What is the debt service coverage ratio?

The debt service coverage ratio measures whether a business generates enough operating income to cover its debt payments, including both principal and interest. The calculation divides net operating income by total annual debt service. A DSCR of 1.25 means the business generates $1.25 in cash flow for every $1.00 in debt service.

What your banker sees first

The loan officer calculates DSCR before looking at much else. A value below 1.0 means you cannot cover debt from operations. Below 1.25 means too tight for comfort. Most banks require 1.25 minimum. If your DSCR fails the threshold, the conversation often ends there.

The covenant trap

Loan agreements often require maintaining a minimum DSCR throughout the term. Business dips, NOI falls, you breach the covenant. Consequences vary: penalty fees, interest rate increases, accelerated repayment, frozen credit lines. Read covenants carefully before signing.