The DSCR is a key financial metric used to assess a company’s ability to repay its debts.
It measures the cash flow available to make debt payments. But it is only one of the many factors considered to determine if a business owner can take on a loan.
The Debt Service Coverage Ratio can also tell a lot about how you manage your business and its future financial value.
In this article, you’ll learn everything you need to know about this valuable business measurement.
What Is Debt Service Coverage Ratio?
DSCR stands for Debt Service Coverage Ratio.
It is the ratio of operating income available to debt servicing for interest, principal, and lease payments.
In other words, it measures a company’s ability to generate enough cash to cover its debt obligations.
It is also known as the “debt coverage ratio.”
A high DSCR indicates that a company can repay its annual debt payments. A low DSCR suggests that a company may have difficulty repaying its obligations or has too much debt.
What Is A Good DSCR?
A good DSCR depends on your industry, as not every business is the same, but as a good rule of thumb, having a DSCR above 1.25 is good, but if it’s below 1.00, it means you probably have financial difficulties.
Learn to also calculate your debt-to-credit ratio
Debt Service Coverage Ratio Formula
The Debt Service Coverage Ratio (DSCR) is the net operating income divided by total debt service.
DSCR = Net Operating Income / Total Debt Service
Net operating income measures a company’s financial performance, calculated as operating income after deducting interest and taxes.
Total debt service is the sum of all payments on outstanding debt minus interest and principal payments.
For example, let’s say a company has an operating income of $100,000 and pays $10,000 in interest payments and $20,000 in annual debt service.
Its DSCR would be calculated as follows: $100,000 / ($10,000 + $20,000) = 1.5. This means the company has 1.5 times more operating income than it makes debt payments, which is considered healthy.
Common Mistakes When Calculating the DSCR
People make a few common mistakes when calculating the debt service coverage ratio (DSCR). Here are three of the most common ones:
- Not taking into account all of the debt payments
- Incorrectly calculating the income or revenue figures
- Not adjusting for inflation
By avoiding these mistakes, you can ensure that your DSCR calculation is as accurate as possible.
A DSCR calculator considers the company’s annual income, debts, and interest rates. Then figure out how much you have left over each year after making all the payments. This number is the company’s DSCR.
An online DSCR calculator that you can use is the dscr-calculator. This calculator lets you input the debt amount, annual interest rate, and principal payments. It will then calculate the DSCR for you.
Why Is The Debt-Service Coverage Ratio Important?
A low DSCR may indicate if your business struggles to generate enough revenue to cover its debt payments, which could be a warning sign for lenders.
It can also give you an early indication of financial distress. If a company’s DSCR starts to decline, it may need to take steps to improve its financial situation before it becomes difficult to obtain new financing.
What Is The Debt Service Coverage Ratio Used For?
The following can use the Debt Service Coverage Ratio:
- Small business owners to assess their business’ ability to make debt payments and evaluate their company’s growth possibilities
- Lenders to determine if they should approve a loan to a small business (they do if the applicant can repay the loan)
- Investors assess a small business’ financial stability and decide if the investment is risky or worthy
Pros And Cons Of DSCR
It is an excellent measure of a business’s ability to repay its debts.
- It takes into account both the business’s operating income and its debt payments.
- DSCR is a standard metric used by lenders to assess a loan applicant’s creditworthiness.
- It’s easy to calculate and understand.
It is not a perfect measure of a business’s financial health.
- It does not consider a business’s assets, which you can use to repay debts in the event of financial difficulty.
- It also does not consider a business’s ability to generate future income, which is essential for repaying debts over the long term.
- Finally, DSCR does not consider the interests on a business’s loans, which can impact its ability to repay its debts.
Ways To Improve Your DSCR
By improving your DSCR, you’ll make it easier for your business to obtain financing in the future and grow.
- Increase your sales. You can do this by expanding your customer base, increasing the frequency of purchases, or selling higher-priced items.
- Reduce your expenses. You can do this by negotiating better terms with suppliers, cutting costs in other business areas, or improving your operational efficiency.
- Finally, you can also improve it by reducing the amount of debt.
- The last option is to refinance your current debt obligations to reduce your interest payments.
Apply For A Business Loan!
You can use a Camino Financial loan to refinance debt.
Different Types Of DSCR
There are two types of Debt Service Coverage Ratios:
- Gross Debt Service (GDS)
- Total Debt Service (TDS)
When you apply for a business loan, many lenders use both as a preliminary assessment to determine if you are already in debt.
