DSCR for Small Business Loans: How It Is Calculated and What Lenders Want

#What is DSCR?

Debt Service Coverage Ratio (DSCR) is the single most important underwriting metric in commercial lending. It answers one question: does your business generate enough cash to pay its debt obligations with margin to spare?

The formula is:

• DSCR = Annual operating cash flow ÷ Annual debt service

A DSCR of 1.00 means your business generates exactly enough cash to make its debt payments and nothing else. A DSCR of 1.25 means you have $1.25 of cash flow for every $1.00 of debt service, a 25% cushion. A DSCR below 1.00 means you are running a cash deficit on debt obligations and need outside support to stay current.

#What counts as "operating cash flow" for DSCR?

Most lenders use one of three definitions, in increasing order of generosity to the borrower:

1. 1Net Operating Income (NOI): Revenue minus operating expenses, before interest, taxes, depreciation, amortization. Closest to EBITDA.
2. 2Net income + interest + depreciation + amortization (EBITDA proxy): Tax return Schedule C or 1120 net income, plus the add-backs.
3. 3Cash flow available for debt service (CFADS): EBITDA minus maintenance capex minus owner draws above a market salary.

SBA uses a CFADS-style number called "business cash flow" plus or minus owner-level adjustments. Banks usually start with EBITDA. Online lenders working from bank statements approximate cash flow as average monthly deposits minus average monthly outflows excluding debt.

#What counts as "debt service"?

Annual debt service is the sum of all required principal and interest payments on all business debt over the next 12 months, including the loan being applied for. It includes:

• Term loans (current portion of long-term debt + interest)
• Lines of credit (interest on average expected balance)
• Equipment loans and capital leases
• SBA 7(a) and 504 loans
• Daily ACH outflow on any active MCA or RBF (annualized)
• The new loan you are applying for

It does NOT include rent on operating leases (some lenders include it as a quasi-debt obligation), accounts payable, or owner draws.

#What DSCR do lenders actually require?

These are common targets, not regulatory minimums. SBA SOP 50 10 directs lenders to document cash flow sufficient to repay; the 1.15 floor is industry convention, not a statutory rule.

#How do you calculate DSCR? A worked example

Take a $4M revenue HVAC business. Last year's tax return (Form 1120-S) shows:

• Revenue: $4,000,000
• Cost of goods sold: $2,400,000
• Operating expenses: $1,300,000
• Interest expense: $40,000
• Depreciation and amortization: $80,000
• Net income: $180,000

Existing debt:

• Equipment loan: $3,200/month ($38,400/year)
• Truck loan: $1,800/month ($21,600/year)
• Total annual debt service: $60,000

Applying for a new $250,000 working capital loan at 12% APR over 5 years, payment ~$5,560/month or $66,720/year.

If revenue had been $3.2M with the same expense structure (net income closer to $50,000), CFADS drops to $170,000, DSCR drops to 1.34, still bankable but tighter. Drop CFADS to $130,000 and DSCR is 1.03, most lenders would decline or require a smaller request.

#How do you improve a thin DSCR?

If your DSCR is too low, you have three structural moves:

1. 1Increase the numerator (operating cash flow). Hardest, slowest. Real revenue or margin improvement over 6–12 months.
2. 2Decrease the denominator (debt service). Refinance shorter-term debt into longer terms. Replacing a $5K/month MCA payment with a $1,500/month 5-year term loan can move DSCR from 1.05 to 1.40 overnight.
3. 3Right-size the new request. Borrowing less directly improves the ratio. If your max DSCR-supported loan is $200K and you applied for $300K, take the $200K.

The fastest of the three is almost always #2. Most owners with thin DSCR are carrying high-cost short-term debt. Consolidating it changes the picture in a single funding cycle.

#What about global DSCR?

For owner-occupied real estate or owner-financed businesses, lenders often calculate global DSCR, combining business cash flow with the owner's personal cash flow and combining business debt service with personal mortgage and consumer debt. The threshold is the same (1.15–1.25), but the inputs are larger.

If your personal balance sheet is heavy with mortgage debt and limited liquidity, a strong business DSCR may not be enough. Conversely, strong personal liquidity can rescue a marginal business DSCR.

#How does ICG handle DSCR?

For revenue-based funding, we model the daily ACH against bank statement deposit cadence rather than running a formal DSCR. For term loans, we calculate DSCR using EBITDA + add-backs against total debt service including the new loan, targeting 1.20+. If your file is borderline, our underwriters will quote a smaller principal that brings DSCR into range rather than declining outright. To see what your file qualifies for, start an application, soft credit pull only.