debt coverage ratio
Debt Coverage Ratio measures whether a business earns enough cash to comfortably pay off its loans, showing lenders and owners how safe the debt really is.
In plain English
The landlord in Ikeja is asking again. Not for rent this time, for the shop owner's bank statement, because the shop owner wants to borrow ₦3,000,000 to restock before Christmas and the bank manager wants proof that the shop can actually pay it back without turning the shop into a funeral.
This is exactly what the Debt Coverage Ratio checks. It compares the cash a business generates from running itself, before loan payments, against the total debt it has to pay that year, both the main amount and the interest. If the number is above one, the business earns more than it owes for that period. If it sits below one, the business is bringing a knife to a gunfight.
Say a small poultry farm in Ogun State makes ₦6,000,000 in operating cash flow this year, and its loan repayments for the year, principal plus interest, come to ₦4,000,000. Divide 6,000,000 by 4,000,000 and you get 1.5. That means for every ₦1 owed, the farm has ₦1.50 available. Lenders love that kind of comfort.
In the United Kingdom, a small logistics company applying for a business loan from a high street bank will be asked for this same figure, sometimes called the debt service coverage ratio, before any offer letter is signed. Banks everywhere speak this language, whether the currency is pounds or naira.
For someone in the diaspora sending money home to help a family business grow, this ratio matters too. Before adding your name to a loan guarantee or investing your hard earned pounds into your brother's transport business in Lagos, ask to see this number. It tells you, in one simple figure, whether the business can stand on its own two feet or whether it will lean on you when the repayment date arrives.
A bakery earns ₦2,500,000 in operating cash flow and owes ₦2,000,000 in loan repayments this year. Debt Coverage Ratio equals 2,500,000 divided by 2,000,000, which is 1.25. The bakery has 25 percent more cash than it needs to cover its debt, a healthy cushion.
Questions people ask
What is considered a good Debt Coverage Ratio?
Most lenders like to see a ratio of at least 1.25, meaning the business earns 25 percent more cash than it needs to cover its debt payments. Anything below 1 signals the business cannot fully cover its debt from operations alone.
How is Debt Coverage Ratio different from Times Interest Earned?
Times Interest Earned only looks at whether earnings can cover interest payments, while Debt Coverage Ratio looks at operating cash flow against the full loan repayment, principal and interest together, giving a fuller consider of repayment ability.
Can a profitable business still have a poor Debt Coverage Ratio?
Yes, and this surprises many people. A business can show profit on paper, especially with heavy depreciation or unpaid invoices, yet still lack the actual cash to meet loan repayments, which is why lenders trust cash flow over profit figures.
Last reviewed