Debt service cover ratio (DSCR)

The debt service cover ratio (DSCR) is a measure of cash inflows available to pay debt compared to the repayments that are due. It is also sometimes refered to as annual debt service cover ratio (ADSCR). DSCR is also sometimes used to refer to a country's ability to pay foreign debt, that is more often called debt service ratio.

Definitions of debt service cover ratio vary somewhat, but I recommend:

(EBITDA - tax) ÷ (repayments of principal + (interest × tax shield))

The advantages of this approach are:

  • EBITDA is relatively easy to calculate and comparatively good measure of cash flow.
  • The impact of the tax deductibility of interest is taken into account.
  • Repayments of principal (not tax deductible) are compared to post tax income

Other approaches may use other measures of profit or cash flow, and may not adjust of tax shields

The difference between the debt service cover ratio and measures of financial strength such as gearing and interest cover is that DSCR takes into account the actual financing arrangements. By taking repayments of principal into account, it tells you the ability of a company to stick be able to avoid default. It is, however, liable to change considerably if debt is refinanced. It is a less fundamental measure.

The DSCR is similar to the loan life cover ratio, but it provides a snapshot of short term ability to pay (over the next year), whereas the loan life cover ratio measures ability to pay over the life of the loan.

Debt service cover ratio is often used by banks when assessing a company's ability to repay debt under particular proposed terms, and if often used in debt covenants. Again, this reflects its use as a measure of ability to repay a debt, taking into account the terms of that debt.

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