What Is DSCR and How Does It Affect Your Business Loan Approval?

Most SBA lenders look for a DSCR of at least 1.25, meaning your annual net operating income should be 25% higher than your yearly debt obligations.

With only 51% of small business loan applications approved in 2023, it’s clear that financial health matters more than ever. Improving your DSCR can boost your approval odds and unlock better terms. Compare our best business loans to find the right fit for your business goals.

What Is the Debt Service Coverage Ratio (DSCR)?

The Debt Service Coverage Ratio (DSCR) measures your business's ability to generate enough net income to cover debt obligations—including principal and interest payments. It answers the lender's most important question: "Can this business afford to repay the loan?"

"DSCR is often the difference between approval and denial," explains Michael E. Carter, a Senior Commercial Loan Underwriter with over 15 years of experience in SBA and commercial lending.

He adds, "When a borrower shows a DSCR below 1.0, the lender's hands are usually tied—it becomes too risky to approve the deal without major adjustments."

How DSCR Works

• Measures cash flow safety: Compares net operating income to total debt service to determine if you generate enough cash to cover loan payments.
• Forward-looking metric: Evaluates current financial health and future repayment capacity, unlike credit scores that measure past behavior.
• Creates cushion requirements: Lenders want you to generate more income than debt payments require, providing a buffer for unexpected expenses.

Understanding the DSCR Formula

DSCR = Net Operating Income (NOI) ÷ Total Debt Service

This simple calculation compares the cash your business generates from operations to your total annual debt payments. A higher ratio means more cash flow cushion, while a lower ratio signals tighter margins that concern lenders.

DSCR Benchmarks: What Lenders Look For

A DSCR above 1.25 creates negotiation power, while ratios of 1.50+ demonstrate you can handle debt even during challenging periods.

How to Calculate Your DSCR: Step-by-Step Example

The business scenario:

A construction company generates $850,000 in annual revenue with $340,000 in cost of goods sold and $310,000 in operating expenses. They currently pay $45,000 per year on their existing loans and want to add a $200,000 equipment loan, which would require $30,000 in annual payments.

Step 1: Calculate Net Operating Income

First, determine how much cash your business generates from core operations. Take your annual revenue, subtract the cost of goods sold, then subtract operating expenses. This gives you the cash available before any debt payments.

For this construction company: $850,000 (revenue) - $340,000 (COGS) - $310,000 (operating expenses) = $200,000 in net operating income.

This $200,000 represents the actual cash available to service debt obligations. Lenders focus on this number because it shows sustainable, recurring income rather than one-time gains or accounting adjustments.

Step 2: Calculate Total Debt Service

Add up all annual debt obligations, including both existing loans and the proposed new loan. This represents your yearly total debt burden.

For this business: $45,000 (existing loan payments) + $30,000 (proposed new loan) = $75,000 in total annual debt service.

Lenders want to see this complete picture because they need to know you can handle all debt obligations simultaneously, not just the new loan in isolation.

Step 3: Calculate DSCR

Divide your net operating income by total debt service to get your ratio.

$200,000 ÷ $75,000 = 2.67 DSCR

This means the construction company generates $2.67 for every $1.00 of debt payments required. With this strong ratio, the business has more than enough cash flow to cover the new equipment loan while maintaining a substantial cushion.

How DSCR Impacts Your Loan Terms

Your DSCR directly influences the terms you receive:

• Interest rates: Borrowers with DSCR ratios above 1.50 typically qualify for the best rates—potentially 0.5% to 1.5% lower than borrowers with a marginal 1.25 DSCR, saving thousands in interest over the loan term.
• Loan amounts: Higher DSCR ratios enable larger loan qualifications, as lenders use your DSCR to determine how much additional debt your business can reasonably handle.
• Collateral requirements: A robust DSCR may reduce collateral requirements or eliminate personal guarantees, while lower ratios often trigger demands for additional security.
• Loan covenants: Businesses with lower DSCRs may face restrictive covenants on additional borrowing, dividend distributions, or major capital expenditures.

3 Proven Strategies to Improve Your DSCR

If your DSCR falls short of lender requirements, these strategies can strengthen your ratio:

1. Increase Your Net Operating Income

• Cut unnecessary operating expenses: Review expense reports and identify cost reduction areas. Even a 5-10% reduction can significantly improve your DSCR.
• Raise prices strategically: Modest price increases on profitable products or services can boost NOI without substantial cost increases.
• Improve operational efficiency: Streamline processes, reduce waste, and optimize staffing to increase profitability.

2. Reduce Your Total Debt Service

• Pay down high-interest debt: Focus on expensive debt first to reduce your debt service burden and improve your ratio.
• Refinance current loans: Lower interest rates reduce annual debt service without changing the principal balance.
• Negotiate extended repayment terms: Spreading payments over a longer period reduces annual debt service, improving your DSCR.

3. Time Your Application Strategically

• Apply after your strongest financial quarter: DSCR calculations often use trailing twelve-month data. Applying after a strong performance showcases your best numbers.
• Wait to apply for new financing: If you recently took on debt, waiting 6-12 months to demonstrate stable repayment history improves your position.
• Delay major capital expenditures: Large one-time expenses temporarily reduce your NOI. Postpone discretionary spending until after securing financing.

How Refinancing Improves Your DSCR Without Increasing Revenue

A business with $600,000 in net operating income improved its DSCR from 1.09 to 1.25 simply by refinancing existing debt—moving from likely rejection to standard approval without generating a single dollar of additional revenue.

By reducing annual debt payments by $70,000 through lower interest rates and extended terms, this business transformed its loan application from risky to acceptable. This shows that strategic debt management can be faster and more effective than waiting for revenue growth.

Beyond DSCR: Other Factors Lenders Consider