DSCR Explained - Debt Service Coverage Ratio

DSCR Explained: Debt Service Coverage Ratio for Small Business Loans

A clear, practical guide to what DSCR is, how lenders use it, and how to improve yours before applying for credit.

Educational guide • Estimated read time: 8–10 minutes

What is DSCR?

Debt Service Coverage Ratio (DSCR) measures your business’s ability to pay current debt obligations from operating cash flow. In short, it answers: “How many dollars of cash flow do we have for every one dollar of required debt payments?”

DSCR formula (with a quick example)

Formula
DSCR = Net Operating Income (NOI) ÷ Total Debt Service

Example: If your business has $180,000 in Net Operating Income and $120,000 in required annual principal + interest payments, DSCR = 1.50. You generate $1.50 in cash flow for every $1.00 of debt payments.

What is a “good” DSCR?

  • 1.25× or higher is a common minimum for traditional term loans.
  • 1.10–1.20× may be acceptable for certain SBA, LOC, or asset-based products—often with compensating strengths.
  • < 1.00× signals insufficient cash flow to cover debt service, which raises approval risk.

Remember: lenders evaluate DSCR alongside overall profitability trends, margins, collateral, owner experience, and bank statements.

How lenders use DSCR (and where it matters most)

  1. Underwriting: Confirms the business can repay without distress.
  2. Pricing & sizes: Stronger DSCR can support larger loan sizes or better pricing.
  3. Covenants: Some loans require maintaining a minimum DSCR; slipping below can trigger reviews.

How to improve DSCR before you apply

  • Increase NOI: Trim non-essential expenses, improve margins, and smooth seasonality with consistent billing.
  • Restructure debt: Refinance short-term or high-interest obligations into longer terms to reduce annual debt service.
  • Delay new fixed costs: Time equipment purchases or hires until after financing is secured.
  • Normalize add-backs: Clarify legitimate one-time or owner-specific expenses with documentation.
  • Maintain cash buffers: Strong cash balances and positive bank flows support the DSCR story.

DSCR FAQs

Is DSCR the same as interest coverage?
No. Interest coverage compares earnings to interest expense only. DSCR compares operating cash flow to total required payments—interest and principal.
Do lenders calculate DSCR using tax returns or financials?
Both are common. Lenders may analyze tax returns, internal P&L, and bank statements—then normalize NOI (e.g., remove one-time items) before dividing by required debt service.
What DSCR do SBA lenders typically like to see?
Many SBA programs look for a global DSCR of ~1.15×–1.25×, depending on overall strength, collateral, and guarantor income. Exact criteria vary by lender and product.
Can I be approved with DSCR below 1.00×?
It’s challenging. Approval generally requires a credible path to ≥1.00×—for example, refinancing expensive debt, adding revenue contracts, or documenting legitimate add-backs that raise NOI.
How often do lenders recheck DSCR after funding?
For loans with covenants, lenders may request periodic financials or tax returns. If the DSCR falls below a threshold, they may ask for a plan to improve cash flow.