Business, Legal & Accounting Glossary
The Debt Service Coverage Ratio measures how effectively a company’s operations-generated income is able to cover outstanding debt payments. The DSCR is calculated by dividing a company’s total net operating revenue during a given period by its total required payments on outstanding debts in the same period.
The Debt Service Coverage Ratio is a benchmark used to measure the cash producing ability of a company to cover its debt payments. Lenders use the debt coverage ratio in order to evaluate applicant companies’ current cash flows as an indication of the companies’ ability to repay a loan.
A Debt Service Coverage Ratio below one indicates a problem with cash flow. For example, a ratio of 0.87 indicates that the company’s net operating income is enough to cover only 87% of its annual debt payments.
To illustrate, suppose that in a given quarter, company ABC generates $5M in net income. Its payments on outstanding debts due in the same quarter amount to $3.3M. ABC’s debt service ratio would be calculated in the following manner:
The debt service ratio is also typically used to evaluate the quality of a portfolio of mortgages. For example, on June 19, 2008, a popular US rating agency, Standard & Poors, reported that it lowered its credit rating on several classes of pooled commercial mortgage pass-through certificates originally issued by Bank of America.
The rating agency stated in a press release that it had lowered the credit ratings of four certificates in the Bank of America Commercial Mortgage Inc. 2005-1 series, stating that the downgrades “reflect the credit deterioration of the pool”. They further go on to state that this downgrade resulted from the fact that eight specific loans in the pool have a debt service coverage (DSC) below 1.0.
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This glossary post was last updated: 22nd March, 2020