Introduction to Debt-Service Coverage Ratio (DSCR)
Debt-Service Coverage Ratio (DSCR) is applicable to many spheres of finance and in many sectors, particularly personal, corporate and governmental. The ratio determines the amount that the entity possesses to meet their current cash requirements and obligations on their credit. DSCR represents a firm’s, project’s or an individual’s ability to pay off their current liabilities from their source of income.
Understanding Debt-Service Coverage Ratio (DSCR)
The prime analysis that banks and financial institutions see in the applicant is whether or not they can pay the principal and the interest in the stipulated time by taking into account their current net income and debt obligations over a period. For businesses, the net operating income is divided by the annual debt payments made by the business. Debt Service Coverage Ratio (DSCR) = Business’s Annual Net Operating Income / Business’s Annual Debt Payments
There are two other ways to calculate DSCR (in business jargon specifically): DSCR = EBITDA / (Interest+Principal) DSCR = (EBITDA – Capex) / (Interest+Principal)
Where, Earnings Before Interest, Tax, Depreciation, and Amortization is EBITDA (net operating income), and Capex is the capital expenditure, that gets subtracted to show the actual available amount of operating income for debt repayment. Though calculating the number doesn’t automatically grant the applicant their loan, regardless of who the applicant is and what kind of loan they are seeking. The interpretation will vary and depend on various factors that account to the applicant’s debt repayment history in the form of credit scores, other financial ratios and balance sheets. If DSCR is greater than 1 then the applicant stands favourable to avail the loan since the greater number shows strong cash inflow to meet debts, and a lesser number will mean vice versa.
Highlights of Debt-Service Coverage Ratio (DSCR)
In cases where DSCR = 0, some banks may sanction the loan, depending on the market circumstances and the credit history. DSCR includes all the existing, still paying debt and the debt the borrower is applying with the bank to take. DSCR is a more comprehensive ratio than Interest Coverage ratio as DSCR takes into account the income of the entity than only profit that Interest Coverage ratio does. DSCR covers the debt, while ICR covers how the interest is serviced.
