What on earth is a coverage ratio in financing with an SBA Loan?

When dealing with financing of various sorts you will come across the term “coverage ratio”. It my be in the context of “Interest coverage ratio”  or “debt coverage ratio” or some other similar nomenclature.

Here’s the basic concept of a coverage ratio. The coverage ratio is designed to determine what margin for error there is in a borrower’s ability to pay back the debt.

Let’s use an example assuming you are buying a business, here are some basics:

  • Business Purchase Price $500,000
  • Seller’s Discretionary Earnings (SDE) $175,000 (Seller’s discretionary earnings is the business earnings before Interest, Depreciation, Taxes, Amortization and Owner’s Compensation).
  • Down payment Buyer has available $100,000
  • SBA Loan $400,000  financed for 10 years @ 7% =  $4,644 per month payment which = $55,750 per year.
  • Salary the Buyer needs from business to pay living expenses  $100,000.
Coverage Ration Calculation  
SDE                                       $175,000
Salary needed                         $100,000
Available for Debt Service      $75,000
Amount of Debt service          $55,750
Coverage ratio is                     1.35   Amount available for debt service divided by actual debt service.
Generally speaking when seeking an SBA Loan the coverage ratio required will be between 1.25 and 1.4.
This entry was posted in Business brokers, buying a business, cash flow, SBA Loan. Bookmark the permalink. Follow any comments here with the RSS feed for this post. Post a comment or leave a trackback: Trackback URL.

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

*