Business Loans: How Underwriters Read Your File, and the Number That Decides It
One ratio approves or declines most business loans. Two legitimate add-backs moved the same company from 1.07. A decline, to 1.37, an approval. Nobody at the bank volunteers this.
- Published
- Read
- 10 min
- 1.25×
- The DSCR threshold most banks require
- 1.07 → 1.37
- What two add-backs did to one file
- 5
- Documents that decide the answer
§On this page(6)
Commercial underwriting looks opaque from the outside and is not. For the overwhelming majority of business loans under a few million dollars, the decision comes down to one calculation: debt service coverage ratio. The cash your business generates, divided by the debt payments it must make. Banks generally want 1.25 or better. Below that, the file is declined however good the story is.
The important part is that the numerator is not simply your net profit. It is an adjusted figure, and the adjustments are legitimate, standard, and entirely your responsibility to identify. A business owner who hands over a tax return and hopes gets scored on the tax return. A business owner who hands over a tax return with a schedule of add-backs gets scored on a considerably better number.
The calculation, run properly
Take a company with $148,000 of EBITDA. Earnings before interest, tax, depreciation and amortisation. Carrying $92,000 of existing annual debt service, applying for $300,000 over ten years at 9.5%, which adds $46,584 a year in payments.
| As filed | With add-backs identified | |
|---|---|---|
| EBITDA from the return | $148,000 | $148,000 |
| Owner salary above market rate | — | +$30,000 |
| One-time legal settlement | — | +$12,000 |
| Adjusted cash flow | $148,000 | $190,000 |
| Existing annual debt service | $92,000 | $92,000 |
| New annual debt service | $46,584 | $46,584 |
| Total debt service | $138,584 | $138,584 |
| Debt service coverage ratio | 1.07 | 1.37 |
| Outcome | Declined | Approved, and better priced |
Nothing about the business changed between these two columns. The same tax return produced both. What changed is that someone identified two adjustments an underwriter would accept as legitimate and documented them, a salary above what the role would cost to hire out, and a legal cost that will not recur. The gap between those columns is the loan.
Global cash flow: why your mortgage is in the ratio
For any loan carrying a personal guarantee, which is nearly all of them under about $500,000. The lender performs a global cash flow analysis. Business and personal are combined into one picture, because you are the one guaranteeing repayment.
- Your personal debts count. Mortgage, car loans, student loans and credit card minimums all enter the denominator. A strong business with an over-leveraged owner fails global cash flow.
- Distributions you take count as an outflow, not as business income you could stop taking, unless you commit in writing to reducing them, which some lenders will accept as a condition.
- A spouse's income counts as an inflow where they are a guarantor, which frequently rescues a marginal file.
- Other businesses you own are pulled in too. A loss-making side venture reduces your capacity for the profitable one, and lenders do check.
- The practical consequence: paying off one personal instalment loan before applying can move a global ratio across a threshold. It is often the cheapest single action available.
The five things being assessed, in order of weight
| Factor | What it means here | How much it matters |
|---|---|---|
| Cash flow | DSCR above 1.25 on adjusted, documented figures | Decisive. Nothing else compensates for failing it |
| Credit | Personal score 680+, clean business payment history, no recent tax liens | Near-decisive. A 640 score closes most bank doors |
| Collateral | Real estate, equipment, receivables, inventory. Each discounted heavily | Affects pricing and structure more than approval |
| Capital | Your own money in the business; 10–20% equity injection on acquisitions | Matters most on new ventures and purchases |
| Character and capacity | Industry experience, management depth, quality of records | Tie-breaker, and it decides marginal files |
Collateral is where borrowers most often misjudge lenders. Banks are not asset traders and do not want your equipment. Collateral discounts are steep, commercial real estate might count at 70% to 80% of appraised value, equipment at 30% to 50% of book, inventory at 20% to 50%, receivables at 70% to 80% of current invoices. Strong collateral improves your rate; it does not rescue weak cash flow.
Covenants: the part signed and then forgotten
Bank term loans carry ongoing conditions. They are routine, they are enforceable, and breaching one puts a perfectly solvent business in technical default, which can trigger a rate increase, a demand for immediate repayment, or a block on further borrowing.
| Covenant | Typical requirement | What breaches it in practice |
|---|---|---|
| Minimum DSCR | 1.20–1.25, tested quarterly or annually | One bad quarter. Seasonal businesses breach on timing alone |
| Maximum debt-to-equity | 2:1 to 4:1 | Taking on additional debt, or a large owner distribution |
| Minimum working capital or current ratio | Often 1.25:1 | Inventory build-up funded from cash |
| Limit on additional debt | Lender consent required | Taking an online loan or advance without asking |
| Limit on distributions | Capped, or subject to ratio tests | Paying yourself a bonus in a strong year |
| Reporting requirements | Annual returns, quarterly statements | Late filing. The most common breach of all |
| Life insurance assignment | Coverage on key owners, assigned to the lender | Letting a policy lapse |
Two practical points. Ask for annual rather than quarterly ratio testing if your revenue is seasonal, it is frequently granted and costs the lender little, and if you can see a breach coming, tell the lender before it happens: a waiver requested in advance is usually granted, while one requested afterwards is a negotiation from a weak position.
