Loan for Business

What is Debt Service Coverage Ratio (DSCR)? Meaning & formula

By Tata Capital
18 February 2026
8 mins read
3478

When approving business loan applications, lenders do not just focus on revenue and profits. They emphasize one crucial financial metric – a company’s debt service coverage ratio. It offers a quick snapshot of a business’s repayment strength and helps lenders judge risk and understand their true borrowing capacity.

Keep reading to learn the debt service coverage ratio meaning, formula, uses, and more.

Understanding Debt Service Coverage Ratio (DSCR)

Debt Service Coverage Ratio, or DSCR, is a financial metric used to assess whether a company can repay its debt obligations using its operating income. In simpler words, it measures how comfortably a business can service its loans with the cash it generates from day-to-day operations.

The DSCR is calculated by dividing a company’s net operating income by its current debt obligations. Lenders can utilize the DSCR value to evaluate a company’s financial health and approve its loan application. A higher DSCR indicates a business can handle its debt without straining operations.

How is DSCR used in loan evaluation?

As mentioned, lending institutions such as banks and NBFCs (Non-Banking Financial Companies) use DSCR to understand how comfortably a company can service its proposed debt. They compare the business’s operating income with its total repayment obligations, including both principal and interest. This helps lenders move beyond projections and look at actual repayment strength.

A consistently healthy DSCR reassures lenders that the company can absorb business ups and downs without missing EMI payments. A DSCR of greater than 1 suggests that a company is generating enough income to meet its debt obligations. On the flip side, a DSCR of less than 1 suggests a cash flow shortage.

Components included in DSCR calculation

The calculation of a company’s DSCR typically involves two core components:

● Net operating income

Net operating income represents the income generated from core business operations. It is calculated after deducting operating expenses such as salaries, rent, utilities, and raw material costs, but before interest, tax, and depreciation. For example, if a manufacturing company earns Rs. 2 crore in revenue and spends Rs. 1.4 crore on operating costs, its net operating income stands at Rs. 60 lakh.

● Total debt service

Total debt service includes all loan-related repayments due in a year, including both principal and interest. For example, suppose the same company pays Rs. 35 lakh as principal and Rs. 10 lakh as interest annually. The total debt service would be Rs. 45 lakh. DSCR compares this obligation against operating income to assess repayment comfort.

DSCR formula explained

A company’s DSCR can be computed using a simple mathematical formula. The Debt Service Coverage Ratio formula in India is as follows:

Debt Service Coverage Ratio = Net Operating Income / Total Debt Service

Here,

Net Operating Income = Total Revenue – Operating Expenses – Interest, Tax, and Depreciation

Total Debt Service = Principal + Interest payments within a year.

Step-by-step method to calculate DSCR

Calculating a company’s DSCR involves a few simple steps. First, you must compute the net operating income and the total debt service. Then, you can simply use a debt service coverage ratio calculator or apply the values in the mathematical formula mentioned above to determine DSCR.

These are the steps on how to calculate the debt service coverage ratio:

1. Calculate the company’s net operating income. This includes earnings from core business activities after deducting operating expenses, but before interest, tax, and depreciation.

2. Determine the total debt service. This is the sum of all loan-related payments due for the year. Include both principal and interest repayments across all existing loans.

3. Divide net operating income by total debt service. The resulting value is the company’s DSCR.

Why is DSCR Important for Businesses?

DSCR is more than just a metric used by lenders to gauge a company’s repayment capability. It even helps businesses in multiple ways, such as:

Helps understand how comfortably a company can repay its debt from operating income.
Enables better financial planning by comparing cash flows with repayment obligations.
Provides a clear snapshot of the business’s financial position at a specific point in time.
Flags early stress in cash flows if debt levels start becoming unmanageable.
Helps analyze whether a new loan is financially viable and make smart borrowing decisions.

What is considered a good DSCR?

Lenders do not look at DSCR in isolation. They analyze it with several other parameters to determine loan approval decisions. While benchmarks may vary from lender to lender, the ideal debt service coverage ratio falls in the following range:

1.25 or above: A DSCR of 1.25 or above is considered excellent. It indicates healthy cash flows and good repayment capabilities.
1.0 to 1.24: A DSCR in this range is considered acceptable. It indicates that the company can meet its repayment obligations, though the margin of safety is moderate.
Below 1.0: If a company’s DSCR is less than 1.0, it means that its debt obligations are higher than its net operating income. Lenders consider such businesses as highly risky propositions.

Benefits of maintaining a healthy DSCR

Maintaining a healthy DSCR is paramount for any business. It not only improves their loan eligibility but also allows better financial planning and risk management.

Here are a few benefits of having a high DSCR:

Secure quick funding: Every business needs funding from time to time for growth and expansion. A healthy DSCR ensures they won’t have to wait for long to secure finances in the hour of need.
Better loan terms: Maintaining a strong DSCR ultimately puts the business in a better negotiating position when raising funds. They can ask the lender for a lower interest rate or more flexible repayment terms, or both.
Increases borrowing capacity: Businesses with above-average debt service coverage ratios qualify for higher loan limits. This helps them meet their day-to-day expenses and tackle seasonal cash flow fluctuations easily.

Limitations of the Debt Service Coverage Ratio

Although DSCR is a useful financial metric, it has certain limitations:

May fail to show the full picture

DSCR focuses only on net operating income and debt. These parameters can fluctuate and may not always represent the true picture of a company’s financial strength. For instance, a business may show a strong DSCR for a particular year, even though cash flows are uneven across months.

Varies across industries

The ideal debt service coverage ratio varies across industries and lenders. For example, a company involved in a manufacturing business usually exhibits a lower DSCR than a company in the software distribution business.

Sensitive to accounting methods

The accounting method used by a company can significantly impact the DSCR calculation. For instance, accrual accounting can sometimes inflate a company’s real revenue and expenses. This may result in an inaccurate DSCR.

DSCR vs interest coverage ratio

Both Debt Service Coverage Ratio (DSCR) and Interest Coverage Ratio (ICR) are used to assess a company’s ability to service debt. However, they focus on different aspects of repayment. While DSCR measures overall debt obligations, including principal and interest, ICR focuses only on the interest component.

The table below depicts a comparison between DSCR and ICR:

Parameter	DSCR	ICR
What it measures	The ability of a business to repay both principal and interest	The ability of a business to pay only interest on debt
Purpose	To check a company’s overall debt repayment capability	To check a company’s interest repayment capability
Formula	Net Operating Income / Total Debt Service	EBIT / Interest Expense
Commonly used for	Assessing long-term financial strength and suitability for loans	Assessing immediate interest-payment capacity

Factors that influence DSCR

Several factors can influence a company’s DSCR. Understanding these factors helps in better calculation and financial planning.

Income stability: Inconsistent income leads to a dip in revenue, which in turn lowers a company’s DSCR.
Operating costs: A company’s DSCR is inversely proportional to its operating costs. It means that the DSCR decreases when operating costs increase, and vice versa.
Debt structure: Factors like loan tenure and repayment schedule also influence DSCR. Loans with longer tenures lead to improved DSCR.
Interest rate: A higher interest rate increases total debt service. This, in turn, can pull a company’s DSCR down if the net operating income remains unchanged.

Tips to improve your DSCR before applying for a loan

Improving DSCR before approaching a lender can significantly strengthen your loan approval chances.

Here are a few tips that can help:

Increase revenue: Focus on increasing revenue through high-margin products/services and tightened receivables.
Reduce operating costs: Try reducing the business’s operating costs by negotiating with vendors, optimizing inventory, and automating routine tasks.
Restructure existing debt: Ask your lender to extend the tenure of your existing loan or modify the repayment structure.
Consider loan pre-payment: If possible, pre-pay some of your existing loans to reduce your total debt service.
Delay non-essential expenditure: Consider delaying non-essential expenses, such as large asset purchases or expansion plans, to strengthen cash reserves.

Conclusion

The debt service coverage ratio is a crucial financial metric. Lenders use it to gauge a business’s repayment capacity when approving a loan application. Businesses use it to understand their financial position and make smart borrowing decisions.

As a business owner, it’s imperative to monitor your DSCR regularly. If it’s below the satisfactory level, you can take steps such as reducing operating costs and pre-paying existing loans to improve it. Maintaining the best debt service coverage ratio can help you qualify for quick funding at favorable terms.

FAQs

What is considered a good DSCR ratio?

The definition of a good DSCR ratio varies from one lender to another. Generally, a DSCR of 1.25 or above is considered excellent by most lending institutions. It denotes healthy financials and comfortable repayment capacity.

What does a DSCR below 1 indicate?

A DSCR below 1 indicates that the business does not generate enough operating income to cover its debt obligations. This means loan repayments rely on external funds or reserves, which increases default risk and makes lenders cautious while evaluating the loan application.

How does DSCR affect loan approval?

A company’s DSCR directly influences its loan approval chances. It improves the lender’s confidence in a business’s repayment ability. A strong DSCR may also lead to better loan terms. A weak DSCR can result in lower sanctioned amounts, stricter conditions, or even rejection of the loan application.

How is DSCR used in project finance?

In project finance, DSCR is used to assess whether the project’s cash flows are sufficient to service its debt over the loan tenure. Lenders rely on projected DSCR levels to structure loan amounts, repayment schedules, and risk buffers for the project.

What is the difference between DSCR and the interest coverage ratio?

DSCR and Interest Coverage Ratio (ICR) focus on different aspects of repayment. DSCR measures a business’s ability to repay both principal and interest using operating income, giving a full picture of debt servicing capacity. ICR focuses only on interest payments, making it more relevant for short-term borrowing or working capital assessments.

Can DSCR vary by industry?

Yes, DSCR can vary significantly across industries. Capital-intensive sectors often operate with lower acceptable DSCR levels, while asset-light businesses are expected to maintain higher ratios. Lenders factor in industry norms and business models before setting DSCR benchmarks.

How can a business improve its DSCR?

A business can improve its DSCR by increasing operating income, controlling fixed and variable costs, restructuring existing debt to reduce annual repayments, and delaying non-essential capital expenditure. Strengthening cash collections and avoiding unnecessary borrowing also helps improve the ratio over time.

Is DSCR applicable to personal loans?

DSCR is generally not used for personal loans. Lenders rely on the borrower’s income, job stability, existing EMIs, and credit score for approving personal loans. DSCR is primarily applied to business loans and project financing, where operating income and cash flows are evaluated to assess the ability to service debt obligations.

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