What Is Debt-Service Coverage Ratio in Business Financing?

When using loans, lines of credit or other forms of debt financing, you should pay attention to your business’s debt-service coverage ratio. Most businesses have at least some debt. Statistics show that the average debt held by small- and medium-sized businesses is $100,000 to $250,000. Whether your business holds more or less debt, though, you should familiarize yourself with debt-service coverage ratio.

What Is Debt-Service Coverage Ratio in Business Financing?

Overview of Debt-Service Coverage Ratio

Debt-service coverage ratio is a ratio of your business’s available cash to its debt payments. It reflects your business’s ability to repay its debt.

Allowing your business’s debt payments to greatly exceed its available cash can prove problematic. As the debt builds up, you may struggle to repay it. With debt-service coverage ratio, you can measure your business’s ability to repay its debt.

How to Calculate Debt-Service Coverage Ratio

You can calculate your business’s debt-service coverage ratio by dividing your business’s net operating income by its debt service, followed by converting this new number into a ratio. Debt service includes all debt obligations, such as loan payments, lines of credit payments, credit card payments and interest.

Debt-service coverage ratio offers a simple and accurate way to measure your business’s ability to repay its debt. A debt-service coverage ratio of 1:1 means your business’s net operating income is equal to its debt service. A debt-service coverage ratio of 2:1, on the other hand, means your business’s debt is twice as much as your business’s net operating income. Therefore, your business won’t be able to meet all of its debt obligations on time.

Why Debt-Service Coverage Ratio Is Important

Debt-service coverage ratio is an important financial metric. It shows whether your business can repay its debt. There’s nothing wrong with using debt financing to get your business up and running. Whether it’s a loan, line of credit or any other debt vehicle, though, you’ll need to repay it. With debt-service coverage ratio, you’ll have a better understanding of your business’s ability to repay its debt. This financial metric takes into account your business’s net operating income and its debt service.

Of course, there are steps you can take to improve your business’s debt-service coverage ratio. Increasing your business’s net operating income or lowering your business’s debt will result in a better debt-service coverage ratio.

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