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A credit analyst must judge whether a small business earns enough cash to pay the interest and principal on its existing and proposed loans.
DSCR equals profit after tax plus depreciation plus interest, divided by interest plus principal due in the same year. A value above 1.0 means cash covers debt service; lenders add a cushion by policy.
Profit after tax, depreciation and interest from the profit and loss account, plus the repayment schedule of every loan for the same year.
A DSCR figure for each year assessed, compared with the lender's policy threshold, and the cash surplus or shortfall after debt service.
DSCR (debt service coverage ratio) is the cash a business has available to pay its debts, divided by the interest and principal it must pay in the same period. A DSCR above 1.0 means the business earns enough to pay; below 1.0 means it does not. Lenders usually want a cushion above 1.0, and many look for about 1.25 or more, but each lender sets its own policy.
How is DSCR calculated?
The common form used for Indian business loans is:
DSCR = (Profit after tax + Depreciation + Interest) ÷ (Interest + Principal repayment due in the year)
Each part has a reason:
- Profit after tax is what is left after all expenses and tax.
- Depreciation is added back because it is a book entry; no cash leaves the business.
- Interest is added back on top because it is part of the debt service being tested.
- The denominator is everything the business must pay lenders in the year: interest plus the principal instalments.
Lenders calculate DSCR for each year of the loan, often using projected figures for future years, and look at both the lowest year and the average.
Worked example: a small manufacturer
A small manufacturer in Coimbatore has these figures for the year:
| Item | Amount |
|---|---|
| Profit after tax | ₹6,50,000 |
| Depreciation | ₹1,50,000 |
| Interest | ₹2,10,000 |
| Cash available for debt service | ₹10,10,000 |
| Interest due | ₹2,10,000 |
| Principal due | ₹6,00,000 |
| Total debt service | ₹8,10,000 |
DSCR = ₹10,10,000 ÷ ₹8,10,000 = 1.247, about 1.25.
The business earns ₹2,00,000 more than it must pay lenders (₹10,10,000 less ₹8,10,000). If the new loan would add ₹1,20,000 of interest and principal in the year, the debt service becomes ₹9,30,000 and DSCR falls to ₹10,10,000 ÷ ₹9,30,000 = 1.086. Many lenders would then reduce the loan or lengthen the tenure.
How is DSCR different from FOIR?
| DSCR | FOIR | |
|---|---|---|
| Used for | Business loans | Personal and salaried loans |
| Income measure | Business cash flow | Monthly income |
| Period | Usually annual | Monthly |
| Expressed as | A ratio, such as 1.25 | A percent, such as 45 percent |
| Good direction | Higher is better | Lower is better |
A proprietor can be assessed on both: DSCR for the business loan, FOIR if they also apply for a home or personal loan.
What if there are no audited accounts?
Many micro and small businesses have only a tax return, GST returns and a bank account. In that case analysts often rebuild an estimate of cash flow from twelve months of bank statements: genuine business receipts in, business payments out, and existing EMIs visible as debits. This is less precise than audited accounts, so lenders usually read it with GST and ITR data.
What to read next
DSCR depends on how much genuine business income passes through the bank, so read next: what is banking turnover and how do lenders calculate it. For the statement-based method, see cash flow analysis from an MSME bank statement and building a synthetic P&L from a bank statement.
TransactIQ helps MSME lenders build synthetic financials from bank statements, alongside 40+ engineered credit signals. See MSME lending.