If you are a small business owner who has ever thought about growing your operations with a loan, one important financial metric you will need to be aware of is your Debt Service Coverage Ratio (DSCR). Calculating this ratio can sound intimidating, but it is a crucial step to understanding your financial health and your ability to make loan payments. In this blog post, we’ll help you understand the basics of the DSCR formula and how to calculate it accurately.
What is a Debt Service Coverage Ratio (DSCR)?
The DSCR is a financial metric used by lenders to assess the amount of cash flow that is left after a borrower has made their debt payments (such as loan repayments, lease payments, and other financial obligations) that can be used to cover future debt payments. A high DSCR indicates that a borrower is capable of comfortably meeting their loan repayments, while a low DSCR indicates a higher risk of missed payments and financial difficulties.
The DSCR Formula
A typical DSCR formula is:
DSCR = Net Operating Income (NOI) / Total Debt Service (TDS)
- Net Operating Income (NOI) = Gross Operating Income – Operating Expenses. Gross Operating Income is the total revenue you earn from your business, while Operating Expenses include all expenditure incurred to operate and maintain the business.
- Total Debt Service (TDS) is the total amount of repayment that is due during a specified period (i.e., your total loan amount). It includes both principal and interest payments.
Understanding Your Debt Service Coverage Ratio
Generally, lenders like to see that your business has a DSCR of 1.2 or higher, as this indicates that you have enough cash flow to cover your loan repayments and still have some left to cover unforeseen expenses, expansion plans, or other investments.
However, lenders may have different requirements for minimum DSCR, especially depending on the nature of your business, the loan amount, location, and other factors. It’s always best to check with the lender you’re applying to and cross-check with a financial advisor to know the ideal DSCR for your business.
Calculating your Debt Service Coverage Ratio (DSCR) is a critical step to understanding your financial health as a small business owner. By having a better understanding of your DSCR, you can accurately forecast your ability to meet your loan repayments and make informed financial decisions for your business. The DSCR formula may seem complicated at first glance, but with a bit of guidance and practice, it will become an easy calculation that will help you improve your financial viability to lenders.