Can You Afford That Loan? The Debt Service Coverage Financial Ratio

Can You Afford That Loan? The Debt Service Coverage Financial Ratio

Be Sociable, Share! Tweet This is the fourth post in a series of articles about financial ratios. In evaluating any borrower for a loan or lease request, one of the financial ratios that lenders run is a Debt Service Coverage Ratio (DSCR or sometimes DSC) to determine if the loan can be repaid. Ideally, the company will have sufficient profits to service the debt completely – with extra left over. How Do You Calculate the DSCR Financial Ratio To calculate the DSC on a proposed loan the formula is as follows: Note that the top of the formula states “Annual Net Profit”.  Once you add back the amortization/depreciation and interest, this is the income or cash flows that are left over after all of the operating expenses have been paid. This is often called earnings before interest, taxes depreciation and amortization – or EBITDA. For “Existing Interest Expense”, make sure to include the interest of any debt that is being refinanced by this loan.  Otherwise, just include the interest expense for any other loans you may have.  Non-cash or discretionary items should include things like management bonuses. On the bottom half of the financial ratio, the principal payments and interest payments are those of the new debt you are looking to take on. The DSCR is also sometimes calculates without adding back in amortization/depreciation, interest expense or non-cash items.  This means you are taking your net profit and dividing it by the loan payment and leases.   Neither method is right or wrong but you get two different numbers, leading to disagreements with or at the bank.  You’ll often find that the person...
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