Cash available to service debt
Depreciation and interest are added back because, for this purpose, neither has left the business as cash before the debt is paid.
Net Worth & Solvency Glossary · Lending
Debt Service Coverage Ratio (DSCR) in Loan Appraisal
noun · abbreviated DSCR · a flow, measured over a period, not a balance at one moment
Definition
The debt service coverage ratio (DSCR) measures how much cash a business generates for every rupee of loan repayment falling due in a period.
A DSCR of one means the business earns exactly what it owes in instalments and interest, with nothing to spare. Lenders use it to judge whether a borrower can service a loan from its own cash flow.
Reading the number
Cash generated for every rupee of repayment due
- below 1A shortfallThe business earns less than it owes in the period. The gap has to come from somewhere else.
- exactly 1Nothing to spareInstalments and interest are met from the period's cash, and no more.
- above 1HeadroomLenders look for a ratio comfortably above one; how far above depends on the sector and the loan.
Lenders' exact definitions vary. The sanction letter or project report states the one used.
The formula
01What DSCR measures per rupee of repayment due
The DSCR formula commonly used in Indian loan appraisal, and what each line holds.
DSCR
profit after tax+depreciation+interest on term loans
principal instalments due+interest on term loans
The full obligation for the period
Principal repayments plus interest, for every loan the business carries.
A ratio below one means the shortfall has to come from somewhere else, such as fresh capital, asset sales or more borrowing. Where a business has several loans, the ratio is worked out on the total obligation, not loan by loan, so taking one more facility can push a comfortable borrower below the line. Lenders' exact definitions vary, and the sanction letter or project report states the one used.
Looking backFrom audited resultsWhat the business actually generated against what fell due.
Looking forwardFrom projectionsWhat the business expects to generate over the life of the loan.
A lender usually wants both.
Stock and flow
02Reading DSCR against a certified balance sheet position
DSCR answers a question net worth cannot, and a lender reads the two together.
Net worth
What is owned at one moment.
Where it misleads on its ownA borrower can be asset-rich and still fail the ratio, as a business holding property while trading thinly often does.
DSCR
What the business produces over a period.
Where it misleads on its ownThe reverse is common in services, where cash generation is strong but there is little on the balance sheet.
A lender reads the two together. A net worth certificate for a bank loan answers the stock question, and the DSCR in the project report answers the flow question.
For a proprietor, household drawings come out of the same cash the ratio measures, so a realistic calculation deducts what the household actually lives on. A projection that ignores drawings overstates coverage, and an experienced appraiser will correct it.
In the project report
03Benchmarks Indian bankers expect in project reports and CMA data
Lenders look for DSCR comfortably above one, with the expected level depending on the sector, the predictability of cash flow and the length of the loan. Longer loans usually call for more headroom.
The projections behind the ratio sit in the project report and in the CMA (credit monitoring arrangement) data the borrower submits. Points appraisers look at closely:
- 1
Average and minimum DSCR
Coverage is examined both as an average over the loan's life and year by year. A loan that averages well but dips below one in a single year has a problem in that year, and the minimum often decides the sanction.
- 2
The moratorium years
During a repayment holiday, coverage looks high because only interest, or nothing, is due. It falls sharply when principal starts, which is the point many projections pass over.
- 3
Optimistic margins
A projection that assumes a sharp jump in margins in year one is discounted.
DSCR rules under specific government schemes are outside this entry.
Written by Subham Jhunjhunwala · Reviewed by CA Sundram Gupta
This entry describes Indian lending practice in general terms. Each lender's sanction terms govern the ratio it applies.
Need help with a certificate that uses debt service coverage ratio? See our CMA data prepared and certified for the bank.The projections behind the ratio, prepared in the form the lender asks for.