Article by Roger Schlueter, MBA
The Business Credit Debt Coverage Ratio is a very simple ratio to calculate. The basic ratio is the Available cash flow, divided by the Total Debt Service. Available cash flow means, Cash Flow, that is left to pay the Total Debt Service. Cash Flow is Net Income plus Depreciation (and other non-cash charges). The Ratio is used in Commercial Lending but mainly in Real Estate Commercial Lending.
Simple Company Example:
Sales $100,000
– COGS $500
Net Sales $500
-SGA $300
= Net Income $200
Net Income $200
+ Depreciation $25
+ Interest* $50 (interest is added back in, because it is part of the Debt Service)
Cash Flow $270
Debt Service – Annual $200
Debt Service Coverage Ratio is $270 / 200 = 1.35
Of Course you want this ratio to be over one (this will cover the Debt Service) but most banks would like to see it at 1.25 to 1.30 as a minimum. They feel that gives enough of a cushion to weather any increases in interest rates or decreases in income.
Simple Rental Property Example:
Rental Income $100,000
– Vacancy (10%) $10,000
– Rental Expenses $15,000
Prop Tax & Maint.
Rental Income $ 75,000
Debt Service $56,250
Debt Service Coverage Ratio is 1.33
The Big Deal with Rental or Commercial Property is the Vacancy Number. The Vacancy rate can be higher if there is only one tenant and lower if there are more that one tenant.
This has been a very brief overview of how to calculate the Business Credit Debt Coverage Ratio, there are many other situations that can influence the outcome so only use this as a guide. Please Email me at roger@rogerschlueter.com or see my website at schlueterfinancial.com