Debt service coverage ratio: Difference between revisions

Revision as of 05:25, 19 June 2020

Revision as of 05:27, 19 June 2020

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While [[Earnings before interest, taxes, depreciation and amortization | Earnings Before Interest, Taxes, Depreciation and Amortization]] (EBITDA) is an appropriate measure of a company's ability to make interest-only payments (assuming that expected change in working capital is zero), EBIDA (without the "T") is a more appropriate indicator of a company's ability to make required principal payments. Ignoring these distinctions can lead to DSCR values that overstate or understate a company's debt service capacity. The Pre-Tax Provision Method provides a single ratio that expresses overall debt service capacity reliably given these challenges.

[https://www.fnrpusa.com/what-is-debt-service-coverage-ratio/ 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 Interest obligations + Principal obligations + Tax Expense ''assuming minimum sufficient income'' + Other necessary expenditures not treated as accounting expenses, like dividends and CAPEX.

The DSCR calculation under the Pre-Tax Provision Method is '''EBITDA''' / ('''Interest''' + '''Pre-tax Provision for Post-Tax Outlays'''), where '''Pre-tax Provision for Post-tax Outlays''' is the amount of pretax cash that must be set aside to meet required post-tax outlays, i.e., CPLTD + Unfinanced CAPEX + Dividends. The provision can be calculated as follows: