Debt Service Coverage Ratio

The arithmetic is a division. On top goes cash available for debt service, which most lenders build from net operating income by adding back non-cash charges such as depreciation and amortization, and adjusting for owner compensation in an owner-operated business. On the bottom goes total debt service for the period: principal and interest on every obligation, including the new one being considered.

Read the result as a cushion. A ratio of exactly 1.0 means the business generated precisely enough to make its payments and nothing more, which leaves no room for a slow quarter, a repair, or a customer who pays late. Anything below 1.0 means the payments were not covered by operations. Lenders want daylight above the line, and how much daylight they want is a policy decision that varies by lender, product and industry.

Suppose an invented set of books: $120,000 of cash available for debt service against $80,000 of annual payments gives a ratio of 1.5. Add a proposed new payment of $30,000 a year and the denominator becomes $110,000, so in that invented example the ratio falls to roughly 1.09. That second calculation is the one a lender actually performs, because it is the one that describes the business after the loan rather than before it.

For your file, this is where bank and SBA decisions are made. SBA loans and conventional term loans are underwritten on documented cash flow, and practice acquisitions and partner buyouts are underwritten on almost nothing else, which is why the ratio does so much work in medical and dental practice financing. Clean books make it computable; messy ones make it a guess, and lenders resolve guesses conservatively.

Revenue-based funders rarely calculate a formal DSCR, but they run the same instinct on your bank statements: they compare the proposed remittance against the balances the account actually holds. Either way you can run the test yourself before anyone else does, from your own profit and loss statement and the payment affordability checker.

Two confusions are worth clearing. DSCR is not the working capital ratio: this one measures income against payments over a period, that one measures balance sheet items at a moment. And it is not a credit score. A strong ratio with poor credit and poor credit with a weak ratio are different problems with different fixes, which is part of why judging whether an offer is too expensive starts with what the business can carry rather than with the rate.