How it works
For each period, DSCR_t = CFADS_t / DS_t. CFADS_t is the cash flow available for debt service in period t, meaning revenue less operating costs, tax and working capital changes, before any payment to lenders. DS_t is the debt service due in the same period, interest plus principal. A ratio of 1.30 means the project earned $1.30 for every $1 it owed. Lenders test it every period, usually every six or twelve months, and track the minimum and the average over the life of the loan.
In project finance the ratio also sizes the loan. The lender sets a target DSCR and applies it to a cautious production case, often P90. Debt service in each period is then capped at CFADS_t ÷ target. This is called sculpting, and it makes repayments follow the shape of the cash flow. The largest loan the project can carry is the present value of those capped payments at the loan's interest rate. Loan agreements add two lower thresholds. Below a lock-up level the owner cannot take dividends, and below a default level the lenders can act.
Why it matters
DSCR decides how much a project can borrow, and so how much equity the owner must put in. A lower required ratio, or a steadier cash flow, means more debt and a higher equity return. Lenders usually accept a lower ratio on contracted revenue than on merchant revenue, because it is more certain. Buyers have a stake too. A seller close to breaching its covenants has less room to absorb a dispute, a curtailment or a late payment.
A worked example
A wind farm's cash flow available for debt service in a P90 year is $13 million. The lender requires a DSCR of 1.30, so annual debt service can be at most 13 ÷ 1.30 = $10 million. For a 15-year loan at 6% with level payments, the annuity factor is (1 − 1.06^−15) / 0.06 = 9.712. The maximum loan is 10 × 9.712 = $97.1 million. On a $150 million project, that is 97.1 ÷ 150 = 65% debt.
Illustrative figures.
Across markets
Indian lenders often size debt by a debt-to-equity ratio, commonly around 70:30 or 75:25, as well as by DSCR, and offer long tenors. In the US, many projects carry tax equity, and the term loan sits behind it as back-leverage, sized on the cash left to the sponsor. In Europe, projects with a government contract for difference or a corporate PPA usually get lower coverage targets than those selling into the market.