In India’s vibrant MSME sector, which forms the backbone of our economy with over 63 million enterprises, securing business loans remains a critical challenge for growth and sustainability. While traditional lenders often focus on collateral and credit history, the Debt Service Coverage Ratio (DSCR) has emerged as a vital metric that can be a deciding factor for loan applications for small and medium enterprises.
For Indian MSMEs struggling to navigate the complex lending landscape, understanding DSCR isn’t just about financial literacy—it’s about unlocking the doors to formal credit, moving beyond informal lending channels, and positioning their businesses for sustainable growth in an increasingly competitive market.
What Is DSCR?
The Debt Service Coverage Ratio (DSCR) is an important measure that lenders use to check if a business can repay its loans. It is calculated by dividing a business’s net operating income by its total outstanding debt (including principal repayments).
For Indian MSMEs, DSCR helps financial institutions assess loan repayment ability. A higher DSCR means the business has enough income to cover its debt, while a lower DSCR may indicate repayment challenges. This ratio is especially useful for businesses with loans that have regular principal repayments, such as monthly or yearly EMIs.
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What is the Use of DSCR?
DSCR plays a crucial role in determining whether a business can take on new loans or issue bonds, while also influencing the interest rates offered on such bonds.
Here’s how DSCR is commonly used by businesses, investors, and lenders:
1. Planning Business Growth
A business’s DSCR provides insight into its financial strength, helping business owners decide whether they can take on additional financing to expand operations. Financial analysts also use DSCR for forecasting and strategic planning.
2. Structuring Business Finances
DSCR helps determine the right mix of debt and equity in a business’s capital structure. A low If your DSCR is low, you might need to bring in investors, but that can be expensive.. Conversely, a high DSCR suggests the business has room to take on more debt at a lower cost while retaining ownership control.
3. Assessing Loan Eligibility
Financial institutions consider DSCR when evaluating loan applications. A good ratio reassures lenders that the business has sufficient cash flow to meet repayment obligations, improving the chances of business loan approval.
4. Measuring Long-Term Performance
When analyzed alongside liquidity and leverage ratios, DSCR helps gauge the overall financial health of a business. A consistent DSCR can signal long-term stability, making it an essential tool for both business owners and financial analysts.
For Indian MSMEs, maintaining a healthy DSCR can improve access to financing, support growth, and enhance credibility with lenders and investors.
How to Calculate DSCR?
Calculating the Debt Service Coverage Ratio (DSCR) is straightforward, requiring two key components: net operating income and total debt obligations.
DSCR Formula:
DSCR= Net operating income/ Annual debt service
Where:
Net Operating Income = Pre-tax income – operating expenses (such as rent, wages, taxes, cost of goods sold, lease payments, etc.)
Alternatively, businesses may use EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) instead of Net Operating Income:
EBITDA= pre-tax income + interest + depreciation and amortization
Annual Debt Service includes all principal and interest payments due within a year.
Example Calculation
A business has a net operating income of ₹50,00,000. It pays ₹10,00,000 as interest and ₹15,00,000 towards loan principal.
DSCR = 50,00,000/(10,00,000 + 15,00,000) = 50,00,000/25,00,000 = 2
A DSCR of 2.0 means the business earns twice the amount needed to cover its debt obligations, making it financially stable in the eyes of lenders.
For Indian MSMEs, maintaining a healthy DSCR can improve loan eligibility, ease access to credit, and ensure sustainable business growth.
How to Improve DSCR?
To improve the Debt Service Coverage Ratio (DSCR), a business needs to either increase its income, reduce its debt, or do both. Here are some practical ways to achieve this:
- Increase Business Income
A higher net operating income strengthens DSCR. Businesses can achieve this by boosting sales, expanding to new markets, or launching marketing campaigns to attract more customers. - Repay Existing Loans
Reducing outstanding debt helps improve DSCR. Businesses should focus on timely loan repayments and avoid taking on new loans if their DSCR is already low. - Reduce Operating Costs
Cutting unnecessary expenses can improve DSCR. This can be done by analyzing operating costs, eliminating inefficiencies, and optimizing processes to improve profitability. - Refinance High-Interest Loans
If a business has multiple loans with high interest rates, consolidating them into a single, lower-interest loan can reduce the overall debt burden, improving DSCR over time.
By managing income and expenses effectively, Indian MSMEs can maintain a strong DSCR, making it easier to secure funding and sustain long-term growth.
Conclusion
For MSME owners, understanding and maintaining a strong DSCR is not just about securing loans—it’s about ensuring long-term financial stability and growth. A good DSCR improves your chances of getting business loans on favorable terms, helping you expand operations, invest in new opportunities, and manage cash flow effectively. By increasing income, reducing debt, and optimizing expenses, MSMEs can improve their financial health and strengthen their position in the market.
At Kinara Capital, we understand that access to timely credit is crucial for MSMEs. Our collateral-free business loans are designed to help small businesses grow without the burden of extensive paperwork or long approval processes. Whether you need machinery loans or funds for expansion, Kinara Capital provides fast, flexible, and hassle-free financing solutions to support your growth journey.
FAQ
1. What happens if my DSCR falls during the loan tenure?
If your DSCR falls during the loan tenure, lenders may see your business as a higher risk. This could lead to stricter loan terms, difficulty in securing additional credit, or potential refinancing challenges.
2. Why is DSCR important for securing business loans?
DSCR is crucial for securing business loans as it shows lenders your ability to repay debt. A higher DSCR indicates lower risk, increasing the chances of loan approval with better terms and interest rates.
3. What is considered a good DSCR?
A good DSCR is typically 1.25 or higher, meaning the business generates enough income to cover its debt obligations with a comfortable margin. A DSCR below 1 may indicate financial risk and difficulty in loan repayment.
4. Can a business with a low DSCR still get a loan?
Yes, a business with a low DSCR can still get a loan, but it may face higher interest rates, stricter terms, or require collateral. Lenders may also ask for a strong business plan or guarantor.
5. Is DSCR relevant for all types of loans?
DSCR is relevant for most loans, especially business and commercial loans. However, for short-term or interest-only loans, lenders may prioritize other financial metrics like the interest coverage ratio or cash flow analysis.
6. Can I Use Interest Coverage Ratio Instead of DSCR Ratio?
The Debt Service Coverage Ratio (DSCR) evaluates a business’s ability to meet its total debt obligations, including both principal and interest. In contrast, the Interest Coverage Ratio measures how well a business can cover just the interest payments on its debt. While DSCR provides a broader picture of financial stability, the Interest Coverage Ratio is more relevant in cases where a loan requires only interest payments.
