Debt-Service Coverage Ratio (DSCR)

Loading the player...

What is the 'Debt-Service Coverage Ratio (DSCR)'

In corporate finance, the Debt-Service Coverage Ratio (DSCR) is a measure of the cash flow available to pay current debt obligations. The ratio states net operating income as a multiple of debt obligations due within one year, including interest, principal, sinking-fund and lease payments.

In government finance, it is the amount of export earnings needed to meet annual interest and principal payments on a country's external debts.

In personal finance, it is a ratio used by bank loan officers to determine income property loans.

A DSCR greater than 1 means the entity – whether a person, company or government – has sufficient income to pay its current debt obligations. A DSCR less than 1 means it does not. 

In general, it is calculated by:

DSCR = Net Operating Income / Total Debt Service

BREAKING DOWN 'Debt-Service Coverage Ratio (DSCR)'

A DSCR of less than 1 means negative cash flow. A DSCR of .95 means that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. In general, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.

Net operating income is a company's revenue minus its operating expenses, not including taxes and interest payments. It is often considered equivalent to earnings before interest and tax (EBIT). Some calculations include non-operating income in EBIT, however, which is never the case for net operating income. As a lender or investor comparing different companies' credit-worthiness – or a manager comparing different years' or quarters' – it is important to apply consistent criteria when calculating DSCR. As a borrower, it is important to realize that lenders may calculate DSCR in slightly different ways.

Total debt service refers to current debt obligations, meaning any interest, principal, sinking-fund and lease payments that are due in the coming year. On a balance sheet, this will include short-term debt and the current portion of long-term debt.

Income taxes complicate DSCR calculations, because interest payments are tax deductible, while principle repayments are not. A more accurate way to calculate total debt service is therefore:

Interest + (Principle / [1 - Tax Rate])

Lenders will routinely assess a borrower's DSCR before making a loan. If the ratio is less than 1, the borrower is unable to pay current debt obligations without drawing on outside sources—without, in essence, borrowing more. If it is too close to 1, say 1.1, the entity is vulnerable, and a minor decline in cash flow could make it unable to service its debt. Lenders may in some cases require that the borrower maintain a certain minimum DSCR while the loan is outstanding. Some agreements will consider a borrower who falls below that minimum to be in default

The minimum DSCR a lender will demand can depend on macroeconomic conditions. If the economy is growing, credit is more readily available, and lenders may be more forgiving of lower ratios. A broad tendency to lend to less-qualified borrowers can in turn affect the economy's stability, however, as happened leading up to the 2008 financial crisis. Subprime borrowers were able to obtain credit, especially mortgages, with little scrutiny. When these borrowers began to default en masse, the financial institutions that had financed them collapsed.

RELATED TERMS
  1. Qualification Ratio

    Ratio of debt to income and housing expense to income that is ...
  2. Debt

    An amount of money borrowed by one party from another. Many corporations/individuals ...
  3. Cash Available For Debt Service ...

    A ratio that measures the amount of cash a company has on hand ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Debt Financing

    When a firm raises money for working capital or capital expenditures ...
  6. Interest Coverage Ratio

    A debt ratio and profitability ratio used to determine how easily ...
Related Articles
  1. Investing

    The Debt-Service Coverage Ratio (DSCR)

    The Debt-Service Coverage Ratio (DSCR) is a simple way to analyze whether a company can adequately manage its borrowing costs. The ratio helps banks evaluate the credit worthiness of an organization ...
  2. Managing Wealth

    Explaining Debt

    Debt is any amount a borrower owes a lender.
  3. Investing

    An Introduction To Coverage Ratios

    Interest coverage ratios help determine a company's ability to pay down its debt.
  4. Personal Finance

    Financing Basics For First-Time Homebuyers

    If you're looking to get your first mortgage, there are many financing options available.
  5. Investing

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
  6. Investing

    Debt Ratios: Cash Flow To Debt Ratio

    By Richard Loth (Contact | Biography)This coverage ratio compares a company's operating cash flow to its total debt, which, for purposes of this ratio, is defined as the sum of short-term borrowings, ...
  7. Investing

    Total Debt to Total Assets

    Total Debt to total assets, also called the debt ratio, is an accounting measurement that shows how much of a company’s assets are funded by borrowing. In business, borrowing is also called leverage.
  8. Investing

    What are Debt Instruments?

    A debt instrument is a documented financial obligation that enables the issuer to raise funds by borrowing money and repaying it in the future.
  9. Investing

    Financial Statements: Long-Term Liabilities

    By David Harper (Contact David)Long-term liabilities are company obligations that extend beyond the current year, or alternately, beyond the current operating cycle. Most commonly, these include ...
  10. Personal Finance

    What’s Considered To Be A Good Debt-To-Income (DTI) Ratio?

    The debt-to-income ratio measures the amount of debt a person has compared to overall income.
RELATED FAQS
  1. How accurate or important is the debt service coverage ratio (DSCR) in evaluating ...

    See how investors can use the debt service coverage ratio to evaluate the solvency of a company before making an investment ... Read Answer >>
  2. How do you use Excel to calculate a debt service coverage ratio (DSCR)?

    Find out how to calculate a company's debt service coverage ratio, or DSCR, in Microsoft Excel, and learn where to locate ... Read Answer >>
  3. What is the difference between interest coverage ratio and DSCR?

    Understand the basics of the interest coverage ratio and the debt-service coverage ratio, including calculations and how ... Read Answer >>
  4. How does the International Monetary Fund function?

    Learn how expenditures and distributions affect the fixed charge coverage ratio, and how this ratio is used to evaluate a ... Read Answer >>
  5. What is a good debt ratio, and what is a bad debt ratio?

    Learn about the factors that influence how investors and lenders evaluate the debt ratio for a company and why the answer ... Read Answer >>
  6. When should a business avoid debt financing?

    Read about the optimal use of debt in a business capital structure and how to know when a business should avoid further debt ... Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center