Debt service coverage ratio: Difference between revisions

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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 principal 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 principal 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 revenueincome 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.

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>