What is the formula for the Debt Service Coverage Ratio (DSCR)?

The Debt Service Coverage Ratio (DSCR) measures a company's ability to service its debt obligations with its operating income. The correct formula for DSCR is derived from comparing a company's operating profit, specifically its cash flow, to its total debt service, which includes both interest payments and principal repayments.

The rationale behind this calculation is to provide insight into the liquidity position of a business regarding its debt payments. By selecting operating profit in the numerator, the formula emphasizes the importance of profits generated from core operations rather than accounting profits or one-time earnings. The sum of interest and principal repayments in the denominator reflects the total outflows needed to meet debt obligations, making the ratio an essential tool for analysts and investors to ensure that a company generates sufficient cash flow to cover its debts.

Using this formula allows stakeholders to gauge financial health and make informed decisions about lending or investing. A DSCR greater than one indicates that sufficient income is available to cover debt obligations, while a ratio less than one suggests potential difficulties in fulfilling those obligations.