DSCR Calculation: Formula, Interpretation, and What Banks Actually Look For
The Debt Service Coverage Ratio tells a bank whether your business generates enough cash to repay term loan obligations. Here's exactly how to calculate it, interpret it, and avoid the mistakes that get loan proposals rejected.
What is DSCR?
The Debt Service Coverage Ratio (DSCR) measures a borrower's ability to service debt — specifically, whether the business generates sufficient surplus to cover term loan principal repayment and interest obligations.
It is the single most important ratio for term loan appraisal. While current ratio matters for working capital, DSCR determines whether a term loan gets sanctioned.
The DSCR Formula
DSCR = (Net Profit After Tax + Depreciation + Interest on Term Loan) / (Term Loan Instalment + Interest on Term Loan)
Breaking this down:
Numerator — Cash Available for Debt Service:
- Net Profit After Tax (NPAT)
- Add back: Depreciation (non-cash charge)
- Add back: Interest on Term Loan (since we're measuring ability to pay this very amount)
Denominator — Total Debt Service Obligation:
- Annual Term Loan principal repayment (instalment)
- Annual Interest on Term Loan
A Real DSCR Calculation
Company: XYZ Industries Ltd seeking a ₹200 lakh term loan at 12% interest, repayable in 5 equal annual instalments of ₹40 lakhs.
| Year | NPAT (₹L) | Depreciation (₹L) | TL Interest (₹L) | TL Instalment (₹L) | DSCR |
|---|---|---|---|---|---|
| Year 1 | 25 | 18 | 24 | 40 | 1.05 |
| Year 2 | 32 | 16 | 19.2 | 40 | 1.13 |
| Year 3 | 40 | 14 | 14.4 | 40 | 1.26 |
| Year 4 | 48 | 12 | 9.6 | 40 | 1.40 |
| Year 5 | 55 | 10 | 4.8 | 40 | 1.56 |
| Average | 1.28 |
Year 1 DSCR: (25 + 18 + 24) / (40 + 24) = 67 / 64 = 1.05
How Banks Interpret DSCR
The Minimum Threshold
Most banks require:
- Minimum DSCR of 1.25 to 1.50 for each year of the loan tenure
- Average DSCR of 1.50 or higher across the entire repayment period
A DSCR of exactly 1.00 means the business generates just enough to pay its obligations with zero margin. Below 1.00 means the business cannot service the debt from its operations — a definite rejection.
What a Strong DSCR Signals
- DSCR > 2.0: Comfortable repayment capacity. The bank sees low credit risk.
- DSCR 1.5–2.0: Adequate capacity. Standard for most term loans.
- DSCR 1.25–1.5: Marginal. Bank may sanction but with additional conditions (higher collateral, personal guarantees).
- DSCR < 1.25: Weak. Likely rejection or request for loan restructuring.
Year-wise vs Average DSCR
Banks look at both:
- Year-wise DSCR should not fall below 1.0 in any year. Even if the average is 1.5, a single year below 1.0 raises a red flag.
- Average DSCR gives the overall picture across the loan tenure.
In our example above, Year 1 DSCR of 1.05 is a concern. The bank may ask the borrower to accept a moratorium on principal repayment for the first year, or to front-load equity contribution.
Common Mistakes in DSCR Projection
1. Inflating Revenue Projections
The most common mistake. Projecting 30% revenue growth annually when the industry grows at 8% makes the DSCR look great on paper but destroys credibility with the credit officer.
2. Ignoring Interest Computation on Reducing Balance
Term loan interest is charged on the reducing balance. If you compute interest on the original loan amount for all years, your DSCR will be artificially lower in later years — but the bank will catch the error.
3. Mixing Up Working Capital Interest and Term Loan Interest
Only term loan interest goes into the DSCR formula. Cash credit interest is an operating cost and stays in the P&L. Including it in the denominator will deflate your DSCR unnecessarily.
4. Forgetting to Add Back Depreciation
Depreciation is a non-cash charge. Failing to add it back means you're understating the cash available for debt service. This is a basic error that signals the preparer doesn't understand the ratio.
5. Not Aligning Depreciation with Capex
If the term loan is for new machinery, the depreciation on that machinery should appear from Year 1. Projecting depreciation at old rates without factoring in the new asset makes the model inconsistent.
DSCR for Different Loan Types
| Loan Type | Typical DSCR Requirement |
|---|---|
| Term Loan (Manufacturing) | 1.50 |
| Term Loan (Services/IT) | 1.25–1.50 |
| Project Finance (Infrastructure) | 1.20–1.30 |
| MSME Term Loan | 1.25 |
| Housing/Real Estate Project | 1.10–1.20 |
How DSCR Connects to Other CMA Ratios
DSCR doesn't exist in isolation. Banks cross-check it with:
- Interest Coverage Ratio (ICR): EBIT / Total Interest. If ICR is low, even a decent DSCR may not save the proposal.
- TOL/TNW: High leverage means the DSCR threshold should be even higher to compensate for financial risk.
- Cash Flow Statement: The DSCR is computed from projections, but the cash flow statement validates whether these projections are achievable.
Automating DSCR Computation
CMA Report computes DSCR automatically from your P&L projections and term loan schedule. It handles reducing balance interest, aligns depreciation with capital expenditure, and flags any year where DSCR falls below the bank's minimum threshold — before you submit.