🔍
Debt Service Coverage Ratio (DSCR): Formula and Examples - YouTube
Channel: Fundera by NerdWallet
[0]
Hi, I'm Priyanka Prakash, senior staff writer
at Fundera.
[3]
When applying for a business loan, one phrase
you'll hear a lot is debt service coverage
[8]
ratio or DSCR.
[10]
Lenders basically use DSCR to figure out if
you are financially able to pay back the loan
[15]
that you're applying for, as well as any business
loans that you might already have.
[20]
Today, I'll walk you through the DSCR formula,
as well as a few examples, so you know exactly
[26]
how to meet this requirement when you apply
for a business loan.
[30]
DSCR basically tells you whether your business's
net operating income is enough to cover your
[39]
business debt payments.
[40]
Ideally, your business’s net operating income,
or NOI, should be about 1.1 to 1.2 times higher
[50]
than your business's debt payments, as this
graph indicates.
[54]
We'll talk more about lenders specifics in
a second, but first I'm going to show you
[59]
the DSCR formula.
[61]
The DSCR formula actually isn't too complicated.
[65]
You simply take your business's annual net
operating income and divide it by your business's
[71]
annual debt payments.
[73]
Now, most lenders look at DSCR on an annual
basis, so you should as well, but if you're
[79]
applying for a short term loan, it might be
better to calculate DSCR on a monthly basis
[85]
or quarterly basis.
[87]
Just make sure you're comparing apples to
apples.
[90]
For example, for annual DSCR, you divide annual
NOI by annual debt payments.
[97]
For a quarterly DSCR, you would divide quarterly
NOI by quarterly debt payments, and for a
[104]
monthly DSCR, you would divide monthly NOI
by monthly debt payments.
[110]
Okay, now that we have the formula, let's
look at a basic example.
[115]
Let's say you're applying for a business loan
for your restaurant and your annual NOI is
[120]
$100,000.
[122]
Let's say that you also have $75,000 in total
business loans.
[128]
That might be $25,000 in existing debt and
$50,000 of new debt that you're applying for.
[137]
However the breakdown, I've emphasized “all”
here to remind you that you should take existing
[142]
debt and new loans into account.
[145]
And for simplicity, let's say that this $75,000
includes the loan principal and interest.
[152]
To calculate DSCR, you would simply take your
$100,000 of annual NOI and divide it by your
[160]
$75,000 of annual debt payments to get a DSCR
of 1.33.
[168]
We'll talk about whether this is a good DSCR
in just a minute, but first I want to cover
[172]
a couple of other ways of looking at DSCR.
[176]
Suppose you know what the lender’s minimum
required DSCR is.
[182]
For example, maybe you found this information
on the lender’s website or asked them about
[186]
their specific requirements, and they told
you that their minimum DSCR was 1.15.
[193]
Assuming you have the same $100,000 of business
NOI, you can flip the formula, dividing $100,000
[202]
by the 1.15 DSCR, which gives you $86,957
in annual debt payments.
[212]
This is your maximum annual debt service,
which means your yearly loan payment should
[218]
be no higher than $86,957 when including for
both principal and interest.
[226]
Finally, you can take this a step further
by calculating the maximum monthly payment
[232]
on your loan.
[233]
Take the maximum annual debt service from
the previous example, and divide by 12 months
[240]
in a year to get a maximum monthly loan payment
of $7,246.
[247]
If a lender charges payments on a weekly or
bimonthly basis, you would simply divide the
[255]
debt service by the number of those periods
in one year to get the maximum payment.
[261]
So now that you've calculated DSCR, you're
probably wondering, is your DSCR good?
[266]
And will you be able to qualify for the loan
that you're applying for?
[270]
Let's look at that next.
[272]
What makes a good DSCR?
[273]
Well, as I alluded to earlier, most lenders
prefer a DSCR of 1.1 or higher.
[281]
If you have a DSCR greater than one, you're
in a good spot because it means that you can
[286]
comfortably cover your debt payments with
your current net operating income.
[291]
A DSCR of one means that you're breaking even,
so you have just enough cash to cover your
[297]
debt payments, but not much wiggle room.
[300]
If you make lower than expected revenues for
the year, or if you lose a big client, you
[306]
could wind up in the negative and you could
be unable to pay back your loan.
[312]
Lastly, if your DSCR is below one, that means
you cannot afford the loan payments.
[317]
Given your current net operating income.
[321]
Global DSCR is a variation on regular DSCR
that many small business owners aren't familiar
[329]
with.
[330]
Global DSCR is different because it includes
your personal income and personal debt in
[337]
addition to business income and business debt.
[340]
Let's take a look at an example.
[342]
Let's say that you run a restaurant with an
annual net operating income of $100,000, but
[349]
you also have a personal day job that brings
in $40,000 per year.
[354]
In terms of debt, you have your $75,000 of
business debt, but you also own a home and
[361]
have a balance on your mortgage of $55,000.
[365]
When you add up the income in the numerator
and the debt in the denominator and divide,
[371]
you get a DSCR of 1.8.
[375]
If you remember our previous example when
we looked just at business NOI and business
[382]
debt, we had a DSCR of 1.33.
[385]
As this example shows, global DSCR will typically
be lower than regular DSCR, especially if
[391]
you have a significant amount of personal
debt.
[395]
But, lenders also have lower requirements
for global DSCR because they understand that
[401]
you might be coming to the table with some
personal loans.
[404]
Now, we mentioned before that you should check
in with your lender about their required DSCR
[409]
minimum.
[411]
This is a good idea because if you don't meet
the requirements, you should focus on improving
[415]
your DSCR instead of starting in on a long
application process.
[420]
DSCR relies on two factors--income and debt--so
you can make improvements from either of those
[428]
two angles.
[429]
On the one hand, you can try to increase your
revenue.
[432]
For example, you might be able to cut costs
or bring on a new client or find some other
[438]
way to generate more income.
[440]
On the other hand, you can try to minimize
debt levels.
[443]
That might mean trying alternatives to debt
when raising capital or refinancing existing
[450]
debt with a lower interest loan.
[454]
And that's our explanation of debt service
coverage ratio or DSCR.
[460]
If you have more questions related to small
business lending, we have a wealth of information
[465]
at fundera.com/blog.
[468]
You can also subscribe to our YouTube channel
for more videos that will help you reach your
[472]
business goals.
[473]
Thanks for watching, everyone.
Most Recent Videos:
You can go back to the homepage right here: Homepage