Presenting the file
How to submit an application that gets approved
Calculate your own DSCR before you apply anywhere
Adjusted cash flow divided by total debt service, including the new loan. If the answer is below 1.20, do not apply yet. Fix the ratio first. Paying off a small personal instalment loan, deferring a distribution, or reducing the loan request are all faster than appealing a decline.
Build the add-back schedule with evidence attached
One line per adjustment, with the amount and the document behind it. Be conservative, include only what you can defend, because a schedule that is 80% solid and 20% aspirational gets the whole thing discounted.
Write a one-page summary and put it on top
What the business does, what the money is for, what it will produce, how it will be repaid, and the DSCR before and after. Underwriters read hundreds of files; the one that frames itself gets framed the way you wrote it.
Approach an SBA Preferred Lender and a local bank simultaneously
Community banks and credit unions often underwrite relationship and local knowledge in a way a national institution cannot, and their pricing is competitive. Two applications in the same fortnight also give you a comparison rather than a single take-it-or-leave-it.
Negotiate covenants and lien position, not just the rate
Rate is what borrowers negotiate; covenants and collateral are what constrain the business for the next ten years. Ask for annual ratio testing, a specific rather than blanket lien, and a distribution allowance that lets you actually get paid.
- A properly documented add-back schedule can move a file from decline to approval without any change to the business.
- Bank and SBA lending at 7% to 13% is a fraction of the cost of the fast money marketed most heavily.
- Fixed-rate term debt on a productive asset is genuinely cheap capital and does not dilute ownership.
- The underwriting process itself produces a clearer picture of your own business than most owners have.
- A relationship with a community bank compounds. The second loan is materially easier than the first.
- Personal guarantees mean the business structure gives you no protection on the debt.
- Covenants can put a solvent, profitable business into technical default on a timing issue.
- Global cash flow analysis means your personal borrowing constrains your business borrowing and vice versa.
- The document burden is real, and thin bookkeeping is often the actual reason a good business cannot borrow.
- Blanket liens taken casually early can block cheaper borrowing for years.
- Four to eight weeks is normal, which does not suit a genuine emergency, and emergency products cost five to ten times more.
VerdictRun your own DSCR first, build the add-back schedule with evidence, and present the analysis rather than a pile of returns. Then negotiate the covenants and the lien position as hard as you negotiate the rate, because those are what you live with after the money is spent.
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Calculate the annual debt service any loan offer would add to your ratio
Before you submit a business loan application
- DSCR calculated on adjusted cash flow, including the new payment
- Add-back schedule built, with a supporting document per line
- Business debt schedule prepared on one page, accurate
- Three years of business and personal returns assembled
- Year-to-date P&L and balance sheet reconciling to the returns
- Twelve-month projection with written assumptions
- Personal debts reviewed. One payoff may cross a global threshold
- One-page summary written and placed on top of the package
- Covenant testing frequency and lien scope raised before signing
- 1.37
- DSCR after legitimate add-backs
- $42,000
- Add-backs identified in the example
- 1.25
- The threshold to clear
- 70–80%
- Value credited to commercial real estate
From 1.07 as filed
Salary premium plus one-off legal
Most bank term loans
Collateral is discounted hard
The underwriter is going to build a spreadsheet about your business whether you help or not. The only question is whether you or they choose the assumptions in it.
Frequently asked questions
- What is debt service coverage ratio and what do I need?
- It is your adjusted annual cash flow divided by your total annual debt payments, including the loan you are applying for. Most bank lenders require 1.25 or better, meaning $1.25 of cash flow for every $1.00 of debt service, and pricing improves above roughly 1.40. Below 1.20 the file is generally declined regardless of how good the business or the story is.
- What add-backs will a lender accept?
- Depreciation and amortisation as standard, interest on debt being refinanced, owner compensation above what the role would cost to hire out, genuinely non-recurring expenses such as a legal settlement or a one-off relocation, and personal costs run through the business. Each needs documentation. What will not be accepted is anything you will keep spending, and an over-aggressive schedule damages your credibility more than a modest ratio does.
- Why does my personal mortgage affect my business loan?
- Because you are signing a personal guarantee, so the lender runs a global cash flow analysis that combines business and personal obligations into one ratio. Your mortgage, car loan, student loans and credit card minimums all sit in the denominator alongside the business debt. This is why paying off one personal instalment loan before applying is often the cheapest way to cross a threshold.
- What are loan covenants and can they be negotiated?
- They are ongoing conditions in the loan agreement. A minimum DSCR tested quarterly, limits on additional debt or distributions, reporting deadlines, and sometimes an assigned life insurance policy. Breaching one puts you in technical default even if every payment is current. They are negotiable, and the two most valuable asks are annual rather than quarterly ratio testing for a seasonal business, and a distribution allowance that lets you actually take income.
- How much collateral do I need for a business loan?
- Enough that the lender's exposure is covered after heavy discounts. Commercial real estate often counts at 70% to 80% of appraised value, equipment at 30% to 50% of book value, inventory at 20% to 50%, and receivables at 70% to 80% of current invoices, but collateral improves your pricing and structure rather than rescuing your approval. A loan with excellent collateral and a 1.05 DSCR is still a decline at most banks.
- How long does a business loan take to approve?
- Four to eight weeks is normal for a bank or SBA loan with a complete package, and most of the delay is documents going back and forth rather than the credit decision itself. Assembling everything before the first application, returns, interim statements, debt schedule, projection, add-back schedule. Routinely halves the timeline. If you need money in a week, you are in a different and much more expensive market.
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