Debt Service Coverage Ratio (DSCR)
What is the ratio
Debt Service Coverage Ratio (DSCR)
How is it calculated?
(Stable and Recurring Net Income + Depreciation/Amortization + Interest Expense) / Debt Payments for corresponding period of time.
Goal of the Ratio
The goal of this ratio is to show the ability of on-going profits to cover on-going debt payments. The ratio identifies how many dollars of profit are generated for each dollar of debt payments.
When is it used?
This ratio can be used in business lending situations to gauge a borrower’s ability to repay.
Rules of Thumb
Higher is better - A higher ratio means the borrower has more profit available to pay their debt payments. A typical Minimum DSCR banks like to see would be 1.20 or 1.25.
Pitfalls of this Ratio
The DSCR is based on profit, but loans can only be in paid using cash; so a rapidly growing company may show sufficient profit to generate an acceptable ratio, but if that “profit” is still in the form of either inventory or accounts receivable, a borrower may still struggle to meet their debt payment requirements.
What changes in the ratio could mean:
- Changes in overall profitability due to causes such as:
- Higher Revenue
- Improved Gross Profit Margin
- Lower overhead expenses
- New loans
- Payoff of existing loans
- Changes in interest rates
Other Relevant Terms
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