What is the DSCR Formula?
DSCR (Debt service coverage ratio) formula provides an intuitive understanding of the debt repayment capacity of the company and is calculated as the ratio of Net Operating Income to Total Debt Service.
Net operating income is calculated as a company’s revenue minus its operating expenses. In most cases, lenders use net operating profit, which is the same as the net operating income. Total debt service is the current debt obligations like loans, sinking fundsSinking FundsSinking funds are a portion of a company's preferred stock or bond indenture set aside for the purpose of repaying debt or replacing a wasting asset at a later date. This is a great tool for achieving an organization's predetermined goals and objectives. that need to be paid in the coming year.
The Debt service coverage ratioDebt Service Coverage RatioDebt service coverage (DSCR) is the ratio of net operating income to total debt service that determines whether a company's net income is sufficient to cover its debt obligations. It is used to calculate the loanable amount to a corporation during commercial real estate lending. formula simply takes in net operating incomeNet Operating IncomeNet Operating Income (NOI) is a measure of profitability representing the amount earned from its core operations by deducting operating expenses from operating revenue. It excludes non-operating costs such as loss on sale of a capital asset, interest, tax expenses. and divides it by the debt service (Interests, sinking funds, tax expense).
It must include all the debt obligation in hand like the following:
- Bank loan
- Short term loansShort Term LoansShort term loans are the loans with a repayment period of 12 months or less, generally offered by firms, individuals or entrepreneurs for immediate liquidity requirements. These are usually provided at a higher interest rate, these short term loans often have a weekly repayment schedule.
- Monthly payments for debt service
Most lenders use operating income, which is equivalent to EBIT. But some also use EBITDA to calculateEBITDA To CalculateEBITDA is Earnings before interest, tax, depreciation, and amortization. Its formula calculates the company’s profitability derived by adding back interest expense, taxes, depreciation & amortization expense to net income. EBITDA = net income + interest expense + taxes + depreciation & amortization expense the ratio.
Examples of DSCR Formula (with Excel Template)
Let’s see some simple to advanced examples to understand it better.
Let’s suppose a real estate developer wants to take a loan from a local bank. Then the lender will first want to do the calculation of the DSCR to determine the ability of the borrower to repay its loan. The real estate developer discloses that it has an operating income of $200,000 per year and has to pay yearly interest of $70,000 on his loan that he had taken. Therefore the lender will do the calculation of DSCR to determine whether to grant a loan to the real estate developer.
- DSCR = 200,000 / 70,000
- DSCR = 2.857
A DSCR of 2.857 is a good DSCR for granting of a loan to the real estate developer.
Now, if the developer has also lease paymentsLease PaymentsLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration. to pay then of $5000, then the debt service will increase to $75000.The new DSCR will be as follows:-
- DSCR= 200,000 / 75,000
- DSCR = 2.66
Therefore the DSCR decreased with an increase in debt service payments.
Calculate the DSCR for company X, who has the following Income Statement.
The operating income is calculated by subtracting the expenses from the gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services..
The debt services will account for the interest expenses and income tax expensesIncome Tax ExpensesIncome tax is levied on the income earned by an entity in a financial year as per the norms prescribed in the income tax laws. It results in the outflow of cash as the liability of income tax is paid out through bank transfers to the income tax department..
Therefore, Operating Income = $13000
Debt Service = $5000
So, the calculation of DSCR will be as follows –
- DSCR = 13000 / 5000
DSCR will be –
- DSCR = 2.6
A DSCR of 2.6 indicates that the company has enough cash to cover its debt obligations.
We will calculate the debt service coverage ratio of ILandFS Engineering and Construction Company. We can get the data of operating profit, which is equivalent to operating income and debt service from profit & loss statement, which is available in money control.
The net operating profit is ₹160.92 in the year 2018.
As for the debt service, we can see that it needs to pay interests that is ₹ 396.03.
Therefore calculation of the DSCR formula will be as follows –
- DSCR = 160.92 / 396.03
DSCR will be
- DSCR = 0.406
A DSCR of 0.406 indicates that the company doesn’t have enough cash to cover its debt obligations.
We will calculate the debt service coverage ratio of MEP Infrastructure Developers. We can get the data of operating profit and debt service from profit & loss statement, which is available in money control.
The net operating profit is ₹218.26 in the year 2018.
As for the debt service, we can see that it needs to pay interests and taxes, which is ₹50.04.
Calculation of DSCR will be as follows –
- DSCR = 218.26 / 50.04
DSCR will be
- DSCR = 4.361
A DSCR of 4.361 indicates that the company has enough cash to cover its debt obligations.
You can use the following DSCR calculator.
|DSCR Formula =||
DSCR is both important to creditors and investors, but creditors analyze it more as it determines the ability of the lender to repay the current debt.
The DSCR ratio will determine whether the borrower will get his loan approved and the terms and conditions of the loan.
How to Interpret DSCR Formula?
A DSCR ratio of 1 and above is a good ratio. The higher, the better.
- A ratio higher than 1 indicates that it is generating sufficient cash flow to cover its debt service.
- A ratio less than 1 indicates that there is not enough cash to cover the debt obligations.
A DSCR of 0.85 indicates that there is only enough operating income to cover 85% of the debt payments.
Mostly lenders look for a DSCR ratio of 1.15 or more depending on the economic conditions of the company.
A lender will never want to make a loss by giving a loan to a borrower who may never be able to repay. The DSCR ratio gives an insight into the company’s cash flow and how much cash does the company has to repay its loan.
It is of great importance in real estate or commercial lending, as this ratio gives us an idea about the maximum loan amount a lender will be able to get.
Benefits of a High DSCR
- Higher chances of qualifying for a loan
- Better chances to get a lower interest rate.
- Businesses can manage debt obligations in a better way.
Therefore higher the ratio, the better it is.
This article has been a guide to DSCR Formula. Here we discuss the formula to calculate Debt service coverage ratio using practical examples along with downloadable excel templates. You may learn more about Financial Analysis from the following articles –