Debt Service Coverage Ratio (DSCR)

It is calculated as: DSCR = Net Operating Income (NOI) ÷ Total Debt Service (TDS)

For example, if a business earns ₹20 lakh in NOI annually and has ₹16 lakh in annual debt repayments, its DSCR is 1.25 (₹20 lakh ÷ ₹16 lakh). A higher DSCR indicates stronger financial stability, while a DSCR below 1 signals repayment risk.

Why DSCR Matters

DSCR is a key metric for loan approval. Lenders typically require a DSCR of 1.25–1.50 or higher for business loans, as a lower ratio suggests default risk. Beyond loan approvals, DSCR reflects financial health. A ratio of 1.5 or more means the business has surplus cash, allowing for expansion, emergency reserves, or debt prepayment. Unlike the interest coverage ratio, which only considers interest costs, DSCR accounts for principal repayments, giving lenders a comprehensive view of debt servicing capacity.

Challenges of DSCR Calculation

Despite its usefulness, DSCR is subject to volatility. Since it relies on NOI, which fluctuates with revenue and expenses, a drop in earnings can significantly impact DSCR. For example, a ₹10 lakh drop in EBITDA could reduce DSCR from 1.3 to 0.9, making loan repayments harder. Another limitation is accounting bias. DSCR relies on accrual-based metrics like EBITDA, which may not show true cash flows. Also, DSCR does not consider short-term liquidity issues. Delayed customer payments can impact immediate debt obligations.

Practical Tips for Managing DSCR Effectively

To improve DSCR, businesses should focus on increasing income and reducing costs. Raising revenue by ₹5 lakh annually can boost NOI from ₹15 lakh to ₹20 lakh, strengthening DSCR. Cutting overhead expenses—such as renegotiating vendor contracts to save ₹2 lakh per year—can further improve financial stability. Refinancing high-interest loans is another effective strategy. Reducing loan interest from 12% to 10% on a ₹50 lakh loan saves approximately ₹1 lakh annually, improving DSCR without increasing revenue. Early debt repayment can also lower Total Debt Service (TDS), increasing DSCR over time. Businesses should prioritize clearing high-cost debt first to reduce financial burden. Lastly, regular DSCR monitoring using projected NOI and TDS helps businesses stay prepared for loan applications. For example, forecasting ₹25 lakh NOI against ₹18 lakh TDS results in a 1.39 DSCR, ensuring better financing options.

Final Thoughts

For Indian MSMEs, a DSCR above 1.25 helps secure loans with lower interest rates and better collateral terms. To improve financial health and borrowing power, businesses should optimize income, manage expenses, refinance debt, and monitor their DSCR regularly.