Debt Service Coverage Ratio

The Debt Service Coverage Ratio compares available cash flow with upcoming interest and repayment obligations. It shows whether a company generates enough to service its debt. A value above 1 means that cash flow covers the payments. It is calculated as cash flow before debt service divided by the sum of interest expense and scheduled amortisation for the same period, with the numerator defined precisely in the credit agreement: a starting point of adjusted EBITDA less taxes, maintenance capital expenditure and the movement in working capital is customary.

The key difference from interest cover is that amortisation is included, which makes the ratio markedly stricter in heavily amortising structures and reflects the real burden better. In credit agreements it appears as a covenant with minimum levels typically set above one with headroom depending on business model and risk profile. It is especially common in project and real estate finance, where cash flows are largely contractually fixed. A value below one does not automatically mean insolvency, because available cash, undrawn facilities or shareholder contributions can close the gap, but it signals that the operating business does not carry debt service on its own.

In assessing a borrower the ratio is therefore a more practical measure than leverage alone. The treatment of periods in which the ratio is temporarily breached matters in practice, because a one-off shortfall does not carry the same meaning as a persistent one. Credit agreements therefore often provide an equity cure limited in number and size. It should also be settled whether voluntary prepayments enter the calculation, since including them makes early repayment worsen the ratio arithmetically even though it improves the position.