Learn how to calculate coverage ratios and what they mean for your business's financial health.
The coverage ratio measures your business's ability to cover debt payments with operating income. The most common is the debt-service coverage ratio (DSCR): DSCR = Net Operating Income ÷ Total Debt Service. A ratio of 1.0 means income exactly covers payments; 1.25+ is considered healthy. Lenders use coverage ratios to assess loan repayment ability—higher ratios mean lower risk and better loan terms.
The most common coverage ratio is the Debt-Service Coverage Ratio (DSCR):
DSCR = Net Operating Income ÷ Total Debt Service
Learn more about debt-service coverage ratio and use our DSCR calculator.
Business: Manufacturing company
Annual Revenue: $500,000
Operating Expenses: $350,000
Net Operating Income: $500,000 - $350,000 = $150,000
Annual Debt Payments:
DSCR = $150,000 ÷ $60,000 = 2.5
✓ Excellent coverage ratio - Business can easily cover debt payments
Strong ability to cover debt payments. Lenders view this favorably, often offering better rates and terms.
Income covers payments but with little cushion. Lenders may approve but require higher rates or additional collateral.
Income doesn't fully cover payments. Lenders are unlikely to approve new loans without significant improvements.
Income insufficient to cover debt. Business is at high risk of default. Immediate action needed to improve cash flow or restructure debt.
Most common. Measures ability to cover all debt payments. Used by lenders for real estate and commercial loans.
Formula: Net Operating Income ÷ Total Debt Service
Measures ability to cover interest payments only (not principal). Useful for assessing short-term financial health.
Formula: Earnings Before Interest and Taxes (EBIT) ÷ Interest Expense
Includes all fixed charges (debt, leases, preferred dividends) in addition to debt service. Most comprehensive measure.
Formula: (EBIT + Fixed Charges) ÷ (Fixed Charges + Interest)
Grow sales, raise prices, or add new revenue streams. Higher revenue increases net operating income, improving the ratio.
Cut unnecessary costs, negotiate better vendor terms, or improve operational efficiency. Lower expenses increase net operating income.
Refinance to lower interest rates or extend terms, reducing monthly debt service. This improves the ratio without changing income.
Use excess cash to pay down principal, reducing total debt service and improving the ratio.
Most lenders require a DSCR of 1.25 or higher. This means your net operating income is 25% higher than debt payments, providing a safety cushion. Higher ratios (1.5+) get better rates and terms.
Calculate it monthly or quarterly as part of your financial health check. Track it over time to spot trends. If it's declining, address cash flow issues before applying for new loans.
Coverage ratio measures ability to cover debt payments with income. Current ratio measures ability to cover short-term liabilities with current assets. Learn about current ratio formula.
Very unlikely. Lenders require coverage ratios above 1.0 because it means you can't cover payments. Focus on improving cash flow or reducing debt before applying. Learn about how to get a business loan.
Our team can help you understand your financial ratios and find financing options that work for your business.
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