DSCR – Debt Service Coverage Ratio
DSCR – The debt service coverage ratio is a financial ratio that measures a company’s ability to service its debts by comparing operating income to total debt service obligations. In other words, this ratio compares a company’s available cash with its current interest and loan principle commitments.
DSCR is a key ratio used by most commercial lenders, adversely it is rarely used by businesses prior to seeking borrowing.
By not using DSCR before applying for finance the business risks;
- The lender not understanding the impact of your new borrowing and how affordable it really is
- The lender not appreciating what outgoings you have which will not continue after your new borrowing
- Being refused borrowing because the lender thinks you cannot afford the repayments
Because of this we think it is important for companies to have an understanding of the Debt Service Coverage Ratio.
How DSCR Works
First things first, it is not about profit on it’s own, it is not about measuring the new loan costs against your net profit. The reason why is that profit never repaid any loan, cash makes the repayment happen, not profit.
Lenders have varying requirements of debt service cover. For the best lending terms you would need to have debt service cover of 200% or 2 x the costs of the loan. It is worth noting that lenders will often stress the interest rate, meaning that they will measure your affordability against a much higher interest rate than you will be paying.
To get a basic understanding of DSCR;
- It takes the net profit before tax
- Adds back in all non-cash costs such as depreciation
- Adds back in all costs which will no longer be payable (such as rent if buying the same property, or interest of a loan being consolidated)
- Takes this figure then divides it by the total capital & interest cost of your new borrowing
This figure should be at least 100% or 1 x otherwise you do not have enough spare cash to meet your loan commitments.
It is important that the business communicates and shows which costs will no longer be payable. Sometimes this needs consideration as some costs which could be taken off are not easily identifiable by a third party, things like one off costs that will not be repeated or where there has been an increase in rent mid year.
To make things a little easier you can download a DSCR template in excel or open office format below. Use this as a guide to DSCR remembering that every lender looks at things a little differently, use the DSCR template as a guide and use it with your lender if approaching them direct.
We use this template to help guide which lender will offer the best commercial loan terms to your business. Just because the DSCR ratio may fall below 100% does not mean you cannot borrow, it just means you may need a little more assistance in the process.
Any queries regarding using this downloads then please get in touch.
By Dave Farmer