- DSCR (debt service coverage ratio) is the ratio of cash available for debt service in a period to the principal and interest due in the same period.
- A ratio below 1 means the cash available for debt service does not cover debt service for the period. The gap has to be closed from sources such as new debt, equity, asset sales or existing cash.
- Lenders use DSCR both in credit assessment and in financial covenants. The definition used must match the definition in the facility agreement exactly.
One of the key questions in credit discussions and restructuring is: “Can the company repay its debt from the cash its operations generate?” DSCR answers that question with a single ratio. The ratio looks simple, but how the numerator and denominator are defined changes the result considerably.
The basic formula
DSCR = Cash available for debt service / Debt service
- Numerator (cash available for debt service): Can start from EBITDA, less tax paid, mandatory capital expenditure and the change in working capital. Some agreements use EBITDA directly.
- Denominator (debt service): Principal and interest payments falling due in the period. Whether lease payments are included depends on the agreement.
The version of the formula being used should always be stated explicitly. Two different definitions can give very different results for the same company.
Hypothetical example
Hypothetical example — not based on a real company. The figures are used only to illustrate the calculation.
| Item (TRY million) | Amount |
|---|---|
| EBITDA | 60 |
| Tax paid | (8) |
| Mandatory capital expenditure | (10) |
| Increase in working capital | (7) |
| Cash available for debt service | 35 |
| Principal repayments | 22 |
| Interest payments | 9 |
| Debt service | 31 |
| DSCR | 1.13 |
Using EBITDA directly for the same company would give 60 / 31 = 1.94. The difference shows why the definition must be stated clearly in a lender presentation.
The main drivers of DSCR
- Working capital: Longer collection periods or higher inventory reduce the numerator even when profit is unchanged. See the cash conversion cycle for detail.
- Maturity profile: Principal concentrated in the short term increases the denominator. The same total debt spread over a longer term improves the ratio.
- Interest and currency: For floating-rate or foreign-currency debt, interest and exchange-rate movements feed directly into the denominator.
- One-off items: Non-recurring cash inflows such as asset sales may be excluded from the numerator, depending on the agreement.
Presenting to lenders
A DSCR analysis presented to a lender should include:
- Definition: What makes up the numerator and denominator, compared with the definition in the agreement.
- Historical periods: Actual ratios for the last two or three years, with a reconciliation.
- Projection: Monthly or quarterly ratios over the life of the facility, with the assumptions.
- Scenarios: How the ratio changes under falling sales, delayed collections or higher interest rates. See the collection delay stress test for the method.
- Action plan: The measures to be taken if there is a risk of the ratio falling below the threshold in the agreement.
Financial covenants
Facility agreements may set a minimum DSCR threshold. Falling below it may, depending on the agreement, be an event of default or a reason to renegotiate with the lender. Therefore:
- the finance team should know the definition and the test period in the agreement,
- the ratio should be calculated each period according to that definition,
- if the ratio is approaching the threshold, the lender should be contacted in advance.
Common mistakes
- Treating EBITDA as cash: Tax, capital expenditure and working capital needs are ignored.
- Assuming short-term debt will be rolled over: Assuming in the projection that short-term loans renew automatically understates the denominator. The assumption should be stated separately.
- Changing the definition from period to period: This breaks comparability and damages trust.
- Looking only at the annual figure: In seasonal businesses the annual ratio may look adequate while serious shortfalls arise in particular months.
What it means for management
DSCR is one of the clearest indicators of debt capacity. Used properly, it forms the basis of a restructuring discussion: it shows which maturity profile and which repayment plan are consistent with the company’s cash generation. A financing plan should be prepared in advance for periods in which the ratio stays below 1.
The figures in this article are hypothetical. For definitions and legal consequences, the facility agreement is the reference and legal advice should be sought where needed. Method: This article is professional analysis; it makes no claim that rests on legislation, a provision of a standard or statistics.
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