DSCR explained: the cash flow test lenders use

What is the DSCR formula?

DSCR equals net operating income divided by total debt service. Net operating income is your profit before interest, taxes, depreciation and amortization, with adjustments the lender decides. Total debt service is every loan payment the business makes in a year, principal and interest, including the new loan you are applying for.

Lenders calculate it from your tax returns and year to date financial statements rather than from what you report, and they usually run it two ways: historical, using last year's actual cash flow, and projected, adding the new payment. Both have to pass. The glossary entry gives the one line definition, and the DSCR calculator runs the numbers for you.

Worked example: how do you calculate DSCR?

Say your business shows $120,000 of net profit on last year's tax return. You paid $25,000 of interest and took $20,000 of depreciation, so net operating income is $120,000 plus $25,000 plus $20,000, which is $165,000. The lender subtracts $15,000 of estimated taxes and distributions, leaving $150,000 of cash flow available for debt service.

Your existing loan payments total $60,000 a year. The loan you want would add $60,000 a year. Total debt service is $120,000. DSCR is $150,000 divided by $120,000, which is 1.25. That passes at most banks. If the new loan added $70,000 instead, debt service would be $130,000 and DSCR would be 1.15: fine for an SBA 7(a) loan, too thin for many banks.

What DSCR do lenders want?

Banks typically require 1.25 on term loans and commercial real estate. SBA lenders typically accept 1.15, which is one reason SBA loans are available to businesses banks decline. Real estate investors are usually held to 1.20 to 1.25 on the property's own income. A ratio below 1.0 means the business cannot cover its payments, and almost no bank or SBA lender will approve it.

Online lenders and cash advance companies do not calculate DSCR. They cap the payment at a percentage of your monthly deposits instead, typically 8% to 15% for a term loan. That is why an online lender can approve a business a bank says cannot afford the loan; it is measuring something different and charging for the extra risk.

What counts as cash flow, and what gets added back?

Lenders start with net profit and add back interest, depreciation and amortization, because the new loan will replace the old interest and the other two are not cash. They add back one time expenses you can document. They may add back owner salary above a reasonable market wage, then subtract a market wage for a replacement manager.

They subtract income taxes, owner distributions beyond salary, and capital expenditures the business needs to keep running. Every lender adjusts a little differently, which is why the same business can have a 1.3 DSCR at one bank and 1.1 at another. Global DSCR adds your personal income and personal debt payments as well; pay down personal debt before you apply if you are close to the line.

How can you improve your DSCR before you apply?

Raise the numerator or shrink the denominator. On the cash flow side, document one time expenses so they are added back, and avoid large distributions in the months before you apply. On the debt side, pay off small high payment debts such as cash advances and equipment loans near the end of their term.

Choose a longer term for the new loan: $500,000 costs about $9,900 a month over five years at 7% and about $5,800 a month over ten, which can be the difference between 1.1 and 1.4. Refinancing several short loans into one long one is often the fastest fix; see refinancing business debt. If your DSCR is still under 1.15, the cash flow is not there yet.

How does DSCR decide how much you can borrow?

Lenders work the formula backward. If your cash flow is $150,000 and the bank requires 1.25, your maximum total debt service is $120,000 a year. Subtract existing payments of $60,000 and $60,000 a year is available for the new loan, which supports roughly $430,000 over ten years at 7%, or about $250,000 over five. The how much can I borrow tool does this for any rate and term.

This is why a longer term or paying off an existing loan can raise your approval amount more than a better credit score. You can apply here and lenders will size the loan from your file, or ask your AI assistant to calculate your DSCR from your documents and apply through our MCP server; see the agents hub.