Determining Debt Service Coverage
Debt Service Coverage Ratio (DSCR) is the amount of accessible cash flow your Small Business has to pay the annual interest and principal payments on your Small Business debt. The Bank not only wants to know the cash position and cash flow of your company, they also want to know how much debt your Small Business currently owes and the available cash it has to pay current and future debt.
The simplified formula is:
DSCR which is below 1:1 indicates a negative cash flow. For example, a DSCR of 0.92:1 indicates the Small Business can only cover 92% of its annual debt payments.
A higher debt service coverage makes it easier for your Small Business to obtain a loan. The Bank typically looks at 1.25 x DSCR .
You may have heard the term Global Debt Service Coverage. This is a combination of both personal and business. The idea behind Global Debt Service Coverage – particularly in the case of Small Businesses – is that looking at the business alone does not provide the whole story (remember . . . In the eyes of the Bank, you ARE your Small Business). The cash flow available to service the debt from the Small Business might be too little to repay a proposed loan, however the reason might be that you as the owner take most the money out in the form of salary, rent or distribution.