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.

In general, the debt-service coverage ratio is calculated as:

DSCR = Net Operating Income / Total Debt Service

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

Components of the Debt-Service Coverage Ratio

The formula for debt-service coverage ratio requires net operating income and total debt service of the entity. Net operating income is a company's revenue minus its operating expenses, not including taxes and interest payments. It is often considered equivalent of 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])

Interpreting the Debt-Service Coverage Ratio

Lenders will routinely assess a borrower's DSCR before making a loan. A DSCR of less than 1 means negative cash flow which means that the borrower will be unable to cover or pay current debt obligations without drawing on outside sources—without, in essence, borrowing more. or example, DSCR of .95 means that there is only enough net operating income to cover 95% of annual debt payments. 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 resources outside income. If the debt-service coverage ratio 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. Typically, a DSCR greater than 1 means the entity – whether a person, company, or government – has sufficient income to pay its current debt obligations

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. Cash Available For Debt Service ...

    Cash Available For Debt Service is a ratio that measures the ...
  2. Debt Service

    The cash that is required for a particular time period to cover ...
  3. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ...
  4. Coverage Ratio

    A measure of a company's ability to meet its financial obligations. ...
  5. Debt Ratio

    The debt ratio is a financial ratio that measures the extent ...
  6. Funded Debt

    A funded debt is a company's debt that will mature in more than ...
Related Articles
  1. Investing

    An Introduction to Coverage Ratios

    Interest coverage ratios help determine a company's ability to pay down its debt.
  2. Investing

    Commercial real estate loans

    Obtaining a commercial real estate loan is quite different from borrowing for residential real estate. Here's what to expect and how to get what you need.
  3. Investing

    Will Corporate Debt Drag Your Stock Down?

    Corporate debt can mean a leg up for firms, or the boot for investors. How to tell the difference.
  4. Investing

    4 Leverage Ratios Used In Evaluating Energy Firms

    These four leverage ratios can help investors evaluate how energy manage their debt.
  5. Investing

    Analyzing Wal-Mart's Debt Ratios in 2016 (WMT)

    Analyze Wal-Mart's debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio to evaluate the company's financial health and debt management.
  6. Personal Finance

    What Millennials Should Know About Good and Bad Debt

    Can you tell the difference between good and bad debt?
  7. Investing

    Debt Reckoning

    Learn about debt ratios and how to use them to assess a company's financial health. You could save a lot of money!
RELATED FAQS
  1. 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 >>
  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. 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 >>
  4. What is the debt ratio for an FHA loan?

    Borrowing through the Federal Housing Administration requires individuals to provide proof of income as well as information ... Read Answer >>
  5. What is a bad interest coverage ratio?

    Understand how interest coverage ratio is calculated and what it signifies, and learn what market analysts consider to be ... Read Answer >>
  6. Understanding the Five Cs of Credit?

    Learn how the five C's of credit affect new credit application decisions, and understand how a lender analyzes each aspect ... Read Answer >>
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center