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{{Short description|Financial metric assessing ability to cover debt payments}}
{{
The '''debt service coverage ratio''' ('''DSCR'''), also known as the '''debt coverage ratio''' ('''DCR'''), is a [[financial ratio]] that measures an entity's ability to generate sufficient cash to cover its [[debt]] obligations, including interest, principal, and lease payments. It is calculated by dividing the [[net operating income]] (NOI) by the total debt service. A higher DSCR indicates stronger cash flow relative to debt commitments, while a ratio below 1 suggests insufficient funds to meet payments.<ref name="investopedia2">{{cite web |title=Debt-Service Coverage Ratio (DSCR) |url=http://www.investopedia.com/terms/d/dscr.asp |access-date=March 31, 2025 |website=Investopedia}}</ref> Lenders, such as banks, often set a minimum DSCR in loan covenants, where falling below this threshold may constitute a [[Default (finance)|default]].
In [[corporate finance]], the DSCR reflects cash flow available for annual debt payments, including sinking fund contributions.<ref name="freedictionary2">{{cite web |title=Debt-Service Coverage Ratio - DSCR |url=https://financial-dictionary.thefreedictionary.com/Debt+service+coverage+ratio |access-date=March 31, 2025 |website=The Free Dictionary}}</ref> In [[personal finance]], it aids loan officers in evaluating an individual’s debt repayment capacity. In [[commercial real estate]], it determines whether a property’s cash flow can sustain its debt, with typical minimums around 1.25.<ref>{{cite web |last=Freitas |first=Taylor |title=What Is Debt-Service Coverage Ratio? |url=https://www.bankrate.com/loans/small-business/what-is-dscr/ |access-date=2024-01-30 |website=Bankrate}}</ref>
== Applications ==
The DSCR serves distinct purposes across contexts. In corporate settings, it assesses cash flow for debt obligations, while in personal finance, it evaluates borrowing capacity.<ref name="freedictionary2" /> In real estate, it’s a key indicator of property viability. During the late 1990s and early 2000s, banks often required a DSCR of at least 1.2,{{Citation needed|date=May 2024|reason=Does not have a reliable source}} though some accepted lower ratios, a practice linked to the [[2008 financial crisis]]. A DSCR above 1 indicates adequate cash flow, while below 1 signals potential shortfall. In project finance, a '''Debt Service Reserve Account''' ('''DSRA''') may offset periods where DSCR falls below 1.<ref name="Corality Financial Modelling2">{{cite web |title=Corality Debt Service Coverage Ratio Tutorial |url=http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio |url-status=dead |archive-url=https://web.archive.org/web/20130718014413/http://www.corality.com/tutorials/dscr-debt-service-coverage-ratio |archive-date=2013-07-18 |access-date=2013-08-15}}</ref>
==Calculation==
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where:
:{{math| Net Operating Income {{=}} Adj. EBITDA {{=}} (Gross Operating Revenue) − (Operating Expenses)}}
:{{math|Debt Service {{=}} (Principal Repayment) + (Interest Payments) + (Lease Payments)}}<ref>{{Cite web|url=https://propertymetrics.com/blog/how-to-calculate-the-debt-service-coverage-ratio-dscr/|title=How to Calculate the Debt Service Coverage Ratio (DSCR)|date=17 February 2016 }}</ref>
To calculate an entity's debt coverage ratio, you first need to determine the entity's [[net operating income]] (NOI). NOI is the difference between gross revenue and operating expenses. NOI is meant to reflect the true income of an entity or an operation without or before financing. Thus,
Debt
For example, if a property has a debt coverage ratio of less than one, the income that property generates is not enough to cover the mortgage payments and the property's [[operating expense]]s. A property with a debt coverage ratio of .8 only generates enough income to pay for 80 percent of the yearly debt payments. However, if a property has a debt coverage ratio of more than 1, the property does generate enough income to cover annual debt payments. For example, a property with a debt coverage ratio of 1.5 generates enough income to pay all of the annual debt expenses, all of the operating expenses and actually generates fifty percent more income than is required to pay these bills.
In the commercial real estate industry, the minimum DSCR set by lenders is 1.25, meaning that the property's net operating income (NOI) is 25% greater than the annual debt service.<ref>{{Cite web |last=Freitas |first=Taylor |title=What Is Debt-Service Coverage Ratio? |url=https://www.bankrate.com/loans/small-business/what-is-dscr/ |access-date=2024-01-30 |website=Bankrate |language=en-US}}</ref>
A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.<ref name=freedictionary /><ref name="investopedia">[http://www.investopedia.com/terms/d/dscr.asp Debt-Service Coverage Ratio (DSCR) on Investopedia]</ref>▼
▲A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95,
Typically, most commercial banks require the ratio of {{val|1.15|–|1.35}} {{tooltip|×|times}} {{pars|{{sfrac|{{abbr|NOI|net operating income}} | annual debt service}}|153%}} to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.
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Let's say Mr. Jones is looking at an investment property with a net operating income of {{US$|long=no|36000}} and an annual debt service of {{US$|long=no|30000}}. The debt coverage ratio for this property would be 1.2 and Mr. Jones would know the property generates 20 percent more than is required to pay the annual mortgage payment.
The
of a portfolio of mortgages. For example, on June 19, 2008, a popular
US rating agency, Standard & Poors, reported that it lowered its credit
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stated in a press release that it had lowered the credit ratings of
four certificates in the Bank of America Commercial Mortgage Inc.
deterioration of the pool". They further go on to state that this
downgrade resulted from the fact that eight specific loans in the
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times.
The debt service coverage ratio provides a useful indicator of financial strength. Standard & Poors reported that the total pool consisted, as of June 10, 2008, of 135 loans, with an aggregate trust balance of {{US$|long=no|2.052 billion}}.
They indicate that there were, as of that date, eight loans with a DSC of lower than▼
▲there were, as of that date, eight loans with a DSC of lower than
1.0x. This means that the net funds coming in from rental of the
commercial properties are not covering the mortgage costs. Now,
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this does not necessarily mean they will default.
===Pre-Tax Provision Method===
Income taxes present a special problem to DSCR calculation and interpretation. While, in concept, DSCR is the ratio of cash flow available for debt service to required debt service, in practice – because interest is a tax-deductible expense and principal is not – there is no one figure that represents an amount of cash generated from operations that is both ''fully available'' for debt service and ''the only cash available'' for debt service.
While [[Earnings before interest, taxes, depreciation and amortization
Debt Service Coverage Ratio as calculated using the Pre-Tax Provision Method answers the following question: How many times greater was the company's EBITDA than its critical EBITDA value, where critical EBITDA is that which just covers its
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For example, if post-tax outlays consist of CPLTD of {{US$|long=no|100M}} and noncash expenses are {{US$|long=no|50M}}, then the borrower can apply {{US$|long=no|50M}} of cash inflow
from operations directly against {{US$|long=no|50M}} of post-tax outlays without paying taxes on that {{US$|long=no|50M}} inflow, but the company must set aside {{US$|long=no|77M}}
(assuming a 35% income tax rate) to meet the remaining {{US$|long=no|50M}} of post-tax outlays. This company's pretax provision for post-tax outlays = {{US$|long=no|50M}} + {{US$|long=no|77M}} = {{US$|long=no|127M}}.
==See also==
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*[[Operating leverage]]
*[[Project Finance]]
*[[Cash-flow-to-debt ratio]]
==References==
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