DSCR (debt service coverage ratio)

The debt service coverage ratio (DSCR), in Norwegian gjeldsbetjeningsevne, is a measure of a company's ability to service its debt. The key figure shows how much cash flow a company has available for repaying debt. Unlike NIBD/EBITDA, which gives an estimate of how large the resources are that a company could potentially use on repaying debt, DSCR gives a measure of how well the debt service in the period is actually covered by operations.

How do you calculate DSCR?

DSCR = Net operating income / Debt service in the period

Net operating income (NOI) is the total profit a company has from its operational activities once all the costs related to operations have been deducted. In many cases this value is the same as operating profit before depreciation and impairment (EBITDA), but NOI does not take into account income from anything other than the core business.

Debt service in the period is the sum of the instalments and interest the company is due to pay in the period for which DSCR is calculated. It is therefore not the outstanding debt, but what the company actually has to pay out during the period.

By dividing net operating income by the debt service for the period you are left with a value that shows how many times the operating income covers the debt service. A DSCR of 2.5 means that the operating income covers the debt service 2.5 times over. The share of operating income that goes towards debt service is the inverse fraction: 1 / 2.5 = 40%.

What can DSCR be used for?

Debt service capacity is used to evaluate a company's ability to repay debt, and its reliability when it comes to loans, investments and other extensions of credit.

A high DSCR (typically a value above 1) tells you that a company has a strong debt service capacity: the company generates a cash flow high enough to repay the debt it has in a given period. It can also mean low risk in investing in the company, since a high DSCR expresses strong financial health.

A low DSCR (typically a value below 1) tells you that a company has a weak debt service capacity: the company generates a weak cash flow and may struggle to pay its debt in a given period. It can also mean higher risk in investing in the company, since a low DSCR expresses weaker financial health.

Tips for increasing DSCR

In general it is favourable for a company to have a strong debt service capacity, so a high DSCR is desirable. A high DSCR value can come either from large net operating income or from low debt service. In order to increase DSCR it is therefore useful to look at opportunities to increase the earnings from operational activities, and to use the profit on repaying debt in order to reduce future debt service.

1. Efficiency. Evaluate the efficiency of the operational activities.
2. Cutting costs. Look at the opportunities for cutting costs in the core business.
3. More marketing. Increase the focus on marketing.
4. Focus on specific products. Increase the focus on products or services that sell better than others.
5. Equity. Increase the equity.
6. Cash flow. Focus on increasing the cash flow.
7. Revise the budget. Revise the budget for the coming period.
8. Repay debt. Use a larger share of the profit on repaying debt.
9. More sources of income. Consider the opportunities for more sources of income.
10. Refinance debt. Consider refinancing the debt.

Advantages and disadvantages

Debt service capacity can be a good measure of risk when it comes to granting a company a loan or investing in it. It is also a key figure that can be used across industries. The size of operating income and debt service varies between companies, but the relationship between the values will usually have the same consequences regardless of company.

The key figure does not, however, take into account other important factors such as tax, future loans or investments. What counts as a favourable DSCR value also varies between industries.

Example: DSCR and varying debt service

To illustrate DSCR, imagine a company that starts with NOK 100 000 in operating income and NOK 40 000 in debt service each year. The DSCR is then 100 000 / 40 000 = 2.5: the operating income covers the debt service 2.5 times over, and 40% of the operating income goes towards servicing the debt. The company's outstanding net interest-bearing debt stands at NOK 400 000, which is planned to be repaid after 10 years. The company wants to increase its DSCR, and has drawn up measures that will make the operating income increase approximately linearly over the next 10 years. The company initially has constant debt service, but as the operating income increases, opportunities for new company strategies also open up. The company then faces three possible choices: continue with constant repayment of debt, increase the repayment of debt, or take on more debt.

If the company continues with constant repayment, the outstanding debt is gradually reduced, and with it the interest element of the debt service. The DSCR therefore gradually increases as the operating income increases.

If the company increases the repayment for a period, the debt service in that period becomes larger and the DSCR falls temporarily, until the outstanding debt has been repaid and the debt service falls away, after which the DSCR increases.

If the company takes on more debt, for example to finance a new investment of NOK 200 000, this increases the annual debt service, which gives a lower DSCR than originally.

In general it is effective to minimise the debt service in order to increase the DSCR, but this depends on continuously high and positive operating income, as well as on no more debt being taken on in the company.

Read more about how the key figures in Capassa calculate DSCR and other debt-related key figures automatically.