Debt-Service Coverage Ratio

• Debt-service coverage ratio (DSCR) looks at a company’s cash flow versus its debts.
• The ratio is used when gauging a business’s ability to pay off current loans and take on future financing.
• If your DSCR isn’t high enough, you can improve it by upping your income or lowering your debt.

In a business context, debt-service coverage ratio (DSCR) is a metric that compares a company’s cash flow against its debt obligations. Business owners and investors can use DSCR to understand if the company is generating enough net operating income to cover existing debts, including principal and interest.

DSCR can help inform future business decisions, including whether a company has the financial ability to repay its existing business loans and take on further debt. It also helps lenders assess the strength of business loan applications and how much risk they’ll take on by lending to you.

How to calculate debt-service coverage ratio

There are two main components in how to calculate DSCR: a company’s annual net operating income and its annual debt service. The formula for determining a company’s DSCR is:

Net operating income / Debt service

So, how do you calculate each of these components? For net operating income, you’ll want to look at the business’s pre-tax revenue minus operating expenses, such as wages, rent and cash taxes, for a given period:

Net operating income = Revenue – Operating expenses

Debt service, on the other hand, is the total of all existing debts owed by the company due in the same period. This should include all interest and principal.

The bottom line

Whether you’re preparing to secure another round of financing or you just want to take a better look at your company’s financial well-being, understanding DSCR’s meaning is a useful exercise. If it’s not quite where it needs to be, there are ways to improve it. Start by turning your efforts toward driving revenue while reducing expenses and existing debt.