What Is the Debt-Service Coverage Ratio (DSCR)? 

The debt-service coverage ratio (DSCR) measures a firm’s available cash flow to pay current debt obligations. The DSCR shows investors and lenders whether a company has enough income to pay its debts. The ratio is calculated by dividing net operating income by debt service, including principal and interest.

KEY TAKEAWAYS

  • The debt-service coverage ratio (DSCR) is a measure of the cash flow available to pay current debt obligations.
  • DSCR measures a business’s cash flow versus its debt obligations.
  • Lenders use DSCR to determine whether a business has enough net operating income to pay back loans.
  • DSCR equals net operating income divided by debt service, including principal and interest.

Understanding Debt-Service Coverage Ratio (DSCR) 

The debt-service coverage ratio is a widely used indicator of a company’s financial health, especially those who are highly leveraged with debt. Debt service refers to the cash needed to pay the required principal and interest of a loan during a given period.

The ratio compares a company’s total debt obligations to its operating income. Lenders, stakeholders, and partners target DSCR metrics, and DSCR terms and minimums are often included in loan agreements.

Advantages

  • Can be calculated over a period of time to better understand a company’s financial trend
  • May be used to compare operational efficiency across companies
  • Includes more financial categories (i.e., principal repayments) than other financial ratios
  • May be a more comprehensive analysis of a company’s financial health as it is often calculated on a rolling annual basis

Disadvantages

  • May not fully incorporate a company’s finances as some expenses (i.e., taxes) may be excluded
  • Has heavy reliance on accounting guidance which may widely vary from actual timing of cash needs
  • May be consider a more complex formula compared to other financial ratios
  • Does not have consistent treatment or requirement from one lender to another

Calculating DSCR 

The formula for the debt-service coverage ratio requires net operating income and the total debt servicing for a company. Net operating income is a company’s revenue minus certain operating expenses (COE), not including taxes and interest payments. It is often considered equal to earnings before interest and tax (EBIT).

​DSCR = Total Debt Service / Net Operating Income​

How Do You Calculate the Debt Service Coverage Ratio (DSCR)?

The DSCR is calculated by taking net operating income and dividing it by total debt service (which includes the principal and interest payments on a loan). For example, if a business has a net operating income of $100,000 and a total debt service of $60,000, its DSCR would be approximately 1.67.

Why Is the DSCR Important?

DSCR is a commonly used metric when negotiating loan contracts between companies and banks. For instance, a business applying for a line of credit might be obligated to ensure that their DSCR does not dip below 1.25. If it does, the borrower could be found to have defaulted on the loan. In addition to helping banks manage their risks, DSCRs can also help analysts and investors when analyzing a company’s financial strength.

What Is a Good DSCR?

A “good” DSCR depends on the company’s industry, competitors, and growth. A smaller company just beginning to generate cash flow might face lower DSCR expectations compared to a mature company already well-established. As a general rule, however, a DSCR above 1.25 is often considered “strong,” whereas ratios below 1.00 could indicate that the company is facing financial difficulties.

The Bottom Line 

DSCR is a commonly used financial ratio that compares a company’s operating income to the company’s debt payments. The ratio can be used to assess whether a company has the income to meet its principal and interest obligations. The DSCR is commonly used by lenders or external parties to mitigate risk in loan terms.