Lenders take several different factors into account when evaluating a commercial loan application, but one of the most important is debt service coverage. This shows the budgetary capacity that a company has to pay the loan that it is requesting. This calculator helps you determine how a potential loan would influence your company’s debt service coverage ratio.
How the Debt Service Coverage Calculator Works
Here’s how the ratio works. You divide your company’s net operating income by the existing debt service. A company with a debt service ratio of 1 is bringing in exactly enough net income to meet its debt service needs. If the ratio is less than 1, that means that the company is losing cash over time, because the net income generated by operations is not enough to service the existing debt.
Just because your company has a debt service coverage ratio below 1 after taking your loan into account does not mean that the bank is going to decline your loan application, though. If you’re also the business owner, and you have outside income that you are willing to commit to the project, some banks will approve the loan application anyway.
How do lenders define net operating income? You take your revenue and subtract your operating expenses (but not payments on taxes or interest). This number is also known as EBIT (earnings before interest and tax). Your total debt service refers to any current debt obligations that your company has incurred. This means any principal, interest, lease or sinking-fund payments that your business has due in the next year. If you’re looking at this on a balance sheet, you’ll see it including short-term debt as well as the current installment of your long-term debt.
What if your debt service coverage ratio is just above 1, as in 1.05 or 1.1? Your company is still fairly vulnerable, as it would only take a small hit in cash flow to make your company unable to make its debt payments. Some lenders may require that you keep your debt service coverage ratio at a particular level while the loan remains outstanding, which means that if your agreement contains this provision and your business’ debt service coverage ratio falls below that threshold, your loan is considered to be in default — even if you’ve been making your payments on time — so you’ll want to read the fine print of your agreement carefully.
This calculator takes your income available for debt service and evaluates the effect of a new loan on your debt service coverage ratio, giving you the information you need to make a savvy borrowing decision.