Determining Your Debt Service Coverage Ratio
The 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 help determine the borrower’s ability to repay a loan. Debt service coverage ratio (DSCR) is the cash available to service debt.
To calculate DSCR, you will take your annual net income and add back any non-cash expenses such as depreciation and amortization. You will also add-back any interest expense – as the interest is a function of your financing activities. This is called EBIDA (Earnings before Interest, Depreciation and Amortization).
Then divide your EBIDA by the total annual debt service for the proposed loan (the total annual principle and interest payments). 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 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.