Debt service coverage ratio

Debt Service Coverage Ratio

A financial metric that measures a company’s ability to service its debt obligations with available cash flow, calculated by dividing operating income (or EBITDA) by total debt service requirements (principal and interest payments).

For instance, a property management company with annual EBITDA of $1.2 million and annual debt service requirements of $800,000 would have a debt service coverage ratio of 1.5, indicating it generates 50% more cash flow than needed for debt payments.

Lenders and creditors closely monitor this ratio to assess default risk, often establishing minimum required levels in loan covenants (typically 1.2 or higher). A ratio below 1.0 indicates insufficient operating income to cover debt obligations, signaling potential financial distress. When evaluating this metric, analysts should consider its stability over time, as fluctuating operating income can create periodic coverage challenges even with acceptable average ratios. Industries with stable cash flows can generally sustain lower coverage ratios than those with more volatile revenue streams.