DSCR and Interest Coverage: What Principal Changes

Interest coverage divides a year of operating cash by the interest bill alone. The debt service cover ratio (DSCR) divides that same cash by interest plus the principal instalment scheduled in the year. On Tapti Crossing Infrastructure Private Limited the readings are 2.07 times and 1.36 times. Every rupee of that difference is the Rs 63 crore instalment. No profit statement anywhere carries that instalment as a cost.

What does each of these two ratios actually measure?

A household shows the shape of the problem. The shape is the same at every scale. A couple takes a home loan. Each month a single instalment leaves the account, and inside that one instalment are two quite different things. Part of that instalment is interest, the charge for having the money. The rest is a repayment of the money itself, and each repayment shrinks the loan. Asked whether they can afford the loan, the couple has two honest answers, depending on which of those two parts the question meant.

If the question meant the charge alone, the answer is comfortable. If the question meant the whole instalment, the answer is tighter, sometimes much tighter. The repayment part is often larger than the charge. Nothing dishonest has happened. Two different questions were asked and two different answers came back.

Interest coverage and the debt service cover ratio are exactly that pair of questions, put to a business instead of a household. Interest coverage takes a year of operating cash and divides it by the interest for that year. Interest coverage is asking whether the business can afford the cost of carrying its borrowing. The debt service cover ratio takes the same year of operating cash and divides it by interest plus the scheduled principalThe part of a loan the borrower has promised to hand back inside a stated period, as opposed to the charge for holding the money. It is fixed by the repayment schedule, not by the rate. falling due in that same year. The debt service cover ratio is asking whether the business can afford everything the borrowing requires it to pay in the period.

The distinction between those two sentences carries everything that follows. The first is a question about cost. The second is a question about a cash obligationAn amount that has to physically leave a bank account by a date, whether or not any accounting statement records it as an expense.. A cost is something a reporting system records. A cash obligation is something a bank transfer settles. Most of the time a business has both kinds, and most of the time nobody notices that the two do not overlap.

Anybody meeting the pair for the first time is tempted to file the debt service ratio as the cautious version of interest coverage, the same measure with a haircut applied. The filing is wrong, and it costs the analyst later. The two are not one question at two levels of caution. The two are separate questions, and each has a setting in which it is the right one to ask. The debt service cover ratio is the question a bank account has to answer, and interest coverage is the question a profit statement answers, and the reason they give different numbers is that the two documents do not contain the same list of things.

Tapti Crossing Infrastructure Private Limited makes the difference easy to see because there is nothing else going on inside it. Tapti Crossing is a single-asset toll road company, formed to build and run one crossing, with no second business and no recourse to anybody standing behind it. Its whole year is one road collecting money and one loan being serviced. Every figure that follows belongs to that one modelled year.

What do both ratios read on the same year of cash?

Take the modelled year of Tapti Crossing Infrastructure Private Limited and build both measures from the identical starting point. Nothing about the comparison can then be blamed on using different inputs.

The road collects Rs 310 crore of revenue in the year and spends Rs 62 crore running itself, leaving Rs 248 crore of operating cash. The Rs 248 crore is the numerator of both ratios and it does not change between them. On the financing side, the project drew Rs 1,260 crore of debt against Rs 540 crore of equity to build a Rs 1,800 crore asset. The project contracted its own rate at 9.5 per cent rather than borrowing at some market average, so the interest for the year is Rs 119.70 crore. The schedule also requires Rs 63 crore of principal to be handed back in the same year. Add them and the debt service for the year is Rs 182.70 crore.

Do the division rather than accepting it. Rs 248 crore over Rs 119.70 crore is 2.071846, written 2.07 times. Rs 248 crore over Rs 182.70 crore is 1.3574165, written 1.36 times. Both are correct arithmetic on the same year, and both describe the same road.

Read the second number in rupees rather than in turns and it stops being abstract: at 1.36 times the project has Rs 65.30 crore of cash left after everything the lenders are owed in the year, or 35.7 per cent of the debt service standing spare. The leftover Rs 65.30 crore is what reaches the sponsors of Tapti Crossing Infrastructure in the modelled year. Hold on to the figure: it turns up again when the structure comes under pressure.

Why the 1.36 times is a bound rather than a target

One point about the rounding matters the moment anybody runs the sizing backwards rather than simply reading the ratio. The 1.36 times that gets reported is a rounded presentation of 1.3574165, and the requirement sitting behind it is a bound: the schedule was sized so that the cover is at least that much, not so that it lands exactly on it. Rounding is harmless while the number is only being read, and stops being harmless as soon as anything is computed with it.

