what is the debt service coverage ratio dscr 
the debt service coverage ratio dscr measures a firm s available cash flow to pay its current debt obligations the dscr shows investors and lenders whether a company has enough income to pay its debts the ratio is calculated by dividing net operating income by debt service including principal and interest mira norian investopediaunderstanding the debt service coverage ratio dscr the debt service coverage ratio is a widely used indicator of a company s financial health especially for companies that are highly leveraged with debt debt service refers to the cash necessary to pay the required principal and interest of a loan during a given period the ratio compares a company s total debt obligations to its operating income lenders stakeholders and partners target dscr metrics and dscr terms and minimums are often included in loan agreements calculating the dscrthe formula for the debt service coverage ratio requires net operating income and the total debt servicing for a company net operating income is a company s revenue minus certain operating expenses coe not including taxes and interest payments it s often considered equal to earnings before interest and tax ebit dscr net operating income total debt service where net operating income revenue coe coe certain operating expenses total debt service current debt obligations begin aligned text dscr frac text net operating income text total debt service textbf where text net operating income text revenue text coe text coe text certain operating expenses text total debt service text current debt obligations end aligned dscr total debt servicenet operating income where net operating income revenue coecoe certain operating expensestotal debt service current debt obligations total debt service refers to current debt obligations including any interest principal sinking fund and lease payments that are due in the coming year this will include short term debt and the current portion of long term debt on a balance sheet 1income taxes complicate dscr calculations because interest payments are tax deductible and principal repayments are not a more accurate way to calculate total debt service would be to compute it like this tds interest 1 tax rate principal where tds total debt service begin aligned text tds text interest times 1 text tax rate text principal textbf where text tds text total debt service end aligned tds interest 1 tax rate principalwhere tds total debt service lender considerationsthe debt service coverage ratio reflects the ability to service debt at a company s income level the dscr shows how healthy a company s cash flow is and it can determine how likely a business is to qualify for a loan lenders routinely assess a borrower s dscr a dscr of 1 00 indicates that a company has exactly enough operating income to pay off its debt service costs a dscr of less than 1 00 denotes a negative cash flow the borrower may be unable to cover or pay current debt obligations without drawing on outside sources or borrowing more a dscr of 0 95 means there s only enough net operating income to cover 95 of annual debt payments the entity may appear vulnerable and a minor decline in cash flow could render it unable to service its debt if the debt service coverage ratio is too close to 1 00 lenders might require the borrower to maintain a minimum dscr while the loan is outstanding a dscr of at least 2 00 is typically considered to be very strong even though there s no industry standard it shows that a company can cover two times its debt many lenders will set minimum dscr requirements of 1 2 to 1 25 2interest coverage ratio vs dscrthe interest coverage ratio indicates the number of times that a company s operating profit will cover the interest it must pay on all debts for a given period this is expressed as a ratio and is most often computed annually divide the ebit for the established period by the total interest payments due for that same period the ebit is often called net operating income or operating profit it s calculated by subtracting overhead and operating expenses such as rent cost of goods freight wages and utilities from revenue the higher the ratio of ebit to interest payments the more financially stable the company this metric only considers interest payments and not payments made on principal debt balances that may be required by lenders the debt service coverage ratio assesses a company s ability to meet its minimum principal and interest payments including sinking fund payments ebit is divided by the total amount of principal and interest payments required for a given period to obtain net operating income to calculate the dscr it takes principal payments into account in addition to interest so the dscr is a more robust indicator of a company s financial fitness advantages and disadvantages of dscrthe dscr is a commonly used metric when negotiating loans but it does come with some pros and cons the dscr has value when calculated consistently over time just like other ratios a company can calculate monthly dscr to analyze its average trend and project future ratios a declining dscr might be an early signal for a decline in a company s financial health or it can be used extensively in budgeting or strategic planning the dscr can also have comparability across different companies management might use dscr calculations from its competitors to analyze how it s performing relative to others this might include analyzing how efficient other companies are in using loans to drive company growth the dscr is also a more comprehensive analytical technique when assessing the long term financial health of a company the dscr is a more conservative broad calculation compared to the interest coverage ratio the dscr is also an annualized ratio that often represents a moving 12 month period other financial ratios are typically a single snapshot of a company s health the dscr may be a truer representation of a company s operations the dscr calculation can be adjusted to be based on net operating income ebit or earnings before interest taxes depreciation and amortization ebitda it depends on the lender s requirements the company s income is potentially overstated because not all expenses are being considered when operating income ebit or ebitda are used income isn t inclusive of taxes in any of these three examples another limitation of the dscr is its reliance on accounting guidance debt and loans are rooted in obligatory cash payments but the dscr is partially calculated on accrual based accounting guidance there s a little bit of inconsistency when reviewing both a set of financial statements based on generally accepted accounting principles gaap and a loan agreement that stipulates fixed cash payments can be calculated over some time to better understand a company s financial trendmay be used to compare operational efficiency across companiesincludes more financial categories i e principal repayments than other financial ratiosmight be a more comprehensive analysis of a company s financial health as it is often calculated on a rolling annual basismay not fully incorporate a company s finances as some expenses i e taxes may be excluded