The Debt Service Coverage Ratio of company A is higher than that of company B. What does this indicate?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Company A is in better position to meet cash commitments.
The Debt Service Coverage Ratio (DSCR) compares the cash profit from the business with the cash needed for interest, preference dividend and loan repayments. A higher ratio means more cash is available for each rupee that must be paid.
Option (1) Company A is in better position to meet cash commitments. — Correct. A higher DSCR shows a better ability to meet cash commitments. Company A has the higher ratio.
Option (2) Company B is in better position to meet cash commitments — Incorrect. Company B has the lower ratio. So its position is weaker.
Option (3) The company A’s potential to increase debt component in its capital structure is lower — Incorrect. It is the other way round. A higher DSCR means the company can take more debt.
Option (4) The company B’s potential to increase debt component in its capital structure is higher — Incorrect. Company B has the lower ratio. So it has less room to add debt, not more.
NCERT (2026-27 Edition): “Debt Service Coverage Ratio (DSCR): Debt Service Coverage Ratio takes care of the deficiencies referred to in the Interest Coverage Ratio (ICR). The cash profits generated by the operations are compared with the total cash required for the service of the debt and the preference share capital. …” “A higher DSCR indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure.” |