The rounded figure does something visible to the sizing. Rs 248 crore of cash taken back through a cover of 1.36 gives debt service of Rs 182.35 crore. Stripping out the Rs 63 crore instalment leaves interest of Rs 182.35 crore less Rs 63 crore, or Rs 119.35 crore, and at the project's own contracted 9.5 per cent that implies a loan of Rs 1,256.35 crore. The project borrowed Rs 1,260 crore, so the chain has lost Rs 3.65 crore somewhere, and it was lost in the second decimal place. The identical chain run through 1.3574165 returns Rs 182.70 crore, Rs 119.70 crore and Rs 1,260 crore exactly. Quoting the rounded 1.36 times is the honest way to report a cover. Compute with 1.3574165 whenever the arithmetic has to tie back to the amount actually lent.

Two cautions attach to both measures equally, and they are stated once here rather than pinned to whichever figure looks less comfortable. The first is that Rs 248 crore is a ceilingThe most a figure can possibly be, because the items that would reduce it have not been counted. Anything actually deducted later can only bring it down. rather than a settled amount. The record for this project carries no tax charge and no maintenance spending. Anything of that kind that turns out to be real reduces the numerator of both ratios, so both readings would fall together. The second is that both belong to one modelled year. The record carries no concession length, no debt tenor and no traffic forecast, so neither ratio may be extended to any other year, and neither says anything about the life of the road.

Where does the whole gap between 2.07 times and 1.36 times come from?

A gap between two ratios is usually a mess to explain. Ratios can differ for several reasons at once, and the reasons tangle. Here the gap is unusually clean, and the cleanliness is the teaching point.

Both numerators are Rs 248 crore. Not similar, not roughly comparable, but the identical figure taken from the identical line of the identical year. The project's cash is a constant across the two, so whatever separates 2.07 times from 1.36 times cannot involve the project's cash in any way. Every explanation that starts with the words "the debt service ratio uses a more conservative cash figure" has already gone wrong at the first clause.

So the difference must live entirely in the denominatorThe number underneath in a division. In a coverage ratio it is the obligation being covered, and choosing what goes into it is the whole design of the measure.. Compare the two: Rs 119.70 crore against Rs 182.70 crore. The two differ by Rs 63 crore, and the Rs 63 crore is the scheduled principal and nothing else. The entire distance between 2.07 times and 1.36 times is one line item, and if the instalment were nil the two ratios would not merely be close, they would be the same number to every decimal place.

The claim that the two ratios would coincide is testable rather than rhetorical, and the simulation below tests it. With the instalment set to nil, the denominator of the debt service ratio becomes Rs 119.70 crore, the denominator of interest coverage. The same numerator over the same denominator gives the same 2.071846. There is no residue, no second effect, nothing left to explain.

The size of that single line relative to the whole obligation is worth knowing. Rs 63 crore over Rs 182.70 crore is 34.5 per cent. So a little over a third of everything Tapti Crossing Infrastructure Private Limited has to pay its lenders in the year is the item that one of the two measures simply does not see.

Why does a profit statement carry one obligation and not the other?

Here is the reason the smaller-looking measure became the popular one, and it is a reason about documents rather than about judgement.

Interest is a trading costAn amount consumed in running the business through the period, which a profit statement records as an expense because it has been used up and is not coming back.. The project used somebody else's money for a year, and the charge for that use is an expense of the year, so it appears on the face of a profit statement as a line that can be pointed at. Rs 119.70 crore, printed, visible, available to anyone reading the document.

A principal repayment is not a cost at all. Nothing is consumed when it is paid. Rs 63 crore of cash goes out and Rs 63 crore of liability disappears, so the business is exactly as well off afterwards as before, on paper. Because nothing was used up, no expense line records it. The repayment appears in a cash flow statement, under financing, and in the movement of the borrowings balance, and nowhere at all in the ladder that runs from revenue down to profit.

The consequence anybody working from published statements has to carry is this: on a project like this one, the second largest thing the lenders are owed in the year is invisible in the measure most readers reach for first, and here it is 34.5 per cent of the total obligation.

