DSCR explained: the ratio that decides whether your term loan actually gets sanctioned

A Katargam diamond-polishing unit applies for a ₹50 lakh machine loan — two laser processing machines to move from manual to laser-assisted cutting. The projections look strong: turnover rising, margins healthy, profit growing every year. The sanction letter comes back with one line the owner has never seen before: "DSCR (avg) 1.57, DSCR (min) 1.32." No explanation. He calls the office to ask what it means and whether it's good news.

It is good news, in this case — but the owner had no way of knowing that, because nobody had shown him how the number was built. DSCR, the Debt Service Coverage Ratio, is arguably the single most consequential figure in a term-loan file. Turnover decides whether the bank reads your file at all; DSCR decides whether it gets sanctioned. It is worth understanding exactly how it is calculated, because unlike your credit score or your collateral, it is a number you can actually shape — honestly — before you submit the file.

What DSCR actually tests

Profit, as reported in your P&L, is an accounting number. It includes non-cash charges like depreciation, and it says nothing about how much cash you must physically hand the bank this year in principal and interest. DSCR translates profit back into cash, and compares that cash to what is actually due. The question it answers is narrow and practical: in this specific year, does the business generate enough real cash to pay this year's instalment — comfortably, not by scraping the account together on the due date?

DSCR doesn't ask whether your business is profitable. It asks whether it can pay this year's EMI without you having to find the money from somewhere else.

The exact formula

Every Indian bank's CMA-format appraisal computes DSCR the same way:

Numerator — Net Profit after tax + Depreciation + Interest on the term loan.
Denominator — Principal of the term loan due that year + Interest on the term loan due that year.

Depreciation is added back because it never leaves the bank account — it is an accounting charge, not a cash outflow, so excluding it would understate the cash actually available. Interest on the term loan is added back to profit and then included again in the denominator, because the numerator is meant to represent cash generated before the cost of this specific loan is paid — the ratio then tests whether that cash is enough to cover the full debt service, principal and interest together.

A working example — five years of one loan

DSCR is never read for one year alone. Because principal instalments here stay flat at ₹10 lakh a year while the interest bill shrinks as the balance is repaid, DSCR on the same loan climbs steadily even without turnover changing much — which is exactly why Year 1, not Year 3 or Year 5, is usually the year that decides the file.

What number banks are actually looking for

There is no single figure fixed by regulation for an ordinary MSME term loan — it varies by bank, product and internal credit policy — but in practice, working across hundreds of these files, the pattern is consistent. An average DSCR across the full tenure of roughly 1.5 or higher reads as comfortable. A minimum DSCR in any single year — almost always the first full repayment year — below about 1.25 draws questions, and below 1.0 means the loan does not cash-flow on its own terms at all. Credit-rating methodology used across Indian lending, such as CRISIL's published approach to financial ratios, uses the same debt-service logic — cash profit measured against what is actually due that year — for exactly this reason: an average alone can hide one dangerous year in the middle.

The honest way to fix a weak DSCR

The instinctive response to a weak DSCR is to raise the projected profit — sell more, cost less, on paper. That is precisely the move a credit officer is trained to distrust: a DSCR that jumps from 1.1 to 2.5 between one draft and the next, with no change in machinery, market or margin explaining it, reads as manufactured, not improved. There is a more honest lever available, and it sits in the denominator rather than the numerator: the repayment structure itself. A longer tenor (say seven years instead of five) or a genuine moratorium during the machine's commissioning period spreads the same principal over more years, lowers what is due in the tightest year, and raises DSCR without touching a single assumption in the P&L. If your Year-1 DSCR is uncomfortably close to 1.0, the conversation to have with your bank is about tenor and moratorium — not about inflating next year's sales.

Where files actually go wrong

Beyond inflated projections, three mistakes recur often enough to be worth naming. First, borrowers compute DSCR only against the new loan and forget the EMIs already running on existing term loans — the bank will not make that mistake, and nor should you, because your file will be judged on total debt service, not the new instalment in isolation. Second, using profit before tax instead of profit after tax, or forgetting to add back depreciation, quietly understates or overstates the numerator and throws the whole ratio off. Third, presenting only the moratorium year or an average across the tenure while omitting the tightest single year — a credit officer will ask for the year-by-year schedule regardless, so it is better to show it, and show that it holds, than to have it requested as a correction later.

Sources

This article is general information, not professional advice. Rules change; verify current provisions or contact the office for advice on your situation.