Debt Service Coverage Ratio (DSCR)
The Debt Service Coverage Ratio determines the repayment capacity of the borrowing party. The higher this ratio, the better the debt-paying capacity of the borrower. It shows the quantum of surplus cash available with the organization for meeting its debt requirements, such as interest and principal amount. Organizations having higher DSCR can ask for better terms of the loan, such as lower interest rates, less collateral security, and more.
The formula for Calculating Debt Service Coverage Ratio
To calculate DSCR, the formula is:
DSCR = Net Operating Income/Debt services
Where, calculation of Net Operating Income & Debt Services is done as:
Net Operating Income = PAT + Interest + Depreciation + Non-cash expenses
& Debt Services = Installment amount (Interest + Principal repayment during the year)
About the Calculator / Features
This calculator provides the result of DSCR by simply inserting the following values into it.
- Net Operating Income
- Debt Services
How to Calculate using a Calculator
You simply have to provide the following data to the calculator.
Net Operating Income
The amount of net operating income can be derived from the financial statements of the organization.
The amount of debt services of the organization, i.e., the borrowings of the organization, can easily be obtained from the Income & Expenditure Statement and Balance Sheet of the organization.
Example of Debt Service Coverage Ratio
Let`s understand the DSCR better with the help of an example. Consider the following details of XYZ ltd.
|Net Operating Income||$120,000|
|Principal payments during the year||$45,000|
DSCR = $120,000/$65,000 = 1.86
Debt Service = Principal payments during the year + Interest expenses = $45,000 + $20,000 = $65,000
Interpretation of Debt Service Coverage Ratio
Calculating DSCR is not enough; one has to interpret it properly. DSCR should always be greater than 1—the higher the ratio, the better the debt serving capacity. DSCR less than 1 shows the inability of the organization`s cash to service its debt. In the example above, the DSCR is 1.86, which is greater than 1.
Does lower DSCR mean the banks should not provide the loan? No, the bank will look for the earning capacity of the business as well as the idea to generate higher profits. Suppose the bank is satisfied with the idea and earning capacity. In that case, it can increase the period of the loan, which will result in decreasing the installment amount and eventually lead to improve DSCR. However, ultimately here also bank would like to see that the DSCR is comfortable even during the extended loan period. Therefore, DSCR becomes an important indicator for the successful evaluation and approval of the loan proposal for banks and financial institutions.
Some writers and teachers suggest that Lease Rental Payments should also be included in this calculation, i.e., they should be added to the numerator as well as the denominator. We, however, have a different view. Lease Rental can be a long-term expense, but it is a rental expense like any other expense and should not be considered as a debt obligation. DSCR is for calculations of debt obligations. Of course, if it is a DPG arrangement, then it will automatically become part of the Debt Obligations. Hence, we have not included lease payments/rentals while calculating DSCR.