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How To Determine Your Business Debt Service Coverage Ratio
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A business’s cash flow is an indicator of the financial strength of the business. A bank or lender will look at the cash flow of the business to determine the borrower’s ability to service payments on a loan. Debt service coverage ratio (DSCR) is the cash available to service that debt.
To calculate DSCR, take your annual net income and add back any non-cash expenses such as depreciation and amortization. In addition, add-back any interest expense — as the interest is a function of your financial activities. This number is called EBIDA (Earnings before Interest, Depreciation, and Amortization).
Next, divide your EBIDA by the total annual debt service for the proposed loan (the total annual principal and interest payments). For example, A DSCR of 1.50 indicates there is 50% more income than is required to repay all debt, or $1.50 available to pay each $1.00 of debt. However, a DSCR of 0.90 would indicate there are only 90 cents available to pay each $1.00 of debt.
Also, calculate a DSCR that includes your officer draw (EBIDA / Debt Service + Officer/Executive Draw) to ensure there are ample funds to pay yourself.
Once you know the strength of your cash flow, you can determine what steps you need to take to improve it and open up cash flow vessels.
