You’ve submitted your SBA loan application. Now what? Behind the scenes, your lender’s underwriter is tearing apart your financials, stress-testing your cash flow, and building a credit memorandum that either recommends approval or decline. Understanding this process gives you an enormous advantage — because you can prepare for exactly what they’re looking for.
Here’s how SBA underwriting actually works.
The Foundational Rule: Cash Flow Is King
SBA’s credit standards start with one non-negotiable principle from 13 CFR §§ 120.101 and 120.150:
The cash flow of the Applicant is the primary source of repayment, not any expected recovery from the liquidation of collateral.
Translation: it doesn’t matter how much collateral you have. If your business can’t demonstrate the ability to repay the loan from operating cash flow, the loan must be declined. Collateral is the safety net, not the justification.
This is why SBA underwriting is fundamentally a cash flow analysis. Everything else — collateral, equity, management experience — supports or undermines the cash flow story.
The Credit Memorandum: What Must Be Covered
The lender’s credit memorandum is the core underwriting document. It’s what SBA reviews (for non-delegated loans) or what SBA evaluates at guaranty purchase time (for delegated loans). Here’s what it must address:
1. Business Description and History
- Nature of the business
- Length of time in business under current management
- Depth of management experience in the industry or a related industry
- Description of the management team, including the principal’s involvement in daily operations
- For changes of ownership: experience of new management and potential impact going forward
2. Financial Analysis of Repayment Ability
This is the heart of the credit memo. The analysis must address:
Historical Cash Flow
- For existing businesses: based on the 3 most recent years of historical financial information (tax returns or balance sheet with debt schedule and income statement) plus interim financial statements
- For new businesses: based on detailed projections with supporting assumptions showing positive cash flow within 2 years
Operating Cash Flow (OCF) Calculation
OCF is defined as EBITDA — Earnings Before Interest, Taxes, Depreciation, and Amortization. This is your starting point.
The lender then adjusts for:
- Unfunded capital expenditures
- Non-recurring income
- Expenses and distributions
- Distributions for S-Corp taxes
- Rent payments
- Owner’s draw
- Global cash flow analysis including affiliate business impact
The 1.15x Debt Service Coverage Ratio (DSCR)
This is the number that makes or breaks most SBA deals:
DSCR = Operating Cash Flow ÷ Total Debt Service
Where Debt Service (DS) = future required principal and interest payments on all business debt, inclusive of the new SBA loan proceeds.
The minimum requirement: DSCR must be ≥ 1.15x on a historical and/or projected cash flow basis.
Additionally, on a global basis (including all affiliates and personal obligations of guarantors), the ratio must be at least 1:1.
What does 1.15x mean practically? If your annual debt service is $100,000, your operating cash flow needs to be at least $115,000. That 15% cushion gives the lender confidence that you can handle unexpected expenses, seasonal dips, or minor revenue shortfalls without defaulting.
Cash Flow Projections
When projections are used (required for startups, acceptable for existing businesses with improving trends), the lender must:
- Calculate the DSCR from projections
- Provide supporting assumptions, including:
- Justification for revenue growth (new product lines, sales channels, new facilities)
- Justification for any reduction in expenses
- Comparison to current industry trends
Projections without solid assumptions are worthless. “Revenue will grow 20% because we believe in the business” doesn’t cut it. Lenders need specific, defensible reasons.
3. Working Capital Adequacy
The credit memo must include an analysis of working capital adequacy for at least the next 12 months. The lender needs to confirm that after the loan closes, the business will have enough liquid resources to operate.
When 50% or more of loan proceeds go to working capital, the lender must explain in the credit memo why this level of working capital is necessary and appropriate for the business.
4. Pro-Forma Balance Sheet
The lender must prepare a spread of the pro-forma business balance sheet — the current balance sheet adjusted for all changes from the SBA loan, other new debt, equity injection, and use of proceeds. This shows the business’s financial position immediately after closing.
5. Financial Ratio Benchmarks
Based on the pro-forma balance sheet and historical/projected income statements, the lender must calculate and discuss:
- Current Ratio — Current assets ÷ current liabilities. Measures short-term liquidity.
- Debt/Tangible Net Worth — Total liabilities ÷ tangible net worth. Measures leverage.
- Debt Service Coverage — The 1.15x requirement discussed above.
- Other industry-relevant ratios — Inventory turnover, receivables turnover, payables turnover, etc.
The lender must compare these ratios to industry trends and discuss whether the applicant is in line, above, or below industry norms. Being below industry standards doesn’t automatically disqualify you, but the lender must explain why they’re still comfortable with the risk.
6. Equity Analysis
A detailed discussion of the borrower’s equity position (net worth) and any required equity injection. For startups and changes of ownership, minimum equity injection of 10% of total project costs is required.
7. Insurance Requirements
The credit memo must address life insurance (on whom and how much, or justification for not requiring it) and business hazard and liability insurance requirements.
8. Collateral Description and Valuation
Description of proposed collateral, estimated values (using SBA’s specific valuation formulas), and analysis of collateral adequacy.
9. Credit Not Available Elsewhere
The credit memo must include the factors demonstrating that the applicant does not have credit available elsewhere on reasonable commercial terms from non-Federal, non-State, non-local government sources. This is an SBA statutory requirement — the guaranty exists because the borrower can’t get the financing without it.
10. Additional Items
- Terms of any seller financing and standby agreements
- Discussion of liens, judgments, or pending litigation (including divorce)
- Franchise analysis (if applicable)
- Debt refinancing justification
- Affiliate impact on repayment ability
- Owner/guarantor analysis including personal financial statements
How the SBSS Score Works (7(a) Small Loans)
For 7(a) Small loans ($350,000 or less), underwriting begins with a FICO Small Business Scoring Service (SBSS) score. This score combines:
- Consumer credit bureau data
- Business bureau data
- Borrower financials
- Application data
The current minimum acceptable SBSS score is 165 (as of the current SOP effective date). An acceptable score satisfies the requirement to consider credit history, business strength, past earnings, and repayment ability.
If the SBSS score is below the minimum, the loan must either be processed as a Standard 7(a) (with full underwriting requirements) or submitted as SBA Express.
What Smart Borrowers Do Before Applying
- Calculate your own DSCR. Pull your last 3 years of financials, calculate EBITDA, add back relevant items, and divide by total projected debt service. If you’re below 1.15x, you need to fix the numbers or restructure the deal before applying.
- Prepare a pro-forma balance sheet. Show the lender you understand how the loan changes your financial position.
- Build projections with real assumptions. Contracts in hand, LOIs, market data, historical trends — give the lender reasons to believe your numbers.
- Get your debt schedule current. The lender needs to know every obligation — including shareholder debt. Don’t leave anything off.
- Address weaknesses proactively. If your current ratio is weak, explain why and what you’re doing about it. If you had a bad year, explain the circumstances and show recovery.
- Organize 3 years of clean financials. Tax returns, P&L statements, balance sheets, interim statements. Make the underwriter’s job easy and you’ll get a faster, more favorable decision.
We Know What Underwriters Want to See
SBA underwriting is methodical. There’s no secret formula — just a detailed, systematic evaluation of your business’s ability to repay. The borrowers who succeed are the ones who prepare for this process, not react to it.
GoSBA Loans pre-underwrites your deal before it ever reaches a lender. We identify cash flow gaps, ratio weaknesses, and documentation issues — and help you fix them before they become decline reasons. Contact us today to get your deal underwriting-ready.
