Merchant Advance Blog

Blog Article: Behind the Lending: Debt Service Coverage Ratio

You might shoot photos with a DSLR, but do you know your business’ DSCR?

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Bad puns aside, the DSCR is a key concept that many small businesses neglect to keep an eye on. The debt service coverage ratio, in other words, is one of the “behind the curtain” metrics that many online and alternative lenders use when looking into a business’ viability during the loan application and underwriting process.

Put simply, you can express it like this:

Debt Service Coverage Ratio = Net Operating Income / Total Debt Service

There are more complex factors involved in figuring out both of these baseline figures, but we will leave those unsaid for now. In plain language, the DSCR expresses how much cash flow you have available to pay your current debt obligations. If it’s equal to 1.0 or greater, you’re on the right track. If it’s less, you’re probably going to need to reevaluate your cash flow system or try to reduce the amount of debt you are carrying.

The minimum ratios acceptable to any given lenders may vary, and are not widely publicized. Regardless of the actual values in question, it’s clear that lenders don’t want to lose their investments, so they seek reassurance that a business has generated—and will continue to generate—enough income to pay back the loan with interest.

Even a debt service coverage ratio of less than 1 may be acceptable to a lender if the business owners’ personal income shows strength and stability. This reinforces the fact that for modern alternative lenders, no one snapshot of a small business is enough to inform the decision to lend or not to lend. A wide and deep appraisal of data, both qualitative and quantitative, is necessary to make sure alternative lenders can limit bad debt and provide the right loans to the right businesses.

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