Understanding Debt Coverage Ratio for Business Loans

Lenders evaluate your eligibility for commercial loans using a variety of metrics. The Debt Service Coverage Rate (DSCR), which answers the question “Can you repay the loan on time and in full?” is particularly important. The DSCR of your company helps lenders determine the loan size and conditions. Understanding the factors and interpretation involved in DSCR calculation is essential. Let’s look at DSCR.

What is DSCR (Discrimination Against Sexual Repression)?

The DSCR is a crucial indicator financial institutions use when evaluating a company’s ability to meet its obligations. Divide the net operating income of an entity by its total outstanding loans to calculate this ratio. This ratio can be used to assess the ability of an entity to repay its debts. It applies to many sectors, including government, corporations, and individuals. Including principal obligations into the denominator is particularly useful for entities with a declining term debt in their financial structure (i.e., Principal repayments can be made monthly or annually).

How to Calculate DSCR

The formula to calculate DSCR is:

DSCR= Net operating income/ Total outstanding debt (i.e., Debt service

The debt service is the principal and interest payments made during the year. Some companies include lease payments in the total amount of outstanding debt.

Subtract your operating expenses from total revenue or income from selling or purchasing products or services. Some companies consider EBITDA (i.e., Earnings before tax, depreciation, and amortization (EBITDA) are often used instead of net income. The formula for calculating each term, in this case, will be:

How Does DSCR Work?

Let’s say your annual revenue for the company is Rs.80,000, and you pay Rs.30,000 in operating expenses. This gives us an operating profit of Rs.50,000. The company now pays Rs. 500 per month towards¬†loans¬†for business and Rs. 1,500 per month towards mortgages, resulting in a total debt payment of Rs. 24,000 each year. The annual lease component is Rs.6000. We get a debt of Rs.30,000.

Can I use the interest coverage ratio instead of DSCR?

The Debt Service Coverage Ratio measures an entity’s capacity to meet current obligations. Meanwhile, the Interest Coverage Ratio evaluates its ability to pay interest on debt. The DSCR should consider both principal and interest. However, the interest coverage ratio only looks at the stake. If the loan only requires interest payments, then the interest coverage is more critical than DSCR.The importance of DSCR

  1. The DSCR is more accurate than the liquidity or leverage ratios, which can be misleading.
  2. Banks can only lend to entities that can repay their loans in full by assessing the DSCR.
  3. DSCR is especially important in real estate lending since it considers property income instead of personal earnings.
  4. The property must generate enough revenue to cover the amount of the loan.

Conclusion:

Small businesses that are seeking funding must consider the debt service coverage ratio. Lenders use this ratio to determine loan affordability and borrowing capability. DSCR also indicates the financial health of your business and its cash flow, which helps assess loan feasibility. A higher DSCR is more likely to be approved, as it reflects a better position for borrowing. If you want to borrow money quickly and are looking for a trusted company, IIFL Finance is the best option.

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