Definition:

The Debt Servicing Ratio (DSR) is a financial metric that measures the proportion of an entity's income that is used to service its debt obligations, including interest and principal payments.

Formula:

DSR = (Net Interest Expense / Cash Flow From Operations) * 100

How to use the metric:

The Debt Servicing Ratio is used to assess the financial health of an individual or organization by determining how much of their income is dedicated to debt repayment. A lower DSR indicates a healthier financial position, as it suggests that a smaller portion of income is being used to cover debt obligations, leaving more available for other expenses or savings.

Limitations:

The DSR does not account for the variability of income or interest rates, which can affect the ability to service debt. It also does not consider the maturity structure of the debt, meaning it might not accurately reflect long-term financial sustainability. Additionally, it does not provide insight into the quality or terms of the debt.

Applies to:

The DSR is applicable across various industries, particularly in sectors where debt financing is common, such as real estate, manufacturing, and utilities. It is also relevant for personal finance assessments.

Doesn't apply to:

The DSR may not be as applicable in industries with highly volatile income streams, such as startups or technology firms, where income can fluctuate significantly, making the ratio less reliable. Additionally, industries that rely heavily on equity financing rather than debt may find this metric less relevant.

Summary:

The Debt Servicing Ratio is a useful tool for evaluating the proportion of income used for debt repayment, providing insights into financial health. However, it has limitations, such as not accounting for income variability or debt quality, and may not be suitable for industries with volatile income or those that rely more on equity financing.