Debt Service Coverage Ratio (DSCR) is an important measuring stick that helps you qualify for a small business loan, line of credit, or other form of financing. DSCR is the measurement of your business’s ability to repay your debt, or potential debt. It’s calculated by dividing your net operating income by your total debt and interest payments.
Typically, if you don’t meet minimum DSCR requirements you won’t qualify for the loan even if your credit score and revenue are both strong. Your DSCR number will not only determine if you qualify, but it could also impact the amount of a loan you’re approved for and what your loan terms look like. It’s a pretty important measuring stick to be aware of.
How to Calculate Your Debt Service Coverage Ratio (DSCR)
Your Debt Service Coverage Ratio sounds like a big accounting term that is difficult to understand, but it’s very easy to calculate. You can calculate it in just three steps if you know how to begin, and each step contains information you should readily have available in your business’s books.
Calculate your DSCR by following these 3 steps:
Step 1: Calculate Your Business’s Annual Net Operating Income
Your net operating income is your revenues minus your operating expenses. You do not include taxes, interest payments, depreciation, or amortization. This calculation is very similar to Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). Those excluded expenses are added back in when calculating your net income.
Step 2: Calculate Your Current Business Debt Obligations
Add up all of the payments you’re going to make for any current debt and combine it with your potential loan payments with any new financing you’re applying for. If you’re refinancing a current loan then you should calculate your new potential payment, and not what you’re currently paying.
Step 3: Divide Net Operating Income By Current Debt Service
You now simply divide your net operating income from step 1 by you debt service in step 2. This will give you your debt service coverage ratio.
Debt Service Coverage Ratio Example
Let’s take a look at an example of how this calculation works. Let’s say your net operating income is $200K and your current debt obligations are $100K. That gives you a DSCR of 2.0 (200,000 / 100,0000).
What DSCR Score Do I Need?
Typically, if you care about your DSCR it means you’re trying to get financing either now or in the near future. All lender evaluate your Debt Service Coverage Ratio a little differently so the required score is going to vary by lender. The key to being successful in getting financed is that you have plenty of income to pay any upcoming debt obligations, including the new loan.
You are generally going to be safe in meeting all lender’s DSCR requirement if you have a score of 1.25 or more. This means that you have 25% more income than you need to fulfill all of your debt obligations even with the new loan you’re taking out. This score, for instance, is a requirement for an SBA loan and it should be enough breathing room for most lenders to approve your loan.
The Smart Hack
You can improve your DSCR by either improving your revenues or decreasing your expenses and debt obligations. If you’re getting ready to take out a loan then you should be eliminating extra or non-essential expenses already. You should be safe to get the financing you need if you have a DSCR of 1.25 or more.