Debt service ratio / Debt service coverage ratio

The debt service indicator helps to determine this whether our company will be able to fulfill its debt service obligations according to the contract. To put it another way will our company be able to regularly repay its debt based on its ability to generate profit.

The words debt and indebtedness are often associated with a negative meaning. However, debt alone does not mean that a company is in a difficult situation. During the operation of the business, it is quite natural that it has long-term liabilities (over a year), i.e. debt. Moreover, to a company in a good market position, if it gets the right conditions to resources, can be highly recommended to expand your capacities. Of course, if you win new markets and customers with it, you can improve it profitability.

There is nothing wrong with the debt as long as the company can fulfill its liabilities related to its repayment on time: it pays according to the contract. For this, of course, it is necessary to produce so much result, of which the company is the repayment (debt service) can fulfill its obligations. 

The debt service indicator it is also often referred to as the debt service coverage ratio. The indicator number provides a clue to determine how big the debt burden (debt service) is that the company's ability to generate profits can handle. 

When calculating the indicator for the given period (typically a for the business year) concerning to taxable income we add it depreciation (costs written off due to the obsolescence of assets), and we divide this by the debt service for that period (all debt-related payment obligations. The latter includes principal repayment, interest and all other items related to the fulfillment of the liabilities. It happens that instead of the after-tax profit plus amortisation, the operating profit (EBITDA) is compared with the payment obligation arising in the given period (i.e. debt service). 

If the indicator is less than one, then the company will not be able to meet its debt service obligations without disturbance. In the event that the value of the indicator is one or more, the company will be able to pay its credits, loans, or liabilities arising from financial leasing contracts. However, a value close to one is a financier not enough for the majority of partners. 

When longer term credit obsession a loan is hired by a company or lease agreement would like to tie, a credit application when applying, financial institutions typically also request a debt service calculation. In this, it must be shown that the improvement in results realized by the investment will provide adequate collateral for the repayment. 

The credit evaluation during this period, the term DSCR (debt service coverage ratio) of 1.3 or loan coverage or debt coverage expectation may be heard. This means that the value of the debt service indicator must reach at least 1.3 in order for the company to receive the loan. Of course, this does not mean that this is a condition, rather it should be treated as a guiding value. It happens that the company receives financing even with a value lower than 1.3, but it also happens that the application is rejected even with an indicator above 1.3.