What is Debt Service Coverage Ratio (DSCR): How is it Calculated

If you are planning to apply for a Business Loan, understanding your financial standing is crucial, and one of the most important indicators lenders look at is the Debt Service Coverage Ratio (DSCR). This simple yet powerful metric helps lenders understand whether your business generates enough income to repay its debts comfortably. In this blog, you will learn what DSCR is, how to calculate it, and how you can improve it. Read on!

What is Debt Service Coverage Ratio (DSCR)

The Debt Service Coverage Ratio is a financial metric that compares your business’s net operating income to its total debt obligations. In simple terms, it tells lenders if you earn enough to repay both the principal and interest on your loan without stressing your cash flow.

A DSCR greater than 1 means your business earns more than enough to meet its debt obligations. A DSCR less than 1 suggests a shortfall.

How to Calculate DSCR

Calculating DSCR is quite simple. Here’s the standard formula:

DSCR = Net Operating Income/Total Debt Service

Let’s break it down:

Net Operating Income (NOI): Your business’s total revenue minus operating expenses (excluding taxes and interest).

Total Debt Service: The total of your loan principal + interest payments over a given period (usually a year).

Sample DSCR Calculation Table: (Assign H2)

In the above example, your DSCR is 3, which means your income is 3 times your annual debt obligations. This puts you in a strong position for loan approval.  

Pros and Cons of Debt Service Coverage Ratio

Understanding the strengths and limitations of DSCR will help you make better financial decisions.

Pros:

• Lender-friendly Metric: It’s a standardised and easy-to-understand indicator.
• Performance Snapshot: Offers a clear picture of your business’s ability to handle debt.
• Risk Reduction: Helps you assess whether taking a new loan is financially viable.

Cons:

• Doesn’t Show the Full Picture: DSCR focuses only on income and debt, not on other obligations like tax dues or CAPEX.
• Can Vary Across Industries: A good DSCR may differ depending on your sector.
• Sensitive to Accounting Methods: The way you report expenses can impact your DSCR value.

Factors That Influence DSCR

Multiple factors can impact your DSCR. Therefore, understanding them gives you more control over your financial profile.

• Revenue Fluctuations: Any dip in revenue directly lowers your net operating income, reducing your debt service coverage ratio.
• Loan Interest Rates: Higher rates increase your total debt service, pulling your DSCR down.
• Operational Efficiency: Leaner operations mean lower expenses, which improves your net operating income and debt service coverage ratio.
• Debt Structure: Loans with higher EMIs reduce DSCR, while longer tenure loans can improve it.

Tips to Improve Your DSCR Before You Apply for a Business Loan

If your DSCR is lower than what lenders expect, don’t worry! You can take steps to improve it before applying for a loan.

• Increase Your Revenue: Explore additional revenue streams or focus on high-margin products or services.
• Reduce Operating Expenses: Review your costs regularly and eliminate inefficiencies.
• Delay Non-essential Expenditures: Temporarily postpone large purchases or expansions to maintain stronger cash reserves.
• Restructure Existing Debt: Consolidating or refinancing high-interest loans can lower your total debt service.
• Choose the Right Loan Tenure: Opt for a longer repayment period to reduce EMI burden and improve DSCR.  

To Conclude

DSCR plays a crucial role in shaping your business’s loan eligibility. It not only helps lenders evaluate risk but also gives you insights into your financial stability. So, before you apply for a Business Loan, take time to assess and strengthen your debt service coverage ratio. A few smart financial decisions today can unlock better funding opportunities tomorrow.

If you’re looking to expand your venture with a hassle-free loan, Poonawalla Fincorp offers a Business Loan of up to ₹75 lakh with a flexible repayment tenure of up to 48 months. Apply now and enjoy the benefits today!

Frequently Asked Questions

1. What is DSCR, and why is it important for a Business Loan?

DSCR (Debt Service Coverage Ratio) measures your business’s ability to repay its debt using its net operating income. Lenders use it to assess your loan repayment capacity and overall financial health.

2. Can DSCR vary by industry?

Yes, acceptable DSCR levels can vary depending on the industry. Capital-intensive sectors may have lower DSCR thresholds compared to service-based businesses.

3. Is DSCR the only metric lenders consider?

No, while DSCR is crucial, lenders also consider credit scores, collateral, business vintage, and overall financial statements.