It is valuable for business owners to understand various financial benchmarks lenders use when evaluating the risk of making a loan to your business. There are many ratios that lenders evaluate, but when it comes to buying real estate and long-term assets, the debt service coverage ratio (DSCR) is perhaps the most critical.
DSCR is the ratio of debt your company currently has and will have when the proposed loan is made to the net operating income (NOI) of your business. It is a ratio that is typically measured and projected on an annual basis. It is a effective measurement of your company’s ability to repay the proposed loan.
Before you can calculate the DSCR you must first calculate NOI.
The first part of understanding NOI is that is the income from the total company once the proposed loan has been made minus the operating expenses the company currently has minus the proposed operating expenses. Here is an example NOI calculation:
Additional Income after Loan
Allowance for Contingencies (5%)
Projected Gross Income
Cost of Goods Sold
Sales, General and Administrative
Total Operating Expenses
Net Operating Income (NOI)
1 Operating expense categories have been simplified for easy understanding.
2 Interest expenses are not included in the NOI calculations.
Once you have computed your NOI, it is necessary to compute your current and proposed amounts for loan repayment (debt service).
Loan Balance (26 mo remaining)
Annual Payment Total
Proposed Loan (10 year,120 mo.)
Interest Rate: 8.25%
Annual Payment Total
Total of All Loan Repayments
Here is the DSCR calculation: NOI/Annual Debt Service = DSCR
In our example the calculation looks like this: 213,750/166,758 = 1.28
A DSCR of 1.0 means that the business has exactly the same amount of money for annual debt service as it will take. Sometimes this is called “breakeven.”
In today’s climate, lenders are seeking a DSCR of at least 1.25 or greater. In my example above, the loan does “debt service” but it is at the very low end of acceptability. Some lenders will consider making a loan when the DSCR is less than 1.25, but there must be strong mitigating circumstances such as very strong personal guarantors or other facts about the business and loan that mitigate the low DSCR.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
You may contact Sam directly at: firstname.lastname@example.org
or follow him on Twitter: SMBfinance
EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his Ask the Expert podcast show.