The debt service coverage ratio compares a company's earnings or its level of ready cash to its debt liabilities. A company may set a minimum debt service ratio to ensure its solvency and to assure its investors that it will not default on its debt. The current ratio affects future business decisions, because a firm that needs cash will seek deals that offer earnings large enough to reach its debt service goals. You can calculate this ratio using information available on a company's balance sheet.
1. Identify the company's earnings before taxes or interest from its balance sheet. For example, suppose that a company earns $120,000.
2. Identify the value of the company's long-term debt from its balance sheet. For example, suppose that the company owes $30,000 in long-term debt.
3. Identify the interest that the company owes on its debt from the balance sheet. For example, suppose that the company owes $1,500 in interest for this period.
4. Divide the company's earnings by the sum of its debt and the interest it owes. Continuing the example, divide $120,000 by $31,500, giving 3.81. This is the company's debt service coverage ratio.
5. Multiply the ratio by 100 to express it as a percent. 3.81 times 100 is 381. The company's income is 381 percent of its debt liabilities.
- This is one of several methods for calculating the debt service coverage ratio. You may use a different one, so long as your investors and others in your company recognize the formula you have chosen.
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