DSCR: Another Factor in Qualifying for Loans
DSCR stands for Debt Service Coverage Ratio. Lenders use DSCR among other financial factors, such as credit scores, past bankruptcy reports, collateral to assess borrowers.
Your DSCR can be calculated by dividing your net operating income by your total debt.
DSCR = Net Operating Income / Total Debt
Rule of Thumb: Keep DSCR above 1.0
All businesses whose DSCRs are greater than 1.0 are able to prove that they can handle their current debt responsibilities because they generate enough income to take on these payment burdens. In fact, many lenders want to see at least a 1.25 debt ratio to ensure that the business will be able to stay afloat and manage payments even if cash flow hits a lull or the business incurs an unexpected expense.
Let’s say your monthly revenue is $50,000, but between rental payments, staff wages, equipment expenses, utilities, debt payments, and taxes, it costs your business $34,000 to operate each month; so your total net operating income comes to $16,000. If your total debt service is $8,000 each month, you will have a DSCR of 2.0, which puts you in a strong financial position to receive a loan.
Example: Net Operating Income [$50,000 (Total Revenue this Month) – $34,000 (Costs this Month)] = $16,000 (Operating Income) / $8,000 (Monthly Payments on Loans) = DSCR of 2.0
If your business’s current ratio is below 1.0: You are probably better off waiting until your revenue picks up (or your debt is payed off) before applying for a loan.
Please note: some lenders calculate DSCR differently than others. It’s a good idea to ask lenders how they calculate these ratios so that you can stay on top of your own ratio through the fiscal year.
If you are interested in learning more about calculating your business’s DSCR, learning strategies to increase your ratio, or simply want to learn more about the typical questions lenders ask regarding DSCR, do not hesitate to reach out to the Currency team to ask for guidance. Currency’s team is comprised of experts who are always ready to offer financial guidance based on your business’s unique needs.