What is Debt Service?
How Does Debt Service Work?
For example, let's say Company XYZ borrows $10,000,000 and the payments work out to $14,000 per month. Making this $14,000 payment is called servicing the
Borrowing allows companies to make investments without having to commit a of their own , but the even greater purpose is to maximize shareholder value. As in personal finance, too much can be a very, very bad thing, but a little can go a long way. For most investors, it is thus usually unwise to avoid in companies with ; the trick is to find companies that manage their well.
This is why companies must consider how service fits into their expansion plans if they're using to the expansion. For example, if Company XYZ is using its borrowed $10,000,000 to build a factory that won't produce anything for five years, how it service the between now and then? In other words, where it scrape up the for those $14,000 payments until the factory is online? And is it sure that the factory generate at least $14,000 per month once it is online? This is the risk that companies take with .
Why Does Debt Service Matter?
Companies that bondholders with set interest and payments on specified dates, and in some cases, must be willing to convert that into equity at specified ratios or repay the early if certain events occur. When a debtor fails to service its , the debtor is sometimes considered in default. In some cases, even the that a debtor might not be able to service its can cause its price to go down and make it very difficult to obtain financing or other help later.
Because debt service responsibilities can vary among similar companies, some financial measures, particularly EBITDA, intrinsically exclude structures in their calculations so comparisons can be made more directly.