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What is a Debt-Service Coverage Ratio?

For the entrepreneur seeking financing to grow a business, financial ratios take on heightened importance. Of course, ratios are crucial in measuring the health of your business, but when you are applying for business loans, ratios are also one of the yardsticks lenders will use in determining whether your company is eligible for a loan, how big the loan can be and what loan terms they will set. One of the financial ratios that every small business owner should understand is the debt-service coverage ratio.

What is a Debt-Service Coverage Ratio?

The term is used in many contexts, including government finance and personal finance, and means something slightly different in each case. However, in a business context, the debt-service coverage ratio (DSCR), sometimes called the debt coverage ratio (DCR), is the ratio of cash a business has available for servicing its debt, including making payments on principal, interest and leases.

Why is the Debt-Service Coverage Ratio Important?

The debt-service coverage ratio is one of many financial ratios that lenders assess when considering a loan application, and it is crucial to any small business owner seeking to obtain a business loan. A huge consideration for any lender is whether the loan recipient will be able to pay back the loan or not. Lenders don’t want to lose their investments, so they seek reassurance that your business has generated—and will continue to generate—enough income to pay back the loan with interest.

In fact, lenders also want to see that you have some “cushion”—cash flow above and beyond the minimum needed to pay off the loan.  If you barely generate enough income to cover the debt service, your business is not doing well enough to warrant a loan.

Every lender has a minimum debt-service coverage ratio requirement for approving a business loan. In general, this needs to be 1.25 or more. In some cases (when the economy is doing great) they might accept a ratio as low as 1.15, but in others (when the economy is tight) they may require a ratio of 1.35 or even 1.5. The higher your ratio, the better your chances of getting a business loan in any economy.

Before approaching a lender for a business loan, you need to calculate your debt-service coverage ratio and take steps to improve it if it’s not up to par. The financial projections in the business plan you present to prospective lenders should include the debt-service coverage ratio for the next three years. In addition, if you have a growing business or are seeking a loan to buy an existing business, the lender will want to see debt-service coverage ratios for the past three years. That way, they’re not just relying on projections, but can see evidence that your business is thriving.

How Do You Calculate Debt-Service Coverage Ratio?

So how do you calculate your company’s debt-service coverage ratio? There is no one answer to this, as different lenders may calculate the figure differently. Essentially, the ratio is calculated by dividing total annual net operating income by total annual debt service. The two most common ways of calculating this are:

Annual Net Operating Income + Depreciation & Other Non-Cash Charges /

Interest + Current Maturities of Long-Term Debt


EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) /

Interest + Current Maturities of Long-Term Debt

These calculations will give you a figure that should be taken to the second decimal point. For instance, if your business’s total annual net operating income is $20,000 and you are applying for a loan whose debt service will cost $16,000 annually, your debt service coverage ratio is 1.25 ($20,000/$16,000).

Bear in mind, of course, that the lender will also consider any current debt service you have before applying for the loan, so you need to figure that into the calculation. In the example above, if you already had debt service of $4,000 annually, taking on a new loan with debt service of $16,000 would bring your total annual debt service to $20,000. Your debt-service coverage ratio would drop to 1.0.

This is not enough to obtain a loan, unless you are able to use financial projections to convince the lender that getting the second loan will enable you to increase net operating income to a point sufficient to boost your debt-service coverage ratio to respectable levels. This can be challenging to do.

Monitoring Your Debt-Service Coverage Ratio

Clearly, maintaining a good debt-service coverage ratio is important whether or not you are applying for a loan. Your ratio will not only affect your ability to get financing in the future, but can also determine whether the lender calls your loan early. Maintaining adequate debt-service coverage ratio will be part of any loan agreement you come to.

In order to make sure you are staying within the terms of your loan agreement, lenders will typically require you to measure your debt-service coverage ratio every year—usually shortly after your business’s fiscal year-end. To ensure your debt-service coverage ratio doesn’t decline, causing you to violate your loan agreement, you should monitor it more often—quarterly, or even monthly—so you can maintain the ratio that’s needed.

Be sure you understand exactly how your lender calculates your debt-service coverage ratio so you can make sure you are using the same measures. You can find many free debt-service coverage ratio calculators online, but if the calculator doesn’t use the same parameters your lender does, you won’t get a correct ratio.

Now that you understand the importance of a healthy debt-service coverage ratio, take steps to protect it. By monitoring and maintaining your debt-service coverage ratio, you will stand a better chance of getting (and keeping) the small business loan you need to grow your company.



Rieva Lesonsky

Rieva Lesonsky

Contributor at Fundera
Rieva Lesonsky is a small business contributor for Fundera and CEO of GrowBiz Media, a media company. She has spent 30+ years covering, consulting and speaking to small businesses owners and entrepreneurs.
Rieva Lesonsky