November 26, 2018 By SmartBiz Team

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.

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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.

Calculating DSCR

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.

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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.

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