Debt Service Coverage Ratio is a type of Solvency Ratio that determines a company’s capacity to pay its debt and debt obligations through its operating profit. It is a measure of extent up to which debt and its components can be fulfilled by the company’s cash flow.
$$Debt\quad Service\quad Coverage\quad Ratio=$$$$\frac { Net\quad Operating\quad Income }{ Total\quad Debt\quad Service } $$ Where,
Net Operating Income = Gross Income – Operating Expenses. Net Operating Income considers income only from principal revenue-generating activities and not the non–operating income.
$$Debt\quad Service\quad Coverage\quad Ratio=$$$$\frac { Net\quad Operating\quad Income }{ Total\quad Debt\quad Service } $$ Where,
Net Operating Income = Gross Income – Operating Expenses. Net Operating Income considers income only from principal revenue-generating activities and not the non–operating income.
Example 1:
A Bank’s income from the sale of old properties, though this is an income it’s not from the principal revenue-generating activity of bank, hence it is a non-operation income.- And Total Debt Service = Principal Repayments + Interest Payments, this includes all outgo of a company with respect to its Debts.
Significance and Interpretation
- Debt Service Coverage Ratio = 1: This implies that the operating profit of the company is just equal to the Total Debt Service payable, this is an alarming situation for the company as all profits are consumed in paying debt-related expenses itself.
- Debt Service Coverage Ratio < 1: This implies that the operating profit of the company is not even enough to pay the Total Debt Service payable, such companies are on the verge of getting insolvent as they are technically running in loss.
- Debt Service Coverage Ratio> 1: This implies that the company’s operating profit is more than its Total Debt Service payable, this seems to be good, but it is not enough for the company to grow and survive.
- The ideal Debt Service Coverage Ratio is = 1.75, below which it is not considered to be safe. A higher Debt Service Coverage ratio implies a better credit profile of the company. It must be noted that this limit may shift depending upon the regulatory reforms and/or type of business.
Examples
Example 2:
M/S ABC Ltd. has reported its Operating Profit as ₹4800 Crores in its annual result. Also, the total interest paid by the company in the period is ₹805 Crores and the principal repayments amount to ₹ 1500 Crores. Find the Debt Service Coverage Ratio for the company.Solution:
Total Debt Service = Principal Repayment + Interest Payable
⇨ 1500 +805
⇨ ₹2305 Crores
Net Operating Income = ₹4800 Crore.
Debt Service Coverage Ratio= Net Operating Income/Total Debt Service
Net Operating Income = ₹4800 Crore.
Debt Service Coverage Ratio= Net Operating Income/Total Debt Service
⇨ 4800/2300
⇨ 48/23
Hence, Debt Service Coverage Ratio = 48/23 or 2.09
Hence, Debt Service Coverage Ratio = 48/23 or 2.09
Example 3:
Consider the following information from the annual Report of M/S XYZ Ltd. and calculate the debt service coverage ratio for the company.| Particulars | Amount (in ₹ Cr) |
|---|---|
| Gross Profit | 1200.00 |
| Operating Expenses | 250.00 |
| Operating Income | 950.00 |
| Interest Expense | 250.00 |
| Principal Repayment | 500.00 |
Solution:
Operating Income = ₹ 950.00 Crores
Total Debt Service = Interest Expense + Principal Repayment
Total Debt Service = Interest Expense + Principal Repayment
⇨ 250 + 500
⇨ ₹ 750.00 Crores
Debt Service Coverage Ratio = Net Operating Income / Total Debt Service
Debt Service Coverage Ratio = Net Operating Income / Total Debt Service
⇨ 950/750
⇨ 19/15
Hence, Debt Service Coverage Ratio = 19/15 or 1.267
Hence, Debt Service Coverage Ratio = 19/15 or 1.267
