Debt service coverage, explained with the actual arithmetic

If a lender declines you with a vague reference to credit criteria, this is usually the number they mean. It is worth understanding because it is calculable in advance, and knowing it before you apply changes what you ask for.

The calculation

In plain terms: cash available to service debt, divided by the debt payments due. A result of 1.0 means the business generates exactly enough to make its payments and nothing more. Lenders want a cushion above that — the exact threshold varies by lender, by industry and by how stable the revenue is.

Why a cushion? Because a business at exactly 1.0 has no room for a bad quarter, an unexpected repair or a customer paying late. The margin above 1.0 is the lender’s tolerance for the business having a normal year rather than a perfect one.

An illustration

These figures are made up to show the shape of it, not to suggest any particular threshold or offer.

Say a business shows $80,000 of net income, plus $30,000 of depreciation and $60,000 of owner compensation that a lender agrees to add back. That gives $170,000 of cash available. If existing and proposed debt payments total $100,000 a year, coverage is 1.7 — comfortable almost anywhere.

Take the same business with $150,000 of annual debt payments and coverage falls to roughly 1.13. Still above one, and thin enough that many lenders would decline or reduce the loan size until the payment fits.

Add-backs, and why Idaho businesses need them

Net income on a tax return understates the cash a small business actually generates, often deliberately. Lenders know this and will add certain things back:

• Depreciation and amortisation, which are accounting entries rather than cash going out.
• Interest on debt being refinanced, since it is being replaced.
• Owner compensation above a reasonable market salary for the role.
• Genuine one-off expenses that will not recur, if you can evidence them.
• Personal expenses run through the business, where they can be identified and documented.

This matters enormously here, because a great many well-run Idaho businesses minimise taxable income efficiently and then discover their tax return says they earn very little. The income exists. It needs to be found and defended.

Documenting them properly

Every add-back needs evidence. "We ran some personal costs through the business" is not an add-back; a schedule listing them with supporting detail is. A file resting on many undocumented add-backs gets sceptical treatment, and the credit committee is not in the room with you to be persuaded.

Prepare the schedule before you apply, with your accountant if you have one. Volunteered and evidenced reads as competence. Produced reluctantly under questioning reads as something else.

If coverage is the problem

1. Borrow less, or over a longer term. Both reduce the annual payment directly, and are the fastest fixes available.
2. Clear small existing debts. Each one consumes coverage out of proportion to its size.
3. Document add-backs properly. This is often worth more than everything else combined.
4. Wait for a stronger tax year, if the need can wait. Changing how the business reports income takes a full cycle to show up.
5. Consider a secured structure. Collateral sometimes buys tolerance on coverage that an unsecured request would not get.

And if the honest answer is that the business genuinely cannot service the debt, that is worth hearing. A lender declining on coverage is telling you the payment would hurt. Sometimes they are right.