What Is the Debt Service Coverage Ratio (DSCR)?
There are many different tools used for assessing loan eligibility. One of these tools  the debt service coverage ratio (DSCR)  can help lenders get to the root of the matter: will this business be able to repay the loan in full and on time. Find out everything you need to know about the debt service coverage ratio formula with our comprehensive guide, starting with our debt service coverage ratio definition. Debt service coverage ratio definition  Put simply, the debt service coverage ratio is a measurement of a companys ability to use their operating income to repay their short and long-term debt obligations. Along with the debt-to-equity ratio, its often used by lenders to analyse whether a business has enough cash flow to pay their debts, while it may also be utilised in leveraged buyouts to explore the debt capacity of the company thats being bought out. EBITDA refers to your companys Earnings Before Interest, Tax, Depreciation, and Amortization. Essentially, its a measurement of the financial health of your core business operations. Principal is the total loan amount of your borrowings, while interest refers to any interest that is payable on your short or long-term debts. Some businesses choose to use a slightly different debt service coverage ratio formula:  Debt Service Coverage Ratio = EBITDA  Capex / Interest + Principal  The rationale behind this is that Capex (Capital Expenditure) isnt expensed on your income statement, as its considered an investment. Substituting Capex from EBITDA may provide you with a more accurate picture of your companys operating income. In short, if your calculation for the debt service coverage ratio produces a figure of 1 or more, then your business has enough operating income to cover the debts. While this doesnt guarantee that your business will be eligible for a loan, its generally a prerequisite. A score of less than 1 indicates that the business wont be able to repay its loan back on time and with interest and is therefore unlikely to be considered for a loan. If your business has a score of exactly 1, it means you have exactly enough cash flow to pay for your expenses, but no more. Again, youre unlikely to be considered eligible for a loan with a debt service coverage ratio of 1. Debt service coverage ratio example  Now, lets take a look at a debt service coverage ratio example to see how this works in practice. Lets imagine that Company A has short-term debts of $10,000 and long-term debts of $25,000. The interest rate on the short-term debt and long-term debt is 5% and 4%, respectively. Company As EBITDA is $79,000. There are a number of different things that you can do. First off, you can increase revenues. Consider boosting prices or negotiating higher contracts with your clients. You can also consider reducing your companys operating expenses. Think about cutting overheads or tightening up your marketing budget. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.