Debt Coverage Ratio

Debt Coverage Ratio measures the ability of a company to meet its debt servicing obligations.  The Debt Coverage Ratio is often used by the banks to decide whether to make or refinance any loan.

 Debt Coverage Ratio

Debt Coverage Ratio measures the ability of a company to meet its debt servicing obligations.  It is an important indicator of the liquidity position of a company. The Debt Coverage Ratio is often used by the banks to decide whether to make or refinance any loan.


Debt Coverage Ratio Formula

There are different formulas used for the calculation of this ratio. Some of the most commonly used formulas are given below.

Another formula used for the calculation of Debt Coverage Ratio is:

Debt Coverage Ratio formula:  (Net Earnings + Depreciation + Amortization) / Total Debt Service

This ratio also has some variations. For example, free cash flows can be used instead of operating cash flows.  Or long term debt can be used instead of total debt.

Debt Coverage Ratio Interpretation

The Debt Coverage Ratio tells the number of times the financial obligations of a company are covered by its earnings. The larger the operating cash flow coverage for these items, the greater the company's ability to meet its obligations.

A good ratio also indicates that the company has cash flow to expand its business, withstand hard times, and not be burdened by debt servicing and the restrictions typically included in credit agreements.

A Debt Coverage Ratio of less than one indicates that there is not enough cash flow to cover loan payments and that bankruptcy is likely within two years if it fails to improve its financial position.

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