Debt Service Coverage Ratio and Financial Health
The amount of debt service coverage that your debt management company offers you is one of the most important considerations when choosing a debt consolidation company. A low debt service ratio (DOC) often indicates that the debt organization is generating too little operating revenue to service its minimum debt obligation per month. As a practical matter, an optimal ratio is approximately 2.5:1.
A debt service coverage ratio of less than 2.5:1 indicates that the company is generating insufficient operating revenue to service its minimum monthly debt obligations. Ideally, a ratio of more than 2.5:1 would indicate a company that is leveraging its assets appropriately. Typically, a property type organization will have lower ratios than a service organization. A typical ratio for a property type business is around 1.25x. Obviously, a ratio closer to or just below this range indicates a company is leveraging its assets in order to service a greater number of debt accounts than would be possible if the organization was operating under more normal operating conditions.
The best way to improve a debt service coverage ratio is to provide the borrower with better operating conditions. For example, if there are positive operating profits, the operating profit margin can be used as a positive leverage point for the debt management organization. Ideally, the operating profit should be greater than 40% of the total company’s overall profits. As a practical matter, a ratio close to one: one indicates a company is leveraging its assets to service a smaller number of debt accounts than would be possible without the use of these assets.
The debt service coverage ratio is a very important measure of the profitability of a debt management organization. It measures the ratio of interest expense to principal. The two factors, interest expense and principal, are the two components of profit for any business. Ideally, a company should not allow its interest expenses to exceed the amount of principal.
The third step in improving a ratio such as this one is to reduce the size of the working capital accounts that provide these financing sources. A company’s operating expenses, primarily the fixed costs of manufacturing and distributing goods, must be replaced with costs of production and sales. The company’s selling and administrative expenses, which include salaries and wages of the employees, need to be replaced with costs of doing business. As stated above, the operational profit of a company should not exceed the amount of principal that is outstanding. When it comes to reducing the size of the operating income accounts, there are several options to consider.
For businesses that have a large number of credit card accounts, calculating the ratio between principal and outstanding debt service on each account would be very difficult. There are two solutions to the problem that do not require the use of individual credit reports. The first solution is to contact all the accounts that are reported individually to a credit bureau. The second solution is to calculate the ratio by manually entering the information each time. The manual method would require the borrower to enter the information three or more times, which could lead to inaccurate data entry and an incorrect computation of the ratio.
In some cases, the financial analyst will meet with the management team of the bank where the borrower obtains a loan. During this meeting, the borrower will be able to discuss the possibility of a debt restructuring. If a financial analyst feels that it is necessary to proceed with a debt restructuring, the financial analyst may discuss payment of principal at a lower interest rate. Although the banks typically prefer to avoid taking on too many unsecured loans, they may agree to a reduced interest rate if it means that they are less likely to default on the debt obligations. Another option that the financial analyst may try is to reduce the number of credit card accounts that are being held by the borrower.
This option is usually preferable for borrowers with reasonable credit histories. A borrower should calculate his/her current debt to income ratio. The debt to income ratio calculates the total amount of money needed to service the interest, make payments, and any other expenditures. Once the borrower has calculated the current debt to income ratio, he/she can determine the optimal amount of payments to be made to reduce the current debt to income ratio. In addition, the financial health of the borrower can be improved by increasing the payment frequency and reducing the total number of credit card accounts that are held.