The debt service coverage ratio (DSCR) is the ratio which measures the cash available for debt servicing of interest and principal repayments. In other words DSCR measures whether interest and installments of loan can be paid out of internal generation of funds or not. It is worked out as follows –
DSCR = Profit after tax + Depreciation + Interest on term loan/Interest on term loan+ Term loan installments
This ratio should be more than 1 in order to take care of any debt repayments as and when they arise and leave certain surplus with the company for its normal growth. Lower ratio implies that company is not earning enough to take care of its borrower’s obligations of the company and it may also to default if company is not able to pay the borrower which is a disastrous situation.
This ratio is used for appraising the term loan proposals by the banks while giving loans to borrowers, for investment decisions, also for rescheduling the repayment schedule of the term loans, for rehabilitation of sick units etc…..