How is DSCR calculated and what threshold indicates adequate debt service coverage?

• A. DSCR = Net income / Interest expense
• B. DSCR = Cash flow available for debt service (annual) divided by total annual debt service
• C. DSCR = Cash flow before debt service divided by total debt service
• D. DSCR = Cash flow available for debt service (monthly) divided by monthly debt service

Answer: (B)

The main idea is that DSCR measures how well a borrower’s cash that is truly available to service debt covers the debt that must be paid. It compares annual cash flow available for debt service to total annual debt service payable (principal plus interest).

The best formula uses annual figures: DSCR equals cash flow available for debt service (annual) divided by total annual debt service. This captures the full year's ability to meet all debt payments and uses a consistent time frame for comparison. Cash flow available for debt service reflects the cash truly available to make debt payments after operating needs are met, and debt service is the sum of all required principal and interest payments over the year.

Thresholds indicate adequacy by showing whether there is enough cash flow to cover obligations. A DSCR above 1.0 means there is at least breakeven coverage, but lenders usually want a cushion—commonly around 1.2 to 1.25—depending on risk factors and loan type.

Other formulas aren’t as appropriate for standard debt service assessment: using net income over interest expense ignores principal payments and cash timing; using cash flow before debt service doesn’t account for all obligations; and using monthly figures instead of annual can obscure seasonal or cyclical patterns and reduce comparability.