If there is one thing you’ll hear very often in banking and finance in general, it’s the concept of debt service capacity.

**on their loans.**

*“the principal and the interest”*If there is one thing you’ll hear very often in banking and finance in general, it’s the concept of debt service capacity.

**on their loans.**

*“the principal and the interest”*What’s a principal?

**What’s a principal? **

The principal depends on the amount the company has borrowed and the amortization schedule of the loan. If you want to know more about the amortization schedule, we have a full article on amortization and how it can have a tremendous impact on your ability to close a deal.

The principal depends on the amount the company has borrowed and the amortization schedule of the loan. If you want to know more about the amortization schedule, we have a full article on amortization and how it can have a tremendous impact on your ability to close a deal.

The $3 million represents the yearly principal repayment of the loan. If we were to calculate the monthly principal repayments, we just have to divide the $3 million by 12 to obtain $250,000 of monthly principal repayment.

This example is easier because we have a linear amortization. For more complex amortizations and how they can impact your deal, you can look at this article.

The $3 million represents the yearly principal repayment of the loan. If we were to calculate the monthly principal repayments, we just have to divide the $3 million by 12 to obtain $250,000 of monthly principal repayment.

This example is easier because we have a linear amortization. For more complex amortizations and how they can impact your deal, you can look at this article.

**Interest Repayment**

**The interest repayment is a function of multiple factors:**

**Interest Repayment**

**The loan amount**

**The repayment schedule**

**The interest rate**

The interest payment is calculated based on the outstanding amount of the loan. Therefore, the closest we are to maturity, the less interests the borrower pays.

What’s the debt service capacity?

**What’s the debt service capacity? **

The debt service capacity is the ability of the borrower to generate enough cash flows during a certain period to cover for the principal and interest payments for the same period.

We usually look at one year period to smoothen the effect of seasonality which may have a rollercoaster effect on the cash flows.

What we mean by cash flows is usually the EBITDA of the company. Based on this, the debt capacity is calculated by dividing the EBITDA by the principal + interest due during the year.

### DSC = EBITDA / (Principal + Interest)

If the DSC is above 1, then the company generates enough cash flow to service its debt.

Real-Life Examples

To better illustrate the importance of DSC and its practical implications, let's consider the following real-life example:

Company A is seeking a $15 million loan to finance a new project. The bank evaluates the company's financial health and discovers that the company generates an EBITDA of $4 million per year.

The proposed loan terms include a 5-year repayment period with equal annual principal payments of $3 million and an interest rate of 5% per year.

In this scenario, the company's annual interest payment starts at $750,000 (5% of $15 million) and decreases each year as the outstanding principal balance reduces. The total debt service (principal and interest) for the first year is $3,750,000.

*The DSC is calculated as follows:*DSC = EBITDA / (Principal + Interest) = $4,000,000 / $3,750,000 = 1.067

At 1.06x let me tell you that this deal will not fly. Usually banks require a certain buffer to be comfortable with a deal.

*If you want to know more about covenants and how it works, you can **download our free covenants workbook here: **

Why is it important for you?

The concept of DSC is very important for you as a banker because there are very few chances any bank will approve a facility to a client if they don’t have the capacity to service the debt. And I’m being very generous when I say few chances because it’s very close to zero chance.

### However, one thing you should keep in mind is that there are two elements in this equation

**EBITDA on the top**

**Principal and interest on the bottom.**

**EBITDA on the top**

**Principal and interest on the bottom.**

Thus, if you want to improve the DSC of your client you can either increase the EBITDA (which is very hard to do for you because you have little to no impact on this) or reduce the principal and interest payments.

*article about the impact of the amortization*schedule on your deal.

If there is one thing you’ll hear very often in banking and finance in general, it’s the concept of debt service capacity.

**on their loans.**

*“the principal and the interest”***What’s a principal? **

What’s a principal?

**What’s a principal? **

The principal depends on the amount the company has borrowed and the amortization schedule of the loan. If you want to know more about the amortization schedule, we have a full article on amortization and how it can have a tremendous impact on your ability to close a deal.

The $3 million represents the yearly principal repayment of the loan. If we were to calculate the monthly principal repayments, we just have to divide the $3 million by 12 to obtain $250,000 of monthly principal repayment.

This example is easier because we have a linear amortization. For more complex amortizations and how they can impact your deal, you can look at this article.

**Interest Repayment**

**Interest Repayment**

**The interest repayment is a function of multiple factors: **

**- ** The loan amount.

**-** The repayment schedule.

**-** The interest rate.

The interest payment is calculated based on the outstanding amount of the loan. Therefore, the closest we are to maturity, the less interests the borrower pays.

**What’s the debt service capacity? **

**What’s the debt service capacity? **

The debt service capacity is the ability of the borrower to generate enough cash flows during a certain period to cover for the principal and interest payments for the same period.

We usually look at one year period to smoothen the effect of seasonality which may have a rollercoaster effect on the cash flows.

What we mean by cash flows is usually the EBITDA of the company. Based on this, the debt capacity is calculated by dividing the EBITDA by the principal + interest due during the year.

### DSC = EBITDA / (Principal + Interest)

If the DSC is above 1, then the company generates enough cash flow to service its debt.

