If you are a banker, you’ll likely refer to this as the Debt Service Ratio (DSR), but for the rest of world, it’s known as the Debt Service Coverage Ratio (DSCR). Either way, it’s the same metric.
Why is it important?
The ratio is primarily used by investors, financial institutions, and essentially anyone evaluating a company’s ability to pay its debt. The higher the computation result, the better.
How is it calculated?
EBITDA OR NOI **
Debt Service (Principal + Interest + Lease Payments)
A result of less than 1 means that a company does not have enough cash flow to cover its debt in which case it will be difficult to obtain financing. Typically, financial institutions look for results of 1.25 or higher.
How does it impact my future strategy and operations?
Simply put, companies with high coverage ratios may be able to grow faster or become more profitable by increasing their debt and using the proceeds on initiatives that provide a profit return in excess of their borrowing costs.
Conversely, companies with lower coverage ratios, are at a higher risk, as they are limited in their ability to raise cash for growth, new initiatives, or sustaining operations.
Disclaimer
Although key performance indicators are an integral tool used to effectively manage your business, no individual ratio or number can tell the whole story. The Florida CFO Group is experienced developing KPI’s that help Grow, Protect and Optimize your business. If you feel your company doesn’t have a real time understanding of their finances, give us a call.