The household version is exact. On a home loan statement the interest is broken out because it is what the loan cost the borrower. The principal portion of the same instalment is not a cost of anything; it is the borrower getting the house back a little at a time. And yet both parts left the account on the same day, in the same transfer, and the bank did not accept the second part as optional because it failed to be an expense.

One clarification before moving on prevents a common confusion. Saying the principal is not a cost is not saying it is unimportant, and it is not saying accounting has made a mistake. Accounting is answering its own question correctly. The question a profit statement answers is what the period consumed. The question a lender is asking is what the period has to pay. The two are different questions, and the instalment is the item on which they visibly disagree.

One question actually decides which measure to reach for, and it is not a question about the ratios at all. The deciding question is about the borrower.

Why can a trading company live on the interest measure when a project cannot?

This is the heart of the comparison, and it is easy to get wrong in a way that sounds sophisticated. The wrong version says that project lenders are more careful than corporate lenders, so they use the stricter ratio. The careful-lender explanation is not it. The difference is structural, and it is about whether repayment is genuinely optional in any given year.

Take Harivansh Packaging Limited, the listed packaging maker used elsewhere in this sequence, purely as an example of an ordinary corporate borrower. Harivansh Packaging runs many plants, sells to many customers, and has been trading for years. When a facility of its matures, the usual outcome is not that the company scrapes together the cash and hands it over. The usual outcome is refinancingReplacing a borrowing that is falling due with a new borrowing, so that the old lender is repaid out of the new lender's money rather than out of the business's cash.: a new facility is put in place, the old lender is repaid out of the new lender's money, and the business carries on. The principal was a question about access to credit, not a question about this year's cash.

So when somebody looks at Harivansh Packaging and asks whether the borrowing is affordable, interest coverage is a reasonable measure to reach for. Interest coverage measures the charge, and the charge is genuinely what has to be found out of trading every year. The repayment is real, but it is a refinancing question, and refinancing questions are answered by looking at the business as a going concern rather than by looking at one year of cash.

Now put the same question to Tapti Crossing Infrastructure Private Limited. The vehicle is ring-fencedSet up so that the vehicle's assets and cash serve only its own lenders, with no claim on anybody standing behind it and no other business inside it. and holds exactly one asset. There is no second business generating cash, no diversified operating history to underwrite, and the right to collect from the crossing does not last forever. The debt has to be repaid out of the road's own collections, inside the life of the right the project runs on. The schedule exists in the first place for precisely that reason: the lenders are not relying on being able to refinance, they are relying on being repaid.

So the same instalment carries a different status for the two borrowers, and it is not a difference of prudence between two kinds of lender: for a continuing company the principal is a refinancing question, and for a single-asset project it is a cash question in every single year. Once repayment stops being optional, a measure that omits it stops describing anything the borrower has to do.

The difference is easy to feel and hard to state, so here is an everyday version. A shopkeeper who has traded on the same street for twenty years can usually roll a loan over; the lender is comfortable because the shop will still be there next year. A person who has borrowed against a stall licence that expires in eight years cannot roll anything over past the eighth year. After the eighth year there is no stall. Both may pay identical interest. Only one of them can treat the repayment as a problem for a future lender.

What happens to the two ratios as the instalment grows?

Now hold everything still except the one item the two measures disagree about, and watch what each of them does. Cash stays at Rs 248 crore. Interest stays at Rs 119.70 crore. Only the scheduled principal moves, from nil up to Rs 126 crore, double the instalment the project actually carries.

The instalment sits inside the debt service denominator, so as the instalment grows the denominator grows and the ratio falls the whole way. At nil it reads 2.07 times. At Rs 31.50 crore it reads 1.64 times. At Rs 63 crore, the instalment this project actually carries, it reads 1.36 times. At Rs 94.50 crore it reads 1.16 times. At Rs 126 crore it reads 1.01 times, a project with almost nothing left after its lenders are paid.

Interest coverage reads 2.07 times at every one of those settings. Not approximately, not with a small drift. The instalment never enters the interest denominator, so a change in the instalment is arithmetically incapable of moving the reading. The identical 2.071846 comes back at nil and at Rs 126 crore.

A measure that does not respond to the item that is changing is not a conservative measure, it is a blind one. Here the blindness runs in the comfortable direction, and that is what allows a project to look untroubled at 2.07 times while its actual headroomThe spare cash left over once an obligation has been met, usually expressed as the part of the obligation that could have been paid again. is being cut in half.

