DCR, Debt Coverage Ratio - the ratio of NOI (net operating income) to the anticipated debt service.

INCOME TO DEBT MEASUREMENTS - DEBT COVERAGE RATIO CALCULATION

Debt Coverage Ratio is Net Operating Income divided by Annual Debt Service of the loan.

For example a business net operating income is $72,000 per year and the debt service for the loan is $55,000 per year the debt coverage ratio is 1.31%

(Calculation) $72,000 per year debt net operating income divided by the debt service of $55,000 per year.

Application)The borrower must be aware of whether the loan has a high probability of getting funded. The higher the DCR, the greater likelihood of the deal closing. A low DCR yields a property that is not cash flowing,

As a Business Broker, your client is most concerned about the future of the business and not the past performance of the business.  While you’re getting ready to prepare an offer the buyer is running his spreadsheets, performing numerous calculations to determine if the business can support the new buyer’s living expenses, cover any debts service and also make him a profit. 

So as the Broker we tend to look to the future, however this is completely contrary to what the Bank will do.

The Bank on the other hand looks backwards.  They carefully examine the last three years of tax returns for the business and determine the NOI for the business.  They then divide the NOI Into the proposed debt service and determine if the debt service coverage ratio is sufficient. 

Most financial lenders want to see at least a minimum of a 110% DSCR.  They actually hope to have at least a 125% DSCR, but 110% with extenuating circumstance can work.

So what do we do if we do not have 110% DSCR, do we just forget the transaction and move on.  No we analyze further the true cash flow of the business, and we start to make an argument that certain add backs should be added back to determine the Sellers’ real cash flow. 

So we add back depreciation, amortization and interest expense immediately.  Then we analyze the owners salary, and the previous owners living expenses.  The lender being naturally conservative will not agree to all your add backs, and most of the tenuous add backs are usually discounted.  After the add backs are added in hopefully you’re got a business that now can be financed.