Which formula defines the debt-service coverage ratio (DSCR)?

Which formula defines the debt-service coverage ratio (DSCR)?

• A. DSCR equals total assets divided by total liabilities.
• B. DSCR equals gross profit divided by total debt service.
• C. DSCR = net operating income / debt service.
• D. DSCR equals net cash flow divided by equity.

Answer: (C)

DSCR measures whether the income from ongoing operations is enough to cover annual debt payments. The best formula uses net operating income in the numerator and debt service in the denominator: DSCR = net operating income / debt service. Net operating income equals revenue minus operating expenses (excluding financing and taxes), while debt service is the total annual principal and interest payments on the loan. A DSCR above 1 means there’s enough income to cover debt service, with a cushion; below 1 indicates a shortfall. The other options don’t reflect this debt-coverage relationship: assets divided by liabilities is a solvency measure, not debt service coverage; gross profit divided by debt service ignores many operating costs and overstates cash available to service debt; net cash flow divided by equity compares cash flow to equity invested, not to debt obligations.

DSCR measures whether the income from ongoing operations is enough to cover annual debt payments. The best formula uses net operating income in the numerator and debt service in the denominator: DSCR = net operating income / debt service. Net operating income equals revenue minus operating expenses (excluding financing and taxes), while debt service is the total annual principal and interest payments on the loan. A DSCR above 1 means there’s enough income to cover debt service, with a cushion; below 1 indicates a shortfall. The other options don’t reflect this debt-coverage relationship: assets divided by liabilities is a solvency measure, not debt service coverage; gross profit divided by debt service ignores many operating costs and overstates cash available to service debt; net cash flow divided by equity compares cash flow to equity invested, not to debt obligations.