Debt service coverage ratio (DSCR): formula, example and what lenders want

What is the debt service coverage ratio?

The debt service coverage ratio, or DSCR, answers one question a lender cares about most: does this business earn enough cash to pay its loans? DSCR is the full form. "Debt service" means the money due on loans in a period: the principal repayment plus the interest.

The ratio puts the cash the business generates on top and the debt service on the bottom. A DSCR of 1 means the business earns exactly what it must repay, with nothing left over. Above 1, there is a cushion. Below 1, the business must find the gap from somewhere else, such as savings, new borrowing or the owner's pocket.

Banks and NBFCs (non-banking financial companies, lenders licensed by the RBI that are not banks) use DSCR on term loans above all. It is the clearest test of whether the instalment you are asking for fits the cash you actually make.

The DSCR formula lenders use

The RBI has written the formula down in its own words, in a 2020 notification on financial ratios. For a given year, DSCR is (RBI notification, 07-Sep-2020):

In plain words:

DSCR = (net cash accruals + interest) ÷ (principal due this year + interest)

"Net cash accruals" is not written out in the RBI text. In practice, lenders usually take it as profit after tax plus depreciation and other non-cash charges (RBI notification, 07-Sep-2020). Depreciation is added back because it reduces profit on paper without any cash leaving the business.

Interest appears on both sides. That is deliberate. Interest is paid out of the cash the business makes, so the ratio adds it back on top before testing whether the business can pay it along with the principal.

Average DSCR is what a lender reads for a term loan of several years. It adds the top and the bottom across every year of the loan and divides one sum by the other (RBI notification). A business may have one tight year in a good average, and the average shows whether the loan works across its whole life.

A worked DSCR example

Here is a simple case. The figures are made up to show the method.

Illustrative reading: for every ₹1 due on loans this year, the business generates about ₹1.38 of cash. The cushion is ₹3,00,000 (₹11,00,000 minus ₹8,00,000).

Now suppose the same business spreads its principal over a longer tenor (the repayment period), so the principal due this year falls to ₹3,50,000. Illustrative result: the bottom becomes ₹6,50,000 and the DSCR rises to about 1.69. Nothing about the business changed. Only the repayment schedule did. That is why asking for a longer tenor is often the quickest way to fit a loan to your cash flow.

To run your own numbers, use the DSCR calculator.

What is a good DSCR?

There is no single number set by the RBI for ordinary business loans. Each lender sets its own minimum in its credit policy, and it can change with the type of loan and the size of the business.

What is clear:

• Below 1: the business does not earn enough to pay its loans. Most lenders will not add more debt here without collateral or a guarantee.
• Exactly 1: every rupee earned goes to the lender. Any bad month means a missed instalment.
• Above 1: there is a cushion. The bigger the cushion, the more comfortable the lender.

As one lender's published guidance, Kotak Mahindra Bank calls a DSCR of 1.5 or higher ideal (Kotak Mahindra Bank). Other lenders may accept less, especially for secured loans or businesses with a long clean repayment record. Treat any figure you read as one lender's view, not a rule.

How to check your DSCR, step by step

1. Take your last full year's profit and loss statement. Note profit after tax, depreciation and the interest paid.
2. Add depreciation to profit after tax. That is your net cash accruals for the year.
3. Add interest to it. That is the top of the ratio.
4. List every loan the business pays, including vehicle loans, equipment loans and any loan in the owner's name used for the business. Note the principal due in the coming year for each.
5. Add those principal amounts to the interest. That is the bottom.
6. Divide the top by the bottom.
7. Repeat with the new loan included. Add the new loan's first-year principal and interest to the bottom. If the ratio drops near or below 1, the amount or the tenor needs to change.

Do the last step before you approach a lender. The lender will do exactly this sum, and it is better to know the answer first.

How to improve a low DSCR

The last row matters more than owners expect. A lender can only count profit that appears in your filed returns and audited accounts. Income that is real but unrecorded does not help your DSCR at all.

Common DSCR mistakes

• Leaving out loans. Lenders see every loan on your credit report. A ratio built without them is wrong, and a lender will notice.
• Using turnover instead of profit. DSCR runs on cash after costs, not on sales.
• Forgetting the new loan. Your ratio today does not matter as much as your ratio after the new instalment.
• Using provisional figures as final. If the year is not closed, say so. Numbers that change later hurt trust.
• Ignoring loans in the owner's name. If the business repays them, a lender will count them.

Ratios lenders read alongside DSCR

DSCR rarely stands alone. The same RBI notification defines other ratios lenders use (RBI notification):

A strong DSCR with a very high debt load can still worry a lender. So can a good debt load with a weak DSCR. Lenders read them together.

Check your full picture before a lender does

DSCR is one of several signals a lender reads, next to vintage, turnover, banking and credit history. The free loan readiness check reads them together and gives you a Capnix score, with the weakest areas to fix first.