Why add back interest expense to calculate debt service ratio?

Answer 1

The interest expense is accounted for in the income statement. This is done on an accrual basis, so there may actually be interest on the income statement that has not actually been paid from cash flow to date as one reason. Secondly, the debts obtained from a credit bureau shows full principle and interest payments being serviced. If the interest expense found on the income statement is not added back, then the lender would be double counting the interest being paid on the loans (once from the income statement and once from the credit bureau). This double counting of interest payments could keep a deal that should be approved from cash flowing, thus causing the lender to decline the deal. Also, you will want to add back depreciation and carry forward expenses as well as those are not actual decreases in cash flow for the current year. I hope this helps. I'm a business banker for a major bank.