- DSCR (Debt Service Coverage Ratio) measures whether a business generates enough cash flow to cover its loan payments—it’s the #1 factor in SBA loan approvals.
- Most SBA lenders require a minimum DSCR of 1.15x to 1.25x, meaning 15-25% more cash flow than needed for debt service.
- The formula is simple: DSCR = Net Operating Income ÷ Total Annual Debt Service.
- If your DSCR is too low, you can improve it by negotiating price, increasing down payment, adding seller notes on standby, or extending loan terms.
Every SBA loan approval comes down to one number: the Debt Service Coverage Ratio, or DSCR. It’s the clearest expression of whether a business can handle the debt it’s asking for.
Lenders use DSCR as the dividing line between “financeable” and “too risky.” Understanding this ratio—and knowing how to improve it—can mean the difference between getting your SBA loan approved or walking away empty-handed.
What Is DSCR?
Debt Service Coverage Ratio (DSCR) measures a business’s ability to pay its debt obligations from operating income. It answers a simple question: Does this business generate enough cash flow to cover its loan payments?
A DSCR of 1.0x means the business generates exactly enough cash to cover debt payments—no cushion, no margin for error. That’s too tight for lenders.
Most SBA lenders require a minimum DSCR of 1.15x to 1.25x, meaning the business must generate 15-25% more cash flow than needed for debt service.
A borrower with a 780 credit score but a 0.95x DSCR will get declined. A borrower with a 680 credit score but a 1.35x DSCR often gets approved. DSCR directly measures ability to repay, is based on actual cash flow (not projections), and accounts for the specific loan being requested.
The DSCR Formula
The basic DSCR formula is straightforward:
| DSCR Formula | |
|---|---|
| DSCR | = Net Operating Income ÷ Total Annual Debt Service |
Breaking Down the Components
Net Operating Income (NOI)
For SBA lending purposes, NOI typically equals:
| Component | Description |
|---|---|
| Net Income | From tax returns |
| + Depreciation & Amortization | Non-cash expenses |
| + Interest Expense | Being refinanced |
| + Owner Salary/Benefits | For acquisitions where buyer replaces owner |
| + One-time/Non-recurring Expenses | With documentation |
This is sometimes called Seller’s Discretionary Earnings (SDE) for small businesses or EBITDA for larger ones.
Total Annual Debt Service
This includes:
- Principal and interest on the proposed SBA loan
- Principal and interest on any existing debt that will remain post-close
- Payments on seller notes (if not on full standby)
DSCR Requirements for SBA Loans
Minimum Requirements by Lender Type
| Lender Type | Minimum DSCR | Preferred DSCR |
|---|---|---|
| Conservative banks | 1.25x | 1.40x+ |
| Middle-market SBA lenders | 1.20x | 1.30x+ |
| Aggressive SBA lenders | 1.15x | 1.25x+ |
| SBA Express (up to $500K) | 1.10x | 1.20x+ |
When Lenders Accept Lower DSCR
Some lenders will approve loans with DSCR below their stated minimums if:
- Collateral coverage is strong (real estate, equipment)
- Buyer has significant liquidity (reserves to cover shortfalls)
- Business has strong growth trajectory (trending upward)
- Industry is low-risk with stable cash flows
- Buyer brings exceptional experience
Expect higher DSCR requirements for: seasonal businesses (restaurants, tourism), single-customer concentration, declining revenue trends, first-time business owners, and industries with higher failure rates.
Step-by-Step DSCR Calculation Example
Example: HVAC Company Acquisition
Business Financials (from tax returns):
- Revenue: $2,400,000
- Net Income: $180,000
- Owner Salary: $150,000
- Depreciation: $45,000
- Interest on existing debt: $12,000
- One-time expense (lawsuit settlement): $25,000
Step 1: Calculate Adjusted Cash Flow (SDE)
| Line Item | Amount |
|---|---|
| Net Income | $180,000 |
| + Owner Salary | $150,000 |
| + Depreciation | $45,000 |
| + Interest | $12,000 |
| + One-time expense | $25,000 |
| = SDE | $412,000 |
Step 2: Calculate Debt Service
Proposed Loan Terms:
- Purchase price: $1,200,000
- SBA 7(a) loan: $1,080,000
- Term: 10 years
- Interest rate: 11.5%
- Annual debt service: $179,000
Step 3: Calculate DSCR
| Calculation | Result |
|---|---|
| DSCR = SDE ÷ Annual Debt Service | |
| DSCR = $412,000 ÷ $179,000 | |
| DSCR | 2.30x |
Result: This deal has a 2.30x DSCR—well above the typical 1.20x minimum. Strong approval candidate.
