Meaning and transaction use
The OCC says DSCR divides net operating income by annual debt service and measures the borrower's ability to service debt. It says the appropriate level should reflect amortisation and cash-flow volatility. [S1]
The IMF uses interest coverage as a measure of capacity to service debt and notes that a ratio below one means earnings do not cover interest without adjustments. [S2]
Proposed underwriting method: calculate capacity separately under cash-flow, leverage, collateral and liquidity constraints, apply the lowest supported amount and retain sensitivities for rates, earnings, working capital and refinancing.
Worked example
Illustrative sizing only. Assume USD 3 million of sustainable annual cash flow available for debt service, a 1.50x minimum DSCR and annual debt service of USD 250,000 per USD 1 million borrowed.
Scroll the table horizontally to view all columns.
| Measure | Calculation | Result |
|---|---|---|
| Maximum annual debt service | 3 million / 1.50 | USD 2 million |
| Debt capacity from service | 2 million / 250,000 | USD 8 million |
| Downside cash flow | 3 million x 80% | USD 2.4 million |
| Downside DSCR on USD 8 million | 2.4 million / 2 million | 1.20x |
| Capacity at 1.50x in downside | 2.4 million / 1.50 / 250,000 | USD 6.4 million |
The base case supports USD 8 million under the assumptions; the downside supports USD 6.4 million at 1.50x. Other constraints may reduce either amount.
Proposed transaction review process
Normalise cash flow
Reconcile earnings, working capital, capex, taxes and permitted adjustments.
Model debt service
Apply rate, fees, amortisation, maturity and existing obligations.
Test constraints
Compare coverage, leverage, collateral, liquidity and covenant capacity.
Stress and approve
Run downside cases and document the binding constraint and headroom.
Evidence checklist
Financial record
Accounts, bank data, forecasts and quality-of-earnings support.
Debt record
Existing facilities, leases, guarantees, hedges and repayment schedules.
Business evidence
Contracts, concentration, pipeline, capex and working-capital drivers.
Credit terms
Proposed pricing, amortisation, security, covenants and conditions.
Decision framework
| Situation | Proposed action |
|---|---|
| Coverage supports more debt than leverage | Use the lower supported constraint. |
| Capacity depends on add-backs | Verify each adjustment and show capacity without it. |
| Rates rise | Recalculate debt service and covenant headroom. |
| A maturity creates refinancing risk | Model repayment or refinancing under a stressed exit case. |
Common errors to check
- Converting EBITDA directly into debt capacity without cash-flow adjustments.
- Ignoring existing and contingent obligations.
- Using base-case ratios without downside tests.
- Treating lender appetite as evidence of sustainable capacity.
Test the debt capacity
Bring the normalised cash flow, debt schedule, proposed terms and downside case to a debt-capacity review. Identify the binding constraint before setting the facility amount.
Discuss the transactionPrimary references and editorial scope
- OCC: Commercial Real Estate Lending
DSCR measurement and consideration of amortisation and cash-flow volatility. Reference checked 17 September 2026. - IMF: Stress Testing Corporate Balance Sheets
Interest coverage as an indicator of debt-service capacity. Reference checked 17 September 2026.
General debt-financing education. Figures are hypothetical. Capacity and loan terms depend on verified cash flow, documents, lender policy and jurisdiction.
General business information. Obtain advice appropriate to the legal, tax, accounting and financing facts. No offer, lender commitment or transaction outcome is represented. All worked examples use expressly assumed figures. Editorial draft date: 17 September 2026.
