The lower the Debt Service Coverage Ratio, the less likely it is a business will generate enough operating profits to pay for debt servicing. This means they either miss making debt payments or have to use cash reserves to do so. Either way, low operating profits represent a significant business problem.
Apply the principles of the BusinessCPR™ Management System to increase your cash flow from profits to lower your debt burden and reduce your stress.
The Debt Service Coverage Ratio is a Coverage Ratio that measures a company’s ability to service its current debts by comparing its Net Operating Income with its total debt service obligations. Comparing a company’s available cash with its current interest, principle, and sinking fund (see below) obligations helps gauge its ability to meet its current debt obligations.
Unlike the Debt Ratio, the Debt Service Cover Ratio considers all debt-related expenses, including interest expenses, pensions, and sinking fund obligations. The challenge with calculating this ratio is that the debt service amount is rarely provided in a set of financial statements.
The formula for calculating the Debt Service Coverage Ratio
Operating Income / Total Debt Service Costs
If a company has a ratio of 1, that means that the company’s net operating profits equal its debt service obligations. In other words, the ratio is 1:1 because the company generates just enough operating profits to pay for its debt servicing with nothing to spare.
Higher is Better: indicates more income is available to pay for debt servicing and that the business is likely to have more cash available to pay their debt obligations on time.
Lower is Worse: less than one means the company doesn’t generate enough operating profits to pay for debt servicing and must use some of its savings to do so.