DSCR Explained: What Business Owners Need to Know About Debt Service Coverage Ratio

Debt Service Coverage Ratio (DSCR) is one of the most important metrics lenders use to approve business loans. Understanding DSCR—and how to improve it—can be the difference between approval and rejection.

What is DSCR?

DSCR (Debt Service Coverage Ratio) measures your business's ability to pay its debts using its operating income. It answers the key question lenders ask: "Can this business afford to make the loan payments?"

The formula is simple:

Breaking Down the DSCR Formula

Net Operating Income (NOI)

Net Operating Income is your business's profit before interest and taxes (EBITDA), calculated as:

• Gross Revenue
• - Cost of Goods Sold (COGS)
• - Operating Expenses
• = Net Operating Income

Important: NOI excludes non-operating income and one-time expenses.

Total Debt Service

Total Debt Service includes ALL debt payments over a period (typically annual):

• Business loan principal payments
• Business loan interest payments
• Credit line payments
• Equipment financing payments
• Merchant cash advance payments

DSCR Example Calculation

Let's calculate DSCR for a restaurant:

A 1.92x DSCR is excellent! This means the restaurant generates $1.92 for every $1 of debt payments, showing strong repayment capacity.

What is a Good DSCR?

Minimum DSCR Requirements by Loan Type

• SBA 7(a) Loans: Minimum 1.25x (prefer 1.35x+)
• SBA 504 Loans: Minimum 1.25x
• Bank Term Loans: Minimum 1.30-1.50x
• Online Lenders: Minimum 1.15-1.25x
• Real Estate Loans: Minimum 1.20x

Why Lenders Care About DSCR

DSCR is the lender's primary tool for risk assessment:

• Predictive: Businesses with DSCR above 1.5x rarely default
• Objective: Based on actual cash flow, not projections
• Protective: Ensures businesses can handle debt even if revenue dips 10-15%
• Comparative: Easy to compare across different businesses and industries

What If Your DSCR Is Below 1.25?

Don't panic! Here are your options:

Option 1: Reduce the Loan Amount

Borrowing less reduces your debt service and improves DSCR:

• Request 20-30% less than originally planned
• Apply again in 6-12 months when revenue increases

Option 2: Extend the Loan Term

Longer terms = lower monthly payments = better DSCR:

• $100K at 8% for 3 years = $31,337/year payment
• $100K at 8% for 7 years = $18,684/year payment
• Extending from 3 to 7 years improves DSCR significantly

Option 3: Improve Operating Income

Increase revenue or cut costs before applying:

• Wait 3-6 months while growing revenue
• Cut unnecessary operating expenses
• Apply during peak season when NOI is highest

Option 4: Pay Off Existing Debt

Reducing existing debt service improves DSCR:

• Pay off high-interest debt first
• Refinance expensive loans to lower payments
• Consider using the new loan to consolidate existing debt

How to Improve Your DSCR (Long-Term)

1. Increase Revenue

More revenue = higher net operating income = better DSCR:

• Expand customer base through marketing
• Raise prices (even 5-10% can significantly help)
• Add new products or services
• Increase order frequency from existing customers

2. Improve Profit Margins

Higher margins = more operating income from same revenue:

• Negotiate better rates with suppliers
• Reduce waste and inefficiencies
• Automate repetitive tasks
• Focus on higher-margin products/services

3. Reduce Operating Expenses

Lower costs = higher net operating income:

• Renegotiate vendor contracts
• Eliminate unnecessary subscriptions and services
• Optimize inventory management
• Reduce overhead where possible

4. Pay Down Existing Debt

Less debt service = better DSCR:

• Make extra principal payments when cash flow allows
• Refinance high-rate debt to lower payments
• Avoid taking on new debt before applying

Common DSCR Calculation Mistakes

Mistake #1: Using Net Profit Instead of NOI

Net profit includes interest expenses, which shouldn't be in DSCR calculations. Always use Net Operating Income (EBITDA).

Mistake #2: Forgetting Existing Debt

Many business owners only calculate payments for the new loan. DSCR includes alldebt service.

Mistake #3: Using Gross Revenue Instead of NOI

Revenue isn't profit! You must subtract COGS and operating expenses to get Net Operating Income.

Mistake #4: Annual vs Monthly Confusion

DSCR is typically calculated annually. If using monthly figures, ensure both NOI and debt service are for the same period.

DSCR vs Other Loan Metrics

DSCR vs Debt-to-Income Ratio

• DSCR: Cash flow coverage of debt payments
• Debt-to-Income: Total debt relative to gross income
• Both are important, but DSCR focuses on repayment ability

DSCR vs Debt-to-Revenue Ratio

• DSCR: Operating income vs debt payments
• Debt-to-Revenue: Total debt vs total revenue
• DSCR is more precise for assessing repayment capacity

Industry-Specific DSCR Considerations

High-Margin Industries (70%+ margins)

Examples: Software, consulting, professional services

• Can support lower DSCR (1.25x) safely
• Strong cash flow cushion even with minimal coverage

Low-Margin Industries (10-20% margins)

Examples: Retail, restaurants, construction

• Need higher DSCR (1.5x+) for safety
• Less room for error with tight margins

Seasonal Businesses

Examples: Tourism, landscaping, tax preparation

• Calculate DSCR using annual average, not monthly
• Lenders may require 1.5x+ DSCR to account for off-season
• Maintain cash reserves for low months

Real-World DSCR Scenarios

Frequently Asked Questions

What is the minimum DSCR for an SBA loan?

Most SBA lenders require a minimum DSCR of 1.25x, though some prefer 1.35x or higher. The higher your DSCR, the better your chances of approval and favorable terms.

Can I get a loan with a DSCR below 1.0?

A DSCR below 1.0 means you cannot cover your debt payments with operating income. Traditional lenders will not approve loans in this scenario. You would need to reduce existing debt orincrease operating income before qualifying.

How often should I calculate my DSCR?

Calculate DSCR quarterly to monitor your business's financial health. If you're planning to apply for a loan within 6 months, calculate it monthly to track improvements.

Does DSCR include personal income?

No, DSCR is based on business operating income only. Personal income is not included in DSCR calculations for business loans.