What it means
A debt service coverage ratio otherwise known as DSCR is the ratio of your loan repayment plus interest to the cash available to service it. It is one of the most important ratios a bank utilises in accessing whether to give out a loan or not.
How it works?
Assuming a bank is considering giving you a loan that warrants that you pay back N100k every month (including principal plus interest). The bank can in their analysis set a DSCR of 2:1. Meaning that the cash your business generates after paying for its expenses must be twice the loan repayment above on a monthly average.
As such, your business must be able to generate a free cash flow after operating expenses of N200k to qualify for the loan. In other words your business must be able to generate N200k monthly after paying for your suppliers, salaries and overhead expenses.
What it means for the business.
As a business, the DSCR is best understood in cash terms than in profits. When you perform analysis on whether to seek a bank loan, you must be sure that your business generates enough cash to not only cover the DSCR but retain enough to pay you dividends. Remember, after paying your suppliers, salaries and overheads you must pay the bank first before paying dividends.
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