Debt Service Coverage Ratio

Definition

The ratio of the total available cash flow divided by the business debt service.

What It Means

The debt service coverage ratio, abbreviated as DSCR, measures the ability of a business to meet its regular debt obligations. DSCR is the ratio of the annual business cash flow available for debt repayment to its total debt service.

It indicates a margin of safety available should the business profits, and its cash flows, decline temporarily. Sophisticated investors and small business lenders insist on debt service coverage ratios greater than 1.

For purposes of small business valuation, the cash flow available for debt repayment is usually defined as follows:

  • Business net after-tax income.
  • Plus the non-cash expenses such as depreciation and amortization.
  • Plus the principal and interest portions of debt repayments.
  • Plus business owner compensation in excess of a reasonable market rate.
  • Minus capital investments such as leasehold improvements and equipment purchases.

Structuring a successful business sale or purchase

When putting together a small business purchase proposal, you need to ensure that the business cash flow supports debt service. The Deal Check calculation in ValuAdder lets you automatically account for the DSCR of 1.25 on all borrowed acquisition capital.