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Can you afford this loan? Learn about debt-service coverage ratios

Team Waddle  •  19 December, 2016

One of the financial ratios that every small business owner should understand is the debt-service coverage ratio when applying for a business loan.

What is it & why it’s important?

The debt-service coverage ratio (DSCR), sometimes called the debt coverage ratio (DCR), is the ratio of cash a business has available or left over each month for servicing its debt, including making payments on principal, interest and leases.

When applying for bank loans or non-bank lenders offering attractive rates, the debt-service ratio is one of the crucial elements lenders will measure up against when deciding if you can afford to take on the repayments. If your business barely generates enough income to cover the debt servicing, your business might not be doing well enough to warrant a loan.

Most lenders (only including banks and other mainstream lenders) have a minimum debt-service coverage ratio requirement for approving a business loan. In general, this needs to be 1.2 or more. In some cases, if business activity on the economy as a whole is doing well they might accept a ratio as low as 1.1, but in others (when the economy is tight) they may require a ratio of 1.5. The higher your debt ratio (cash you have left over to pay principal + interest), the better your chances of getting a business loan.

Waddle receives between 5-10 applications per day for businesses owners seeking working capital, and one of the first assessments we make is affordability based on all other borrowings and profit. Even though Waddle does not require a debt-service ratio to meet funding requirements, our credit team will still assess the health of the business, which includes future opportunities to determine if our funding is the right option for the borrower and is not going to hinder growth in any way.

Some basic calculations

There is no hard and fast rule we can offer up, as different lenders calculate the figure differently. The ratio is calculated by dividing total annual net operating income by total annual debt service. The two most common ways of calculating this are:

EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) /

Interest + Current Maturities of Long-Term Debt


Annual Net Operating Income + Depreciation & Other Non-Cash Charges /

Interest + Current Maturities of Long-Term Debt

These calculations will give you a figure that should be taken to the second decimal point. For instance, if your business’s total annual net operating income is $30,000 and you are applying for a loan whose debt service will cost 24,000 annually, your debt service coverage ratio is 1.25 ($30,000/$24,000).

Lenders will also consider any current debt service (another cost of loans) you have before applying for the loan, so you need to figure that into the calculation. In the example above, if you already had debt service of $6,000 annually, taking on a new loan with debt service of $24,000 would bring your total annual debt service to $30,000. Your debt-service coverage ratio would drop to 1.0.

This would not be enough to obtain a loan and you are borderline negative cash flow unless you can use financial projections to convince the lender that getting the second loan will enable you to increase income/profits to a point sufficient to boost your debt-service coverage ratio to respectable levels. There are lenders out there that will still lend on low or negative ratios, however; careful consideration should be taken when deciding if you can meet the repayment and the loan taken will result in increased revenues. These loan/lenders almost always relate to fixed-term loans, as fixed, daily/weekly/monthly payments each month need to be met in order to stay out of the red.

You should be watching anyway

A good business owner will know what their ratios are, keeping a tight grip on profitability and affordability of all money coming in and out of business. If you’re having trouble determining these figures, we recommend enlisting professional help from your accountant or possibly outsourcing to a CFO or business adviser.

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