DSCR for a business loan: the ratio your bank checks

The question behind every business loan

A bank lending to a small business asks one thing before anything else: can the business pay the EMIs out of what it earns, without the owner selling something? The debt service coverage ratio, or DSCR, is that question as a number.

Our guide on running a small business by the numbers lists DSCR as one of five checks. This post works through a full loan application, shows where the figure comes from, and what changes it.

The formula

DSCR = net operating income ÷ annual debt service.

• Net operating income is revenue minus the running costs of the business. It leaves out depreciation (not a cash cost), income tax, capital spending and interest. Interest belongs on the other side of the ratio.
• Annual debt service is everything the loans cost in a year: principal repaid plus interest, on the new loan and on every existing one.

A DSCR of 1.0x means every rupee of operating income goes to the lender. Many banks want at least 1.20x to 1.25x. The DSCR calculator tests against 1.25x. There is no RBI-mandated minimum; each lender writes its own in its credit policy.

A worked example: a diagnostic lab in Nagpur

This is an illustration with assumed numbers. A pathology and imaging lab wants to add an automated analyser and a digital X-ray unit costing ₹1 crore. The owner offers ₹20 lakh as margin money and asks for an ₹80 lakh term loan. Assume 10.5% a year, reducing balance, over 5 years. The lab also pays ₹25,000 a month on a vehicle loan.

The new loan's EMI, from the EMI calculator, is ₹1,71,951 a month. In the first year that is ₹7.79 lakh of interest and ₹12.84 lakh of principal, ₹20.63 lakh in all. Add ₹3 lakh for the vehicle loan.

The lab covers its loans, but only just. One soft quarter, a reagent price rise or a large customer paying late would push it below 1.0x. At 1.19x the application falls short of a 1.25x floor. To clear it, operating income would need to be about ₹29.5 lakh, or the debt service about ₹22.4 lakh.

Four ways to raise it

Longer tenure is the strongest lever for coverage. The EMI falls to ₹1,34,885 and the ratio clears the floor with room to spare. The price is more interest over the life of the loan. Run both tenures through the EMI calculator and look at total interest, not only the monthly figure.

More margin money works directly: every rupee you put in is a rupee not borrowed. At a 1.25x floor, 10.5% and 5 years, ₹28 lakh of operating income supports a new loan of about ₹75.2 lakh alongside the vehicle loan. Over 7 years the same income supports about ₹95.9 lakh.

Counting the new income is legitimate, and it is how project loans are appraised. The analyser should bring in more tests, so the bank will look at projected income with the loan, not only last year's. Projections have to be believable: show current test volumes, the waiting list, and what the equipment adds per day.

Clearing small loans first helps more than it looks. The ₹3 lakh vehicle EMI is 13% of total debt service here. Paying it off before applying, if cash allows, lifts the ratio to about 1.36x on the 5-year loan. The loan prepayment calculator shows what an early payoff saves.

How banks actually compute it

Banks appraising a term loan usually use a variant: profit after tax, plus depreciation, plus interest on the term loan, divided by interest plus principal for the year. Tax comes out of the numerator, so the bank's figure is a little lower than the operating-income version above. Two more points matter:

• They look at every year, not only the first. The EMI is fixed, so debt service stays flat, but income may not. Banks often want a minimum-year DSCR of 1.20x to 1.25x and an average of 1.50x to 2.00x across the loan's life.
• The average is a ratio of sums. Add up five years of income and divide by five years of debt service. Averaging the five yearly ratios overweights easy years.

Pitfalls

• Leaving existing EMIs out. The bank sees every loan in your credit report. Your CIBIL score is checked alongside the ratio, and raising it takes months, so look before you apply.
• Using revenue instead of operating income. A ₹1.6 crore lab is not a ₹1.6 crore borrower; it is a ₹28 lakh one. The profit margin calculator shows the operating margin behind that figure: 17.5% here.
• Ignoring working capital. A lab whose corporate clients pay in 60 days needs cash before it has income. Check the cycle with the working capital calculator, and the volume needed to cover costs with the break-even calculator.
• Comparing quotes on flat rates. A "7% flat" quote is far dearer than 7% reducing; the flat vs reducing calculator converts it.
• Missing a guarantee scheme. Collateral-free loans to micro and small enterprises can be covered under the CGTMSE guarantee, which changes what the bank asks for, not the arithmetic of repayment.

Property loans use the same test with rent as the income; the rental yield calculator gives that side. And keep the household separate from the business. An owner whose own income depends on the lab needs personal savings outside it; the emergency fund calculator suggests at least nine months of essentials for the self-employed.

This post is for education only. The example uses an assumed interest rate and assumed accounts. Lenders' DSCR floors, formulas and margin requirements vary; check with your bank before applying.