What is DSCR?
DSCR refers to debt service coverage ratio. In simple terms, DSCR refers to a company’s ability to meet its debt obligations. It is a financial metric that is used to measure the cash flow available for an outstanding debt servicing to a company’s total debt service requirements. This includes both the principal and interest on the debt.
DSCR is crucial for lenders, investors, and financial analysts to evaluate the financial health and creditworthiness of an organization.
How to Calculate DSCR?
Formula to calculate DSCR: Net Operating Income/ Total Debt Service.
- NOI (Net operating income): this is the cash flow available of the company to deal with the debt. NOI includes earnings before interest, taxes, depreciation, and amortization (EBITDA) or operating profit.
- Total Debt Service: Calculating the total of both the principal and interest repayment within a specific period of time.
DSCR Interpretation
- If DSCR > 1: Here, the company is generating sufficient cash flow to deal with the debt obligations. For example: If the DSCR of a company is 1.7 that means the company has more than 50% cash flow available for the repayment of debt.
- If DSCR= 1: A DSCR of 1 signifies that the company’s cash flow is just enough to cover its debt service requirements, with no excess cash available. This implies a tight financial situation where any unexpected expense could lead to difficulty in meeting debt obligations.
- If DSCR < 1: This indicates that the company is not generating a cash flow that could meet the debt obligations. For example a DSCR of 0.6% means the company’s cash flow repayment capability is only 60%, which could signal potential financial distress and may be a concern for lenders.
Importance of DSCR
- Creditworthiness: DSCR clearly indicates the ability of a company for the repayment of debt. A higher DSCR indicates a lower risk of default, making the borrower more attractive for loans.
- Financial health: By analyzing the DSCR of a company, one can evaluate the operational efficiency and financial health of the company before lending a debt.