One of the two is doing more work here. The debt service ratio moved from 2.07 times to 1.01 times, a full turn, in response to an instalment change. Interest coverage delivered the same reading five times over. For anyone paid to know what was happening to this project, only one of those two measures was saying anything at all.

How does a project lender actually use the two together?

A credit team looking at Tapti Crossing Infrastructure Private Limited is not choosing between the two ratios as though one had to win. A credit team reads them in a fixed order and takes something different from each. The order is worth knowing, and it is the practitioner habit that matters most on a project.

The debt service cover ratio answers the question the lender is actually exposed to, so it is read first. At 1.36 times the year covers Rs 182.70 crore of obligations and leaves Rs 65.30 crore over. The Rs 65.30 crore left over is what a lender cares about. The leftover is the only buffer between a normal year and a missed payment. The sponsors are looking at the same number from the other side, where the Rs 65.30 crore reaching their equity of Rs 540 crore is a cash return of 12.09 per cent in that year alone and not over the life of anything.

Interest coverage is read second, and it is read as a diagnostic rather than as a verdict. Because it strips the schedule out, it isolates the rate. If a structure looks tight, comparing the two shows where the tightness is coming from: a project reading 1.36 times on debt service and 2.07 times on interest is tight because of its repayment schedule. A project reading 1.36 times on debt service and 1.40 times on interest would be tight because of what it is paying for the money. The two are different problems with different remedies, and the second ratio is what separates them.

Neither ratio is the lender's answer on its own: the debt service ratio says how close the year runs to the edge, the interest measure says how much of that closeness is the instalment rather than the rate, and the pair together says something neither one says alone.

A third practitioner habit is worth naming, and it stops a reader from over-reading a single year. Both of these ratios describe one year. A structure is also carrying a debt service reserve, on this project two quarters of debt service, or Rs 91.35 crore. A reserve is not cash the year produced, so it does not improve either ratio by a single decimal. A reserve converts a timing problem into a funded buffer, and it is cash the sponsors cannot take out. Any reading of a coverage ratio that ignores whether a reserve exists is reading half the structure.

When is interest coverage the right measure to reach for?

An account that only criticised interest coverage would hand over a prejudice rather than a tool, and a prejudice is worse than the original error because it feels like knowledge. The honest case for the measure runs to three settings in which it is the better of the two.

The first is affordability out of trading. If the question is whether a business can carry the cost of its borrowing from what it earns, the cost is exactly what belongs in the denominator, and adding the repayment schedule would be answering a different question badly. Harivansh Packaging Limited carries Rs 60 crore of finance cost against Rs 477 crore of operating earnings, and interest coverage is a perfectly sensible way to look at that.

The second is comparison across borrowers whose schedules differ. Two businesses with identical earnings and identical debt can show quite different debt service ratios purely because one is repaying faster than the other, and the faster repayer is not the weaker business. Stripping the schedule out is the only way to compare what the two are paying for their money on the same basis. Two home loans are compared on their rate before being compared on the size of the monthly instalment, for the same reason.

The third is where the principal genuinely is refinanceable. If the borrower is a going concern with access to credit and the maturity is being rolled rather than repaid, then treating the instalment as this year's cash obligation overstates the pressure. The instalment is real, but it is not a claim on this year's operating cash.

All three of those are questions about a business that continues. A single-asset project is exactly the borrower that does not continue, and that is the whole of the reason interest coverage is the wrong first measure on this road and a perfectly good one elsewhere.

Which one is read first on a project?

The debt service cover ratio, always, and the reason is short enough to keep. The debt service cover ratio is the one that describes what has to leave the bank account.

The ranking is not a claim that 1.36 times is a good number or a bad one. The ranking says something narrower and more useful: of the two measures available, one counts everything the year has to pay and the other counts part of it, and on a borrower that cannot postpone the part being omitted, the complete count comes first.

Interest coverage is read second, and read for what it uniquely establishes: how much of the tightness is schedule and how much is rate. On Tapti Crossing Infrastructure Private Limited the answer is that almost all of it is schedule: 2.07 times on interest against 1.36 times on debt service says the money is not expensive relative to the cash, but the repayment is demanding relative to the cash. A demanding schedule is a genuinely different diagnosis from a project struggling to pay its interest, and a reader who only saw one of the two numbers could not have told them apart.

The instruction that survives being repeated is this: read the debt service ratio first, read interest coverage second to see how much of the tightness is the instalment rather than the rate, and never quote the second without the first.