Do you need to take out a loan for your business but are worried your debt service coverage ratio (DSCR) may not be high enough to qualify? Your DSCR is an important metric lenders consider when reviewing loan applications, as it measures your ability to repay debt obligations from operating income.
The higher your DSCR, the more favorably lenders will view your loan eligibility. A DSCR of 1.25 or higher is generally preferred, though requirements vary by lender. If your ratio falls below that threshold, don’t panic – there are steps you can take to boost your DSCR and strengthen your chances of loan approval in the UK.
What Exactly is a Debt Service Coverage Ratio?
Before diving into ways to improve your DSCR, let’s make sure you have a solid understanding of what the ratio entails.
The DSCR Formula
The debt service coverage ratio is calculated with a simple formula:
Net Operating Income / Total Debt Service = DSCR
- Net Operating Income (NOI): Your gross income minus operating expenses over a set period of time (often annually).
- Total Debt Service: The total amount you pay towards debt obligations over a period of time, including principal, interest, fees, etc.
- Debt Service Coverage Ratio (DSCR): The output of dividing your NOI by total debt service.
DSCR Thresholds for Loan Eligibility
As mentioned, most lenders look for a minimum DSCR of 1.25 when evaluating loan applications. Here are some common thresholds:
- DSCR below 1: Indicates you do not generate enough operating income to cover your current debt payments. Highly unlikely to qualify for additional financing.
- DSCR of 1 to 1.24: In the caution zone. Additional debt may be difficult to obtain or come with unfavorable terms.
- DSCR of 1.25 to 1.49: Considered sufficient by many lenders to take on additional debt, though still on the lower end.
- DSCR of 1.5 or higher: A strong ratio that clearly demonstrates adequate income to service debt. Preferred by lenders.
The higher your ratio, the more confident lenders will feel in your ability to handle new loan payments atop existing obligations. Boosting your DSCR closer to or above 1.5 will significantly improve your chances of approval.
5 Strategies to Increase Your DSCR
Ready to strengthen your DSCR and eligibility for financing? Here are five proven ways businesses can improve their ratio:
1. Increase Revenue
The most direct way to improve your DSCR is to increase your net operating income, the numerator in the calculation. Focus on driving higher revenue through strategies like:
- Raising prices on products/services
- Selling more to existing customers
- Gaining new customers
- Adding new product or service offerings
- Expanding to new markets
Even marginal revenue gains can have a meaningful impact on your NOI and DSCR when sustained over time. Set realistic revenue goals and work diligently towards growth.
2. Reduce Operating Expenses
Rather than solely focusing on revenue gains, reducing operating expenses can also improve your DSCR by lowering the denominator. Some ideas to cut costs:
- Renegotiate contracts with suppliers and vendors for better rates
- Optimize staffing to control labor costs
- Consolidate services like IT, marketing, HR onto single platforms
- Lower energy costs by upgrading equipment, installing smart thermostats
- Cut unnecessary expenses like unused software subscriptions
Be careful not to sacrifice important investments in growth. But a lean, efficient operation will translate to a healthier bottom line and DSCR.
3. Refinance/Consolidate Debt
Refinancing existing debts can lower your total debt service payments through more favorable repayment terms like:
- Lower interest rates
- Longer loan tenors
- Lower or deferred payments
You may also consider consolidating multiple debts into a single loan or line of credit. Work with your finance team to model the impact refinancing options could have on reducing your DSCR denominator.
4. Reschedule Loan Payments
If refinancing isn’t an option, explore rescheduling or deferring upcoming loan payments. Pushing payments back even a quarter or two can provide temporary DSCR relief while you execute revenue-building strategies.
5. Make One-Time Contributions
If your DSCR is very close to lender thresholds, a one-time capital injection to temporarily inflate your NOI for the purposes of securing financing may make sense. This could include:
- Infusing personal funds
- Bringing on an investor
- Creating a special one-time revenue event
This is not a sustainable long-term approach, but can be tactical if you’re confident in plans to improve the underlying business.
Other Factors Impacting Loan Eligibility
While DSCR is critical, don’t forget lenders also weigh other variables when reviewing and pricing loan offers. Some key considerations:
Your business and personal credit scores communicate loads about your financial health and behaviors. Aim for scores above 680, and ideally over 720, to unlock better loan terms. Pay bills on time, limit new credit lines, and correct any reporting errors.
Lenders favor companies operating in growing, stable industries with clear upside versus decline or turbulence. Be ready to demonstrate how broader economic conditions and shifts in your niche present opportunities, not threats.
The assets you can offer as collateral act as a form of insurance for the lender. Tangible assets like real estate, inventory, and equipment typically provide the most collateral value to improve loan access and rates.
Business Plans and Financials
Well-prepared projections, forecasts, growth plans, and financial statements will instill confidence in lenders that you have a viable roadmap for repaying debt. Being transparent and thorough is key.
Final Tips for Improving Your Chances
Here are a few closing pieces of advice as you work to boost your DSCR and position yourself for loan approval:
Work with financial advisors and accountants to understand your numbers and opportunities. Their expertise can prove invaluable for modeling best paths to enhance your DSCR.
Choose Lenders Wisely
Not all lenders have the same approval processes and requirements. Shop around to find those focused on working with businesses like yours. Be ready to make your case on future potential, not just current DSCR.
Temper expectations, be strategic in your approach, and understand certain tactics like refinancing may not always be feasible. With realistic planning and financial discipline, a stronger DSCR is within reach.
The Bottom Line
A low DSCR doesn’t have to be a barrier to securing financing for your UK business. With focus on driving revenue, controlling costs, refinancing strategically, and putting your best foot forward with lenders, you can boost your ratio and improve loan eligibility. Monitor your DSCR closely and always be pursuing avenues to enhance it over time.