Same business at different purchase prices: $1.6M purchase = 1.73x DSCR (still good). $2.0M purchase = 1.38x DSCR (getting tight). $2.4M purchase = 1.15x DSCR (at minimum—many lenders would decline).
What Lenders Include (and Exclude) in DSCR Calculations
Adjustments Lenders Typically Accept
- Owner’s salary and benefits (if buyer will replace owner)
- Documented one-time expenses (legal settlements, non-recurring repairs)
- Rent to related party above market rate (adjustment to market)
- Depreciation and amortization
- Interest on debt being refinanced
Adjustments Lenders Typically Reject
- Undocumented cash income (not on tax returns = doesn’t exist)
- Projected revenue growth (lenders use historical, not future)
- Aggressive expense cuts (“I’ll reduce marketing spend by 50%”)
- Personal expenses run through business (unless clearly documented)
If it’s not on the tax return, it doesn’t count. Many business owners minimize reported income for tax purposes. This backfires when seeking SBA financing. Lenders underwrite based on tax returns, not verbal claims about “real” profitability.
How to Improve Your DSCR
If your DSCR is below lender minimums, you have several options:
1. Negotiate a Lower Purchase Price
The most direct solution. Lower price = smaller loan = lower debt service = higher DSCR.
2. Increase Your Down Payment
More equity means less debt. Going from 10% to 20% down can meaningfully improve DSCR.
3. Add a Seller Note on Standby
A seller note on full standby (no payments during SBA loan term) reduces the debt service used in the DSCR calculation.
4. Extend the Loan Term
If real estate is included, you may qualify for a 25-year term instead of 10 years, significantly reducing annual debt service.
5. Document Add-Backs Thoroughly
Work with the seller’s accountant to document all legitimate add-backs. A missed $50,000 add-back can change your DSCR from 1.10x to 1.20x.
6. Wait for Better Financials
If the business is on an upward trajectory, waiting 6-12 months for stronger tax returns may push DSCR above minimum thresholds.
DSCR Expectations by Industry
| Industry | Typical DSCR Requirement | Why |
|---|---|---|
| Professional services | 1.15x – 1.20x | Stable, predictable cash flows |
| Healthcare practices | 1.15x – 1.20x | Recurring revenue, essential services |
| Manufacturing | 1.20x – 1.30x | Capital intensive, concentration risk |
| Restaurants | 1.25x – 1.35x | High failure rate, seasonal fluctuations |
| Retail | 1.20x – 1.30x | Competition, inventory risk |
| Construction/Contractors | 1.20x – 1.30x | Project-based, cash flow timing |
| Hotels/Hospitality | 1.30x – 1.40x | Highly seasonal, economic sensitivity |
Common DSCR Mistakes
Mistake 1: Using Monthly Instead of Annual Figures
DSCR is always calculated annually. Using monthly figures without annualizing leads to incorrect ratios.
Mistake 2: Forgetting About Existing Debt
DSCR must include all debt that will remain after closing—not just the new SBA loan.
Mistake 3: Counting Projected Growth
Lenders use trailing 12-month financials, not projections. “The business will grow 30%” doesn’t improve your DSCR.
Mistake 4: Ignoring Seller Note Payments
If your seller note requires payments (not on full standby), those payments count in your debt service calculation.
If you plan to work in the business, you need a salary. Don’t add back the seller’s salary to cash flow while also assuming you won’t need to pay yourself. You must deduct a reasonable owner’s salary from SDE when calculating DSCR.
DSCR isn’t just a number lenders calculate—it’s a tool you can use to evaluate deals before you pursue them. Most SBA lenders require 1.15x to 1.25x minimum, with higher requirements for riskier industries. If your DSCR is too low, you have options: negotiate price, increase down payment, add standby seller notes, or extend terms. Understanding where your DSCR stands helps you structure competitive offers that will actually get financed.
Frequently Asked Questions
Most SBA lenders require a minimum DSCR of 1.15x to 1.25x. Conservative banks may require 1.30x+, while aggressive lenders may accept 1.10x with strong mitigating factors like collateral or buyer liquidity.
No. A DSCR below 1.0 means the business cannot cover its debt payments from operating income—no lender will approve this without significant changes to the deal structure.
Use the target business’s SDE or adjusted EBITDA as the numerator. Calculate annual debt service on your proposed loan as the denominator. DSCR = Cash Flow ÷ Debt Service.
Generally no. SBA lenders focus on whether the business can service its debt. Personal income may be considered as a “global cash flow” mitigant in some cases, but is not part of the standard calculation.
Options include: negotiating a lower purchase price, increasing your down payment, adding a seller note on standby, extending the loan term (if real estate is involved), or waiting for improved business financials.
