UNDERSTANDING YOUR BUSINESS CASH FLOW AND DEBT SERVICE COVERAGE RATIO

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Cash flow and debt service coverage ratio (DSCR) indicate the ability to pay back debt. The following are some key metrics and formula to help you determine your debt capacity. Depending on your business structure (i.e. General partnership, sole proprietorship, etc.) the method of calculating your cash flow formula may look different. Please work with a lender to ensure that the calculations are correct.

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Cash Flow

Your cash flow is the amount of cash available after ordinary business expenses are paid. If there is more cash coming in from revenues than going out from expenses , the cash flow is positive. If expenses are higher than revenue, the cash flow is negative. Lenders will primarily look at three things when evaluating the creditworthiness of a proposal, and that is - can the business cash flow support:​

1. The business' existing debt.

2. The proposed debt of the new opportunity.

3. Will the current owners be able to maintain their current personal lifestyle post-project?

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DSCR

Debt service coverage is the cash available to service debt. For example, a DSCR of 1.50 indicates that ther is $1.50 available to pay each $1.00 of debt. A DSCR of 0.90 on the other hand shows there is only 90 cents to service each dollar of debt.  Banks generally require a DSCR of at least 1.25

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Key metrics that determine business cash flow and DSCR

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1. Revenue: the total amount of income generated by the sale of goods and services related to the primary operations of the company.

2. Cost of Goods Sold (COGS): inventory, materials, contract labor, etc.

3. Gross Profit: revenue minus COGS

4. Operating expenses: may include utilities, lawn care, snow removal, advertising, accounting expenses, wages, and other non-capitalized expenses.

5. Net income: gross profit minus total expenses.

6. Addbacks: expenses that are assigned to cash flow to normalize a profit and loss statement. Common addbacks are interest, depreciation, amortization, rent(if you own your building or are purchasing a new one) etc.

7. Net Operating Income (NOI): often referred to as cash flow and includes net income + addbacks + owner’s compensation.

8. Total Debt Service: any existing debt + proposed future debt.

 

Cash Flow Example

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Revenue: $2,850,000 – COGS: $1,710,000

-Gross Profit: $1,140,000 – Operating Expenses: $1,026,000

-Net Income: $114,000 + Addbacks: $100,000

-NOI: $214,000 excess cash flow available to service existing and new debt payments.

 

DSCR Example

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NOI: $214,000 / Total Debt Service: $142,000 = 1.5x DSCR

1. Addbacks: expenses that are assigned to cash flow to normalize a profit and loss statement. Common addbacks are interest, depreciation, amortization, rent(if you own your building or are purchasing a new one) etc.

2. Net Operating Income (NOI): often referred to as cash flow and includes net income + addbacks + owner’s compensation.

3. Total Debt Service: any existing debt + proposed future debt.

 

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Improving Cash Flow

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*Improving Gross Margins

*Keeping up With Price Changes

*Zero Based Budgeting - Making sure that every expense item helps to support the business

*Well Trained Staff

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