debt service coverage ratio
Debt Service Coverage Ratio shows whether a business earns enough to pay back its loans comfortably, or is limping from one repayment to the next.
In plain English
Two landlords in Lagos collect the same rent every month, ₦500,000 each. One of them owns the property outright and simply banks the money. The other took a loan to build the house and must pay ₦420,000 every month to the bank before he can call anything his own. On paper, both look like they are doing fine. Only one of them is actually breathing.
That difference between money coming in and money that must go straight back out to lenders is what the Debt Service Coverage Ratio measures. It compares a company's operating income to its total debt obligations for the period, meaning the principal and interest due. A healthy ratio tells you the business earns comfortably more than it owes. A ratio close to one means every naira earned is being swallowed by repayments, and any small shock, a slow sales month, a broken generator, a delayed customer payment, could tip it into default.
Banks and investors lean on this number heavily because profit alone can lie. A company can report a lovely profit and still fail to pay its loan on time if that profit is sitting in unpaid invoices or unsold stock rather than cash. The Debt Service Coverage Ratio strips away the illusion and asks a blunter question: can you actually pay what you owe, when it is due?
A Nigerian manufacturing firm borrowing from a bank to import machinery will almost certainly be asked for this ratio before the loan is approved, and again every quarter after, as a condition of keeping it. In the United Kingdom, a small property company refinancing a mortgage on a block of flats faces the same test from its lender, who wants comfort that rental income clears the mortgage payments with room to spare.
For someone abroad sending money home to keep a family business afloat, this ratio is a calm reminder of why the business struggles even when sales look decent. If most of the incoming cash is servicing an old loan, growth stalls no matter how hard everyone works.
A company earns ₦12,000,000 in operating income for the year and owes ₦8,000,000 in loan principal and interest for that same year. Its Debt Service Coverage Ratio is 12,000,000 divided by 8,000,000, which is 1.5. That means it earns one and a half times what it needs to cover its debt, a comfortable cushion most lenders would be happy with.
Questions people ask
What counts as a good Debt Service Coverage Ratio?
Most lenders like to see at least 1.2 to 1.5, meaning the business earns 20 to 50 percent more than it needs to cover its debt. Below 1.0 means the business cannot cover its debt from operating income alone and is dipping into savings or new borrowing to survive.
Is this the same as a credit score for individuals?
Not quite, but it plays a similar role for businesses. A credit score looks at a person's borrowing history and habits, while the Debt Service Coverage Ratio looks specifically at whether current income can support current debt repayments, which lenders check again and again over the life of a loan.
Can a profitable business still fail this test?
Yes, and it happens often. A business can show healthy profit on its income statement while its actual cash is tied up in unpaid invoices, unsold inventory, or slow paying customers, leaving too little real cash to meet loan repayments on time.
Last reviewed