What is the DSCR Formula?
DSCR (Debt service coverage ratio) formula provides an intuitive understanding of the debt repayment capacity of the company. It 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 funds that are periodically accumulated by the company as reserve. Later the reserve fund is used for a specific purpose—repayment of debts or repurchase of bonds on maturity. As a result, companies are not burdened with paying a huge sum at once. that need to be paid in the coming year.
Table of contents
- DSCR helps an investor comprehend the debt-fulfilling ability of a company. It helps the investor understand the fiscal state of a company and check whether the company is established or not.
- One can calculate DSCR by dividing the company’s net operating income by the total debt service. The value that is thus generated is interpreted in two ways; if the ratio is more than one, the ratio is good, and it suggests that the company can fulfill its debt using its income.
- A DSCR ratio of less than one indicates that the company cannot pay its debts using its current earnings and that it isn’t a well-established company.
- A high DSCR ratio indicates that the company has higher odds of qualifying for a loan and a better chance to get a lower interest rate, and the business is flourishing.
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 defined as borrowings undertaken for a short period to meet immediate monetary requirements.
- 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.
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DSCR (Debt Service Coverage Ratio) Video Explanation
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 calculate 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 a yearly interest of $70,000 on the loan he had taken. Therefore the lender will calculate 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, which 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 operating profit data, equivalent to operating income and debt service, from the 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 operating profit and debt service data from the 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 one indicates that it is generating sufficient cash flow to cover its debt service.
- A ratio less than 1 indicates that there is insufficient 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.
Most 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 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 can 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.
Frequently Asked Questions (FAQs)
Since this concept has a clear-cut formula that analysts can use to understand the outcome, it can easily be calculated in excel by dividing the company’s total net operating income by its total debt service.
The formula for calculating DSCR for rental property is divided using PITIA constituting monthly principal, interest, taxes, insurance, and association dues by the gross monthly rent. Therefore, the above 1.2 ratios are considered good and appropriate for the investor to decide.
If the interest rate is reduced, the interest amount would decrease, reducing the installment. It thus limits the denominator (total debt service) and improves the DSCR ratio.
This article has been a guide to the DSCR formula. Here we discuss the formula to calculate the debt service coverage ratio using practical examples and downloadable excel templates. You may learn more about Financial Analysis from the following articles –
- Coverage RatioCoverage RatioThe coverage ratio indicates the company's ability to meet all of its obligations, including debt, leasing payments, and dividends, over any specified period. A higher coverage ratio indicates that the business is a stronger position to repay its debt. Popular coverage ratios include debt, interest, asset, and cash coverage.
- Debt YieldDebt YieldDebt yield is a risk measure for mortgage lenders and measures how much a lender can recoup their funds in the case of default from its owner. The ratio evaluates the percentage return a lender can receive if the owner defaults on the loan and the lender decide to dispose of the mortgaged property.
- Financial Ratios Formulas
- Net Debt CalculationNet Debt CalculationDebt minus cash and cash equivalents equals net debt, which is the amount of debt a company has in comparison to its liquid assets. It is a metric that is used to evaluate a firm's financial liquidity and aids in determining if the company can meet its obligations by comparing liquid assets to total debt.