one. There are types of coverage ratios that are used most often are the following:

• interest coverage ratio
• debt service coverage ratio
• cash coverage ratio
• asset coverage ratio.

In the sphere of finances, the debt-service coverage ratio (also known as the abbreviation DSCR) or the debt coverage ratio (DCR) can be defined as a measurement of the cash income in order to be available to pay current debt obligations. DSCR is the ratio of money which is achievable to be spent on debt servicing, such as:

• interest
• lease payments
• principal payments.

The ratio states net operating income as a multiple of debt obligations due within one year, including interest, principal, sinking-fund and lease payments.

Debt service coverage in various spheres

DCR is a measurement that is used by bank loan officers to decide income property loans. It is the measurement of any entity, that means a person or a corporation, and their capacity to produce enough money in order to cover the debt payments. The rule is that the higher the ratio is, the easier it is for a person or a corporation to be granted a loan.

In corporate finance world DSCR is ratio of the money flow which allows to pay actual debt obligations. The measurement defines net operating income as a multiplicity of debt obligations during a year, that includes principal, interest, lease payments and sinking-fund. DSCR or DCR can also be used in commercial banking. It may be defined as a minimum measurement which a lender can accept. In some cases and circumstances, the breach of DCR covenant can be perceived as an act of default.

When it comes to authority section Debt Service Coverage Ratio is the ratio of export incomes which are needed to pay annual interest and principal payments on the external debts of a country. In all the cases, the measurement presents the capacity to service debt given a particular level of income.

Calculating the Debt Service Coverage Ratio

In general, the DSCR can be calculated with the use of following structure :

${\text{Debt Service Coverage Ratio}}={{\text{Net Operating Income}} \over {\text{Total Debt Service}}}$

This means that net operating income (which is revenue minus certain operating expenses) are divided by total debt service, id est current debt obligations. What is more, total debt service relates to actual debt obligations, this means principal, interest, principal, and lease payments which have to be paid in the next year. This will include both short-term debt as well as long-term debt in a specific and current portions. It is very often investigated as the counterparts of the company's earnings before interest and tax (also known as EBIT).

References

• Andrukonis D., (2013), Pitfalls on Conventional Earnings - Based DSCR Measures and a Recommended Alternative in The RMA Journal, May 2013
• Bragg M. S., (2012), Business Ratios and Formulas John Wiley & Sons, Inc., New Jersey
• Gibson H. C., (2013), Financial Reporting & Analysis South - Western, Cengage Learning, USA
• Hayes A., (2019), Debt-Service Coverage Ratio - DSCR Definition

Author: Jakub Chmiel