When a company is looking for finance to power growth, the main question that they have to ask themselves is ‘can they afford this business loan?’
Debt Service Coverage Ratio
For an individual or business to understand if and how much they can borrow, they have to first work out what they can afford to repay. Use the figures from your bookkeeping Kent to work out your finances. By calculating their debt service coverage ratio, they will be able to find out how much cash is available to pay back debt, such as paying interest, fees and capital.
To calculate your debt service coverage ratio you can use one of the following formulas:
- Profit before tax, interest, depreciation and amortisation ÷ current maturities of long term debt + interest
- Annual net operating income + non-cash charges and depreciation ÷ current maturities of long term debt + interest
Once you have worked out your debt service coverage ratio, you can then determine if you are able to afford a business loan. If your debt service coverage ratio is below 1, then you have a negative cash flow and will be unable to afford the loan repayments.
Lenders will use your debt service coverage ratio to evaluate your financial situation and will require different criteria before handing out a business loan. Some lenders will offer a business loan to those with a ratio of 1.25 or above, and others will require a minimum of 1.35 before offering a loan.