Gross Debt Service Ratio Formula
This percentage shows your current housing or property debt issues.
To determine your GDS, you’ll need to add the principal, interests, taxes, and utilities and divide it by your gross annual income. Then multiply that sum by 100, and you’ll have your GDS ratio.
GDS = Principal + Interest + Taxes + Utilities / Gross Annual Income
What Is A Good GDS?
Lenders use the GDS as a framework on whether it’s appropriate to lend to people like you.
Favorably, this number should fall below 30% to prove you’re not overwhelmed with debts.
Even just a few percentage points above this can mean you have far too many unacceptable expenses at the moment to safely borrow from a lender.
For instance, if you have to pay $12,000 a year in mortgage and several thousand dollars per year in property taxes, you’ll need to have an income above $50,000 to avoid going into debt. A lower income will be a red flag for a business loan.
Total Debt Service Ratio Formula
Your TDS ratio is the percentage of your income needed to cover all of your debts.
It is similar to the GDS, except that it considers all your monthly debts (not just housing). This includes car payments, credit cards, alimony, and any loans.
To calculate your TDS ratio, add all of your monthly debts and divide that figure by your gross monthly income. Then multiply that sum by 100, and you’ll have your TDS ratio.
TDS = ( Monthly debts / Gross monthly income ) x 100
What Is A Good TDS?
You need to fall under 40% on the total debt service ratio to properly qualify for a loan.
Interest Coverage Ratio (ICR) vs. DSCR
Both ratios are essential for assessing a business’s finances, but each provides different insights.
As we’ve explained, the DSCR measures the ability to make its loan payments out of its cash flow.
On the other hand, the ICR looks at a company’s earnings before interest and taxes (EBIT) in relation to its interest expenses. This ratio assesses a business’s ability to generate enough income to cover its interest payments.
A high ICR indicates that a company has plenty of earnings to cover its interest payments. In contrast, a low ICR suggests that the company may have difficulty meeting its debt obligations.
Both the ICR and the DSCR are important ratios for assessing a company’s financial health.
If You Have A Healthy DSCR, Apply For A Loan
If you have a healthy DSCR, you can take on new debt. A business loan can help you finance growth or take advantage of opportunities as they come up.
You can use a business loan for a variety of purposes, including:
- Hiring new employees
- Strengthening your cash flow
- Purchasing new equipment
- Opening a new location
- Expanding your product line
Whatever your needs, there’s a good chance that a loan can help you meet them.
At Camino Financial, we offer small business loans with competitive rates and flexible terms.
We understand that every business is different, so we work with you to tailor a loan that meets your specific needs.
We encourage you to get started today if you’re interested in applying for a loan. The application process is quick and easy, and you can have the funds you need in 2 to 10 days.Apply now!
What is DSCR?
DSCR stands for Debt Service Coverage Ratio. It measures the ability to meet debt obligations.
The higher the ratio, the more likely the company is to be able to repay its debt. To calculate it, divide a company’s Operating Income by its Total Debt Service. (This includes the principal and interest payments on a loan).
How do banks use the Debt Service Coverage Ratio?
The Debt Service Coverage Ratio is a key financial metric that banks use to determine a business’s ability to repay its annual debt payments. Banks will typically only lend money to companies with solid ratios.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Because it strips out certain non-operating expenses, such as interest and taxes, which can give a false impression of a company’s profitability.
It is often used with the Debt Service Coverage Ratio because the DSCR provides a more accurate picture of a company’s ability to repay its debts.
What are some factors that can impact a company’s DSCR?
Some factors that can impact a business’ Debt Service Coverage Ratio include:
What does a 1.25 DSCR mean?
A 1.25 DSCR means that for every $1 of debt the company has, it generates $1.25 of income. It is a healthy Debt Service Coverage Ratio.
Debt Service Coverage Radio vs. Debt Service Reserve Account
A debt service reserve account (DSRA) is an account that a borrower may set up with a lender to contain funds sufficient to pay debt service on certain types of loans.
The two are not mutually exclusive – a company can have both a DSCR and a DSRA. A DSCR measures how easily current earnings cover current interest payments. A DSRA measures how easily future cash flows will cover future interest payments.
What is a DSCR loan?
A DSCR loan is a type of loan designed for businesses with difficulty making debt service payments.
A DSCR loan is a loan that uses this metric. This is to help businesses struggling to make monthly debt service payments.