The debt service coverage ratio (DSCR) is the ratio of cash on hand for debt servicing to interest, principal as well as lease payments. It is an accepted yardstick utilized in the measurement of an entity’s (person or corporation) capability to make sufficient cash to cover its liability (together with lease) payments. The higher this ratio is, the easier it is to acquire a loan. The expression is also used in commercial banking and can be expressed as a minimum ratio that is satisfactory for a lender; it might be a loan stipulation or covenant. Violating a DSCR agreement can, in a number of circumstances, be an act of default.

• In order to calculate the Debt Coverage Ratio you need the entity’s net operating income. However the general formula for calculating Debt coverage ratio is – Annual Net Income + Amortization/Depreciation + other non-cash and discretionary items (such as non-contractual management bonuses) / Principal Repayment + Interest payments + Lease payments. This means that taking the entity’s total income and deducting any vacancy amounts and every one of the operating expenses. Then take the net operating earnings and divide it by the property’s yearly debt service, which is the full amount of all interest and principal paid on all of the property’s loans all through the year.
• If an asset has a debt coverage ratio of less than one, the proceeds that property produces is not sufficient to cover the mortgage payments and the property’s operating expenses. An asset with a debt coverage ratio of 0.8 merely produces adequate profits to pay for 80 percent of the annual debt payments. Nevertheless, if a property has a debt coverage ratio of more than one, the property does produce sufficient income to cover yearly debt payments. For instance, a property with a debt coverage ratio of 1.5 produces sufficient returns to pay all of the yearly debt expenses, all of the operating expenses and in fact produces fifty percent more revenue than is necessary to pay these bills.
• DSCR is used both in personal as well as corporate finance and is a reliable yardstick of the risk associated in any contract. In corporate finance, DSCR is the amount of cash flow accessible to meet yearly interest and principal payments on debt, together with sinking fund payments. In personal finance it is used for determining debt servicing ability by bank loan officers. In commercial real estate finance, DSCR is the most important measure to decide if an asset will be capable of sustaining its debt based on cash flow. In the late 1990s and early 2000s banks typically required a DSCR of no less than 1.2. A DSCR above one indicates that the entity makes enough cash flow to pay its debt commitment. A DSCR under 1.0 points toward the fact that there is not adequate cash flow to cover loan payments.

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