**Real-Life Examples **

To better illustrate the importance of DSC and its practical implications, let's consider the following real-life example:

Company A is seeking a $15 million loan to finance a new project. The bank evaluates the company's financial health and discovers that the company generates an EBITDA of $4 million per year.

The proposed loan terms include a 5-year repayment period with equal annual principal payments of $3 million and an interest rate of 5% per year.

In this scenario, the company's annual interest payment starts at $750,000 (5% of $15 million) and decreases each year as the outstanding principal balance reduces. The total debt service (principal and interest) for the first year is $3,750,000.

*The DSC is calculated as follows:*### DSC = EBITDA / (Principal + Interest) = $4,000,000 / $3,750,000 = 1.067

At 1.06x let me tell you that this deal will not fly. Usually banks require a certain buffer to be comfortable with a deal.

*If you want to know more about covenants and how it works, you can **download our free covenants workbook here: **

Why is it important for you?

The concept of DSC is very important for you as a banker because there are very few chances any bank will approve a facility to a client if they don’t have the capacity to service the debt. And I’m being very generous when I say few chances because it’s very close to zero chance.

**However, one thing you should keep in mind is that there are two elements in this equation: **

**-**EBITDA on the top.

**-**Principal and interest on the bottom.

Thus, if you want to improve the DSC of your client you can either increase the EBITDA (which is very hard to do for you because you have little to no impact on this) or reduce the principal and interest payments.

The interest side is not something you want to play with too much because it should technically reflect the risk of your borrower. The principal is where you have a bit more control using the appropriate amortization schedule.

If you want to know more about this, you can check our article about the impact of the amortization schedule on your deal.

**on their loans.**

*“the principal and the interest”***on their loans.**

*“the principal and the interest”*### What’s a principal?

**What’s a principal? **

**Interest Repayment**

**The interest repayment is a function of multiple factors:**

**Interest Repayment**

**The loan amount**

**The repayment schedule**

**The interest rate**

The interest payment is calculated based on the outstanding amount of the loan. Therefore, the closest we are to maturity, the less interests the borrower pays.

What’s the debt service capacity?

**What’s the debt service capacity? **

The debt service capacity is the ability of the borrower to generate enough cash flows during a certain period to cover for the principal and interest payments for the same period.

We usually look at one year period to smoothen the effect of seasonality which may have a rollercoaster effect on the cash flows.

What we mean by cash flows is usually the EBITDA of the company. Based on this, the debt capacity is calculated by dividing the EBITDA by the principal + interest due during the year.

### DSC = EBITDA / (Principal + Interest)

If the DSC is above 1, then the company generates enough cash flow to service its debt.

Real-Life Examples

To better illustrate the importance of DSC and its practical implications, let's consider the following real-life example:

Company A is seeking a $15 million loan to finance a new project. The bank evaluates the company's financial health and discovers that the company generates an EBITDA of $4 million per year.

The proposed loan terms include a 5-year repayment period with equal annual principal payments of $3 million and an interest rate of 5% per year.

In this scenario, the company's annual interest payment starts at $750,000 (5% of $15 million) and decreases each year as the outstanding principal balance reduces. The total debt service (principal and interest) for the first year is $3,750,000.

*The DSC is calculated as follows:*### DSC = EBITDA / (Principal + Interest) = $4,000,000 / $3,750,000 = 1.067

At 1.06x let me tell you that this deal will not fly. Usually banks require a certain buffer to be comfortable with a deal.

*If you want to know more about covenants and how it works, you can **download our free covenants workbook here: **

Why is it important for you?

The concept of DSC is very important for you as a banker because there are very few chances any bank will approve a facility to a client if they don’t have the capacity to service the debt. And I’m being very generous when I say few chances because it’s very close to zero chance.

### However, one thing you should keep in mind is that there are two elements in this equation

**EBITDA on the top**

**Principal and interest on the bottom.**

**EBITDA on the top**

**Principal and interest on the bottom.**

Thus, if you want to improve the DSC of your client you can either increase the EBITDA (which is very hard to do for you because you have little to no impact on this) or reduce the principal and interest payments.

**on their loans.**

*“the principal and the interest”***What’s a principal? **

What’s a principal?

**What’s a principal? **

**Interest Repayment**

**Interest Repayment**

**The interest repayment is a function of multiple factors: **

**- ** The loan amount.

**-** The repayment schedule.

**-** The interest rate.

The interest payment is calculated based on the outstanding amount of the loan. Therefore, the closest we are to maturity, the less interests the borrower pays.

**What’s the debt service capacity? **

**What’s the debt service capacity? **

### DSC = EBITDA / (Principal + Interest)

If the DSC is above 1, then the company generates enough cash flow to service its debt.

**Real-Life Examples **

*The DSC is calculated as follows:*### DSC = EBITDA / (Principal + Interest) = $4,000,000 / $3,750,000 = 1.067

At 1.06x let me tell you that this deal will not fly. Usually banks require a certain buffer to be comfortable with a deal.

*If you want to know more about covenants and how it works, you can **download our free covenants workbook here: **

Why is it important for you?

**However, one thing you should keep in mind is that there are two elements in this equation: **

**-**EBITDA on the top.

**-**Principal and interest on the bottom.

The interest side is not something you want to play with too much because it should technically reflect the risk of your borrower. The principal is where you have a bit more control using the appropriate amortization schedule.

If you want to know more about this, you can check our article about the impact of the amortization schedule on your deal.