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

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.

Small Business Accounting Cash vs Accrual Made Easy

Small business accounting

Cash Flow Made Easy

Small business accounting – Cash vs Accrual – Does it matter? Yes it Does.

It is not uncommon for us to receive financial information from business owners where for instance the tax returns are done on a cash basis and the financials are done on accrual basis. Often they are technically both correct but just looking at the numbers you’d think they were 2 different businesses.

Accrual accounting, done coreectly, usually presents a more accurate picture of the business. Accrual accounting simply attempts to match the revenue to the expenses when they are incurred or earned. Cash accounting simply accounts for the revenue or expenses when you recieve the cash or pay the bills.

In reality, cash accounting is almost never pure nor is accrual accounting.

Some (many) small business owners don’t understand the difference nor the effect on their financials. One way to sort out the difference is really easy. In QuickBooks and most other small business accounting packages there is a check box for reports. You can decide if you want accrual or cash. I suggest you run both on the same day and look at the differences. You might be surprised at what you learn.


Drop me a note below if you want me to take a shot at any other small business accounting or financing issues.

Also, look at Expense to profit Cash Conversion Process for more info on working capital and cash management.

Other Articles about Running a Small Business: