What is a Debt-Service Coverage Ratio (DSCR)?

Also called the Debt Coverage Ratio, the Debt-Service Coverage Ratio (DSCR) is the ratio of cash a company keeps available for covering their debt as it relates to interest, principal and lease payments. A well known benchmark used to evaluate whether or not a company or individual can generate enough cash to cover their debt, the higher the ratio, the easier it is for the entity to obtain a loan. If you have heard this term before it was probably involved in a commercial banking transaction.

Depending upon the environment, personal or commercial, the DSCR can be the most important tool used to assess if a borrower will be able to sustain their debt. The ratio demanded by banks varies with the industry and the circumstance. Clearly, the banks will look for a ratio of more than 1.0 to insure their investment of capital. A ration of less than 1 indicates a negative cash flow.

The Equation is simple: Net Operating Income/Total Debt Service

While it is not impossible to obtain a loan with a negative cash flow, the company or individual must be able to show a strong source of external income. This income must be provable and consistent or obtaining the financing is unlikely.

When investing in companies you will want to see that the DSCR is over 1.0 as well. In fact the higher the DSCR the safer your investment is likely to be. Under most circumstances a positive debt-service coverage ratio (DSCR) is a sign of a healthy company.

Understanding Return on Investment (ROI)

The concept of return on investment (ROI) is a simple one. It is a tool used to evaluate the effectiveness of a particular investment in comparison with others. In the most global sense possible it is a way to measure what you will get back in comparison to what you put in. The formula used to determine the ROI is as follows:

ROI =(Your gain from Investment – Cost of your investment)/Cost of the investment

The gain from your investment relates to what you expect to obtain when you sell the investment involved.

Return on investment is a particularly popular tool for investors because it is simple and easy to apply. If you are looking at a potential investment and the ROI isn’t positive, you simple don’t put your money down. Alternatively, you search for the options that offer the highest potential ROI and put your money there.

The catch when using ROI as your major tool when investing is that the calculation can be manipulated in order to provide an inaccurate, and rosier, picture of a particular situation. Different investors account for the ROI differently; one may look at gross profit while another will prefer total value of resources. How the equation is manipulated is designed to suit the user’s needs.

If you choose to use return on investment as a one of your benchmarks then make sure you understand which figures are being used to generate the numbers. The Return on Investment (ROI) numbers are only valuable to you if you know how they were reached.

Time Deposits Reveal the Incentives for Sticking to Investments

Anyone who’s ever attempted to know how to get a how to get a high yield on a savings account knows that the price you pay for a large return is being unable to touch the deposit. While it’s apparent how an individual would see the benefits to this arrangement, the incentive for a bank to formulate such an agreement aren’t as obvious. Yet it takes no more than understanding the basis principles of banking to know why such institutions are willing to give you a higher interest rate on the basis that you don’t touch the money: it allows them to use the funds in your deposit for other purposes, and enables them to avoid having to plan for the possibility of that money being withdrawn. These perks are valuable to banks, and thus they will reward you with a higher interest rate.

It’s clear then, that there is a financial incentive attached to situations where money stays put for a significant length of time. In the world of investing, especially at a time when every stock option seems risky and everyone is telling you to diversify, this financial fact cannot be overlooked. There are big earnings potentials attached to the act of keeping your investments in one place for a long period of time, more so than in situations where it’s either been projected or flat-out expected that you’ll be pulling your capital out in a short amount of time. After all, it’s real money at the end of the day, and the companies and entities you invest in want to be able to use that capital to grow. When they know they can count on that being true, the growth process occurs at a much faster rate.

The bottom line reasons for sticking with an investment or choosing to sell it or dump it are very different from the reasoning behind whether or not to enter into a high yields savings situation. But the overall principle is the same. In exchange for forking over a large amount of capital today, you ensure that you are entitled to more money tomorrow, at least as long as the business itself survives that long. The only real difference is the risks involved; you’ll never lose your deposit and you’ll always net the interest in a bank, whereas investments are not so secure.

Hopping around from stock to stock won’t make a million dollars magically appear, because you’re completely neglecting the entire purpose of stock investments to begin with. The point of the stock market is to enable individuals to support a percentage of a company and in exchange have the potential of seeing the value of that percentage grow as the business grows with the money they invested. Just like a time deposit, the agreement to surrender today’s capital in exchange for the chance for more money in the future is a two-way street: you like this arrangement for the easy profit, while the institution likes it for the easy money.

Never let this cold hard fact about investing leave the forefront of your financial thinking.

Jenna is a journalism student at Saint Louis University. Upon graduation, she hopes to travel the world while producing compelling content for the masses. When she isn’t writing, you can find Jenna with her nose in a book, or her headphones in to block out the rest of the world.

Just What is A Leveraged Buy Out (LBO)?

You hear the term in the news often enough, but knowing what a leveraged buy out (LBO) is may have been beyond you until know. Simply put, a leveraged buy out involves the purchase of a company while using a large amount of borrowed funds. It is common that the assets of the purchased firm will be used as collateral for the borrowed funds as well as the assets of the purchasing company. This allows the company making the purchase to acquire large items without committing significant amounts of capital.

By using the strategy of a leveraged buyout the purchaser may put down as little as 10% equity. Not considered investment grade purchases, LBOs have a reputation of leading to eventual bankruptcies when managed poorly. The higher the leverage ratio the more likely bankruptcy is. LBO is considered a hostile maneuver since the company’s own assets are used against it as collateral by the opposing firm. If the bonds used in the purchase are not repaid the LBO may be challenged by the creditors under the belief that the transaction was a fraudulent transfer.

The size of a company has little to do with its vulnerability to a leveraged buy out. There are certain characteristics which are common to companies which are in danger of such a maneuver:

• A stable history with recurring cash flow
• Low debt loads
• Market conditions which make the stock appear depressed
• Significant hard assets which can be used for collateral
• The potential for new management to restructure after the leveraged buy out (LBO) is complete to increase profits

Anticipating Earnings Per Share (EPS)

As the name implies, the anticipated earnings per share gives investors a simple way to anticipate exactly what they will earn per share of stock they own. The Financial Accounting Standards Board demands that each company include in its income statements the EPS for each major category of income. These categories include continuing operations, discontinued operations, net income and any extraordinary items.

The simplest of the equations used to determine EPS is as follows:

EPS = Net Income – Dividends on Preferred Stock/Average Outstanding shares

For categories outside of continued operations or net income, the EPS formula does not include preferred dividends. Since the calculations are much more complicated in those categories, preferred dividends are removed from net income prior to the math being managed. It is also a result of preferred stock rights being higher on the totem pole than common stock. The monies set aside for preferred dividends are not used in the distribution of each share of common stock. To calculate things more accurately one uses a weighted average number of shares outstanding, which can change over time.

EPS is often considered the most important variable when share price is set. It is used to calculate price-to-earnings ratios, however, since capital is ignored in generating the figures. Companies with vastly different equity could end up with very similar earnings per share (EPS) numbers. The better choice would be the company which produced more with less equity. However, since it is possible to manipulate earning numbers more than one tool should be used to assess a stock or company.

You may also want to check out this EPS article.