Glossary
DSCR
Debt service coverage ratio (ratio de couverture du service de la dette)
The DSCR divides the cash a company generates over a period by the interest and principal it must pay over the same period.
Definition
The DSCR (debt service coverage ratio) measures how many times the cash generated in a period covers the debt service of that period, meaning interest and principal instalments. In its simplest form, the numerator is EBITDA and the denominator is the sum of interest and principal due over twelve months. A ratio of 1 means that all of EBITDA goes to repaying the debt and that nothing is left for tax, investment or dividends. The assessment grids of lenders to SMEs regard a ratio of 2 or more as healthy. Each lender sets its own threshold. In a leveraged facilities agreement drafted on the Loan Market Association (LMA) model, the same test is called Cashflow Cover: it compares a cash flow built from EBITDA, adjusted for all cash and non-cash items, with the debt service of the period. The required level is almost always 1:1. The test is calculated over a rolling twelve months and checked every quarter with the compliance certificate. For you as borrower, the negotiation covers both definitions. Including voluntary or mandatory prepayments in debt service lowers the ratio. Lenders then ask that the proceeds funding those prepayments be included in the cash flow.
Worked example
A mid-sized services company generates €30m of EBITDA. It carries a €90m unitranche facility that costs it €7.2m of interest a year and a €20m amortising loan repaid at €4m a year. Its debt service reaches €11.2m. The DSCR calculated on EBITDA comes out at 30 / 11.2, or 2.7. If the agreement uses cash flow after €6m of capital expenditure and €5m of tax, the numerator falls to €19m and the ratio to 1.7.
Points to check
- The definition of the numerator: gross EBITDA or cash flow after capital expenditure, tax and change in working capital requirement.
- The treatment of voluntary and mandatory prepayments in debt service.
- The required threshold and the headroom between that threshold and your business plan.
- The test period (rolling twelve months) and the delivery date of the compliance certificate.
- Consistency with the other covenants in the agreement, total leverage and interest cover.
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