Debt Service Coverage Ratio

Other Category: Accounting, Cashflow, Financial Statements & Reports

July 23, 2013
Dan
cash flow, debt, debt service coverage ratio, EBIT, ebitda, financial ratio, Interest, net income

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 business. Benchmarking 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.

ARTICLES YOU MIGHT LIKE

Is Mexico the New China?

June 1, 2023

In the wake of the COVID-19 pandemic and escalating tensions with China, American companies are actively seeking alternatives to mitigate their supply chain risks and reduce dependence on Chinese manufacturing. Nearshoring, the process of relocating operations closer to home, has emerged as an explosive opportunity for American and Mexican companies to collaborate like never before.

The Accounting Gap Between Large and Small Companies

March 8, 2023

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

The Struggles of Private Company Accounting

June 9, 2022

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

MARCH 28TH-31ST 2022

Days

Hours

Min

August 7-10th, 2023

Days

Hours

Min

SHARE THIS ARTICLE