In financial management, debt service coverage ratio (DSCR) refers to the amount of cash flow available with the firm to service the interest and principal cost for one year. This includes sinking fund payments.

It is a reliable tool to determine the repayment capacity of the firm, i.e., if the firm’s income is sufficient to service the debt.

Formula

$DSCR = \frac{Net \;Operating \;Income}{Total \;Debt \;Service}$

Where:

Net Operating Income = Annual Net Income + Interest Expense + Amortization & Depreciation + Other discretionary and non-cash items

Total debt service = Annual principal and interest payments of all outstanding loans.

Interpretation

A DSCR ratio of less than 1 means that the firm doesn’t have sufficient funds to service its debt, and is not desirable. For example, a DSCR ration of 0.8 means that the firm can service only 80% of its annual debt payment from its net operating income. The higher this ratio is, the easier it is for an individual or a corporate to take a loan. A DSCR of 2 or more is desirable.