The Debt Service Coverage Ratio (DSCR) is an important measure in understanding a borrower’s ability to make payments on their current debt, as well as potential additional debt, so mastering this calculation is crucial to lending decisions. There are several ways to calculate this ratio, so familiarize yourself with the following approaches:
1. Perhaps the most traditional calculation for DSCR, this formula divides cash flow by debt service: DSCR = Net Operating Income / Total Debt Service where Total Debt Service = Principal & Interest Payments + Contributions to Sinking Fund.
2. This calculation is most useful for analyzing business financial statements, or calculating the DSCR for a business, and uses EBITDA, instead of Net Operating Income: DSCR = EBITDA / Total Debt Service where EBITDA = Pre-tax income + Interest Expense + Depreciation + Amortization.
3. The global DSCR approach provides the broadest scope, looking at both the business and business owner. It takes the personal salary of any people in the relationship into account in cash flow, as well as personal debt service and living expenses: Global DSCR = EBITDA + Personal Income / Business Debt Service + Personal Debt Service.
Now that you’ve calculated a customer’s DSCR, what does it mean? A ratio of less than 1 is not favorable, as it indicates that the borrower has more debt than income to cover that debt. A ratio greater than one indicates that the entity has sufficient income to pay its current debt obligations.
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To learn more about DSCR and how you can improve this ratio, check out What is the debt service coverage ratio?