What is Debt Service?

The term "debt service" is typically used in the financial sector to describe the sum of interest and principal a certain company must pay to its creditors, which could be a financial institution or bondholder. Since people are also subjected to loans like vehicle loans, credit card debt, mortgages, and many others, this idea also applies to individuals.

Additionally, the concept of debt servicing is used to calculate the exact amount that a business or a person consistently pays to its creditors. An analyst can determine a company's liquidity and ability to satisfy its long- and short-term liabilities by looking at the debt servicing figure.

How to calculate debt service?

A loan's periodic principal and interest payments are calculated to estimate the debt service. To do this, you must be aware of the loan's rate of interest and repayment terms. It is crucial to calculate debt service to establish the cash flow needed to make payments. The annual debt service can thus be calculated and compared to the annual net operating income of the company.

The debt-service coverage ratio formula requires the company's net operating income and total debt servicing.
Revenue less certain operating expenses (COE), excluding taxes and interest, is a company's net operating income (NOI). It is frequently regarded as being similar to income before taxes and interest (EBIT).

DSCR= Total Debt Service /Net Operating Income

where:

Revenue - COE = Net Operating Income
COE = Specific Operating Costs
Current Debt Obligations = Total Debt Service

For instance, if a company's net operating income is ₹1,24,000 and its overall debt service is ₹60,000, its DSCR would be about 2.06.

What is a good debt service coverage ratio?

A "good" DSCR will vary depending on the sector, rivals, and business development stage. For example, a local company that is only now begun to generate cash flow can have lower DSCR goals than a more established, mature business. However, a DSCR of 1.25 is generally regarded as "good," but ratios below 1.00 may be an indication that the business is having financial issues.