Definition
Debt Service Coverage Ratio or DSCR is a metric used to gauge how effectively a company is using its operating cash flows to pay its debt (interest and principal).This metric is commonly used in commercial lending transactions. It allows lenders to get a fair idea about the ability of a business to repay a loan on time. The higher the DSCR, the better chances of the business repaying the loan.
Example
DSCR = Net Annual Operating Income/Annual Debt Payments If a company's DSCR is one or higher, it means that the company is capable of managing its financial obligations using the revenues generated. DSCR equal to one means that the company makes exactly how much is needed to repay its outstanding loans. Therefore, it may have future financial problems resulting in an inability to make timely debt repayments.
Why it matters
DSCR is essential while gauging a borrower’s financial strength. Lenders use this metric to analyze a borrower's debt position. Banks prefer to use this metric while sanctioning loans to companies. Lenders may observe industry trends in DSCR before deciding whether to approve a loan for the borrowing company. Banks may also consider the historical trend of a company's DSCR to assess its future capabilities.