DSCR

What it means

DSCR, the debt service coverage ratio, compares the cash a company generates from operations with the amount it has to pay in principal and interest over the same period. It answers the question of whether the company earns enough to service its loans.

A value of 1 means the company generates exactly as much cash as it needs for repayments, with nothing left over. Below 1, repayments have to be topped up from reserves, a new loan or the owners’ money. Banks usually require a value comfortably above 1, with the exact threshold depending on the bank and sector.

The numerator is calculated in different ways: sometimes from EBITDA, sometimes from operating cash flow after tax and essential capital spending. The denominator is all loan and lease repayments for the period. When comparing figures, it is important to know exactly how the bank defines it in the contract.

How it works in practice

In loan agreements DSCR is a common covenant: the company undertakes to keep it above an agreed level and to evidence it regularly, for instance annually from the financial statements or half-yearly from interim accounts. If it is breached, the bank can raise the rate or demand early repayment.

When a company applies for an investment loan, the bank also projects DSCR from the financial plan. We help clients prepare a plan that is realistic, so the ratio does not look good only on paper.

If DSCR is falling, the remedies include extending the loan term, refinancing expensive debt, cutting capital spending or collecting receivables faster. It is better to talk to the bank before the covenant is breached, not after.

What to watch out for

The most common mistake is calculating DSCR from accounting profit without regard to cash. Profit may be high, but if the money is tied up in receivables and stock, nothing is left for repayments. The ratio should be based on cash, not on the result.

The second risk is forgetting leases and shareholder loans. Banks often include them in debt service even if the company sees them as separate. It is safer to include all regular repayments in the calculation.