Also called the Debt Coverage Ratio, the Debt-Service Coverage Ratio (DSCR) is the ratio of cash a company keeps available for covering their debt as it relates to interest, principal and lease payments. A well known benchmark used to evaluate whether or not a company or individual can generate enough cash to cover their debt, the higher the ratio, the easier it is for the entity to obtain a loan. If you have heard this term before it was probably involved in a commercial banking transaction.
Depending upon the environment, personal or commercial, the DSCR can be the most important tool used to assess if a borrower will be able to sustain their debt. The ratio demanded by banks varies with the industry and the circumstance. Clearly, the banks will look for a ratio of more than 1.0 to insure their investment of capital. A ration of less than 1 indicates a negative cash flow.
The Equation is simple: Net Operating Income/Total Debt Service
While it is not impossible to obtain a loan with a negative cash flow, the company or individual must be able to show a strong source of external income. This income must be provable and consistent or obtaining the financing is unlikely.
When investing in companies you will want to see that the DSCR is over 1.0 as well. In fact the higher the DSCR the safer your investment is likely to be. Under most circumstances a positive debt-service coverage ratio (DSCR) is a sign of a healthy company.
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