The business debt service coverage ratio is a metric that reveals a business’s ability to take on a loan based on its income. Learn more about this calculation and what it means for your loan eligibility.
What is the Debt Service Coverage Ratio?
The debt service coverage ratio (DSCR) helps lenders determine whether a business can take on a loan. The calculation is based on the business’s available cash flow when compared to its debt. This is one of the key metrics used to assess your eligibility for small business financing.
In order to get an understanding of a business’s ability to cover a loan’s principal and interest, the debt service coverage ratio is usually calculated on a yearly basis. Dividing your annual net operating income by your business’s total debt service will return a number that’s typically between 0 and 2.
Debt Service Coverage Ratio = Net Operating Income ÷ Total Debt Service
If your business’s debt service coverage ratio is 1, that means it can cover exactly 100% of the yearly loan payments.
This means that to take out a loan that totals $100,000 in principal and interest, for example, a business should have at least $100,000 in net operating income to get a business DSCR of 1 or higher.
Learn more about calculating DSCR from our Lending Manager, Kevin!
The DSCR and Business Loans
Lenders usually have their own unique requirements for assessing your business’s financial health. Typically, having just enough income to cover expenses, meaning a DSCR of 1, is the minimum when qualifying for a business loan. The higher the ratio, the better your chances at getting approved for the best loan terms. For example, a DSCR of 1.25 shows lenders that your business has some breathing room when it comes to taking on debt.
Improving your DSCR
Hoping to bring up your DSCR so you can qualify for low-rate, long-term financing like an SBA loan? Three general measures you can take are increasing business revenue, decreasing expenses, and lowering business debt. If you’re looking for personalized recommendations specific to your unique business situation, sign up for SmartBiz Advisor today. This free, educational tool can help you assess where your business stands based on our bank partners’ key criteria such as the DSCR. We’ll break down all the metrics you need to know, as well as give you the resources you need to qualify for the funding you deserve.
* The information provided through SmartBiz Advisor, including the Loan Ready Score, is for educational purposes and is not the same as scores used by lenders for credit decisions. SmartBiz Advisor is not a financial or legal advisor as defined under federal or state law. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances or credit history.