The debt coverage ratio is used to determine whether or not a company can turn enough of a profit to cover all of its debt. This is also often referred to as the debt service coverage ratio (DSCR). Typically banks and lenders use this formula to decide whether or not to award a company a business loan.
Click here to download the template
If the company has any loans or credit lines on their account, this ratio would certainly be applicable. Additionally, this ratio can also be used by the individual company as an evaluation of their ability to cover their debts.
For example, let’s say that a company wants to take on more debt to feed growth. But they want to figure out if they can safely take on that debt without serious risk to the health of the company. This would be a great use of the debt coverage ratio.
FAQs
1. What is the Debt Service Coverage Ratio?
The debt service coverage ratio is the number of times a company’s income can cover its debt payments. In other words, it measures a company’s ability to repay its debts.
2. What is a good Debt Service Coverage Ratio?
Most lenders want to see a debt service coverage ratio of at least 1. This means that the company’s income can cover its debt payments at least once.
3. How do you calculate the Debt Service Coverage Ratio?
You can calculate the debt service coverage ratio by dividing a company’s income by its debt payments.
4. Is a higher Debt Service Coverage Ratio better?
Higher debt service coverage ratios are typically seen as better, but it really depends on the company’s situation. For example, a company with a lot of cash on hand might not need a high debt service coverage ratio. But a company with little cash might need a higher ratio to be considered safe.
5. Why is the Debt Service Coverage Ratio important?
The debt service coverage ratio is important because it shows a company’s ability to repay its debts. This is especially important for lenders, who want to make sure that they are lending to a company that can afford to pay back the loan.
