What is DSCR?
Debt Service Coverage Ratio (DSCR) measures whether the business generates enough annual cash flow to meet its term loan repayment obligations. It answers a simple question banks ask before sanctioning any term loan: "If this loan is approved, can this business comfortably repay it from its operations?"
DSCR is applicable only for term loans — equipment finance, machinery loans, building construction loans, vehicle loans, and project finance. It is not computed for working capital facilities like Cash Credit.
It is calculated for every projection year in the CMA — not just Year 1. The bank looks at the full repayment period to ensure coverage is adequate throughout.
The DSCR Formula — Explained Line by Line
+ Depreciation (non-cash, added back)
+ Interest on Term Loan (TL Interest)
─────────────────────────────────────
Annual TL Principal Repayment
+ Interest on Term Loan (TL Interest)
─────────────────────────────────────
= DSCR
Why Each Component Is Used
| Component | Why Included |
|---|---|
| Net Profit After Tax (PAT) | The primary source of repayment — what the business earns after all expenses including tax |
| Depreciation | Non-cash expense — it reduces profit on paper but no cash actually leaves. Adding it back gives true cash generation. |
| TL Interest (Numerator) | TL interest was already deducted to arrive at PAT, so it's added back — we're measuring ability to pay it |
| TL Principal (Denominator) | The actual annual repayment of loan principal |
| TL Interest (Denominator) | The actual annual interest obligation on the term loan |
Worked Numerical Example
Let us take a manufacturing unit with a ₹200 lakh term loan at 11% per annum, repayable over 5 years in equal annual instalments.
| Item | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| Net Sales | 600.00 | 720.00 | 864.00 |
| Net Profit After Tax (PAT) | 36.00 | 52.00 | 68.00 |
| Depreciation | 24.00 | 21.60 | 19.44 |
| TL Interest | 22.00 | 17.60 | 13.20 |
| NUMERATOR = PAT + Depreciation + TL Interest | |||
| Cash Accrual (Numerator) | 82.00 | 91.20 | 100.64 |
| TL Principal Repayment | 40.00 | 40.00 | 40.00 |
| DENOMINATOR = Principal + TL Interest | |||
| Debt Service (Denominator) | 62.00 | 57.60 | 53.20 |
| DSCR | 1.32 | 1.58 | 1.89 |
Year-wise DSCR — Why Every Year Matters
Banks compute both individual year DSCR and average DSCR across the repayment period. A good average DSCR can mask a dangerous dip in a specific year.
If Year 1 DSCR is 0.95 — meaning cash flow cannot even cover the first year's repayment — the bank will either:
- Grant a moratorium (grace period) of 1–2 years before repayments begin
- Reduce the loan amount
- Extend the repayment period to reduce annual principal
- Require a promoter guarantee or additional collateral
Always check DSCR for every single year, not just the average. Present it year-wise in the CMA — never aggregate it.
What DSCR Values Banks Accept
| DSCR Range | Bank's Assessment | Likely Outcome |
|---|---|---|
| Below 1.00 | Cash flow negative — cannot repay | Rejection |
| 1.00 – 1.24 | Very thin — no buffer for downturns | Rejection or heavy conditions |
| 1.25 – 1.49 | Marginal — some banks accept for MSME | Conditional sanction, higher collateral |
| 1.50 – 1.99 | Acceptable — standard comfort zone | Sanction likely |
| 2.00 – 2.50 | Comfortable — strong repayment capacity | Fast sanction, may support higher quantum |
| Above 2.50 | Very strong | Sanction — bank may even offer better rate |
Common DSCR Calculation Errors
Using total interest instead of TL interest
Working capital interest should not appear in the DSCR formula — neither in numerator nor denominator. Only the term loan interest component.
Not adding back depreciation
Depreciation is a non-cash charge — the business has the cash, even though it shows as an expense. Missing this step significantly understates repayment capacity.
Using profit before tax (PBT) instead of PAT
Tax is a real cash outflow. Always use Net Profit After Tax in the numerator, not PBT.
Not matching repayment schedule to CMA year
The principal repayment amount changes each year (especially for reducing balance loans or step-up repayments). Use the actual repayment schedule — not a fixed average.
How to Improve a Low DSCR
If your DSCR comes out below 1.5, here are legitimate adjustments to improve it before submission:
Extend the repayment tenure
Stretching from 5 years to 7 years reduces annual principal — directly improving the denominator. Works well for assets with long useful lives (buildings, heavy machinery).
Increase promoter equity contribution
Reducing the loan quantum (more equity, less debt) reduces both principal and interest in the denominator. A 30:70 debt-equity vs 50:50 can meaningfully shift DSCR.
Request a moratorium period
A 6–18 month moratorium (no principal repayment during project construction) means Year 1 has only interest — dramatically improving early-year DSCR.
Refinance existing high-cost debt
If existing term loans carry high interest rates, refinancing at current rates reduces the interest component — improving both profitability and DSCR.
Build more conservative but justifiable revenue projections
Paradoxically, revising projections to show slightly higher margins (with evidence — pricing contracts, cost reduction plan) can lift PAT and thus the numerator.
DSCR vs Interest Coverage Ratio (ICR)
These two ratios are often confused. They measure different things:
| DSCR | ICR (Interest Coverage) | |
|---|---|---|
| Formula | (PAT + Dep + TL Int) ÷ (Principal + TL Int) | EBIT ÷ Total Interest |
| What it measures | Ability to repay principal + interest from cash flows | Ability to pay interest from operating profit |
| Used for | Term loans in CMA analysis | Quick solvency check, bond covenants |
| Includes principal repayment? | Yes | No |
| Bank threshold | ≥ 1.5 | ≥ 2.0 (informal benchmark) |
ICR is a weaker test — a company can have a high ICR but still struggle to repay principal. Banks rely on DSCR for term loan decisions.
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