Financial Statement Analysis
- Debt Ratios
- Debt to Equity Ratio
- Debt Coverage Ratio
- Debt Ratio
- Debt to Asset Ratio Formula
- Coverage Ratio
- Coverage Ratio Formula
- Debt to Income Ratio Formula (DTI)
- Capital Gearing Ratio
- Gearing Ratio Formula
- Capitalization Ratio
- Interest Coverage Ratio
- Times Interest Earned Ratio
- Debt Service Coverage Ratio (DSCR)
- DSCR Formula (Debt service coverage ratio)
- Financial Leverage Ratio
- Financial Leverage Formula
- Degree of Financial Leverage Formula
- Net Debt Formula
- Leverage Ratios
- Leverage Ratios Formula
- Leverage Ratios for Banks
- Operating Leverage vs Financial Leverage
- Current Yield
- Debt Yield Ratio
- Solvency Ratio Formula
- Ratio Analysis (17+)
- Liquidity Ratios (29+)
- Turnover Ratios (17+)
- Profitability Ratios (66+)
- Efficiency Ratios (7+)
- Dividend Ratios (9+)
Debt Coverage Ratio Formula
We use debt coverage ratio formula to determine how much net operating income a firm can generate in terms of the debt payment it has to make in the same period.
Let’s have a look at the Debt Coverage Service Ratio Formula –
Example of Debt Coverage Ratio Formula
Let’s look at a practical example to illustrate how we can calculate the debt coverage service ratio formula.
Jaymohan Company has been looking for debt financing. They approached near-by banks and financial institutions. Jaymohan Company has found out that the debt service cost would be around $40,000 for a particular period. They want to know whether their net operating income is enough to cover the expenses. You are the accountant of Jaymohan Company and you found out that the operating income for this particular period is $500,000. Would you think that Jaymohan Company should go for debt financing after all?
The solution lies in debt coverage service ratio calculation.
As an accountant, you should first see the proportion between the net operating income and the debt service cost.
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- Formula = Net Operating Income / Debt Service Cost
- = $500,000 / $40,000 = 12.5.
As per the ratio is concerned, Jaymohan Company has enough net operating income to cover the debt service cost for the period.
However, the accountant also needs to see whether similar companies under the same industry have similar or closer results. Or the accountant can also check the norm of the industry to be certain that 12.5 is a good proportion.
Explanation of Debt Coverage Ratio Formula
The formula is important to two groups of individuals.
- The first groups of people are those who would like to invest in that particular company. Before they ever loan the amount to the firm, they want to know whether the firm has enough operating income to cover the payments.
- The second groups of individuals are internal people. They can be from top management or they can report to the top management. They use this formula to see whether the firm has enough operating income to go for external sources of finance like debt finance.
By using this formula, we get a clear idea of whether a firm is capable of handling the debt payment regularly or not. If the proportion between the net operating income and the debt payment is too low (like 1 or less), it’s better not to go for debt financing; and for investors, it’s better not to loan the amount to that particular company.
Also, you may have a look at this detailed post on DSCR
Before the groups of investors decide to loan the amount of debt to the company, they look at various metrics.
One of the most important metrics is to see whether the company has been earning enough operating income to cover the debt payment. If not, then the investors drop the idea of investment into that particular company.
This ratio may not be the only formula for the investors to check the stability of the company they would like to invest into, but it certainly is one of the most important to ratio to check whether a firm is worthy or not.
Debt Coverage Ratio Calculator
You can use the following Debt Coverage Ratio Calculator
|Debt Coverage Ratio Formula =||
Debt Coverage Service Ratio Formula in Excel (with Excel Template)
Let us now do the same example above in Excel. This is very simple. You need to provide the two inputs of net operating income and the debt service cost. You can easily calculate the ratio in the template provided.
You can download this debt coverage ratio template here – Debt Coverage Ratio Excel Template
Debt Coverage Ratio Formula Video
This has been a guide to debt coverage ratio formula, practical examples and debt coverage ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –