Debt service coverage ratio: Difference between revisions

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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, not included in operating expenses are financing costs (e.g. interests from loans), personal income tax of owners/investors, capital expenditure and depreciation.

Debt Service are costs and payments related to financing. Interests and lease payments are true costs resulting from taking loans or borrowing assets. Paying down the principleprincipal of a loan does not change the net equity/liquidation value of an entity; however, it reduces the cash an entity processes (in exchange of decreasing loan liability or increasing equity in an asset). Thus, by accounting for principleprincipal payments, DSCR reflects the cash flow situation of an entity.

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 revenue 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.