Access to finance plays a fundamental role in bringing your business plans to life. But the financial jargon and measurements used by lenders can often feel like a barrier.
One important metric to get your head around is the Debt-Service Coverage Ratio (DSCR) which lenders use to assess your borrowing power.
What is a Debt-Service Coverage Ratio (DSCR)?
At its core, the DSCR measures the available cashflow your business has to pay its current debt obligations. While your balance sheet shows what you own and owe, the DSCR shows whether you are actually generating enough liquidity to cover your interest and principal payments.
From a lender’s perspective, it’s the primary indicator of your company’s financial health and your ability to weather economic downturns without defaulting on your loan.How do lenders use the DSCR metric?
Lenders want to know that you’re capable of repaying the money lent to you. They’ll use the DSCR ratio to gauge the level of risk involved in offering capital to your business.
The DSCR provides a measurement that lenders can use to assess your risk as a borrower:
- A DSCR of 1.0 means the business has exactly enough net operating income to cover its debt, leaving no room for error.
- A DSCR below 1.0 indicates negative cashflow, suggesting that the business may need to dip into savings or take on more debt to stay afloat – a major red flag for lenders.
- A DSCR of 1.25 or higher is typically the gold standard for commercial lenders. If you can attain a high DSCR score, you should have fewer issues accessing funding.
By calculating the DSCR ratio, lenders can decide not just if they should lend to you, but also the terms of the loan. A higher ratio means the risk of default is lower, often leading to lower interest rates and more favourable repayment periods.
How to Calculate Your DSCR
If you’re talking to banks and lenders, it makes sense to calculate your DSCR before any meetings or loan applications, so you’re aware of your potential rating:
The formula is:
DSCR = Net Operating Income / Total Debt Service
- Net Operating Income (NOI) is your revenue minus operating expenses (excluding taxes and interest payments).
- Total Debt Service is the sum of all your interest, principal payments and lease payments that are due within the financial year.
Calculating and monitoring your DSCR as a business
By monitoring your DSCR regularly, you can make informed decisions about when to expand, when to cut costs and when your business is truly ready to take on new investment.
If you’d like to know more about calculating and improving your DSCR score, come and talk to our team. We’ll be glad to run you through the equations and the proactive steps you can take.
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